The current subsidy regime is poorly targeted and disproportionately benefits wealthy families.
Pakistan’s current economic crisis has once again brought to the fore the issue of electricity subsidy. While at one end of the policy arena, economists argue that a withdrawal of subsidies is necessary because of our financial situation, on the other hand, we are strongly in favor of retaining subsidies to keep electricity affordable and protect the public from inflation. .
The issue becomes even more acute when we realize that we cannot avoid raising electricity prices indefinitely. More than 65 percent of Pakistan’s electricity is generated using imported fossil fuels, exposing us to international supply shocks and fluctuating fuel prices, and there is no escape in the short term.
Expensive policies on the production side – eg capacity payments – make up our electricity most expensive in the area, Add to this the inefficiencies of the distribution side – high transmission and distribution losses and poor bill collections – further driving up the cost of delivering electricity, and it is no surprise that the power sector has been caught in a high cost-poor service balance. Is.
As economists who have been studying Pakistan’s power sector for some time, we present an alternative to tackling the thorny issue of electricity subsidies, based on keeping electricity affordable for those who actually pay for it. Can’t, but in a financially prudent way.
We first argue that the current subsidy regime fails to meet its desired objectives and imposes an unsustainable financial burden and, therefore, should be reformed. It is important to get this message out to the masses in an easy and accessible way, as there must be a broad consensus to rationalize the subsidy system to help us move away from populist and simplistic rhetoric. We then propose a system of reforming electricity subsidies based on targeted in-kind transfers in the form of the electricity voucher programme.
What is wrong with the current subsidy regime?
From an economic point of view, the purpose of subsidies is to correct the under-provision of a socially desirable good or service by the market. If we consider access to electricity as a basic need and want to ensure a good level of consumption for every household, we want a policy instrument that enables us to achieve this objective, with the least amount of unintended There are negative consequences. However, the existing subsidy regime has failed to meet the objective of ensuring access to electricity due to several reasons.
One of the most significant drawbacks of the current subsidy regime is that it is poorly targeted and disproportionately benefits wealthy households.
Under the current system, residential customers are billed under an incremental block tariff structure as shown in Table 1, The tariff is increasing in the consumption slabs of 0-100, 101-200, 201-300, 301-700 and above 700 units. There is also a lifeline slab with consumption less than 50 units.
The National Electricity Power Regulatory Authority (NEPRA) sets a tariff based on the cost of electricity generation and distribution. The Government of Pakistan (GOP) then notifies consumer tariffs that are lower than the NEPRA tariffs, therefore subsidizing the cost of electricity for end consumers. At each tariff slab, the subsidy rate per unit of electricity consumed declines as consumption moves from one slab to another.
For example, on the first 100 units, the subsidy rate is Rs 6.85 per unit, for the next 100 units the subsidy rate is reduced to Rs 6.35 per unit, and for the next 100 units, the subsidy rate further reduces to Rs 5. 38 per unit. For additional units with consumption exceeding 300, the subsidy is reversed and consumers pay a higher price than the Nepra tariff.
In figure 1, we simulate the total bill amount based on Nepra fixed tariff (blue line) and GOP fixed prices (green line) at all levels of consumption up to 1,000 units per month. The difference between the two is the subsidy amount in rupees that a family gets on their monthly bill (orange dashed line).
The subsidy amount (about Rs 1,800) is highest for households consuming around 300 units. Figure 2 Represents the subsidy amount as a percentage of the total tariff set by NEPR at each level of consumption. Although consumption increases as subsidy percentages decline, due to the incremental price structure, even those with higher levels of electricity consumption (and income) receive subsidies. Actually, all consumers consuming up to 933 units are getting subsidy.
Who benefits from subsidy?
Using Delegate at the National Level Pakistan Social and Standard of Living Measurement Household (PSLM-HIES) Survey Data, we find the share of households falling in each tariff slab. We then estimate the subsidy burden from each tariff slab using the average per unit subsidy, assuming the average consumption level per household within each slab. This exercise gives some important insights.
The largest group to benefit from the subsidy are households with consumption between 301-700 units, accounting for 56 per cent of the consumers, or about 16.8 million households. Assuming the average household in this group consumes 500 units per month, the total subsidy burden becomes Rs 25.8 billion per month – out of the total monthly subsidy of Rs 37.8 billion for all groups.
Under this structure, the annual subsidy burden would be Rs 454 billion. This is almost double the share of social security programs, which was allocated Rs 255 billion in the 2021-22 federal budget. Thus, the current subsidy structure means that affluent households also benefit and overall, they are the recipients of the bulk of the electricity subsidy.
Is the current subsidy system achieving its target?
If the purpose of the subsidy system is to ensure access to electricity to poor and low-income households, it is certainly not serving its purpose. These households can get subsidized electricity, but only if it is available from the grid.
Electricity is highly unreliable in most parts of the country and frequent load shedding undermines access. In fact, distribution companies practice fragmented load shedding – load shedding hours are longer in areas with high power losses and low recovery, which are always low-income neighborhoods.
Poor service delivery means disgruntled customers who are unwilling to pay the bills, and may even resort to informal and illegal connections to meet basic needs like running a water pump. Meanwhile, wealthy families invest in self-generation such as diesel generators or rooftop solar to save themselves from frequent interruptions.
Power Sector Circular Loan Inter-corporate debt due to outstanding receivables of firms in the energy supply chain – currently stands at Rs 2.5 trillion, or 6 per cent of GDP. One of the main reasons for circular debt accumulation is not allowing electricity prices to rise in line with rising fuel prices in world markets.
High operating losses and poor recovery of distribution companies, coupled with the demand side issues discussed above, also contribute to circular debt. The poor financial condition of the power sector means that we cannot pay the generating companies for costly power.
Plants remain idle even when we have the capacity. Due to this the process of load shedding continues unabated. In addition, loss-making distribution companies are unable to make substantial investments in the maintenance and expansion of the grid network. around 25 percent of the population (about 50 million people) are still living without electricity connection. Therefore, we must accept that the present system is failing to achieve its objectives even without taking into account the unbearable financial burden of subsidies.
consider options
One policy option that has been advocated recently is to replace the current subsidy system with targeted cash transfers that poor households can use to pay electricity bills.
National Socio-Economic Registry, which covers about 85 percent of the households in the country, can be used to identify people below a certain eligibility in terms of income or wealth. The biggest challenge of such a system may be that since cash is interchangeable, it may be difficult for people to repay this money to pay electricity bills, especially if they are paid at the end of the month. be payable.
Instead of providing assistance through cash transfers, we propose a targeted voucher and discount system. The voucher system provides a simple and non-distorting way of providing in-kind assistance to households for electricity consumption. Since the support would be applied directly to the electricity bill, it should be easy to build consensus around such a system as opposed to eliminating the current subsidy system altogether.
To ensure that assistance is provided only to deserving households, the government would first need to set a power consumption limit below which households are to be protected. For example, using nationally representative PSLM-HIES survey data, we found that electricity consumption in the lower two quintiles of the income distribution was in the range of 250–300 units.
Using the National Socio-Economic Registry from the distribution company and the customer’s electricity consumption history, we can define the following two categories of recipients:
- level 1: Households with monthly consumption less than 200 units get a voucher of 100 units of free electricity and the next 100 units with a discount of 30 pcs on the cost recovery tariff set by Nepra. This equates to an effective subsidy of 50 per cent on each unit, which is higher than the 46 per cent subsidy received by this group on their monthly bills as shown below Figure 2,
- tier 2: Households with monthly consumption between 200-300 units get 100 units of free electricity and a voucher for the next 200 units along with a discount of 15 pcs on the cost recovery tariff set by NEpra. This equates to an effective subsidy of 43.3 per cent on each unit, which is higher than the 38pc-43pc subsidy received by this group on their monthly bills as shown in Figure 2,
Families consuming more than 300 units in a month do not get any subsidy on any unit.
We propose that the vouchers and discounts should be applied directly to the consumer’s bills so as to avoid unnecessary delays in the delivery of such endorsements. Vouchers and discount units may also be allowed to be accumulated over time, for example, if household consumption falls below the tier threshold in one month, the remaining tier units can be carried over to the next month. Tier thresholds can be adjusted upwards, taking into account seasonal changes in energy demand.
Apart from providing financial assistance to eligible households, this targeted subsidy equivalent voucher scheme can have a number of positive broad-based impacts.
Firstly, it will increase bill payments as vouchers can be used only for payment of electricity bills, thereby improving the revenue position of utilities. Second, it will reduce the fiscal pressure on other budgetary expenditure by reducing the government’s circular debt burden. Third, it will encourage households to conserve energy according to their needs as consistently exceeding limits means losing support. Fourth, wealthy households, who do not receive any subsidy, will be motivated to install solar power as an additional energy source to meet their energy consumption from the grid. Lastly, considering the dire situation in the energy sector, a low-cost loan arrangement for installing solar systems for middle-income households may be proposed.
In short, a simplified electricity voucher and rebate system has the potential to achieve a number of goals, including improving access to electricity, encouraging electricity conservation, promoting the adoption of clean energy sources, and reducing CO2 emissions, Whereas the circular aims to reduce the financial burden of the loan. ,
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