Pakistan sends mixed signals to investors

02 August 1996

In early June, Pakistans Fauji Electric Power Company (Fepco) received an unwelcome letter from the government. The company had spent more than five years planning a 340-370 MW oil-fired power station but was informed, quite simply, that the authorities no longer wished the project to proceed.

Fepco is not the only developer to be disappointed. Enron Corporation of the US, which was developing a 762-MW oil-fired power station, has also been told to drop its scheme. Enron only announced in January that it would build, OWfl and operate the plant; six months later it says the project will no longer go ahead.

The unexpected demise of the projects makes for a stark contrast with the celebrations that accompanied financial close for the Hub power project two years ago. At Hub, a private consortium led by the UK's National Power and Saudi Arabia's Xenel Industries concluded an agreement worth about $1,600 million to design, build, finance, own and operate a 1,292-MW oil-fired plant. It was a landmark deal and Pakistan was showered with praise as a pioneer of private power projects in Asia. In the light of the latest developments, analysts and investors are asking what has gone wrong in the meantime.

The kindest conclusion is that Pakistan is the victim of its own success. The success of Hub spurred such interest in private power projects that Pakistan can now confidently expect to meet its immediate power requirements, huge and expensive though they are. Pakistan built on Hub's groundbreaking co-operation between the private sector, the government and multilateral agencies to create an attractive package for investors. The project demonstrated how exchange rate guarantees and political risk guarantees could make a power project viable for foreign investors. Spotting a solution to its looming power problems, the government moved swiftly.

The Private Power & Infrastructure Board was duly formed and in March 1994 the government published a policy framework. This crucial document outlined standardised fuel supply and power purchase agreements and set pricing formulas for the power to be supplied to the government. It also provided fiscal incentives such as exemption from import licence fees and the use of foreign banks to underwrite share and bond issues.

International and local private investors fell over each other to pour money into new power stations. The government wanted fasttrack projects using imported fuels and received applications to install 25,000 MW of new capacity. It had an actual requirement for just 3,500 MW by 1998. Nevertheless, it issued letters of support for projects with a total capacity of 7,020 MW in the belief that about half of the proposals would not succeed.

That assumption could have been a fatal mistake. As the decision to cancel the Fepco and Enron projects suggests, the government had got its calculations wrong. An IMF official agrees that this is a possible interpretation of recent events. 'Perhaps the government did support too many projects,' he says. 'But there was a fine line between supporting too many, and getting enough implemented.'

A statement from Enron suggests the government had indeed backed too many schemes. 'The government of Pakistan', it says, 'has determined that it faces excess generation capacity and has therefore limited the amount of power it will purchase from the private sector.' This is a far cry from only six months ago when the same government signed a guaranteed power purchase agreement with Enron, providing the US company with the assurance it needed to proceed with its multi-million dollar investment.

If the US company is shaken by the rebuff, it is keeping quiet about it. 'Enron continues to have a good relationship with the government of Pakistan and will continue to review projects there,' a spokesman said. Fepco, however, is less circumspect. 'We have had our fingers well and truly burned,' one manager says. 'We do not understand the government's decision and can only conclude that the implementation of private power policy has become a mess.'

It is not yet clear whether the second phase of the government's private power policy faces a similar fate. To meet longer-term needs, Pakistan is encouraging investment in power schemes using indigenous fuels. Two such projects, using low British thermal unit (BTU) gas, have already reached financial close. Hong Kong businessman Gordon Wu is developing a third using coal, expected to have an eventual capacity of 5,280 MW and to require investment of about $6,000 million.

The Board of Investment says that the government has granted letters of support, or signed memoranda of understanding for indigenous coal-fired projects totalling 11,696 MW. If alI these projects go to financial close, some of them could face a similar fate to the Fepco and Enron projects and be cancelled because they are surplus to requirements.

Foreign investors considering Pakistan will draw their own conclusions, but the privatisation programme could be the ultimate casualty of the government's inconsistency. The comprehensive sell-off of state assets is a key part of the government's attempts to liberalise the economy, increase efficiency and reduce its massive budget deficit.

Privatisation sales in the power sector have so far gone more or less to plan. Despite early objections from trade unions, the Kot Addu power station was successfully transerred to National Power in June. The Privatisation Commission is confident that the sale of the Jamshoro power station will also go ahead smoothly.

Having privatised power generation, the next stage is the privatisation of transmission and distribution, which is a far more daunting prospect. The government will have to produce agreements and guarantees similar to those it provided for power generators if it is to make transmission and distribution attractive to investors. The role of a regulator, procedures in the event of non-payment and the relationship of the privatised entities to government and the municipalities have all still to be clarified. Bidders for two utilities the Karachi Electric Supply Corporation and the Faisalabad Area Electricity Board which are to be offered later this year, will need to know what they are taking on. And they will need reassuring that the government will not later rescind agreements, as they did with Enron and Fepco.

Such uncertainties are reflected in other areas of government as Prime Minister Benazir Bhutto struggles to implement growth-promoting economic policies. Her whole strategy was thrown into doubt by the 1996/97 budget and its subsequent revision in the face of fierce opposition to her tax proposals. Following violent clashes, the government agreed in July to make certain concessions, the most significant of which is a reduction of the sales tax on important sectors from 18 per cent to 10 per cent.

The bout of political violence and the government's retreat on its IMF-inspired financial strategy offer little comfort to prospective investors. They are equally aware of the persistent allegations of widespread government corruption; the violence that rocks the commercial capital, Karachi; and the continued friction with neighbouring India.

By cancelling power schemes at an advanced stage, Pakistan is in danger of scaring off those foreign investors who believe in its long-term potential despite the short-term threats to political and economic stability. With 12 large-scale power projects which have now reached financial close and more large-scale privatisations on the cards, the Bhutto government will not want to turn away any more prospective investors. However, it will also have to work much harder to gain their attention.

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