ISLAMABAD: With limited progress on reforms and over Rs4.6 trillion in accumulated liabilities, Pakistan’s energy sector continues to strain the economy, weighed down by weak collections, theft, poor infrastructure, governance failures and market inefficiencies.
According to a detailed report by the Washington-based Institute of International Finance (IIF), “taken together, there is about 4pc of GDP worth of debt stemming from the energy sector. The repercussions reverberate throughout the economy, not only impacting the fiscal but also growth, inflation, the external balance and the financial sector.”
Circular debt has plagued the country since 2006. While successive governments have made periodic payments to ease the pressure — including a recent Rs800bn settlement — the flow of new debt remains unchecked. As of June 2025, the stock of circular debt stood at Rs1.6tr (1.4pc of GDP), compounded by another Rs3tr (2.6pc of GDP) owed by power producers to the oil and gas sector.
The report said the debt has severe fiscal consequences. To contain high servicing costs, the government created Power Holding Limited (PHL), a special purpose vehicle mandated to inject liquidity into the energy market, hold power sector debt, and reduce financing costs. But by absorbing PHL liabilities into the national books, the government effectively increased public debt and assumed additional risks.
IIF says circular debt exceeds Rs4.6tr, equal to 4pc of GDP, fuelling fiscal risks and stalling reforms
Currently, circular debt accounts for about 2.2pc of total government debt, excluding arrears of state-run generation companies to fuel suppliers. Along with energy subsidies, this has exerted persistent pressure on public finances, forcing the diversion of resources away from social programmes, development spending and infrastructure.
Spillover effects
The IIF stressed that the challenge extends far beyond fiscal management. On the financial side, borrowing through PHL has relied heavily on domestic banks, contributing to the crowding out of private sector credit.
On the growth front, recurring power outages — often imposed in areas with poor recovery rates — disrupt industrial activity, investment and productivity, undermining competitiveness. At the same time, high electricity tariffs feed into headline inflation, while a heavy reliance on imported fuel aggravates external imbalances, particularly during episodes of sharp rupee depreciation.
Policy responses
Recognising the gravity of the problem, the authorities have introduced a series of measures. These include approval of the Competitive Trading Bilateral Contract Market (CTBCM), designed to break the monopoly of distribution companies (Discos) by allowing large consumers to negotiate directly with power producers.
Contracts with independent power producers are being shifted from the “take-or-pay” model — under which payments are made regardless of consumption — to “take-and-pay” arrangements where only consumed energy is paid for. At the same time, electricity tariffs have been raised, subsidies are being better targeted, and steps have been taken to address theft, improve bill recoveries and reduce technical and distribution losses.
A gradual shift towards domestic energy sources such as hydropower and coal is also under way in an effort to cut reliance on expensive imported fuels.
Still unsustainable
Despite these initiatives, the IIF observed that reforms have not delivered meaningful improvements in sectoral performance. The recent fall in circular debt during FY24/25 was largely due to a one-off clearance made possible by commercial loans rather than structural fixes.
“As inefficiencies in distribution companies, T&D losses and poor collection rates persist, large bailouts are not a coherent or sustainable strategy in the long run,” the report warned. It underlined that systematic inefficiencies remain deeply embedded in the energy sector, ensuring that the flow of debt continues.
Reform deficit
The institute pointed out that many of the structural issues behind circular debt are well known but difficult to resolve due to entrenched institutional reluctance and vested interests. The problem, it said, has become the “clearest example of why Pakistan’s reforms continue to fall short and why fiscal risks remain entrenched.”
“Until this hurdle is overcome, circular debt will continue to weigh heavily on the economy, eroding fiscal space, constraining growth and fuelling instability,” it concluded.
Published in Dawn, September 6th, 2025
