Tuesday, February 22, 2011

Pakistan : Affected by Circular Debt !

Some good reads on the topic, I strongly agree with the last para :

from : http://www.finance30.com/forum/topics/circular-debt






It is easier to explain with an example. Suppose A owes 100 to B, B owes 100 to C and C owes 100 to A then we have a classic circular debt case. It will make the balance sheets of all 3 (i.e. A, B and C) unnecessarily weaker than what they are (both assets and liabilities higher by 100).

I have been reading about circular debt problem in Pakistan's power sector for over a year. However, I could not really understand it. I think Pak ministers are using circular debt as a euphemism for the government's inability to pay the promised subsidies to power producers / distributors.

The way it unfolds is, power producers sell power to distributors who are unable to collect full payment from power users, naturally distributors are unable to make full payment to producers, who fail to make full payments to fuel suppliers. Fuel suppliers stop supplying fuel (furnace oil etc) which leads to lower production and consequent widespread load shedding. Government says the load shedding is due to circular debt! I find the circle incomplete.




I am not fully acquainted with all the facts. As I have said earlier, to me it does not appear to be circular debt as the circle is incomplete. My knowledge is based on published reports available to me in Mumbai.

Suppose, the circle is indeed complete. In that case, handing over cheque to one party and expecting to receive it back from the last one down the chain would be naive. A more robust mechanism would be to nominate a commercial bank as a central agency (temporary - for this purpose only) that would examine all the links and after assuring itself of the circularity, will open special current accounts for this purpose only.

All claims and liabilities forming part of the circular debt problems will get assigned / novated in favour of the central agency, who will credit / debit the special accounts accordingly. If the claims are properly identified (that they do indeed constitute a circular debt problem) all special accounts will have zero balance at the end of the day, with all claims satisfied.

You might have noticed, what I am suggesting is a typical stock exchange clearing house arrangement. These clearing houses consider the claims and liabilities of scores of brokers and after canceling out circular claims determine net liabilities / claims of each broker.

It appears simplistic, it indeed is; but if we have real circular debt issue, I think it should be an effective and inexpensive way of tackling it.

I, however, feel you do not have a circular debt problem. The problem seems to be the one we have in India - power theft, inefficient (corrupt) distribution companies and non payment of power charges by many of those consumers who are not stealing. Tackling it, like in India, will require political grit.



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