High-interest rates and their ripple effects have been and will continue to be one of the most important business stories since April 2022.

This is a large topic with far-reaching repercussions that the State Bank of Pakistan (SBP) has used in its monetary policy reviews to steer money markets. In light of the IMF’s recent direction to the SBP on adopting a tighter monetary policy stance, I want to discuss how high-interest rates will affect Pakistan’s power sector, which is apparently the most visible fiscal expenditure but also the easiest route for collecting big taxes.

Straight off, higher interest rates appear to be bad news for energy investments. The logic is straightforward: sustainable energy sources such as wind and solar and the usual hydro-powered behemoths require the Ministry of Planning, Development & Special Initiatives to advocate clearance of large sums of money in the guise of PSDP in order to build these projects.

The government tends to typically finance these projects by accumulating debt via commercial banks, both local and overseas. This, coupled with higher interest rates make borrowing money more expensive, which can considerably increase the cost of a project.

On the other hand, the cost of energy generated by traditional sources—namely, RLNG, coal, and furnace oil—is mostly determined by the cost of the fuel rather than the cost of constructing the plant in the first place.

Energy specialists familiar with NEPRA’s latest power tariff hike refer to the levelized cost of power to understand the cost of generating electricity during the lifetime of any power project. This represents an average of what it will cost to create electricity in today’s rupees, taking into account everything from building to fuel to finance costs.

Interest Rates and Power

According to an expert, power generation has gone down in Pakistan by at least 10 percent since last year, while the cost of fuel has remained largely stable which doesn’t reflect the regulator’s decision to hike electricity rates.

“We’re looking at the pro-IMF agenda at play here. The government aims to generate an additional Rs. 600 billion with the Rs. 7.5 per unit hike in basic tariff which doesn’t complement the high cost of production but gets us $3 billion. Energy fuel as a commodity (e.g. LNG, Coal) has become less expensive in the past couple of months but the twist is no one wants to sell to Pakistan at cheap rates,” he said in an emailed response.

“Importers bear the additional heavy burden of the State Bank’s logic-defying interest rates. SBP has started lifting rates since June, and another hike is expected on Monday. 23% next week, 25% September, or just hype all over; import costs continue to rise which makes energy imports costlier,” he explained.

A 1 percent increase in interest rates next week would increase the cost of power from an RLNG plant only a little though, while it might increase the cost of electricity from hydropower and coal by a third, he further added.

Bad Investment Environment

In recent years, austere fiscal dynamics have made energy an extremely depressing investment and an untoward obligation. Borrowing got a hell of a lot more expensive after flash floods last year since the SBP has hiked interest rates by 700 basis points to 22 percent to date. At the same time, fossil fuel prices have been fluctuating, causing mayhem for domestic entities that purchase electricity.

The higher-interest-rate environment has now complicated matters. What we’re seeing so far is that the levelized cost of electricity is rising orderless for the first time in Pakistan’s history.

However, it is not all bad news for renewable energy. Solar is still slightly more expensive to set up but is getting better.

Conversely, because fossil fuel prices are projected to remain volatile in the next years as local/global tensions over energy continue, the rising electricity demand is expected to cause headwinds until 2025 unless the SBP interest rate and wealth building sweep inflationary trends early on.

Sadly, many multinational corporations continue to see the disadvantages of doubling down on energy projects in Pakistan. As per SBP data, net foreign direct investments in the Electricity, Gas, Steam & Air Conditioning Supply sector saw a 17.6 percent decline in FY23 from $749 million to $617 million.

Way Forward

Despite these issues, the government has set lofty goals to alleviate the country’s energy shortage and lessen its dependency on costly energy generation methods. The goal is to generate 60 percent of the country’s power from clean energy sources by 2030, with a focus on renewables. To that end, the government has started a few energy projects, including the Fast Track Solar Initiatives, which aim to install 6,000 MW of solar photovoltaic power.

It’s an encouraging indication for those working for a full-fledged transition to renewable energy, but the true test will come in the months ahead when the new interest rate environment settles in. An inflationary environment could offset any big moves into the renewable segment, so it would be wise for SBP and the state to underscore policies that shield the power sector from price shocks of any kind.

The views expressed here do not necessarily reflect ProPakistani or its management.

Source: Pro Pakistani