Few issues illustrate Pakistan’s governance challenges as starkly as the circular debt crisis in the energy sector. What began as a financial shortfall in power payments two decades ago has metastasized into a structural problem that threatens not only energy security but also the fiscal sovereignty of the state. At its core, circular debt refers to the accumulated unpaid obligations within the power supply chain—when power purchasers fail to fully pay generators, who in turn cannot pay fuel suppliers. The shortfall is eventually passed back to the government, creating a cycle of debt that expands each year.
As of early 2025, Pakistan’s circular debt stock reportedly exceeds Rs 2.6 trillion—a staggering figure that underscores how energy inefficiencies and fiscal mismanagement have become mutually reinforcing. The crisis is not merely a technical issue of delayed payments; it represents a symptom of systemic governance failures, ranging from poorly designed subsidies and weak regulatory oversight to political reluctance in enforcing structural reforms.
How Circular Debt Works
Circular debt accumulates through a chain of inefficiencies:
- Distribution companies (DISCOs) fail to recover the full cost of electricity from consumers, due to line losses, theft, and subsidized tariffs.
- Generation companies (GENCOs) are then underpaid, preventing them from clearing dues to fuel suppliers such as Pakistan State Oil (PSO).
- The government, facing public pressure to avoid tariff hikes, often absorbs the shortfall through budgetary support, but insufficient fiscal space results in arrears being rolled over.
This cycle produces what analysts describe as a “governance trap.” Instead of investing in grid modernization, renewable energy, or efficiency, scarce fiscal resources are diverted to patch over systemic losses.
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Drain on State Capacity
The fiscal impact of circular debt is profound. Servicing this debt consumes billions annually from the national exchequer, crowding out investment in health, education, and infrastructure. According to the International Monetary Fund (IMF), energy-sector losses and subsidies account for a significant share of Pakistan’s persistent budget deficit.
Moreover, the reliance on sovereign guarantees to bail out power producers has weakened the credibility of public finances. Each injection of funds temporarily averts crisis but erodes long-term capacity, reinforcing a cycle of dependency. The World Bank has warned that unless structural reforms are undertaken, circular debt will remain a “perpetual drag on Pakistan’s economy.
Energy Policy Paralysis
At the heart of the crisis lies a failure of policy coherence. Successive governments have oscillated between populist tariff freezes and ad hoc bailouts, avoiding politically costly decisions such as:
- Rationalizing consumer tariffs to reflect actual generation costs.
- Strengthening the independence of regulatory bodies like NEPRA (National Electric Power Regulatory Authority).
- Investing in renewable energy to reduce reliance on expensive imported fuels.
Instead, policy short-termism has deepened the crisis. For example, capacity payments to independent power producers (IPPs) have locked the state into long-term obligations, regardless of whether electricity demand materializes. This mismatch between supply contracts and actual consumption exacerbates debt accumulation.
The Political Economy of Reform
Circular debt is not just a technical issue—it is entrenched in the political economy of Pakistan. Energy tariffs are politically sensitive, with any hike provoking public backlash and, at times, street protests. Governments, wary of political fallout, often defer or dilute regulatory adjustments.
Similarly, vested interests within the energy sector benefit from status quo inefficiencies. Powerful lobbies tied to fuel imports, IPPs, and distribution companies exert influence over policy choices, making reform both politically risky and institutionally difficult.
As a result, the crisis reflects deeper failures of governance and political will. It highlights how state institutions struggle to balance fiscal discipline with political imperatives, eroding both economic stability and public trust.
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Broader Implications for Governance
The persistence of circular debt underscores a troubling reality: Pakistan’s governance framework is locked in a cycle of crisis management rather than long-term capacity-building. The energy sector becomes a microcosm of broader governance dysfunctions:
- Fiscal Mismanagement: Subsidies designed as temporary relief morph into permanent liabilities.
- Regulatory Weakness: Enforcement of efficiency targets and recovery of dues is routinely compromised.
- Erosion of Public Trust: Load-shedding, high bills, and frequent bailouts fuel citizen frustration, reducing compliance and further deepening the debt spiral.
Crucially, circular debt weakens the state’s ability to negotiate with international lenders. Bailout programs by the IMF and World Bank often hinge on energy sector reform benchmarks, yet repeated failures to deliver undermine credibility and bargaining power.
A Narrowing Window for Reform
The way forward demands difficult choices. Experts recommend a multi-pronged strategy:
- Tariff Rationalization – Aligning tariffs with actual costs, while shielding vulnerable segments through targeted subsidies.
- Loss Reduction – Modernizing distribution infrastructure and cracking down on electricity theft.
- Renewable Integration – Expanding investment in solar, wind, and hydropower to diversify the energy mix.
- Institutional Reform – Strengthening NEPRA’s regulatory autonomy and insulating energy policy from political cycles.
None of these measures are politically easy, yet the alternative is continued fiscal hemorrhage. As economist Hafiz Pasha has observed, “Without energy reform, Pakistan will remain trapped in a cycle where fiscal crises feed energy crises, and energy crises deepen fiscal crises.”
Circular debt is more than an accounting anomaly—it is a structural governance challenge. It drains fiscal resources, erodes institutional credibility, and perpetuates dependence on external bailouts. Left unresolved, it risks not only undermining energy security but also the very capacity of the Pakistani state to govern effectively.
Breaking this cycle will require political courage to implement reforms that are socially sensitive yet fiscally sustainable. In the absence of such will, the “circular debt” of governance will continue to expand—both literally in the energy sector and metaphorically across Pakistan’s broader policy landscape.
