The World Bank has cancelled over $500 million in budget support loans to Pakistan after Islamabad failed to meet key conditions in a timely manner, including the revision of power purchase agreements related to the China-Pakistan Economic Corridor (CPEC).

This decision means that the Washington-based lender will not provide any new budget support loans during the current fiscal year, a move that could significantly impact the Pakistani government’s budget estimates, which anticipated receiving $2 billion in fresh loans.

Sources indicate that the World Bank cancelled the loan under the Affordable and Clean Energy program, known as PACE-II. Initially, the World Bank had agreed to provide a loan of $500 million, which was later extended to $600 million to help address the external financing gap facing the country. The PACE-II program had been approved in June 2021, and the first tranche of $400 million was released at that time. However, the second tranche was contingent on meeting multiple conditions, including negotiations with all Independent Power Producers (IPPs), particularly those related to Chinese power plants established under CPEC.

Pakistani authorities reported that no significant breakthroughs were achieved during the renegotiations with CPEC power plants. China has consistently refused to reopen these agreements, including its refusal to restructure an energy debt totaling approximately $16 billion. In an effort to reduce electricity prices, the Pakistani government is also renegotiating energy deals associated with policies from 1994 and 2002. The Chinese power plants and several government-owned facilities, including four LNG-fired plants and two nuclear plants, were established under the 2015 energy policy.

So far, the government has renegotiated about 22 energy contracts, but these efforts have not resulted in any major reductions in electricity costs, which remain around Rs65 to Rs70 per unit, inclusive of taxes and surcharges. The government has been hesitant to eliminate a cross-subsidy of up to Rs16 per unit that is charged to higher consumption users to lower prices for consumers using less than 200 units monthly. Eliminating this unjustified cross-subsidy could substantially ease the financial burden on residential and commercial electricity consumers.

When contacted, a spokesperson for the World Bank confirmed that “slower-than-expected progress led to a shift in strategy in our support for reform” in Pakistan’s energy sector. The spokesperson also indicated that the World Bank had been requested to comment on the cancellation of the PACE-II loan.

The spokesperson elaborated that the World Bank has been supporting power sector reforms through the PACE development policy operation, which was intended to be followed by PACE-II in the fiscal year 2022. However, due to the slower-than-expected progress, the World Bank adjusted its lending strategy. Despite this, the Bank continues to support the sector through direct financing of low-cost hydropower projects, including an additional $1 billion for the Dasu Hydropower project.

Additionally, the World Bank is working closely with various counterparts to accelerate the implementation of the Electricity Distribution Efficiency Improvement Project, which aims to enhance efficiency in the distribution sector while providing technical assistance for private sector participation in power distribution companies (DISCOs).

In response to inquiries about the provision of any new budget support loans to Pakistan, the spokesperson stated: “No budget support is in the pipeline for the current fiscal year,” which ends in June 2025. For the current fiscal year, the government had budgeted a total of $2 billion in lending from the World Bank. However, as of now, only about $349 million, or 18% of this annual target, has been disbursed during the July to October period.

Under the PACE-II program, Pakistan was also required to address inefficiencies within the power distribution companies and to address the flow of circular debt. Unfortunately, the government has not met either of these objectives. As part of PACE-I, a roadmap for private sector participation in the distribution sector was approved, but this has not been implemented, which is essential for assessing the progress of the power sector reform program.

The National Electric Power Regulatory Authority (NEPRA) reported this week that inefficiencies in power distribution companies resulted in losses of Rs660 billion in the last fiscal year. Additionally, the circular debt has surged to Rs2.393 trillion, far exceeding the targets set with the International Monetary Fund (IMF) and the World Bank.

To obscure its inefficiencies, the Power Division has not been regularly updating the monthly circular debt report on its website, violating commitments made under the Circular Debt Management Plan framework. For this fiscal year, the IMF has identified a $2.5 billion external financing gap that needs to be filled with new loans. The World Bank’s decision not to provide any new policy loans complicates efforts to bridge this gap. Despite this, Finance Minister Muhammad Aurangzeb remains optimistic.

“The external financing gap is covered, and we will now borrow on our own terms at very competitive rates,” he stated on Wednesday. The government has also planned for a $1 billion Eurobond loan but has yet to enter global markets. With a CCC-Plus rating, Pakistan currently cannot access international capital markets to issue sovereign bonds, according to the finance minister.

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