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CONTENTS

9 Interbank market runs out of dollars 10 The SBP is controlling car imports 12 Under a new rule, the PTA seeks total internet control

14 16 What imperils the mobile phone industry? Uzair Younus 17 A primer on refinery margins Ammar H Khan 18 Squabbles, regulation and bans the state of Pakistan’s mobile manufacturing industry

27 24 Why aren’t we buying Russian oil? 28 The grim reality of oversubscription

Profit

31 Has the country finally embraced a progressive tax regime?

Publishing Editor: Babar Nizami l Editor: Khurram Husain lJoint Editor: Yousaf Nizami l Assistant Editor: Abdullah Niazi Reporters: Ariba Shahid l Babar Khan Javed l Taimoor Hassan l Meiryum Ali l Shahab Omer Chief of Staff & Product Manager: Muhammad Faran Bukhari Regional Heads of Marketing: Muddasir Alam (Khi) l Zulfiqar Butt (Lhr) l Malik Israr (Isl) Layout: Ahmad Salahuddin l Photographers: Zubair Mehfooz & Imran Gillani l Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk

Editorial Interbank bloodbath We are now in the danger zone. The interbank market is operating on borrowed dollars just to make routine trade related payments. These are complicated enough already since many banks are finding it hard to find counterparties willing to entertain Pakistani Letters of Credit (LCs), even with a 100 percent cash margin. This situation can continue for a few days more, perhaps even a few weeks. But the time when the country is unable to pay for its energy imports is now within sight, and when fuel imports stop. That is the threshold which, if crossed, brings us into default territory, where the system begins shutting down. There is one simple fact driving this: shortage of dollars in the country. So far the State Bank had been supplying dollar liquidity to the banks, which according to some sources stopped about a month ago. Early in the month of June the shortages began appearing in short tenor dollar swaps – one week – whose forward premium went negative for a day. But the last week saw a near bloodbath in the interbank market, as premiums went negative for tenors out to 3 months. On the last day of the week premiums plunged sharply but the tenors in which the action was concentrated shortened. Monday opens to much anxiety as news of a breakthrough in the talks with the IMF is keenly awaited. Finance minister Miftah Ismael is trying to

put on a brave face through all this. He held a round of meetings with the IMF on Friday night, another on Saturday, and is putting out the message that a staff level agreement is now imminent. We can only hope he is right. Without that agreement the chances of pulling back from the brink – which is where we stand currently – are next to nil. The biggest steps towards an agreement have now been taken. There are lingering issues with the budget, especially the question of provincial surpluses that look far too optimistic in the federal budget, which can be straightened out more easily. But if a breakthrough does not come within this week, the situation will teeter dangerously close to the edge. The government has taken the toughest of the steps that were required off it. The IMF now needs to share in the urgency of the authorities to reach a deal. The Fund must realize that it is the lender of last resort and Pakistan is now so close to the edge of a potential economic catastrophe that the room to bicker over a few line items in the budget is limited. If there are issues that can be left to the next review they should be. This is not the time to drive the hardest of all possible bargains. This is not a commercial negotiation and extracting maximum value for themselves should not be the Fund’s motivation. Ensuring the system does not start to shut down should be their prime motivation.

IN BRIEF The IMF clarifies that it did not push Pakistan to renegotiate energy agreements as part of the CPEC, saying it’s “simply untrue”. Esther Perez Ruiz, the representative of the International Monetary Fund in Islamabad, has stated that the money lender has not requested Pakistan to renegotiate energy arrangements made through the China-Pakistan Economic Corridor (CPEC), calling the accusations “simply untrue.”

IMF talks breakthrough is expected soon IMF talks continue till the filing of this report, Finance Minister Miftah had a meeting on Friday night and was scheduled for another on Saturday as we went to print. Word coming out unofficially from the government quarter is that an agreement is expected within days.

Fuel price spikes drive up weekly inflation by 3.3 percent.

The graph shows the PSO cost of supplying petrol against the petroleum development levy and sales tax. Historically speaking the government has increased the petroleum levy and sales tax in relatively good times when the price of oil was down. This is shown in the graph during the pandemic when the cost of supply was very low, at the same time the government was charging its highest petroleum levy of Rs 30. Looking at the recent trend as the cost of supply reaches a five year high on the back of rising international oil prices, the government is charging neither the petroleum development levy or the sales tax. However that might change given the precarious economic situation of the country.

According to figures issued recently by the Pakistan Bureau of Statistics (PBS), inflation jumped by 3.38 % from the previous week, owing mostly to the greatest recorded increase in petroleum product prices.

Twitter criticises the police for mistreating Baloch demonstrators

Karachi police aggressively arrested 28 demonstrators, including women, who were rallying near the Sindh Assembly’s main entrance over the alleged abduction of two University of Karachi (KU) Baloch students by law enforcement authorities.

Interbank market runs out of dollars Forward premiums go negative for tenors up to three months By Khurram Husain & Ariba Shahid

anks have run out of dollars and are now borrowing from various sources, including their own depositors, to make trade related payments for their clients. As a result, forward premiums in dollar swaps in the interbank market have plummeted in the last few days to go negative, a very unusual development which points towards a dire shortage of dollar liquidity in the banks. Bankers with visibility on developments in forward markets for foreign exchange tell Profit that the State Bank of Pakistan (SBP) has stopped selling dollars into the market nearly a month ago. The SBP has also been rationing dollars through various means despite a ban on imports of certain goods. Measures include making “administrative” delays in processing LCs. Same sources inform Profit that the drying up of dollar liquidity in the interbank market has led to the collapse of forward premiums on dollar swaps altogether. In Pakistan’s case, the long term trend shows that the difference between the spot and future rate mostly results in a premium. For a high yielding currency the dollar trades at a higher rate versus the spot rate, i.e. ideally it should be the interest rate differential between the two currencies and the forward value should be greater than the spot value.

What’s happening now?

n June 6 2022, the difference between the spot price and forward 1 week tenor turned negative for the first time since November of last year. That was the day the exchange rate in the interbank market closed above Rs200 to a dollar for the first time in Pakistan’s history. The next day the State Bank summoned treasurers of major banks for a confidential meeting and told them to bring the exchange rate down in the interbank market, even if doing so required them to run losses. They were told this was an issue of national importance, and the cost of the privilege to continue running a banking business in Pakistan. It didn’t work but forward premiums on one week swaps that dipped in negative territory for the first time since November 2021 came back up into positive on the same day.

The source explains that the SBP is asking banks to sell dollars to customers without being allowed to buy them back from the inter-bank market. This exposes banks to changes in the FX rate, which could also mean potential loss of money for banks. A few days later, however, the shortages began to bite again, and the premiums fell in one tenor after the other like dominoes. On June 13, premiums on one week, two week and one month tenors turned negative. The next day the shadow of negative forward premiums extended itself out to three month tenors as well. It was shortened briefly on June 15 and 16, retreating back into two week tenors. Then came the bloodbath on June 17, the closing day of the week. Premiums fell sharply in all tenors out to two months. “There are no dollars left in the interbank market” a senior source in the banking system – whose job includes dealing directly with the forward market in foreign exchange – tells Profit. “I’m now using dollars from deposits in order to cover my transactions.” On Friday, the last trading day of the week, forward premium was negative by fifty paisa (rounded up) which annualises to 25 percent (including T-bill yield). This means banks are buying dollars today at Rs208 only to have to sell them a week later at Rs207.50. In the overnight market, data for which is not published by the State Bank, the premiums have plummeted far more, touching negative 0.95 in some cases, which annualises to 55 percent (inclusive of T-bill yield). “I have to service my customer’s payments” says a senior banker impacted by this development. “So pulling out of this market is not an option. Since the market is so short of liquidity, those with dollars can demand a large premium.” Some banks have resorted to borrowing from their depositors to meet the payments they need to make, and if they have exhausted this source of supply, they can turn to their overseas branches to borrow from abroad in order to continue making trade related payments. Doing so is costing them more and more, causing forward premiums to plummet and turn negative.

Has this happened before?

uring the current fiscal year, on 18 November 2021, 19 November 2021, 22 November 2021, 26 November 2021, and 29 November 2021; the dollar was

trading at a discount. A discount happens when the forward exchange rate is less than the spot rate. This, however, was only in the one week tenure. The remaining tenors were trading at a premium. But the November 19 2021 Monetary Policy Statement seemed to correct things quickly as the SBP hiked the policy rate by 150 bps to 8.75 percent in an unscheduled announcement. The MPS read, “While the market-based exchange rate has played its due role as a shock absorber, it has borne a considerable burden in terms of adjusting to the widening current account deficit. The rupee has depreciated by a further 3.4 percent since the last MPC meeting. The US dollar also appreciated against most emerging market currencies since May as expectations of tapering by the Federal Reserve have been brought forward. However, the fall in the value of the rupee since May has been comparatively large. As other adjustment tools normalize, including interest rates and fiscal policy, pressures on the rupee should abate.” The pressures on the rupee did abate through the policy rate hike as the discount remained limited to the 1 week tenor and turned into a premium by 30 November 2021.

What does this mean?

he forward rates resulting in a discount usually occurs in the shortest 1 week tenor. This does not push the interbank market into a big frenzy and usually corrects itself in a short span of time such as that witnessed in November. However, in the current scenario, the situation does not seem to be improving. Instead, it is worsening. The drying up of dollar liquidity in the interbank has led to the collapse of the forward premiums all together. If this situation persists in the same way, the longer tenors of 6 months, 9 months, and 1 year may also start trading at a discount. With the SBP already holding banks accountable in order to slow down the pace of the depreciating rupee, the government curbing imports, and SBP taking its sweet time with LCs, it signifies that the FX crunch is getting real and significant. The solution to this situation is an FX injection. As soon as the IMF tranche lands into Pakistan and other dollar denominated assistance in the form of bilateral assistance comes in from friendly countries like China, the FX frenzy may calm down. However, this is expected by the end of June at best. n

The SBP is controlling car imports. Here’s what that means The State Bank of Pakistan (SBP) now oversees car imports and the automobile industry is not having it

By Daniyal Ahmad and Ghulam Abbas

ll eyes in the automobile manufacturing industry are currently on the State Bank of Pakistan (SBP). Why? Because the fate of Pakistan’s automotive industry is currently hanging in the balance, and the central bank is holding the thread. Nearly a month ago, the SBP released a circular addressed to banks, letting them know that they needed the SBP’s permission before performing transactions in dollars for the import of CKD (completely knocked down) units of cars. This meant that auto assemblers in the country will now need express permission from the central bank to be able to import and assemble cars. The effects of this are far reaching. Senior industry executives had already been predicting that the upcoming year would see a serious rise in the prices of cars, particularly because of the dollar shooting up, and a fall in demand. The President of Automotive Division at Lucky Motors Corporation, Muhammad Faisal, has told Profit that a fall in sales by 40-50% compared to last year is expected, and other leading executives in the industry have expressed similar sentiment. For the assemblers, the immediate worry is hammering out a quota system with the SBP, under which every manufacturer gets a certain slice of foreign exchange to import CKDs. However, there are already disagreements within auto manufacturers over what formula should be used to calculate this quota. For consumers, it means rising prices of cars, a serious dip in demand, and the end of ‘on’ premiums.

What exactly has happened

he crux of it is this - the government is trying to fight the current account deficit and has as a result tried to curtail the imports of cars into the country through the SBP. The SBP will now decide on a case to case basis how many dollars worth of a certain car can be imported into the country. So, for example, Lucky Motors will make a request through their bank to the SBP asking that they be allowed to import their car, the KIA Picanto. The SBP will then tell them how many KIA Picantos they can import. To understand this completely, it is necessary to know that cars are imported in two forms. They are either imported already assembled or ‘completely-built-units’ (CBUs) or they are imported in parts and then assembled in Pakistan as ‘completely-knocked-down’ (CKD) units. The import of CBU units into Pakistan has already been banned under the incumbent government’s import ban on luxury items. It is now the CKDs that are a bone of contention. The auto industry, already expecting lower demand because of the economic crisis and rising car prices, is aware of the realities. “The industry, as a whole, is cognisant of the macroeconomic environment. As such, forcing the government to rescind its ban on CBUs is not a major concern. However, the government should provide manufacturers with CKD import quotas instead of handling import approvals on a case-by-case basis,” says one senior automobile executive. Right now the SBP is micromanaging the import of all cars. They are telling Suzuki how many Swift CKDs they can import and how many Cultus CKDs they can import, while telling Toyota how many Yaris and Corolla CKDs they can individually import.

The ban only delays the inevitable. The global commodity super-cycle will lead to demand destruction. He cites reduced purchasing power and predicted price increases due to increased cost of production for manufacturers for his claim Muhammad Ali Tabba, Chairman Lucky Motors Corporation

In response, the industry is essentially demanding that instead of dictating on a car-tocar basis, the SBP give assemblers a set amount that they can spend on importing CKDs, and let them determine themselves which model they want to import into the country. Of course, the issue here is that different auto manufacturers are in disagreement over what the best way to calculate this quota is. Some manufacturers, such as Lucky Motors, are in favour of the quota being calculated in accordance with how different car manufacturers performed in the previous year. This would be ideal for companies like KIA and Toyota, which had breakthrough years with new models of their cars. Other manufacturers would argue that it should be dependent on the capacity of the assembly line - such as Hyundai which doubled its capacity just last year. Others still like Changan will also be against basing the quota off performance since they have only just introduced new models of their cars which they did not have in the market to compete with KIA, Toyota, Honda, and others before.

The inevitable price hike

et us just put this out there again - cars are about to get more expensive. With imports being tightly curtailed and supply low, the natural response will be for prices to go up. Revenue volumes are going down, so profit margins will have to be increased via a price hike. Assemblers will want to make up their costs and increase their profit margins, which will then mean fewer people will buy cars. This

Government intervention distorts the automotive sector, which was otherwise on the precipice of self-correction. He cites price reductions by Peugeot and KIA to some of their models as examples. The import ban, in his opinion, creates deadweight losses,” Suneel Manj, Pakwheels founder is the one certainty of the SBP’s measures - that demand will outstrip supply and will subsequently lead to some form of demand rationing by automobile companies and vendors. Since the SBP will monitor imports now, and the dollar is yet to settle on a price, for now many assemblers have stopped taking orders for their cars and are set to announce their new prices. At the new prices, people will not buy cars as they were buying before, which is where Muhammad Faisal predicts this dip to be 40-50% of the 2021-22 volume. When this happens, ‘on’ prices will also go as cars will be readily available at showrooms and there will not really be a waiting period for many cars. Of course, in Pakistan there is also the possibility of this not happening since cars are considered an asset class that people ‘invest’ in rather than buy for their utility. There is also another angle to this. “The situation has flipped overnight for us. We have gone from working overtime to meet the unprecedented demand seen this year to experiencing bottlenecks in managing routine production. Furthermore, this increased volatility will negatively impact the future of the industry,” says Abdul Waheed Khan, DG of Pakistan Automotive Manufacturers Association (PAMA). “These measures may delay payments to foreign suppliers, who, in turn, may subsequently reduce engagement with their Pakistani counterparts going forward due to the higher moral hazard. It is pertinent that the SBP expedite CKD import approvals to mitigate industry losses.” The second part, of course, is very unlikely to happen, since Pakistan is not an important enough market for companies to launch any kind of retaliatory ban or to approach their embassies in Pakistan to settle their debts. “Pakistan does not constitute enough demand amongst foreign companies and consumption for such severe measures,” explains Dr Ishrat

Why is the SBP at odds with the auto industry? In April this year, CKD imports registered at $1.6 billion. This was a 96.6% year-on-year increase from 2021. It came at a time when cash-strapped Pakistan needed to finance its Rs 25 billion a month fuel subsidy, and faced an external finance deficit of $35.068 billion for the upcoming fiscal year, per the IMF. On the 20th of May, the SBP released a circular addressed to all ‘authorised dealers in foreign exchange’ - meaning Pakistani banks. All international purchases for things such as imports are conducted in dollars, and any company importing a product needs to process payments through a dollar account in a bank. The SBP’s letter stated that banks now had to get ‘prior approval’ before initiating any payments in dollars. Among the products they listed - CKD units of cars. Hussain.

Is there any other course of action?

he flipside of this is that the government is passing on a possible revenue stream through import duties.Muhammad Ali Tabba, in an interview, believes that increasing import duties is a better alternative to the import ban. “This will both assist the government in combating the current account deficit (CAD) and also raise revenue to meet the Rs 200 Billion surplus targeted in the budget for FY 2022-23,” he says “The ban only delays the inevitable. The global commodity super-cycle will lead to demand destruction. He cites reduced purchasing power and predicted price increases due to increased cost of production for manufacturers for his claim.” Dr Ishrat Hussain voices similar concerns, who says “banned goods are those that are primarily consumed by the most well-off segments of Pakistan. Increasing the duties would allow the government to recoup lost forex.” “Strictly in terms of the automobile sector, the ban on importing CKDs is counterproduc-

tive. The rupee’s devaluation with a steady flow of CKDs required for local assembly provides the opportunity for import substitution” Muhammad Ali Tabba and Suneel Munj, like Ishrat, also critique of the import ban in the context of the automotive sector. Both, in their own capacity, cite the 2018-19 automotive market as an example of a rational automotive market. “Government intervention distorts the automotive sector, which was otherwise on the precipice of self-correction. He cites price reductions by Peugeot and KIA to some of their models as examples. The import ban, in his opinion, creates deadweight losses,” says Pakwheels founder Suneel Manj.

Conclusion

he true fallout of these measures on the macroeconomy and national exchequer, though expected, will only unfold within the coming weeks to months. The severity will vary. They may not be as bleak as the prospects painted by PAMA. However, the concerns may be indicative of the Government possibly forsaking better alternatives such as the ones highlighted by the aforementioned individuals. n

Strictly in terms of the automobile sector, the ban on importing CKDs is counterproductive. The rupee’s devaluation with a steady flow of CKDs required for local assembly provides the opportunity for import substitution Dr Ishrat Hussain, economist

AUTOMOBILE INDUSTRY

COVER STORY

By Taimoor Hassan

digital dictatorship could be coming. The Pakistan Telecommunication Authority (PTA) is moving ahead with implementing a policy that will give them complete control over who can see what on the internet, and in getting this control, they might break the internet altogether across the country. The PTA is the de-facto authority in Pakistan which controls which websites can and cannot be accessed from Pakistan. It has till now exerted this control by ordering the Internet Service Providers (ISPs) to block the websites it does not to be accessed from Pakistan through a Centralised Domain Name System (C-DNS). Now, it wants to extend that control and be able to block the websites on its own by taking control over the DNS servers via the C-DNS. The fact that there is already an effective mechanism through which the government controls which websites can be accessed from Pakistan, puts a question mark on the motives of this policy. The move can curb internet freedom, violate internet privacy of individuals, but most importantly the new system is against the way DNS operates and could actually bring down the internet for everyone in Pakistan. To understand what the government plans to do and how it plans to do, it is imperative to understand how DNS works.

What is PTA aiming to do with DNS?

o if some website has to be blocked in Pakistan, all that any ISP has to do is put the URL of the website that needs to be blocked in the DNS server and stop the DNS from getting the IP address for that website. So for instance, if your ISP blocks Facebook.com, when you search for Facebook.com on your browser, the DNS would simply not lookup for IP address against Facebook.com domain name. And if your browser does not get any IP address, it won’t be able to retrieve any webpage with that name. This is quite simply how blocking of pornography websites is being done in Pakistan right now - at the DNS level. The PTA has a list of websites that they have declared as illegal and do not want users here to have access to. There is a blanket ban on accessing pornography websites from Pakistan and the government implements this ban by asking the ISPs to block such illegal websites at the DNS level. The PTA itself provides the list of URLs of such sites to be blocked.

The PTA currently does this blocking through the CDNS (or C-DNS/Centralized DNS), which is a supervising automation tool for domain blocking to control illegal content. It is managed by the PTA and integrated with DNS servers of operators/ISPs through APIs. This API provides a platform for pushing single/multiple website URLs for blocking and unblocking with internet service providers in Pakistan. All PTA has to do is it pushes the URLs of pornography websites from its CDNS onto the DNS servers of operators and ISPs. Once these websites are recognised for blocking, the DNS stops looking for IP addresses of these websites. The PTA really has this ability to control the internet right now and block any website that they declare as illegal, and ISPs have to abide by what the PTA asks them to do as part of their licensing requirement. The PTA now is asking for more control over the internet by directly controlling the DNS. And they are doing this under the pretext of policing illegal content, over which they already have effective control. Under the new policy, the PTA has asked all the ISPs in the country to connect with one single centralized DNS server through which all the DNS lookups would go through. “The ISPs have been asked to stop routing requests for any DNS in the country. They have to stop routing any requests for DNS lookups outside the country, or to anybody else. There should be one centralised server in the country where every ISP routes all DNS lookups,” said an official from a top tech company. Under this new policy, whenever anyone searches for any website name, the CDNS is where the DNS lookups to retrieve IP addresses will happen. So if you are a PTCL user and you search for Facebook.com on your internet browser, the search on the DNS will go to your ISP which will route it to the CDNS, which will retrieve the Facebook.com IP address against your search. Similar process will follow for users of other ISPs like Nayatel, Cybernet or Multinet. Because it is the centralised DNS controlled by the government where all the searches are going, the government would be able to do DNS level blocking on its own, without distributing any URLs to ISPs for blocking. So if the government wants to ban Youtube.com tomorrow, the CDNS would simply refuse to get IP addresses for Youtube.com for all of Pakistan’s internet users, whenever they search for Youtube.com on whichever internet provider’s service. This higher control comes with different levels of consequences though. Engineers and officials from a big tech

company, in a deep background conversation with Profit, warned of the dangers of such a system. “One entity knows every single [website] name a user has searched for. So you are trusting that whoever is running that [centralised] server, isn’t using it in a nefarious way. Because now every endpoint that is using that [IP address] lookup, that person knows what name did you ask for in the address book,” says a network engineer from a top tech company. While internet privacy is a strong concern because one single entity would have access to search records of each user, more importantly, such arrangement runs the hazard of breaking the distributed nature of DNS servers and could lead to internet winters across the country. “If you decide that you dictate what DNS server address everyone should use, and that is one centrally controlled server, the first big concern is reliability because what you have now done is that there is just this one place, which maybe has a primary or secondary address, that you can go to look up an address book,” the tech engineer said. “This raises the risk of overloading the system. If someone has nefarious intentions, they know they have to take down just two or three IP addresses in the country and that will break DNS for the entire country.” “So reliability, privacy and security are the main concerns,” he says. The caveat here is that if an authority dictates which DNS server address everyone should use, all the searches would now be directed to a single centralised server which could overload the system and lead to an internet slowdown for everyone. In fact, if anyone wanted to take down the entire internet in Pakistan, they could send fake queries in big numbers to this server, overloading it and bringing down the internet for everyone. When it is distributed, users of different ISPs are using various servers of ISPs for internet searches, balancing out the load to many such servers. The centralised DNS server would also have an IP address of its own and one or two backup IP addresses. If someone with heinous intentions planned to take down the entire internet for Pakistan, they could just attack the centralized DNS server and would have to take down just two or three IP addresses, which will again breakdown DNS for the entire country resulting in internet outage for everyone. All of the internet users, have at some point in time, faced internet outage. Maybe because the DNS of their provider broke down, or because of some other issue. But these outages would most likely have been restricted to individual ISPs, unless it was

a country level breakdown for all due to some reason. The situation at present is that because each user is connected with the DNS of their respective ISP, any problem with their DNS would not affect users of the other ISP. For instance, PTCL users may face a service outage because PTCL’s DNS service broke down but other ISPs users would be surfing the internet just fine. That is because their networks are different and their DNS servers are different. One ISP’s trouble in DNS servers does not affect the others. But once DNS is centralized under the new regime, because all the lookups will be happening through the central server, any breakdown of DNS at the centralized server means no internet for anyone. In another scenario where the CDNS is unaffected, but the network supporting the CDNS runs into some problem, the internet for all would still be down, even though the individual ISPs would have no problems in their networks and systems. This is the third major problem with centralizing the DNS arrangement. That because it sits on a single network, any trouble with this network would mean that every other network that is relying on the CDNS system for reachability to the internet, may also be broken. Hence internet outage again for the entire country. The situation again becomes where all other ISPs are providing service seamlessly but a single problem with the network at CDNS makes everyone lose access to internet. If users of different internet service providers are not able to reach the phonebook (meaning they are not able to lookup and get IP addresses for the searches they make on the internet through the DNS), they search at the CDNS because of some issue with the network, access to everyone is interrupted because there is only one server carrying out these operations. Because of these reasons, it is important that the DNS is available at many places. By allowing them to be redistributed, it allows the internet as a distributed infrastructure to actually function. And if it is centralized, all the users get affected. The magnitude of the impact centralizing this arrangement is horrendous. It affects all the internet users in Pakistan simultaneously, and impacts all the ISPs, too, simultaneously. These ISPs have made expensive investments to set up these DNS servers so that internet goes up and running seamlessly for their users, which they would have to see going to waste. It is not only the websites that would be impacted. Some of the mobile applications have IP addresses hardcoded into them. So if a website is blocked on the CDNS, if its IP is being used by mobile apps, those apps would also stop functioning. For instance Google

What is DNS?

Every time you enter a website name on the internet, for instance Facebook.com, this search query goes to a DNS server operated by your internet service provider (ISP). The DNS is responsible for taking that name and matching that to an IP address for that website address. Think of DNS as a phonebook for the internet which has information on IP addresses associated with the billions of domain names on the internet. Each unique domain name would have one or more IP addresses associated with it. Just like in real life phonebooks you can look up for phone number(s) of individuals, DNS is where these phone numbers of websites translated into their IP addresses could be looked up. So when you put up a search for Facebook.com, the DNS would look up for the IP address for the server hosting Facebook.com, and let the browser at your computer know that this IP address is where Facebook.com could be accessed. The browser then sends a connection request to that IP address to retrieve the Facebook.com webpage. While users enter website names, at the back, internet routing is taking place on the basis of IP addresses. It is only for the convenience of users so that they don’t have to remember IP addresses for websites that these IP addresses are converted into and searched as website names. Just like phone numbers for people, websites can have multiple IP addresses. It is the DNS that identifies which IP address to look for, and what the other IP addresses are in case one of the IP addresses is down. “That is all the DNS does. It is a globally distributed internet phonebook. It says that every name on the internet can only be reached by having a phone number. In the internet terms, that phone number is an IP address,” said a network engineer at one of the big technology companies, during a deep background conversation with Profit. Users can access websites directly as well by putting IP addresses of the servers hosting these websites, in which case DNS is not involved. But a majority of people would not know what the IP address of the website they are searching for is. Even if they did know, they would not be able to remember it, or wouldn’t be able to remember many IP addresses at the same time. Think about a situation where you have to remember a twelve digit number each for Youtube, Facebook, Google and Netflix, and use that number each time you want to access one of these sites. It is going to be painful. All major internet service providers in Pakistan have their own DNS servers which check if the IP address of the website a user has searched for is the latest one or not, and then direct the user to that IP address. Different ISPs have their own DNS servers that give the DNS a distributed nature. So if PTCL’s DNS server is not working, it will not affect users of another ISP. apps on your phone. On the other hand, some ISPs do argue that it is a Sovereign’s right to implement policies to exercise its right as a Sovereign. Every state has national interests and if there is some content on internet that is against the interest of the state, they have the right to block it. The usual course of such blocking is to request the platform, say YouTube, to take down anti-state content. Now YouTube might have its own policies and might not cater to the request of a Sovereign state, in which case, the state needs to have some mechanism in place to block content not favorable to the state. “A country should have the ability to block off a website, complete end to end, if the social media site does not have the ability to respond very quickly to a country’s request. The social media site should do that. In case it does not, then a Sovereign might want to block it altogether,” said an official from a

local ISP in a deep background conversation with Profit. Speaking to Profit, official from another internet service provider likened it to “halting the entire traffic on the road just to stop one car.” Then again, blocking some websites does not seem like a motive of this move to many. As mentioned earlier, the PTA already has mechanism in place through which it can block any website even right now. Profit reached out to Mukarram Khan, director general of Cyber Vigilance Division (CVD) of the PTA, to learn about the ins and outs of the policy from a PTA perspective. The DG asked Profit to contact their spokesperson for comments. Khurram Ali, PTA spokesperson, was contacted who also refused to comment on the phone call with him, and asked for questions to be emailed to him. The queries were posted to him via email. No response has yet been received from PTA to those queries. n

COVER STORY

OPINION

Ammar H. Khan

A primer on refinery margins

o a casual observer, refining is a boring and largely commoditized business often exposed to volatility in commodity prices. During the last few months, as a consequence of supply constraints, refinery shutdowns, geopolitical volatility, and increasing demand for oil products, refinery margins exploded, increasing by more than four times of its historic range as refineries globally could not keep up with increased demand for refined products. The economics of a refinery is largely dependent on the Gross Refinery Margin (GRM). Simply put, the GRM is simply the difference between the total value of petroleum products produced by a refinery, and the price of crude oil. A refinery uses crude oil as an input, which then goes through something called a fractional distillation process. The crude oil is heated in a furnace, and at various temperatures different products are derived from the crude oil, ranging from asphalt (used in road construction), to fuel oil (used in power generation equipment), diesel, kerosene, petrol, and other products. In-effect each barrel of oil contains different products which are then sold off separately. A refinery essentially separates the products from the crude oil, and is profitable if the weighted value of products sold is greater than the cost of procurement of crude oil. As an example, if a refinery receives US$ 140 from the sale of products refined from one barrel of crude oil that costs US$ 130, then the gross refinery margin is $10 per barrel. To enhance profitability, refineries keep optimizing its product mix in order to maximize profitability. For example, fuel oil is a low to negative margin product for local refineries, but it is still produced at a loss, such that profits from higher margin products such as petrol, and diesel can compensate for the same. While evaluating prices of petrol and diesel at the pump, a thumbof-rule approximation that people make is with the price of crude oil per barrel, which may be a flawed comparison as a barrel of crude oil just doesn’t include petrol, and diesel, but many other products. The energy markets right now are in a flux, due to underinvestment in supply and refining infrastructure over the last few years, ability to increase supply in the short-term is restricted. As the economy recovers from the pandemic, the demand continues to increase. Due to a mix of increased demand, and

The writer is an independent macroeconomist and energy analyst.

restricted supply, coupled with geopolitical volatility which keeps Russian oil reaching its traditional markets, price of oil and its derivative products has increased significantly globally. As demand for refined products, mainly petrol and diesel keep on increasing, the price for the same also increases at a much higher rate than the price of crude oil, mainly due to restricted refinery operations globally. In the Middle Eastern energy markets, on average the difference between a barrel of petroleum and a barrel of crude oil (refined v/s crude) was in the range of US$ 10 per barrel. However, due to increased demand, and restricted refining capacity, the same has increased to more than US$ 50 per barrel during the last few weeks, effectively increasing by more than five times. Similar trend has also been observed in the case of diesel prices globally, with only respite being available once more refinery capacity comes online, or demand tapers off.

Figure 1: Price of Gasoline (white), Price of Crude oil (blue), Refining margin (green) - US$ / barrel Higher margins have led to rebuke from politicians globally, with a former finance minister of Pakistan also suggesting that refining margins be capped by the government. Such knee-jerk reactions set a bad precedent wherein capping profitability would also lead to an expectation that there should also be a floor on losses. A state should generally stay away from mandating caps, and floors on prices – the consequence of which is rarely desirable in the mid to long term. Refineries in Pakistan are still using decades old technology and are rarely in a position to invest heavily in upgrades given heightened sovereign risk. As our neighbor to the East imports Ural crude (from Russia), and exports finished product, capitalizing on a market opportunity, our local refineries can’t even meet local demand, let alone export any surplus. Due to lack of refining capacity, we are stuck with importing more expensive refined products, resulting in higher outflow of foreign exchange. In the case of commodities, the cyclicality is clear. After every shortage, there is a glut, the demand and supply dynamics will readjust and prices may find a new equilibrium. However, it remains essential that the country finally puts in place a refinery policy which is forward looking in nature, and actually leverages the strategic location which is more suited to fables now than real economic strength. Establishing and upgrading refineries to meet local demand, while re-exporting the surplus to the region, and beyond needs to be a core pillar of any macroeconomic growth strategy of the country. Ignoring this crucial component of the energy value chain may not bode well for future energy security, and will keep the country susceptible to vagaries of the international commodity markets.

COMMENT

OPINION

Uzair Younus

investors with an environment where volatility is the exception, not the norm. For investors looking to set up manufacturing units, such volatility is unacceptable. Think of a world in which there are only two mobile phone manufacturers, and one is deciding to set up an assembly unit in Pakistan. When developing the financial models to figure out the exnother day another industry raising its voice about pected returns and profitability of the said unit, the manufacturer makes issues it is facing with regards to doing business a set of assumptions on a whole host of issues, including operating in Pakistan. It is a common enough trope - induscapacity, cost of electricity, currency value, and taxation rates. tries complaining and asking the government to fix Based on these assumptions, the manufacturer develops comthings for them. While most of the time it is just fort around the expected rate of return of the said unit, which in most industry associations cribbing, on rare occasions cases has a lifespan of over 5 years. What this means is that should the complaints point towards deeper issues that we may have. This the assumptions prove to be wrong in the coming years, or should the time around it is the Mobile Phone Importers and Manufacturers government change its policy environment related to things such as tax Association (MPIMA), a group that represents significant players in rates or cost of power, the financial viability of the entire investment is the Pakistani market. put at risk. Their concerns revolve around measures being taken by the This said investor, when looking at Pakistan, would of course look country to save foreign currency, which are scarce and are leading to at the sovereign’s behavior in the past. Based on this analysis, an astute sustained depreciation of the rupee. The issues being faced by the ininvestor would conclude that the Pakistani government cannot be taken dustry are yet another exhibit of why Pakistan continues to struggle at its word, meaning that the investor must bake in a high-risk premium when it comes to attracting investment, both domestic and foreign, when assessing the viability of an investment. into new manufacturing sectors. Now assume that despite these issues, one of the two investors The issues identified by MPIMA are as follows: a hundred moves ahead and sets up shop in Pakistan. It quickly runs into the percent cash margin on imports of mobile phone kits into Pakistan; issues identified by MPIMA which are mentioned above, meaning that increased red tape from the State Bank of Pakistan for import of its operations are not as profitable as they were expected to be. In such goods by the industry; failure to issue an SRO related to an approved a scenario, if the issues remain unresolved, this investor is likely to cut duty drawback scheme; and an increase in research and development production, delay investments in further expansion, and plan to divest allowance that is comparable to peer countries such as India and its operations in the coming months and years. The second manufacVietnam. turer, who may have been looking at Pakistan following the entry of its While the merits of the above issues can and should be debated peer into the country, is also scared away, given that the first mover in by folks much more knowledgeable than this author, it is important Pakistan is facing an uncertain and volatile policy and macroeconomic to recognize that the cash margin imposition and increased red tape environment. around import approvals is a result of macroeconomic instability the Given this outcome, the mobile phone manufacturing industry country is experiencing at this point in time. in Pakistan is likely to face a premature death or face stagnation. What Additionally, delays in issuing an SRO, following an agreement, ends up developing is a stunted sector where the investor is unlikely to is also indicative of bureaucratic hurdles being created to find a way reinvest its profits to improve capabilities and manufacture next-generato reduce the pressure on the fiscal balance. Both are a result of a tion mobile phones or their components. consistent failure, across governments over the decades, to provide The ongoing experience of mobile phone manufacturers in Pakistan is a perfect case study of how and why foreign investors look at other jurisdictions, while domestic investors either siphon off their wealth abroad or stash it into Plotistan. After all, why bother with all this uncertainty and drama when one can buy a few plots, pay literally no taxes on profits, and declare the wealth gains by paying a pittance when The writer is Director of the next real estate amnesty is declared? the Pakistan Initiative Some may argue that mobile phone manufacturers are not manufacturing phones in Pakistan, they are at the Atlantic Council, a just assembling them, meaning that there is little value addition in the country. Washington D.C.-based This is a fair argument, but one must recognize that any new industry begins in this way. It is only think tank, and host of the through the right incentives and stability that investors grow their local capacity and catalyze the developpodcast Pakistonomy. He ment of an ecosystem. Such things do not happen overnight, and they are surely not going to happen when tweets @uzairyounus. first-movers are left dealing with a sovereign that is neither able to provide macroeconomic stability nor interested in honoring its commitments.

What imperils the mobile phone industry?

COMMENT

By Taimoor Hassan

“T

he government solution to a problem is usually as bad as the problem.” This maxim by the towering 20th century economist Milton Friedman aptly encapsulates the last 15 years of policy making by democratic governments in Pakistan. Take the recent import ban by the Pakistan Muslim League-Nawaz (PML-N) government. The pressure on the foreign exchange reserves to save the country from a default compelled the government to think of measures to choke the outflow of dollars to stabilise foreign exchange reserves. In their ingenuity, they chose to ban imports of what were termed as ‘luxurious and non-essential goods’. From frozen food to home appliances, a blanket ban was imposed on the imports of 38 different categories of products. The solution has turned out to be as bad as the problem - one of the categories of products for which the import ban has been put into effect is mobile phones, which has sent the industry scrambling when it was just starting to take up. In 2020, the then Pakistan Tehreek-e-Insaf (PTI) government introduced a Mobile Devices Manufacturing Policy to boost local manufacturing of mobile phones which introduced import tariff structure that incentivised local manufacturing by importing raw materials, over importing completely built mobile phones. “Before the 2020 Mobile Devices Manufacturing Policy, manufacturing a mobile phone in Pakistan was not a viable business,” says Aamir Allawala, CEO of Techno Pack Telecom which manufactures Infinix mobiles in Pakistan. “CBUs had low duty but the duty on the parts to assemble mobile phones was the same as CBUs. It was not a lucrative proposition to manufacture cellphones in Pakistan but the PTI government created a differential of about 15% in duty of CBUs compared to CKD and SKD parts that are imported by the industry for manufacturing,” he adds. Imports of cellphones, just like automobiles, are carried out under three categories: they can either be imported as completely built units (CBUs) of mobile phones, semi knocked down (SKD) kits or partially assembled parts of mobile phones which would have to be assembled at the destination of import, or as complete knocked down (CKD) parts which are totally unassembled parts and have to be assembled from scratch.

TECHNOLOGY

“When local assembling and manufacturing takes up, localisation will start happening. The parts used in the manufacturing of mobile phones that are being imported now will be started to be produced locally Muhammad Naqi, CEO and director of Premier Code

Because of the policy in 2020 that reduced duties on import of raw materials as CKD or SKD parts and incentivised local assembling and manufacturing of mobile phones, within a period of one year, almost all the brands that are sold in Pakistan, are assembled in Pakistan. The most notable and famed entry into local manufacturing of mobile phones was of Samsung which contracted its mobile manufacturing in Pakistan to Lucky Group. Samsung mobiles are now manufactured in Pakistan by Lucky Group at their plant in Karachi. Similarly, Vivo, which has huge volumes of sales in Pakistan, is now manufactured at a plant in Faisalabad which was setup by Chinese investors. OPPO has set up a plant in Lahore, Nokia has set up a plant in Pakistan, and Xiaomi is now manufactured in Pakistan at a plant set up by Airlink. “Manufacturing is a very lucrative business globally. It’s the same here for us as well but it can only remain lucrative for as long as the government policy is aimed at keeping it lucrative. Till now, the policy from the government has been favorable for us,” says Muzaffar Piracha, CEO of Airlink Communication, which is the importer and distributor of iPhone in Pakistan. Except iPhone, almost all the mobile phone brands that are sold in Pakistan, are assembled and manufactured in Pakistan. Why iPhone has not yet set up a plant? Pakistan is still a low-income country with majority of the people having limited purchasing power to afford an iPhone. The number of iPhones sold in Pakistan is too small yet for Apple to consider setting up a plant in Pakistan. According to market research by Profit and imports data, 198,869 iPhones worth $72 million were imported and sold in Pakistan last year. Compare that to 1.38 million Samsung phones worth $248 million, whose parts were imported into Pakistan, were assembled here and then sold locally in 2021. Cumulatively, Pakistan imported $1.67 billion worth of CBUs, and SKD/CKD parts in 2020. In 2021, these imports were $1.97 billion. In 2021, according to numbers provided by

the cellphone manufacturing industry, iPhone share in the market was 1.32%. Since iPhone is the only sizeable CBU import, the remaining imports were of CKD and SKD parts in 2021. On the other hand, purely local brands such as QMobile, DCode, Digit 4G, Mobile Club and Hello Tech also import all the parts for manufacturing of mobile phones. “More than 95% of the mobilephone imports are SKD and CKD kits because all of these brands are manufacturing in Pakistan locally,” says Muhammad Naqi, the CEO and director of Premier Code which manufactures local born DCode mobile phones in Pakistan. “Samsung, OPPO, Vivo, Xiaomi, likes of Nokia and all have their own setup in Pakistan one way or the other. They have either setup plants directly or have set up plants through joint ventures,” he says. So when the government introduced the import ban, it was only considered to be on the CBUs. Meaning that no completely built mobile phones, like iPhones, could be imported but SKD and CKD parts were considered to be not under the effect of the ban. Since the bulk of the imports are CKD and SKD kits, the ban would not have had any significant impact on the industry, as Naqi tells us. If we do some back of the paper calculations, 95% of CKD and SKD imports of the total $1.97 billion in 2021 would only save roughly $98 million in import payments for the government - a negligible impact of the ban on import of mobile phones. The situation, however, has now evolved towards a different direction where it seems to be threatening the entire industry which employs 30-50,000 people.

So what is going on with the mobile phone manufacturers?

ollowing the import ban by the PML-N government last month, on paper, the ban is on CBUs. So under the new policy, iPhone distributor

in Pakistan, Airlink, can not import iPhones into Pakistan but should be able to import CKD (cmpletely knocked down kits) or SKD (semi knocked down) kits for assembling and manufacturing Xiaomi phones. Following the 2021 policy, Airlink setup a plant in Lahore to assemble and manufacture Xiaomi phones for local sales. The manufacturers, however, are unable to import the CKD and SKD kits either. While the import ban on CBUs was overt, covertly, the government has effectively choked the imports of CKD and SKD kits as well by setting two conditions: i) the government subjected the import of these kits to a 100% cash margin and ii) the central bank now has to approve the opening of LCs (letter of credit) before any import is authorised. The cell phone manufacturing in Pakistan is done through imported parts. All of it. A typical smartphone constitutes more than 60 parts and none of these parts are locally made. If Lucky Group plans to manufacture a Samsung smartphone in Pakistan, they have to import the parts for that smartphone from some other part of the world (say South Korea where it is headquartered). Even if a purely local brand like QMobile wants to manufacture one of their smartphones, they also have to import the parts from some other parts of the world (think China). The central bank’s conservatism when it comes to the outflow of dollars from Pakistan is well established. For the mobile phone manufacturing industry now, the central bank approves LCs itself before commercial banks can open them for imports by cell phone manufacturers. The process currently is that the manufactures send a request to a commercial bank to open an LC. The commercial bank then asks the State Bank to approve the opening of the LC for the manufacturer. This process used to be completed expeditiously and the central bank would give the approval within one or two days. It is now taking its sweet time to approve those LCs, perhaps in a bid to stretch the imports and the dollar outflow as much as possible. The LCs that used to be approved in a

Roughly 4 million phones (parts and CBUs) are imported each month and the ballpark number is that at least 3 million mobile phones are sold each month. So it is unlikely that the government will continue the import ban on a product that is sold in such volumes. The ban will eventually be lifted because there is no other source of raw materials for the industry Faisal Motiwala, the CEO of United Mobiles

matter of two to three days, have not been approved since May 19 by the central bank, leaving the cell phone manufacturers in desperate straits. Manufacturers have also been subjected to a 100% cash margin. Commercial banks ask them to have a certain amount worth a certain percentage of the import value to be present in their accounts before opening an LC for them. Now, that percentage has been increased to 100% meaning they need to have an amount worth the complete value of the import, to be able to import. This kills the concept of working on credit, constraining the working capital of these manufacturers. The immediate impact is on the production of mobile phones and the secondary impact, but not any less important, is on the sellers of mobile phone parts as well as the investors of the project. According to a mobile phone manufacturer who commented on the condition of anonymity, the exporters of these equipment are feeling restless because the payments to them are dependent on the opening of LCs here in Pakistan. If the SBP is not approving LCs, the exporters of these equipment are not able to receive payments for parts that they have ready to be exported, but can’t do because of the problems here. The import of CKD or SKD kits is based on credit instead of cash, and hence the requirement of opening LCs. Now the manufacturers importing these raw materials have their own cycles based on their working capital, according to which they import the raw materials. From industry stakeholders, Profit learned that the usual import cycle is of 1-2 months, which means that a cell phone manufacturer would have, say a month or two month’s inventory of raw materials after which they would have to import. So if the SBP has not approved LCs for the last two to three weeks, the raw materials are going to deplete completely in the next 2-3 weeks. The cell phone production declines or stops, and the idle workforce gets laid off. Layoffs are another problem that the

industry faces, and legitimately uses it to show the impact the current policy is having on the industry in the presence of an effective ban on imports. And it does not stop there. Most of the brands like Samsung, OPPO, Xiaomi, and Vivo that are sold in Pakistan, are assembled and manufactured in Pakistan following the Mobile Device Manufacturing Policy. Some of the plants to manufacture some of these brands have been set up by foreign investors on their own or through a joint venture with a local partner. For instance, Vivo plant was set up in Faisalabad SEZ and has 100% Chinese investment. OPPO plant in Lahore, too, has been set up by Chinese investors. Tecno Transission Electronics, which owns brands like Tecno, Infinix and iTel, is a joint venture between Tecno in Pakistan and China’s Transsion Holdings. The foreign investors, and even the brands that have completely contracted out their manufacturing in Pakistan to a local business group, are not going to have a good impression about investing in Pakistan. “Vietnam is a mobile manufacturing success story. The Vietnamese government brought in Samsung in Vietnam in 2013 and set up the first mobile phone assembly plant. Today, Samsung exports $40 billion worth of mobile phones from Vietnam to the rest of the world,” says Aamir Allawala, CEO of Tecno Pack Telecom which owns Infinix brand. “When the Vietnam mobile phones manufacturing became successful, they brought in their appliances as well. Samsung’s exports from Vietnam are roughly $60 billion now and they employ about 170,000 people. Following the Samsung success story, other brands also jumped in,” Allawala adds. There is a case to be made that with one success story, you can attract many others to create more success stories. If you are able to attract one pigeon on the roof, others will follow too. Contrarily, with one shot, you can scare all the pigeons away. The ban may have been just be that shot.

The squabbles

he situation is painful for mobile phone manufacturers. Some of them have laid off staff they trained only like a little over a year ago when the new policy was introduced, citing that they can not afford their expensive payrolls in this situation. Manufacturers are scaling back, and have warned of a complete shutdown in the coming week if the situation is not salvaged. And in an attempt to salvage the situation, they wrote a letter to Finance Minister Miftah Ismail to allow CKD and SKD kit imports (effectively banned because of LC approvals by the State Bank and 100% cash margin requirement) for cell phones less than $100 in value. The letter, written by the Mobile Phones Manufacturers Association (MPMA) claims that 70% of the mobile phones manufactured in Pakistan are below $100, and their import bill is only 30% of the total import value of mobile phones. Hence, allowing this category of cellphones which forms the bulk of the market but consumes less than half of the foreign exchange, would not have a substantial impact on forex reserves. Is the measure prudent? The Mobile Phones Manufacturers and Importers Association (MPIMA) doesn’t think so. The industry has two associations, both of which claim to be the official representatives of the industry. The MPIMA has also sent a letter to Miftah Ismail with the same suggestions to ask the SBP to open LCs without any discrimiation of the value of the cell phones, withdraw cash margin requirements and give an R&D (research and development) allowance to the industry to help them export mobile phones. MPIMA does not agree with the MPMA’s suggestion of allowing imports for cell phones worth less than $100, and accuses it of pursuing a vested interest. In its letter to the finance minister, the MPIMA even tried to discredit the MPMA by calling it a ‘selfclaimed and unregistered association’ which

TECHNOLOGY

Manufacturing is a very lucrative business globally. It’s the same here for us as well but it can only remain lucrative for as long as the government policy is aimed at keeping it lucrative. Till now, the policy from the government has been favorable for us Muzaffar Piracha, CEO of Airlink Communication

only has 20% members from the industry and is, therefore, not the true representative of the industry. Whereas MPIMA claims to have members that represent 80% share of the mobile manufacturing market and has members such as Lucky Group with the Samsung brand, OPPO, Vivo and Xiaomi - four of the biggest mobile phone brands in Pakistan. MPIMA has members that are big distributors and manufacturers like Airlink, which is the distributor for iPhone in Pakistan and manufactures Xiaomi mobiles. Airlink Chief Executive Officer (CEO) Muzaffar Hayat Piracha serves as the chairman of the MPIMA. On the other hand, MPMA is headed by Abdul Rehman of G’Five Mobile and has Aamir Allawala of Tecno Pack as the senior vice chairman. MPMA claims to have 26 manufacturers as members of the association. The total number of mobile phone manufacturers in Pakistan are estimated to be around 35. The big distributors like Airlink have a stake in the market with the iPhone brand, which is currently under complete ban because it is imported as a CBU. iPhone is worth over $100 for sure so if MPMA’s suggestion gets through, most of the manufacturers get to import (since 70% of the cellphones are worth less than $100 as claimed by MPMA), except

“Before the 2020 Mobile Devices Manufacturing Policy, manufacturing a mobile phone in Pakistan was not a viable business Aamir Allawala, CEO of Techno Pack Telecom

high value phones such as iPhone, and save many jobs in the process. So instead, MPIMA has asked for the lifting of ban for everyone and has pitched to the ministry that if imports are lifted, they would be able to export as well. The suggestion of exports might not be so prudent however because the decision to export from Pakistan will be taken by Samsung in Korea or Xiaomi in China. Even if they allow exports, more raw materials would have to imported to manufacture mobile phones for exports. The net effect on forex reserves because of exports would be less. The MPMA, too is wary that MPIMA is seeking its own interest. And that its better to get something out from the government even if it is at the expense of big distributors and manufacturers. The distrust between the two associations is discernible and is certainly not good for the industry that is still trying to get onto its feet and claims to be promising for the country. The eventual aim of the 2020 policy is to boost the ‘Made in Pakistan’ brand. “When local assembling and manufacturing takes up, localisation will start happening. The parts used in the manufacturing of mobile phones that are being imported now will be

started to be produced locally,” says Muhammad Naqi. For the time being, the problems related to imports persist. Faisal Motiwala, the CEO of United Mobiles, one of the oldest and largest mobile phones distributor in Pakistan says, “Roughly 4 million phones (parts and CBUs) are imported each month and the ballpark number is that at least 3 million mobile phones are sold each month. So it is unlikely that the government will continue the import ban on a product that is sold in such volumes. The ban will eventually be lifted because there is no other source of raw materials for the industry. We are quite hopeful that the problems regarding the LCs are going to be solved by the end of this month.” However, on June 17, media reports surfaced claiming that the State Bank had allowed the opening of LCs for the import of mobile parts. CEO of a mobile phone manufacturing company also told Profit that the central bank had allowed opening of LCs for imports of cell phone parts. The SBP had not approved any LCs since May 19, 2022. And on June 17, the central bank approved only a handful of LCs of some manufacturers. There is no clarity yet that the central bank would resume giving approvals for LCs for all manufacturers, and it would do it, like before, in a matter of days. If the SBP has given approval to some manufacturers right now, its surmising that imports will begin in full swing. According to the CEO of a mobile manufacturing company, since the entire industry is getting affected, the SBP might set up some quotas for each manufacturer and approve LCs based on that quota, so that all manufacturers are able to keep the business running, albeit at lower scale. When would the imports resume is unsure, but it will certainly happen. What is also certain is that the industry needs to get its act together to achieve the goals envisaged in the policy that led to the creation of this industry. n

TECHNOLOGY

Why aren’t we buying Russian oil? Many other countries are benefitting. But a host of reasons make it difficult for Pakistan By Asad Ullah Kamran

uch has been made of the suggestion that Pakistan could have avoided the current economic crisis it is in if it had managed to import cheap crude oil from Russia. Former Prime Minister Imran Khan has made it the cornerstone of his political campaign - claiming he had reached an understanding with the Russians and was deposed by an international conspiracy as a result. While the claims may be a tad bit on the fantastical side, particularly ever since the Russian Ambassador to Pakistan recently confirmed that no MoU was signed on the trade of wheat and oil at cheaper prices with Pakistan, could looking towards Moscow for cheap fuel be our ticket out of this crisis? Here is the crux of it - Countries like India are indeed importing cheaper fuel from Russia and in turn undercutting the global economic crisis domestically by having cheaper oil. In fact, India is even exporting the oil at higher rates than they get from Russia. Similarly, China is also taking full advantage of the situation. So why can’t Pakistan? The problem is three-fold. For starters, given our particular dire-straits it might prove to be more economically disastrous to test the patience of the United States and other Western powers that have put sanctions on Russia. It would also jolt the relationship we have built with the Arab world over decades if we started buying Russia’s Ural blend of crude oil over the Arab blend. The second part of the equation is the fact that currently we do not have the facilities to process

Russian crude oil in Pakistan. And lastly, even if these issues were set aside, Pakistan as a market is not large enough for Russia to consider selling their oil at a discounted price. Of course, there are always going to be hitches in any plan. Setting aside the obstacles and the fact that Prime Minister Imran Khan was wrong in his claims that an MoU had been signed with Russia, how viable would it be if Pakistan decided to go ahead and buy Russian oil anyways - even if not at discounted prices.

Why buy Russian?

imply put, because Russian oil is cheaper generally and on top of that the Russians are desperate to sell. Waging war isn’t cheap, and Russia will very much be looking for markets to sell to as it tries to shore up revenues. That is why the impulse to turn towards Russia for oil is not entirely unfounded. As of this moment, many European countries are also importing Russian oil and gas despite public condemnation and sanctions. Consistent posturing by EU member states to strip Russia of its oil and gas revenues have been little more than words. In 2021, the EU imported 155 billion cubic metres (bcm) of natural gas from Russia. This accounts for over 40% of the EU’s overall gas consumption, with Germany’s reliance reaching 65%. Russian oil and gas sales to the EU directly fund the Kremlin’s military budget. Russia has exported €63 billion worth of fossil fuels since the start of the war, with the EU accounting for 71% of that, according to a research released by the Centre for Research on Energy and Clean Air. In absolute terms, Germany, Italy, and the Netherlands are among Europe’s top importers. At the same time, China and India are

taking full advantage of the predicament as well. Indian refineries, both public and private, have increased their purchases of Russian crude on the back of the sanctions and trade restrictions from the west, which have driven most purchasers to back out of deals with Russia. This has made Putin’s Russia somewhat desperate to increase revenues as waging a war is not cheap, this led to offers at lucrative discounted rates. According to Bloomberg projections based on trade data, India purchased upwards of 40 million barrels of Russian oil from late February to early May, accounting for 20% higher flows for the entire year of 2021. According to Kpler statistics, Russian oil arrivals in India increased to 740,000 barrels per day in May, increasing from 284,000 barrels in April and 34,000 barrels a year ago. Access to low-cost crude is already helping to enhance India’s petroleum imports, which increased by over 16% in April alone compared to the previous year. According to Indian government data, the Eurasian (including Russia) region’s oil contribution increased to 10.6% in April from 3.3 percent a year earlier. Cheaper oil therefore gave the BJP government fiscal space to reduce domestic petrol and diesel prices while the prices in the rest of the world continue to inflate. At the same time China continued to acquire considerable energy from Russia, with imports of oil, gas, and coal increasing by 75% by almost $6 billion in April. According to Chinese customs data, imports of Russian liquefied natural gas increased by 80% year on year to 463,000 tonnes. Imports of crude followed a similar trend, increasing by 4% to 6.55 million tonnes for the year.

Could Pakistan do the same?

he recent increase in fuel prices have wreaked pandemonium in the economy. And we are being told that a cheaper source of fuel is just a little north of us. Currently, Pakistan consumes approximately 500,000 barrels per day (bpd) in which Russian oil has no share. In India, Russian oil has a 10% share in comparison. Hypothetically speaking, if we shifted to the same ratio of 10% Russian oil, that would translate into 50,000 bpd. Given that we purchased this oil with no discounts would amount to approximately $4.5 million per day and a total of $1.6 billion annually. Even if Pakistan was refused any discounts it would still be cheaper considering the fact that the primary export blend Ural brent is cheaper than Arab blends. Now if we did the same calculations using a hypothetical discount of 30% on the Ural Brent price that would mean a per barrel rate of $64. Using the same consumption levels as above would generate a revenue of approximately $1.2 billion for Russia on an annual basis. Even if we manage to transition completely to Russian oil, it would only generate $16 billion for Russia. While $16 billion may seem like a lot, it is dwarfed by the revenues coming from Europe, India and China. It wouldn’t be wrong to say that purchasing Russian oil would have saved the government invaluable foreign exchange in the range of $400 million if the share of Russian oil in imports was 10%. That would have helped the government in saving foreign exchange as well as save some of the subsidies that the government had to give in the form of price differential claims. At the same time it is important to mention that the government paid north of Rs 150 billion for subsidies on petrol and diesel. If we converted the savings of $400 million into the domestic currency it would amount to Rs80.8 billion at the current exchange rate (PKR200/ USD). If we were to compare that to that of China, India or Europe even at the current levels, $1.2 billion annually for Russia is pocket change. Comparing the revenue that Russia has earned approximately $66 billion from EU and an additional $3.6 billion from India since the start of the war. This effectively disproves the claims that the regime change was orchestrated because Pakistan was getting cosy with the Russians.

The effect on our foreign relations

hat being said it is also clear that Pakistan would not be allowed to go scott free as has been the case with both China and India according to

some foreign policy experts. It must be understood that Pakistan has a smaller market and in a much weaker economic position compared to China and India, it can reasonably be concluded that Pakistan would have had to face sanctions. Not to mention that Pakistan has desperately been trying to get back together with the IMF, importing Russian oil would’ve closed that door altogether. Another key underlying factor that is often ignored on TV is our strategic and economic understanding with Saudi Arabia and other gulf states. This relationship built over decades will be jeopardised and constrained if we start looking towards Russia. The Saudis and Russians aren’t on best terms as was the case in the 2020 oil price war between the two.

Can we refine Russian oil ?

part from this another technicality that is often ignored is the fact that the Russian Ural oil has a relatively higher content of sulphur, therefore the price of this blend is lower than the market benchmark. Refining high-sulphur crude oil is costly owing to its high oxidation and corrosion properties. The costs of excessive oxidation and corrosion damage caused to a refinery not adequately equipped to sustain high sulphur crude will outweigh the revenues from the cheaper oil. Apart from the Parco refinery which is a mild conversion refinery, all other refineries utilise hydroskimming. We won’t dig into the engineering and technical details of the two different types of refineries, the point of the matter is that our refineries cannot process it. As far as the capacity of the refineries that are able to refine Russian goes, only Parco has the ability according to an industry expert. That makes the argument of importing from Russia even weaker given that local refineries would have to undertake massive upgradation.

Can we pay for it ?

resident Putin said in March that ‘unfriendly’ countries will have to pay for Russian gas in roubles in retaliation to sanctions against Russia following the invasion of Ukraine or have their gas supplies suspended. This was a reply to the sanctions that these nations had immediately agreed upon in response to Russia’s invasion of Ukraine. This put the West in a very precarious position as this statement would practically defeat the purpose of the sanctions targeted at destroying the value of the rouble. However as the EU weans itself off of Russian energy the revenues of Russia have not been affected

despite lower export volumes. Following the sanctions on Russia any financial transactions with the country are seen as high risk, especially in the case of Pakistan. To get Russian oil, nations must first purchase the currency, which may be done at the Central Bank of Russia or on the foreign exchange market. Dealing directly with Russia’s Central Bank, which has been sanctioned, will be difficult. Buying rubles on the open market will necessitate the use of non-sanctioned Russian banks to complete the transaction. Despite this, if Pakistan is able to position itself to purchase oil from Russia, we’re still in the FATF grey list and any deals with Russia can potentially jeopardise this. Also the country has recently got back on the IMF program after making extremely painful decisions in terms of fuel prices. By making deals with Russia the US lender and other financial organisations might be hesitant to offer loans. If we were to compare ourselves with China or India we would be sorely mistaken. Both countries enjoy very strong economic and military ties and have traditionally leaned more towards the former Soviet Union. This has allowed both of them to circumvent the sanctions imposed by the west. China has an alternate equivalent to the Western SWIFT called Cross-Border Interbank Payment System (CIPS). Russia also has a similar system called System for Transfer of Financial Messages (SPFS). Although these systems are relatively newer as compared to SWIFT, they still have a similar potential. Both the countries are using these systems to side step the sanctions. Similarly India has bilateral trade agreements with Russia dating back to the 1950’s that allow the countries to make trade payments denominated in their respective currencies. At the same time India isn’t being pressurised as much by the West as it’s viewed as a key ally in the region to challenge China.

Bottom line

s much as we all want cheaper fuel, importing Russian oil might not be the answer. Although it might provide the public and government with much needed relief, the costs to refineries which are strategic assets as well as the diplomatic capital burned would be too much. Not to mention that it would make it extremely difficult to secure loans that we need so desperately from time to time. The economy is already struggling and the country as a whole cannot afford to burn bridges and get on the bad side of major global players especially at this tricky crossroads we find ourselves in. A very surgical and diplomatic approach is needed to navigate the seas ahead. n

OIL

The grim reality of

oversubscription By Saad Tanvir

he first IT sector company to get listed on the Pakistan Stock Exchange’s (PSX) freshly constructed GEM board, Supernet, concluded its book-building on Wednesday with a whopping Bid Size of Rs659 million and a major oversubscription of 1.4 times its offer size of Rs475 million. This has lately become a trend whereby recently listed corporations have all managed to acquire more than what they asked for. This, in particular, creates a disequilibrium in the market and takes away its true essence. Taking a deep dive into the IPOs concluded since the start of 2021, Pakistan has had a list of 9 IPOs - 3 on the recently introduced GEM Board and 5 on the conventional stock listing - out of which, all have been oversubscribed. While this may be perceived as exceptional by some, this does indicate a fundamental flaw. The objective of the book-builder is essentially to calibrate a suitable price for the share to be offered. If not, let the market forces decide. However, due to a term called price ceiling, there exist certain limits as to how much the price can climb as a response to the excessive demand. This has been witnessed in the last couple of years in the Pakistan stock market and is dangerous to the market’s ability

to devise the accurate strike price for the stocks on offer. Companies recently listed include: Supernet; Pak Agro Packaging; Universal Network Systems; Airlink Communications; Octopus digital; Service Global Footwear; Pak Aluminum and Beverages; Citi Pharma; and Panther Tyres.Investors participate in IPOs to benefit from the capital gains in the stock(s) acquired. However, such returns are compromised when the shares are restricted from trading at the market price during the auction period. It is pertinent to mention that oversubscription has no direct relationship with the auction price or the IPO listing price, rather it indicates that the bids received for the stock were in surplus of the amount of shares available. In essence, demand > supply and hence market disequilibrium. While, in ECON101 we’re taught that the market has an invisible hand and that it’s self-correcting in such situations, that’s not the case over here. We’re taught that the price reflects the disequilibrium and that in case of access demand, it increases to cover up the surplus until the market reaches equilibrium again. However, if that was the case, we wouldn’t be looking at every IPO being oversubscribed, rather the difference between the bids received and the offers (available shares)

would be reflected in the listing price until the bids and offer would reach an equilibrium. This is primarily because the PSX sets a price ceiling for the stocks, which hampers market’s fluency and restricts it from running freely.

The GEM Board

he freshly formed Growth Enterprise Market (GEM) Board is to enable and facilitate small and medium enterprises (SMEs), greenfield projects, tech start-ups and other companies to streamline their listing process on the Pakistan Stock Exchange and raise capital. SMEs are a crucial element in the Pakistani economy where they constitute about 90% of all enterprises, contribute approximately 40% to the annual GDP, and employ about 80% of Pakistan’s non-agricultural labor force. Alongside this, such companies also provide people with diversified products, invest in Research & Development, create supply chains, increase market outreach and penetration, add to their infrastructure, and increase their production capacity. It is crucial for them to access sufficient funding to succeed. However, such funding is rather less accessible and costly at the same time. This is one of the reasons that Pakistan Stock Exchange has incorporated the GEM

Board as it not only helps such enterprises expand, diversify by raising capital, but also helps the development of the Capital Markets which is vital for trade enhancement and industrial development. The platform encourages investors to invest in fast paced growth companies, for which they can yield the fruits in the long-term. Investors can invest in such stocks for both capital appreciation and dividends, while the companies get access to the much needed capital. Listing primarily provides companies with long term low-cost capital, in comparison to the high cost of borrowing in Pakistan; making it cheaper for SMEs to acquire equity than debt. The GEM board also gives the companies access to funds without collateral and provides them with a tax benefit of 20% on tax payable in the first two years of listing and 10% on each of the subsequent two tax-years. In addition to this, the minimum free float of shares requirement is a meager 10%. This allows for a strong majority of the shareholding to be retained by the owners and directors. The mandatory requirements for listing on the GEM Board include the availability of audited financial statements of the last two preceding years of the company (or of shorter period if it has been less than two years since commencement of business); It must publish the statements on their website whereby the website must contain basic company information, Information Memorandum (IM), and half yearly progress providing status of commitments mentioned in the IM. It is imperative to mention that the companies going public on the GEM Board have fewer compliance and regulatory bindings, compared to conventional listings on the PSX. Henceforth, only Institutional Buyers and NCCPL (National Clearing Company of Pakistan Limited) registered investors are eligible to invest in shares of GEM Board listed company. Companies listed on the GEM Board At present, 3 companies are listed on the GEM Board, all of which conducted their IPOs in the ongoing fiscal year. All three IPOs had been oversubscribed, indicating investor interest in the GEM board as well as growth stock. All currently listed companies on the GEM board touched their strike price or price ceiling during their respective auctions and henceforth oversubscribed. We can observe that all three stocks are currently trading at

a substantially lower price compared to their strike price. Pak Agro Packaging Limited (currently trading at Rs 11.05) was the first listing on the GEM board with a big oversubscription of 1.85 times. It showcased massive investor confidence on the platform as well as the company itself. With a strike price of Rs 24.75, the company witnessed a nosedive within a month and was trading at Rs 15.15 on december 06, 2021. A similar case was with Universal Network Systems Limited, a company which conducted its IPO through the GEM board in december 2021, witnessed a downfall from Rs65 to Rs44.75 within a span of 5 months. The courier company, formally known as ‘Blue-ex,’ was oversubscribed by 68%, touching its strike price of Rs65 during the Auction. The recent IPO of Supernet Limited - a subsidiary of Telecard Limited - further escalated the issue, where the book-building process was concluded with an oversubscription of 1.4 times. Supernet was the first IT company to list on the freshly constructed Gem board, where a diverse range of investors participated including institutions investors, high-net worth individuals, and Roshan Digital Account holders.

The price ceiling and its reality

rice ceilings are essentially imposed by the Securities and Exchange Commission Pakistan (SECP) through SRO 7(I) announced on January 5, 2018. As per the official notification of the SRO, the amendment was “to promote quality listing, ensure fair price discovery through book-building process and increase investors’ base.” “The concept of price band with the upper limit of not more than 40% of the floor price” was introduced to improve the mechanism of fair price discovery in the IPOs. Floor price was set as the minimum price per share set by the issuer in the building process. The amendment was essentially put forward to delete the FOMO effect during the book-building process felt by the investors. In the dutch auction model, the last bid during the auction is proclaimed as the market price for a particular stock. Some may say that this is the right mechanism to determine the market price of a share. However, due to the FOMO (Fear of Losing Out) effect, investors tend to bid more than the justified market

price of a share (based on its fundamentals) and resultantly the security gets overvalued. To curb such activity, the Commission formulated SRO 7, and deemed the maximum bid price to be 40% above the share’s floor price. Since the strike price is determined at 40% above a share’s floor price, the devil lies in determining the floor price. Now, the power to curb the mispricing lies in the hands of Investment banks who have to determine the IPO floor price based on the stocks projections and forecasted demand. Since the passing of the SRO, all IPOs have been oversubscribed, particularly Octopus Digital Limited, which witnessed an oversubscription of a massive 27.3 times. A subsidiary company of Avanceon, Octopus Digital, a strike price of Rs 40.6 per share was determined through the Dutch Book building process. This meant retail investors could buy Octopus Digital shares at a maximum price of Rs 40.6, essentially a ceiling. The IPO was oversubscribed 27 times by the end of the two day process. The company received offers of over 745.6 million shares against its offer of 27.35 million at the initial price of Rs 29 per share. To put this in perspective, the IPO was fully subscribed within the first half hour on the first day. “The price ceiling for an IPO is essential because the given demand for a company’s shares does not mean the company is valuable. Also, not all investors who participate in IPOs are aware of a company’s actual worth. Sometimes actual fundamentals of a business can be overshadowed by book runners, which is why it is so important to have a ceiling at a specific fair value price. In the case of Octopus, the challenge of investing in an IPO was calculating the actual worth of cloud and artificial intelligence financial vagaries without the company’s little experience in that business. Hence here the ceiling safeguarded the risk of investing,” says Naushad Chamdia, CEO of Standard Capital Oversubscription fundamentally implies that the market forces have been restricted and the pricing mechanism is not doing a very good job at determining the fair market price of a stock. The price ceiling keeps the market forces in check where the disparity between the bids received and the shares on offer (demand & supply), is not truly reflected in the market price of a particular stock and the greater the disparity, the greater the disequilibrium & the more mispriced a share would be. n

PSX

Has the country finally embraced a progressive tax regime? By Ahatsam Ahmad

he government needs money. All governments everywhere always need money, but for Pakistan right now shoring up revenues is a vital part of getting out of the eye of the storm we find ourselves in. And for that, the most indispensable part is revenue collection. The IMF is also breathing down the government’s neck, peering very closely at whether or not the fund’s recommendations on revenue collection are being followed to a T, with the disbursement of the bailout package on the line. So what changes has the government proposed in the finance bill? And more importantly, how do they line up with the expectations of the IMF? Additional revenue measures of around Rs 440 billion, out of which 70 percent pertain to direct taxation and the remaining 30 percent will be through sales tax and duties. These measures include taxing unproductive assets like real estate, tightening the minimum tax regime, introducing wealth taxes and additional super tax, direct and fixed

TAXATION

taxation for sectors like imports and retail while savings and investments in financial markets are also being taxed at an elevated rate to generate incremental revenue. There has also been a downward revision in salary tax rates and income slabs is a positive development for the working class, however it is contrary to what IMF demanded and the authorities might not be able to see this proposed amendment through. Relief for some sectors through sales tax exemption is provided but other sectors are on the receiving end of proposed amendments like reduction in input tax adjustments and increased sales tax rates. Profit investigates how these key amendments affect the broader narrative of tax regulation. Particularly with regards to docu-

mentations of the economy and streamlining procedures for ease of doing business.

Sales sax

efore diving into the details of the proposed amendments to the sales tax regime, let’s see an example to understand how the sales tax liability is calculated and what does the commonly used jargon actually mean. The calculation above is a simplified version of how sales tax liability is computed. The two main components are input and output taxes. Input, as the name suggests, is tax charged on purchases by suppliers/vendors while output tax is collected from the customers by the business.

The chargeability of these goods to sales tax and rate for that is determined by the classification of the goods whether they are ordinary goods or those classified in different schedules of sales tax act. Once the gross amounts are available for output and input taxes, the net input tax is compared with 90% of gross output tax and the lower of two figures is deducted from the gross output tax to calculate the sales tax liability. (The net input tax is gross input tax less proportion of input tax pertaining to exempt sales, inadmissible sales like sales of more than Rs. 100,000 without obtaining CNIC and Zero rated sales like exports for which input is not adjusted rather refunded in full.) A further tax of 3% is also charged in some cases like the one mentioned in the example where supplies are made to customers that are not registered with sales tax authority even though they are legally required to. Now that we have a better understanding of the sales tax mechanism, let us go through the important amendments proposed in the Finance Bill. A major change in the sales tax regime is the exemption provided to the sector importing and manufacturing tractors. This is being perceived as a positive step for reduction of the prices of tractors for the final agri consumer. However, the fact is that by exempting sales tax, the input tax of tractor manufacturers would also be disallowed meaning the cost of that would be passed on to the final consumer. Further, there are existing refunds of the industry around Rs8 Billion that would be disallowed if the pro-

“This is a regressive provision as it will have negative cash flow implications. Also, the need for audit should have been diminished because there are no more manual filings of returns and data regarding input and output is available for reconciliation on the FBR portal. Further, the curtailed input tax is only paid through a refund and it is no secret how difficult it is to get a refund in this country.” Asim Zulfiqar, Senior Tax Partner of AF. Ferguson posed amendment is to be implemented. Moreover, as explained in the example before, input tax is allowed to be adjusted upto 90% of the output tax and any excess amount is refunded after conducting an audit as per the mechanism laid down by Sales Tax Rules. However, Public limited companies were an exception to this rule and were allowed a 100% adjustment. The finance bill now proposes to remove this exception and bring the public companies under the same ambit. Asim Zulfiqar, Senior Tax Partner of AF. Ferguson & Co. Chartered Accountants, while addressing the matter in ICAP’s Post Budget Conference stated, “This is a regressive provision as it will have negative cash flow implications. Also, the need for audit should have been diminished because there are no more manual filings of returns and

data regarding input and output is available for reconciliation on the FBR portal. Further, the curtailed input tax is only paid through a refund and it is no secret how difficult it is to get a refund in this country.” A further tax of 3% is also proposed on sales to taxpayers that are registered but not active (due to non filling or other offenses). Though the step is in line with the existing treatment of sales to unregistered customers, it adds to the tasks of businesses who will now be compelled to check taxpayer status each time before invoicing as the FBR’s active taxpayer list is updated on a real time basis. In addition to the changes above, the provision for disallowance of input tax credit relating to supplies made to customers in excess of Rs100,000 without obtaining CNIC was also removed. Asif Kasbati, A senior Chartered Accountant while commenting on the issue stated, “The amendment is not in the spirit of documenting the economy. However, from the perspective of the businesses it was a huge inconvenience as their customers were not willing to share their CNICs while the FBR officials were also misusing the provision to exploit them.”

Income Tax

he direct taxes form a major part of the government’s efforts to increase the revenue in the forthcoming fiscal year. The proposal to implement multiple wealth taxes is one of the key measures to enhance revenue collection. As per the IMF, “Two major types of taxes are levied on wealth: those applied sporadically or periodically on a person’s wealth (net wealth taxes), and those applied on a transfer of wealth (transfer taxes).” The proposed levy of wealth tax in the finance bill 2022 includes capital value tax while changes in taxation for capital gain and deemed rental income can also be loosely classified as a wealth tax. Capital Value Tax (CVT) was reinstat-

ed in the recent budget proposal after being repealed through the finance act 2020. The proposed tax is to be applied on Motor vehicles held in Pakistan having value in excess of PKR 5 million at a rate of 2% and Assets of a resident individual (the person who stays in Pakistan for at least 183 days during a tax year), whether movable or immovable, held abroad having value in excess of Rs100 million at a rate of 1%. While talking to Profit, Dr. Ikram ul Haq, expert in Corporate Law and Taxation, stated, “ The implementation of capital value tax is not permissible as it is in contradiction with the entry 50 of federal legislative list which restricts the federal government from charging CVT on immovable property.” Further, Asim Zulfiqar, Senior Tax Partner of AF. Ferguson & Co. Chartered Accountants, while addressing the matter in a ICAP’s Post Budget Conference stated, “ In case of foreign assets that were taxed under declaration laws (Amnesty Schemes) there was a sovereign guarantee given regarding no further taxability of declared assets. However, the CVT seems to go against that assurance and this might become a hindrance in its implementation.” There has also been a concept of deemed income tax on immovable property introduced. This tax, as per many experts, is a wealth tax due to a characteristic similarity with other wealth taxes which is being levied on fixed rate irrespective of the returns generated by the asset. As per the proposed amendment, income tax would be charged at the rate of 20% applied on an immovable property’s assumed rental value equivalent to 5% of its Fair Market Value (can be ascertained through FBR rates and DC rates). Exception to this includes self owned properties that are used; for agricultural related activity (includes only land), as a business premises from which business is carried out. Further, the CVT is not applicable on a single self owned property and where the Fair Market Value of property(s) does not exceed Rs25 million excluding the aforementioned properties. This can be seen as a positive step to capture unproductive real estate assets. However, as

“In the case of the IT sector, the additional tax might be a blessing in disguise as it saves them the time by not having to go through the agonizing procedure of obtaining exemption certificates from FBR and then getting it renewed.” Asad Ali Shah, former President of ICAP per legal experts the applicability of this can be challenged in the court of law. The scope of taxation on inheritance and gifts is also proposed to be increased in line with the government’s efforts to tax wealth. As per the existing laws covering the capital gains on assets, the value of an asset transferred under inheritance, succession or as a gift would be the fair Market Value of the asset. The new proposal aims to change it to the tax base of the asset in the hand of the original transferor. We can better understand this through an example. The capital gains are calculated as the difference between consideration received and the cost of the asset. If you were to receive a car as a gift from, let’s assume, Person A, the cost of asset for you would be zero but for tax purposes it would be the fair market value at the time of transfer. So, at the time of receiving the gift if the market value of the car was 2,500,000, that would be the cost for you and if you sell it after a year for 3,000,000 your capital gain would be 500,000. However, under the proposed amendment the cost would not be 2,500,000 rather it would be the tax base of the asset (The original cost paid by the Person A less any depreciation claimed). So in that case, if Person A bought the car for 1,500,000 and claimed depreciation of around 500,000 on the car, the effective tax base would be 1,000,000. The same would be the cost for you to calculate your capital gain which would now increase to (3,000,0001,000,000) 2,000,000. The finance bill also proposed to abolish the carrying forward of minimum tax to subsequent tax years. Minimum Tax (in this

case refers to turnover tax) is charged at a rate of 1.25% on the gross sales of the company. To better understand this provision let’s take a simplified example of a company that has gross sales of Rs400,000 and a taxable profit of Rs10,000. The Minimum tax would be (400,000*1.25) Rs5,000 while the corporate tax would be (10,000*29%) Rs2,900. The differential of Rs2,100 under the existing tax regime can be adjusted against future tax liability within five years. Abolishing this rate would mean that the businesses that are currently low on profitability would not be able to obtain future relief once they are able to improve their performance. Further, from an accounting perspective, this will have a negative impact on the deferred tax assets on the company’s balance sheets if applied retrospectively. (There is ambiguity regarding the application but as per experts it is likely to be applied prospectively). Dr. Ikram ul Haq, expert in Corporate Law and Taxation, while explaining the situation to Profit, commented, “The Turnover Tax is confiscatory in nature and not allowing a carried forward would further add to the vows of businesses. If you see other similar jurisdictions like India, the minimum taxes are charged on accounting profits rather than the revenue.”

Minimum tax rates in India as per PwC

urther, regarding the real estate sector, the holding period to avail exemption from capital gain tax on sale of immovable property is increased to 6 years form 4 and the rates for taxation have also been revised upwards. Asif Haroon, a Senior Chartered Accountant, while addressing the ICAP Post Budget Conference stated, “It is estimated that increasing the holding period by one year can generate incremental revenues of around Rs20 billion.” Tax regimes for a few sectors have also been revised including retailers other than Tier-1 who have a commercial electricity connection will now pay tax through monthly electricity bills which would be a final tax. Also, commercial importers will also pay a

TAXATION

“The implementation of capital value tax is not permissible as it is in contradiction with the entry 50 of federal legislative list which restricts the federal government from charging CVT on immovable property.” Dr. Ikram ul Haq, expert in Corporate Law and Taxation

final tax at the import stage which would be a shift from their existing minimum tax regime. The 100% tax credit for the IT sector exports has also been removed and replaced with a 0.25% final tax.

These measures will not only reduce documentation of the economy but will enable the businesses to pass on the incidence of tax to the customer, a trait that is usually associated with indirect taxation.

Asad Ali Shah, former president of ICAP told Profit that “the shift to final & fixed taxation discourages the documentation of the economy as the businesses falling under the ambit of it don’t file returns either due to the law or they have no incentive to do so. Also there is no reconciliation of their wealth. The commercial importers, majority of whom already avoid taxes through under-invoicing, will now be allowed to not disclose their profits.” “In the case of the IT sector, the additional tax might be a blessing in disguise as it saves them the time by not having to go through the agonizing procedure of obtaining exemption certificates from FBR and then getting it renewed.” Shah further added. There are other measures also proposed in the budget to increase collection through direct taxation including wealth taxes in the shape of poverty alleviation tax and super tax. While measures like abolishing tax credits on investments, increasing the scope and rate of taxation on gains from investment is likely to discourage investing activities. Overall, the budget might give a perception of tilting heavily towards direct taxation but the matter of fact is that the incidence of many proposed amendments can easily be passed on to the final consumer while the taxation on wealth might not be implemented due to issues pertaining to its legality. However, one thing remains constant that the FBR is still relying on others to collect taxes on its behalf rather than utilizing its own resources. As discussed in ICAP’s Post Budget Conference, “If withholding taxes and indirect taxes are combined the effort based taxation of FBR is reduced to less than 10% and this raises a question of whether the board justifies the exuberant amounts spent for it to maintain a team of more than 20,000 personnel.” n

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