Profit E-Magazine Issue 257

CON TENTS

9 Frying the competition: How KFC made a comeback in Pakistan

14 To utilise its natural resources, Pakistan must not repeat the mistakes of the past

Profit

25 The State Bank’s short-lived independence

26 Does big tech evade taxes in Pakistan and what can we do about it?

28 Mirpurkhas Sugar Mills looks towards paper for profit

29 Expensive energy: Everything you need to know to understand your electricity bill

Publishing Editor: Babar Nizami - Joint Editor: Yousaf Nizami

Senior Editor: Abdullah Niazi

Executive Producer Video Content: Umar Aziz - Video Editors: Talha Farooqi I Fawad Shakeel

Reporters: Taimoor Hassan l Shahab Omer l Ghulam Abbass l Ahmad Ahmadani

Shehzad Paracha l Aziz Buneri | Daniyal Ahmad |Shahnawaz Ali l Noor Bakht l Nisma Riaz

Regional Heads of Marketing: Mudassir Alam (Khi) | Zufiqar Butt (Lhe) | Malik Israr (Isb) Business, Economic & Financial news by 'Pakistan Today'

Contact: profit@pakistantoday.com.pk

Note from the editorial board

After the deal

Problems persist, starting with the discount rate

In its latest monetary policy statement the State Bank of Pakistan decided to keep the discount rate unchanged. The policy rate has increased by 12.25 percentage points since April 2022, a first for Pakistan, both in terms of the intensity and frequency of the rate hikes and that it is currently at 22%. Market views were mixed before the MPC issued its statement on Monday, with some expecting a minimal cut of 25 bps, while others were looking at status quo or even an increase. The latter view seemed much likelier to transpire given the IMF’s ‘advice’ to continue increasing interest rates despite inflation receding after hitting a peak of 38% in May, dropping to 29.4% in June, a reduction in prices seen after seven painful months of rising prices.

The $3 billion IMF lifeline was secured in the nick of time. The country was literally one big-ticket dollar outflow away from default. Tough measures were taken, that included hastily adopted changes to the federal budget just prior to the meeting with IMF officials to seal a deal. It was therefore logical to expect that the government would adhere to the IMF’s instructions with regards to the discount rate, given how much groundwork has already been put in, at the expense of political capital, to secure the crucial deal. A discount rate hike would not have been surprising, a cut would have and maintaining it at the prevalent level was a reasonable middle ground.

While one can accept the rationalisation for keeping the policy rate where it is at, that inflation had peaked, evidenced by the first drop in months, there is a need to consider events that have taken place simultaneously, whose effects have already been reflected in the month-on-month CPI figure, with prices rising by 3.5% in July.

The basic electricity power tariff increase came first, with an announcement of a rise of Rs 7.5 per unit. While the effect of the basic tariff hike will come into effect in next month’s billing cycle, the Fuel Charges Adjustment (FCA) for May was reflected in July’s bills

that significantly increased electricity bills of even the poorest of consumers. Additionally, fuel prices have also been hiked by Rs 20 per liter for both petrol and diesel, with another possible increase expected this month as well. Additionally, with the restrictions on imports mostly removed, a reduction in the current account surplus, leading towards a deficit cannot be ruled out either. The effect is delayed, but it will come and when it does, the rupee will lose value against the greenback, adding more inflationary pressure.

Ishaq Dar is taking a victory lap and painting a deceptively rosy picture of the economy in light of the success with restarting a stalled IMF program. But the conditions that have been set to not revert to the distant yet confrontational relationship with the Fund, must be met, by hook or by crook, all of which will add to the inflation number.

Since there is every possibility of interest rate hikes in the coming months, it is necessary to determine if, at all, monetary tightening addresses rising inflation. In short: it does not. One only needs to look at the effect the LC ban to curb imports had on the current account deficit to understand that as a net importer of goods and services and most importantly, furnace oil to produce energy, discount rate adjustment is a grossly insufficient and inadequate central bank tool to address rising prices.

Perhaps a combination of both works better to address both cost-push inflation, which is most attributable to our high prices problem, and also some demand-pull inflation as well that requires the mopping up of excess liquidity from the market. However, we are at the mercy of the IMF at the moment. The fund will ignore and wait on any incident of macho posturing by the finance minister and get its way. That is exactly what has happened and will continue to happen unless the condition of the economy truly improves in a sustainable manner. That takes long-term macroeconomic reform, something no elected government of the past and present has given any time or thought to.

Frying the competition:

How KFC made a comeback in Pakistan

By Nisma Riaz

KFC’s infamous Colonel Sanders’ recipe is arguably one of the best kept culinary secrets in the world. No one has been successful in unveiling or even replicating the recipe in over seven decades. We fathom that embarking on an adventure to unpack the colonel’s recipe would be a fruitless endeavour, so we settled on uncovering KFC’s next best kept secret. Its revival in Pakistan!

KFC loyalists stood on the sidelines for almost a decade and a half, watching their favourite fast food chain experience a painfully slow death. From cold food to shabby restaurants, abysmal service and unjustified pricing, nothing was right with KFC.

Until we saw the brand, quite unexpectedly, resurge from the depths.

This is a story that explores how amidst the complex web of Pakistan’s unstable economic conditions, a general lack of customer service culture at the bottom, and the prevailing seth culture at the top that plagues much of the Pakistani business land-

KFC was dying a slow death when an HR professional was brought in.

scape, KFC managed to defy the odds, charting its path to success.

For the sake of narrative prowess, let’s start from the beginning.

1997: Pakistan gets the first taste of the Colonel’s crispy fried chicken

In 1997, KFC made its debut in Pakistan through a Belgian company called the Artal group. The response was nothing short of spectacular. The first ever KFC outlet in Gulshan Iqbal, Karachi saw long line-ups of excited customers for months to come. The craze was almost like a fever and the demand was so high that they would run out of Zinger burgers hours before closing time.

Things were looking good till May 1998, when Pakistan conducted its nuclear tests, complicating the country’s foreign relations and jolting its economy. The subsequent US sanctions made it difficult for KFC to operate, since it was completely backward integrated, whereby it would import a lot of its raw materials, instead of outsourcing from local vendors.

This shock caused serious operational difficulties, forcing Artal to sell their assets to Arif Naqvi’s Cupola group in 2001.

Cupola was effectively managing the brand amidst challenges, including the 2008 economic crisis. However, since the founders of Cupola had other business interests that diverted their focus, KFC started getting compromised with every passing day. Things started going south in 2004 and its reputation continued to dwindle.

Until only a few years ago, when KFC made an unexpectedly strong comeback.

A big managerial change

By 2014, KFC’s problems had multiplied and the American multinational fast food corporation Yum! Brands that own KFC’s global franchise, started getting concerned. Fearing that KFC Pakistan’s bad reputation might bleed into the brand

image of the global franchise, Yum! urged KFC Pakistan to fix their issues. The pressure from the top resulted in a big managerial change, with an entirely new team that was to reset the course of the brand’s fate.

In conversation with Profit, KFC Pakistan’s CEO Raza Pirbhai recalled that, “The brand was in horrible shape when I took over as the Chief People Officer in 2014. They had over 55 outlets but none of them made any sense. They were all losing money, the restaurants were debilitating, the service was bad, and KFC had lost the grace and talent that it once possessed.”

But there was hope.

“I say this to my people; KFC is a crocodile brand. No matter how hard you try to kill it, it finds a way to survive. If it could have survived the last 15 years, it could endure and thrive through further transformations,” Pirbhai shared.

Within a span of five years after the new management took over, Pakistan witnessed a brand new KFC. All of a sudden, their restaurants were cleaner and brighter, their staff was nicer, the prices were appealing and the food had actually started tasting finger lickin’ good!

How did they do this?

The first step was identifying the problems. AC Nielsen conducted an in-depth study for KFC that confirmed their doubts. Their troubles were a combination of a negative perception of the brand’s appearance, pricing, and positioning.

Initially, KFC was priced and marketed as an upscale establishment, competing with brands like McDonald’s. The premium pricing did not align with their international brand image, that of being a Quick Service Restaurant in the food pyramid. What they needed was to become an everyday brand.

“We changed our positioning strategy entirely. For example, we stopped hosting birthday parties and events because we did not want to be an occasional brand,” Pirbhai explained.

They switched their focus from following the path of fast-food giants like McDonald’s; instead, started building KFC as a neighbourhood store competing with local fast food

restaurants.

Pricing and positioning: The volume game

KFC’s pricing has perhaps been the biggest question mark in this entire discourse.

Their revised prices were so threatening that they made competitors quake with fear and envy.

But it also spiked their curiosity.

It is way beyond competitive pricing, almost teetering on the edge of predatory pricing. It flipped the game completely, blurring the McDonald’s and Burger Kings of the world into the background and putting KFC in direct competition with small local players, such as the likes of Yasir Broast, Fried Chick, Jaan Broast, and other local players selling chicken broast.

A simple price check validates this. We used Foodpanda to determine the price of comparable portions of Yasir Broast and KFC’s broast offerings. The platform and delivery fee is not included in the prices; just what the restaurant charges and tax with payment on cash.

A quarter sized broast (choice of leg or breast piece) from Yasir Broast that comes with a bun and small fries costs Rs 565 plus Rs 90 VAT, totaling Rs 655. In comparison KFC’s Crispy Box that includes two pieces of its flagship fried chicken, fries, coleslaw and a drink will set you back Rs 650 plus the same Rs 90 VAT, making it a hefty meal for a mere Rs 740.

If one adds a 34 ml Pepsi to the Yasir Broast order for Rs 100, the total goes to Rs 755, Rs 15 more than KFC’s order.

Why wouldn’t then anyone going out for a family dinner choose KFC over Yasir Broast?

Concerning questions arose, with some suspecting foul play, such as tax evasion to explain KFC’s low prices, while others believed they were incurring losses to gain market share.

“The secret lies in volumes. Our strategy is to increase volumes not margins. If we are successful at achieving the sort of market penetration that we aim to achieve, the margins will automatically come,” Pirbhai revealed.

I say this to my people; KFC is a crocodile brand. No matter how hard you try to kill it, it finds a way to survive. If it could have survived the last 15 years, it could endure and thrive through further transformations

Raza Pirbhai, CEO of KFC Pakistan

According to Pirbhai, it is important to understand Pakistan’s economy to understand KFC’s market penetration strategy. “You can spread only horizontally, by increasing volumes because expanding vertically, i.e., by increasing prices will not work in an economy like ours. If we want to be a brand that has 250-300 outlets, we will need to cater to more people and that ultimately comes down to pricing.”

So what KFC essentially did was to become affordable enough for the masses. And why would someone land at Jaan Broast when they could eat at a KFC for the same price?

“We are basically selling broast and also competing with others selling broast, because what else is KFC? When we were revising our pricing strategy, we compared it to broast only. So, if you can get broast from a local shop for Rs 250, we introduced our two pieces chicken and chips for Rs 250.”

So, what exactly is KFC’s volume game and how does it cover their margins?

Pirbhai explained how local seths underestimate the vast market potential and population opportunity. “It took me quite some time to explain this to our vendors too.”

“Our beverage and poultry partners insisted on a five year contract but we convinced them to deal in volumes. We let them quote a large volume of their choosing and we then asked them to give us a discount on that. They quoted a hefty number, thinking that we won’t be able to meet that even in six years. We are likely to finish that volume within three years and they will have to revise the contract again,” he added.

According to Pirbhai, the volume has grown so much that even four vendors, including K&N’s, Sabroso, Big Bird and Menu, combined struggle to cover KFC’s poultry requirements.

The bottom of the pyramid, with a 250 million population, offers significant untapped potential. While there was still some focus on the top five to ten percent, KFC now has a dif-

ferent strategy and targets the broader market. When they set off to create an ‘everyday brand,’ the main aim was to cater to all, which was aided by dividing the menu into tiers. They did not come in and slash their prices to appease the masses. Instead, they designed a menu that had something for everyone.

“We implemented a menu ladder with different price tiers. Our low-end menu offers everyday value items like the krunch burger, 2-piece chicken and chips, zingeratha, and rice and spice. We maintained the mid-range options with value meal combinations including fries and a drink. Additionally, we introduced a high-end meal layer featuring our family festival bundles,” Pirbhai highlighted.

Profit compared the prices of similar products from KFC and McDonald’s, only to discover that the price differential is not much. However, KFC’s value meal additions have given it the impression of an extremely affordable restaurant, when in reality the regular menu is not that cheap.

It is safe to assert that the competition felt the heat from KFC’s new pricing strategy. KFC’s competitively priced value bundles eventually forced competitors to offer similar deals, in order to retain their market share.

You can get KFC’s Family Festival meal that includes 4 Zinger burgers, 4 pieces of Hot and Crispy Chicken, 2 Dinner rolls and a 1.5 Litre drink, sufficient for a family of four to five people in just Rs 2450.

Similarly, McDonald’s Chicken Plus Share Bag, includes 2 Chicken Big Mac Burger, 2 McChicken Burger, 2 Medium Fries, 6 Pieces Of Chicken McNuggets And 4 Medium Drinks in just Rs 2009! T

The increased volumes and reduced prices helped KFC revise their entire positioning, transforming from a premium international fast food restaurant to a mainstream and affordable one.

KFC’s new objective was to offer clean, delicious, affordable and conveniently accessi-

ble

But what else did they fix apart from their pricing? Well, they had a glow up!

KFC gets a makeover

One of the problems with KFC that AC Nielsen had identified was the brand’s appearance. To address this, KFC invested in improving both the physical infrastructure of their brick and mortar, as well as their online experience.

Globally, KFC outperforms McDonald’s in taste, while McDonald’s excels in providing a superior overall experience. Although KFC’s restaurants may not be extravagantly designed, their taste surpasses any comparison. But they tried doing something new with KFC Pakistan.

“During our efforts to revitalise KFC, our primary focus was on ensuring the product’s exceptional taste because that is what we are known for. But then we were like, why not have the taste but also create a memorable experience?” Pirbhai shared.

So, KFC went and got another research done, this time on their brand persona. The feedback compared the brand to an old-time but popular actress who has now become irrelevant. So, despite its style, there were clear signs of ageing and diminishing grace in KFC’s brand image. To provide a better experience, the brand perception that KFC required was that of a vibrant rockstar.

So they transformed their physical locations, revamping existing stores and opening new ones, all with a vibrant, youthful and fresh aesthetic. But offline is not the only experience, therefore next on the makeover list were KFC’s digital platforms. “We fixed up the stores but we also strategised for better online communication and marketing. We wanted a youthful image, which is now evident in all aspects of our customer interactions and KFC’s advertising,” Pirbhai explained.

And that is how KFC became younger, cooler and better.

Ripples of culture change

None of what we have discussed so far would have been possible without a mindset and culture change within the organisation.

In order to achieve what the new KFC aimed to achieve, i.e., good quality, affordable food and a pleasant experience, they required better service, the prerequisite for which was a better staff and a positive attitude.

“We created a new team from scratch so we could induct the kind of people with whom a transformation of this scale could be possible. Changing attitudes across the board can be difficult, especially once people are set in their

ways,” Pirbhai highlighted. So, KFC replaced their staff and brought in new people.

“We inducted new people at every level, who then worked towards fostering the kind of attitude we wanted, training the rest layer by layer. We provided a safe work environment, empowerment and autonomy, and equipped our team with the tools for growth, instead of going about with the same old sethstyled strategies,” he elaborated.

Finding and empowering the right kind of people at the right time was perhaps the best move KFC made, which enabled their entire transformation journey. The new managerial team that KFC hired in 2014, was unlike any other multinational company’s leadership in Pakistan. It comprised individuals who had a shared experience of starting from scratch and progressing within the restaurant industry.

It is rare, in an HR professional’s career cycle, to end up in an executive role. But Pirbhai had been a culture and people driver for many years, starting as a kitchen assistant at Pizza Hut, he rose up the ranks to become a general restaurant manager to an area manager to the head of HR within Pizza Hut. His experience with both people and operations made him the ideal person to be made the Chief People Officer of an evolving KFC.

“The rest also had humble beginnings, either in KFC only or at Pizza Hut. Notably, the current COO, Humayun, and the CBO, Sohail, both originated from KFC Pakistan. Our collective background in the food industry gave us a clear vision for identifying and fixing the problems,” he shared.

What made this team ideal for changing the organisation’s culture was that they understood people, as well as the intricacies of day to day operations, something that executive level staff is usually far detached from.

What KFC was able to pull off after taking a chance on Pirbhai and his teammates proves Pirbhai’s earlier assertion correct. When a capable team is provided with the right tools and empowerment, unexpectedly great things can happen!

Pirbhai refuses to call himself and his team a bunch of geniuses but he asserts they are the most passionate group of people, who might not always have all the right answers but possess the utmost passion to run the food business. “So, we are able to find the answers somehow,” he concluded proudly.

It was not just the brick and mortar of KFC that saw these transformations. With the digital space evolving, KFC had to worry about the online market, as well. For that, their service on every platform and for every kind of customer had to be the best.

FoodPanda is one platform they utilise, however they never completely gave their last mile to FoodPanda. “It’s only in a few limited locations, where FoodPanda gets the last mile and that is also only because we believe we need to maintain some relationships,” Pirbhai explained. They encourage customers to contact them directly, either through their online app or through the call centre extension, making sure that their customer service is better than ‘the FoodPandas of the world’.

How successful has the new strategy been?

On face value, KFC’s improvements are evident, but how successful has this transformation been in financial terms?

In the absence of publicly available financial data, one will have to take KFC and

its detractors’ word on the matter.

While competitors are adamant that KFC is sustaining losses in exchange for market penetration, Pirbhai insists that the transformation has resulted in profitability. The following metrics can be used to verify KFC’s claims of profitability.

Firstly, the global recognition that KFC’s revival has received is a tell-tale sign of good fortunes. KFC Pakistan now ranks number one globally in terms of sales growth and has garnered accolades for sales and brand performance among KFC franchises across 143 countries.

Another yardstick to determine profitability is KFC’s impressive revenue growth, which according to Pirbhai, has increased more than fourfold since 2014. Moreover, despite the challenges posed by the Covid-19 pandemic, the company managed to open 14 new stores, marking a significant milestone post-rebranding, which would have been unlikely if the business had been unprofitable.

However, to not miss the forest for the trees, the real feather in KFC’s cap is that it has transformed Pakistan’s fast food industry, particularly the one around burgers, into a duopoly. Whilst, KFC’s competitors across the spectrum merely lambast whether it might be profitable, KFC, instead, has spent this time chipping away at their only other competitor in this duopoly. So much so, that it is the one with a cult following, media buzz and a dynamic brand.

The mere fact that KFC is being discussed in this light, would have been unfathomable ten years ago.

The industry is now at an impasse. While competitors wait for KFC’s pricing tactics to take the steam out of Pirbhai’s locomotive, KFC might just capture the entire market and have the last laugh. n

Pakistan must not repeat the mistakes of the

past

To utilise its natural resources,

By Abdullah Niazi

The most powerful people in Pakistan were all at the Serena Hotel in Islamabad this week to mark the first Pakistan Mineral Summit. The country’s top political and military leadership along with scientists, experts, and industry high-ups were present to discuss the country’s potential as a hub for mining and natural resources.

The theme of the event seemed to be hope. The claim was that with its vast and unexplored natural resources Pakistan could possibly be home to over $6 trillion worth of natural resources. In the face of this very hopeful and very generous estimate those at the conference gave the impression of a tightly sealed united front.

The minerals summit titled “Dust to Development: Investment Opportunities in Pakistan” was a joint effort by Pakistan’s Special Investment Facilitation Council (SIFC) and Canada-based Barrick Gold Corporation, facilitated by Pakistan’s Ministry of Petroleum. Pakistan’s Prime Minister Shehbaz Sharif and Pakistan Army Chief General Syed Asim Munir addressed the keynote sessions at the summit.

The event was bolstered in particular by a high-profile delegation from Saudi Arabia which arrived in Pakistan to participate in the inaugural summit. Led by Saudi Vice Minister for Mining Affairs, Engineer Khalid bin Saleh Al Mudaifer, the delegation also included representatives from Saudi mining companies Ma’aden and Manara Minerals. Saudi Arabia is currently the world’s fourth-largest net importer of mineral products.

In the midst of these tall claims it is important to remember something — the $6 trillion figure is not just an estimation but one that is on the more generous end. In reality, with projects and initiatives like this, the full potential is rarely unlocked and even what is usually there takes decades upon decades to explore and mine. But putting that aside the reality is that Pakistan does indeed have vast natural resource potential. The question is, can we harvest it? In the past there have been some successes and other times when literally golden opportunities were embarrassingly fumbled.

Perhaps because of this one of the most interesting speeches at the conference was developed by the CEO of Engro, Mr Ghias Khan,

who pointed towards the need for public-private partnership to make such chances count. More than anyone else, Engro and its CEO are in a place to comment on this because they have been at the center of one of the biggest natural resource related successes Pakistan has seen — Thar Coal.

“Thar produces 10% of PK’s power & saves $1bn in imports/yr. Its socio-economic success provides a blueprint of how to unlock Pakistan’s $6 trillion mining potential,” Ghias said in a tweet following the event. “What would be really good to see is the presence of the Pakistani private sector in mineral mining as well because, with the stewardship of the federal and provincial government, it was the private sector that led Thar’s development. The Thar example gives us this blueprint which is namely:

1. The power of public-private partnership models

2. Patient capital with a long-view is essential

3. Projects of national interest should transcend politics

4. Private sector involvement is key to mineral mining success and development of local regions. These are the kinds of projects that can change the fate of nations.

Thar coal is indeed a good, home-grown example of managing and profiting from natural resources. Then again, Pakistan also has a glaring example of how not to manage its natural resources — Reko Diq. With the discovery of new natural resources and mineral reserves Pakistan is poised to possibly change its destiny. Foreign investors will be interested and while it might not be worth $6 trillion Pakistan can make this a major source of exports and income. We must focus on learning from both our mistakes and our successes to take full advantage of whatever potential Pakistan possesses.

The Thar Coal example

It is a simple problem. Pakistan relies heavily on imported fuel sources such as reliquified natural gas (RLNG) to produce electricity. Whenever there is an international crisis, such as the Russia-Ukraine war, Pakistan’s energy sector is rocked by the ripple effect. There is a simple solution. Cheaper fuel — something like coal perhaps. And the source

is right there too. Spread over more than 9000 km2, the Thar coal fields are one of the largest deposits of lignite coal in the world — with an estimated 175 billion tonnes of coal that according to some could solve Pakistan’s energy woes for, not decades, but centuries to come.

The question is, if this rich natural resource is available, why has it not been utilised more than it is currently? Discovered in the early 1990s by the Geological Survey of Pakistan (GSP), Thar Coal accounts for around 2000 MW of electricity produced in the country — a number that has risen from 660 MW just one year ago.

In short, Thar Coal offers a cheap, alternative, local source of energy that can be used to produce electricity and help Pakistan escape its topsy-turvy reliance on international markets to maintain its energy supply.

“The total reserves from Thar Coal are more than the combined oil reserves of Saudi Arabia and Iran. The reserves are around 68 times higher than Pakistan’s total gas reserves. Compared to this potential the current utilisation of Thar Coal in the total power generation mix is less than 10% which means that there is huge opportunity to expand in this sphere,” said Amir Iqbal, CEO of Sindh Engro Coal Mining Company, in an earlier interview with Profit. “That means Thar Coal has the potential to produce approximately 100,000 megawatts of electricity for 200 years – enough to make Pakistan self-sufficient in the energy sector.”

“The recent global supply chain disruptions have brought to light how Pakistan’s reliance on imported fuels is detrimental to its long-term economic growth,” says Engro Mining boss Amir Iqbal. “The country’s energy mix needs an urgent overhaul with more indigenous sources like Thar Coal added to it. This will save precious foreign exchange reserves and put Pakistan on the path of sustainable energy security.”

“This is one of the major advantages of using Thar Coal, as it is the most economically viable source of fuel for the country. Thar coal expansion could also provide a huge relief for FOREX reserves of Pakistan with savings of approximately USD 2.5 billion, while it will result in the reduction of more than PKR 100 billion in circular debt on an annual basis.”

Already, Thar Coal is being touted as the solution to many of Karachi’s electricity woes as well. The new owners of K-Electric have said an investment of $3.5 billion will be made

If the govt and its partners are serious about utilising the $6 trillion potential of the country’s natural resources, some serious reflection is needed

in the next five years for cheap electricity. This investment will encompass wind, coal, and solar energy projects to ensure affordable electricity for the citizens of Karachi. In the first phase, the power plant located in Jamshoro will be shifted from imported coal to Thar coal as the production at Jamshoro Coal Power Plant has been shut down due to non availability of imported coal.

As of now, other than Engro’s plant, all coal power plants in the country are reliant on imported coal. Using Thar coal would mean Pakistan could indigenously produce electricity. All of this has only been possible because on this occasion, Thar coal has not faced undue red-taping or court involvements. A big part of this is because Thar Coal was part of an early harvest CPEC project and thus the government was on its best behaviour. In actuality the government of Pakistan is not always the most reliable business partner — something that was clearly on display in our other example: Reko Diq.

The Reko Diq debacle

Reko Diq, which means sandy peak in Balochi, is a small town in district Chagai, Balochistan. Geological literature reveals that the Chagai district is part of a belt called the Tethyan Magmatic Arc, which stretches from Turkey and Iran into Pakistan. The arc is a known reservoir for rare earth metals, and Pakistan’s share lies underneath the region between Chagai and North Waziristan. Reko Diq is said to hold an estimated 5.9 billion tons of mineral resources, with an average copper grade of 0.41 percent and gold grade of 0.22 grams per ton.

Out of a total 5.9 billion tons of ore, only 2.2 billion tons are economically extractable. The total area of the Reko Diq mines is said to be spread over 13,000 square kilometres. With such figures, it is believed to hold the world’s fifth largest deposits of copper and gold. The resources were originally explored in 1993 by an Australian company, BHP Billiton, after signing an agreement with Balochistan’s then

Shehbaz Sharif, Prime Minister Pakistan

caretaker government under the leadership of chief minister Naseer Mengal.

To put it very briefly it was a golden opportunity. But over the next two decades the exploration of Reko Diq kept changing hands. This was the first bad sign. In April 2000, BHP suspended its exploratory work and handed over its obligations to another Australian company, Mincor Resources. In 2006, Mincor was acquired by the TCC which is a subsidiary of Mincor and a joint venture between Canadian-Israeli owned Barrick Gold and Antofagasta of Chile. In the same year, the legality of CHEJVA was challenged in the Balochistan High Court.

Throughout this process the government did not resist these transfers — something perceived to have been because of inefficiency. On top of this, different cases were filed in both provincial and federal courts over the matter. Very briefly put the entire matter became a legal quagmire that nobody wanted to touch.

In 2012, the TCC took the matter to the International Centre for Settlement of Investment Disputes (ICSID) to seek compensation for $11.43bn in damages after the Balochistan government turned down a leasing request from the company. In July 2017, the ICSID ruled against Pakistan by declaring that there was no wrongdoing in CHEJVA – the ground on which the Supreme Court of Pakistan had terminated the agreement. Eventually the tribunal held that Pakistan was liable to pay damages.

This had Pakistan in a complete bind. By 2022, some of these matters had settled. In fact, after receiving a favourable ruling from the Supreme Court of Pakistan, Barrick Gold even announced its intentions to reconstitute work on the site.

Using the figures provided by Arif Habib Limited report “Revival of Reko Diq Project”, the scope and earnings this project would generate are massive to say the least. The project is divided into two phases, with a total projected capex cost of $7 billion, with the first phase requiring $4 billion and the second phase re-

quiring $3 billion. In addition, the project’s total entry amount is $2.2 billion, bringing the entire project size to $9-10 billion. Annual copper output is predicted to be between 650 and 700 million pounds per annum for the first ten years, increasing to 800 to 850 million pounds per annum when phase 2 is completed. Furthermore, gold production is estimated to be 300,000 to 350,000 ounces on yearly basis for the first ten years (first phase) before increasing to 450,000 to 500,000 oz. following the planned expansion.

To estimate the overall value of the project we’ll assume constant pricing for both gold and copper, taking the average price of the commodities over the period of the last ten years. If we were to only look at the first phase of the project, keeping in mind the numbers above, it would generate an estimated $ 14 billion for the government in only the first 10 years of its operation. The significant portion of the revenue would be dominated by the sale of Copper and would account for 83.25% or $11.67 billion of the revenue in the first phase, whereas Gold would account for the remaining 16.75% or $2.35 billion.

Likewise, with the expansion envisioned for the second phase the output of the mine would increase, and with it the revenues generated would also rise. An accumulative revenue amount of $62 billion is expected to be generated over the course of the second phase that has a stipulated time period of 35 years.

To sum it all up, the Government of Pakistan would be able to generate an average of $1.4 billion annually over the course of the first phase and an additional $1.7 billion over the next 35 years during the second phase of the project. This would amount to a whopping $76 billion over the next 45-50 years. Although these estimates and calculations provide a simplistic understanding of the monetary returns expected to be generated by Reko Diq, these are still estimates nonetheless. The considerations taken to keep the number crunching consistent do not account for the variable price of copper and gold in the international market

We need to build a stronger narrative for a better future and the mineral wealth of Pakistan is a great opportunity for us to make our mark in the global economy. SIFC is an excellent step that can help Pakistan optimise the opportunities for Foreign Direct Investment.

Mian

as well as other direct and indirect factors.

The government is an unreliable partner

And this is also where the problem mostly exists. All of these projections are well and good. The fact of the matter is that the government of Pakistan first started its exploration of Reko Diq in the early 90s. It has been more than three decades since then.

The scale of such projects is not quite understood by most people. Even with Reko Diq, now that the dust has settled from more than 30 years of legal battles, there are countless problems that exist. A key concern that still requires attention is the logistical aspect of this mega project, considering the remoteness of the project site, and consequently the logistics required to make this a feasible project have to be further developed.

Taking the example of the Saindak silver mine located in Chaghai, the silver ore extracted from the mine has to be transported 1,127 km from the site to the port in Karachi by trucks. That is absolutely ridiculous, as the costs associated with using trucks would have an adverse effect on the bottom line and overall feasibility

of the project. If a similar plan is on the table for Reko Diq, the margins of Barrick and the Government would significantly diminish.

Water was highlighted as the project’s “most critical” issue in the Risk Assessment Report pertaining to Reko Diq published by Behre Dolbear in October 2007, and Pakistan underlined it during the ICSID hearings whilst examining the feasibility of ensuring water supply. Water is most commonly used in mining to process ore and to water mine roads to reduce dust. Aquifers, surface water, collected precipitation, and even water from the mine itself, provided the mine is actively dewatered, are all possible sources of water for mining.

Naturally due to the remoteness of the site location, developing infrastructure and building a sustainable water source for the next 45 years for the mining operations is a monumental challenge.

And then there is the biggest challenge. Historically as Pakistanis all of us have been witness to unsuppressed corruption, inefficiencies as well as plain and simple stupidity on part of the decision makers and various government entities. The country has a chequered past of poorly executed projects and pitiful government oversight with next to little or no support to investors. To compound all

this, bureaucrats and politicians in positions of power never fail to get their kickbacks from projects like these.

As things stand now, the country’s leadership seems united on the potential of mineral mining in Pakistan. During his address, Army Chief General Syed Asim Munir emphasised the importance of joint efforts to realise the country’s mineral potential. With abundant mining opportunities, he invited foreign investors to contribute to realising the potential of Pakistan’s estimated $6 trillion worth of natural deposits.

“Foreign investors will be an integral part of the mines and mineral projects” and their investment will be secure under the SIFC established in June this year to offer single-window operations to potential investors. Gen Munir promised an investor-friendly system, ensuring ease of doing business and minimising unnecessary delays.

Prime Minister Shehbaz Sharif expressed optimism that initiatives like the SIFC could turn hope into reality, enabling Pakistan to make its mark in the global economy. He emphasised the importance of transforming the country’s fortunes and attracting international investors for economic prosperity and development.

“We need to build a stronger narrative for a better future and the mineral wealth of Pakistan is a great opportunity for us to make our mark in the global economy. SIFC is an excellent step that can help Pakistan optimise the opportunities for Foreign Direct Investment”, the prime minister said.

But even the most efficiently managed natural resources project can take years upon years to kick off and start paying off. In Pakistan’s case there is the added baggage of the government’s long history of being an unreliable business partner. In the case of Reko Diq, decades later we are now in a position to start. On the flip side, Thar Coal has proven to be a natural resources exploration project that has paid off.

Which route Pakistan takes for the future will determine a lot. n

The total reserves from Thar Coal are more than the combined oil reserves of Saudi Arabia and Iran. The reserves are around 68 times higher than Pakistan’s total gas reserves. Compared to this potential the current utilisation of Thar Coal in the total power generation mix is less than 10% which means that there is huge opportunity to expand in this sphere

Amir Iqbal, CEO Sindh Engro Coal Mining Company

Is the SBP taking minority shareholders of Security Papers for a ride?

The government, through the SBP is the majority shareholder in Security Papers Limited. But some other public shareholders suspect nepotism, incompetence and outright foul play. Profit places the single-buyer single-seller business of creating paper money in scrutiny

By Babar Nizami & Areeba Fatima

Nestlé Pakistan recently moved its head office by renting a space in Packages Mall. For those who are unaware, Packages Limited and its sponsors, the Syed Babar Ali family, also have a fairly substantial shareholding in Nestlé Pakistan. So much so that Syed Babar Ali and other members of his family are on the board of directors of both of these companies. So, when Nestlé rents a space from Packages, this can be considered problematic, as there is a clear conflict of interest.

Other shareholders of Nestlé Pakistan — the ones that have nothing to do with Packages or the Syed Babar Ali family — might feel that the management of Nestlé could be giving an undue favour to one of its substantial shareholders and directors, and the decision to move its head office might not be the most prudent one otherwise. They might even suspect that Nestlé might be paying above market rent, etc.,

to Packages to please a substantial shareholder (read Syes Babar Ali).

But before you, dear reader, start accusing Nestlé, Packages or Syed Babar Ali of foul play, let us clarify that such ‘related party’ transactions are not illegal, per se. However, there are some rules set by the Securities and Exchange Commission of Pakistan (SECP) for such transactions. In its role as regulator, the Commission has created safeguards. The first safeguard is that these related transactions must be done at an ‘arm’s length’. In our example above, this means that common directors such as Syed Babar Ali should not be sitting in meetings held to negotiate such a rental arrangement. Instead, it should be independent directors who make these decisions. These are directors on a company’s board who are not employees of either company and should be asked to approve such arrangements.

But this alone is not enough. The SECP mandates companies to make comprehensive public disclosures regarding such transactions, giving out the details of the pricing mechanism and other terms in a transparent manner.

Even then, companies that believe in

following good corporate governance try to keep such related party transactions to a bare minimum.

But what if there was a company that sold not just a small portion but almost all of its production to a related company? What if the product that this company made had only a single potential buyer that happened to be a related company — i.e., a company with substantial common ownership? And what if this company was the sole producer of this product and the related company also had no choice but to buy from this company? Unlike in our earlier example of Nestlé and Packages where it would not have made a big dent to Nestlé’s profitability even if it had hypothetically given Syed Babar Ali a favour and agreed to pay double the market rental rates, here, this one agreement — if reached unfairly — can be extremely beneficial for one company and extremely detrimental to the other. Obviously, the incentive to cheat will be much much higher here.

Will the safeguards put by the SECP still work? Or would the enormous incentive to cheat, ensure that such safeguards be brazenly flouted? Now imagine if this buyer was the

government itself. Would the SECP be able to regulate its own or would this powerful buyer succeed in getting a favourably low price for itself? Would this not mean that other smaller shareholders in the seller company would lose out big time?

What we have described above is not just some hypothetical example. This is exactly the conundrum that minority shareholders of Security Papers Limited face today. In fact, in a recent letter written to the Chairman of the SECP, one such minority shareholder of Security Papers made several accusations about the lack of implementation of the related party safeguards mentioned earlier in our story. But before we delve into the concerns of this and other minority shareholders of Security Papers, let us first provide some necessary background.

Background

In the mid 1960’s the State Bank of Pakistan (SBP) established Security Papers and listed it on the stock exchange. This meant that despite government control some of its shares were also sold to the general public.The company was given the task to manufacture the special paper required by the SBP to print its own currency.

Due to the sensitive nature of the product, the company to date, is the sole manufacturer of security paper in the country, most of which is naturally used in printing currency-notes. But this is not all. From ballot papers used in elections to stamp papers, passport booklet paper, and cheque book paper and the paper used to print college degrees, Security Papers makes it all. But since the main use of its security paper is in currency, its major buyer is a fully owned company of the SBP called Pakistan Security Printing Corporation, with more than 80% of Security Papers sales being made to Pakistan Security Printing. The most minimalist explanation of how this works is that Security Papers manufactures the paper on which Pakistan Security Printing prints the currency which SBP injects into the economy as part of its monetary and fiscal policies.

The fact that both of these companies effectively enjoy monopoly status, where a single buyer, and a single seller business of creating paper currency, already makes the dynamics between the two an interesting study. But what further complicates matters is the fact that Pakistan Security Printing (the buyer) also owns 40% shares of Security Papers (the seller) and thus is at least on paper in a position to influence the decisions of Security Papers. As already mentioned, shares of Security Paper are traded on the PSX regularly and more than two thousand individual shareholders own approximately 12% of the company. It is some of these minority shareholders that are always uncomfortable with the considerable influence of Pakistan Security Printing, a fully government owned entity, over their company.

Recent happenings and the pricing agreement

At the centre of this discomfort is the pricing arrangement between the two companies. Considering the peculiar situation of non-existent market forces, and the magnitude of the related party transactions, it was obvious that a special mechanism had to be created to decide the price that Security Papers would charge Pakistan Security Printing for its security paper. How this mechanism changed during the last sixty odd years is not relevant to our story. But what is relevant are the two relatively recent changes to this mechanism.

Nearly seven years ago, Security Papers reached out to Deloitte, an international accounting firm, to help configure a well-balanced pricing formula which would enable both Pakistan Security Printing and Security Papers to enter into a clear-cut and fair agreement on pricing. The disclosure in Security Papers’ financials mentions that all sales transactions with Pakistan Security Printing Corporation are carried out by the company using the cost plus mark-up method. Are there any more specifics

mentioned in the disclosure regarding the Deloitte formula? We are afraid not.

However, Imran Qureshi, the current CEO of Security Papers, told Profit that the way it worked was that Deloitte would help Security Papers come up with a cost structure to charge Pakistan Security Printing. They suggested using a cost plus mark-up method, the modalities of which would be determined by the mutual consultation of the two boards. Very briefly put, the two boards would sit together in a tea-and-sandwiches meeting and decide the pricing formula between themselves.

Remember the two safeguards that the SECP had put to ensure that there is no foul play in related party transactions? The first was that these transactions are done at an arm's length and the other was that details of the agreement are publicly disclosed. From the explanation of the current CEO, it seems that both these safeguards were being flouted in the past. This is where the most recent change to the pricing mechanism comes in.

In 2022 Security Papers and Pakistan Security Printing decided to fix the issues with the old Deloitte pricing mechanism. Both Companies approached PWC (another international accounting firm) to come up with a new cost plus markup formula but one which was more objective and which did not require the two boards to sit together in a tea-and sandwiches meeting. The new pricing mechanism was put in place some six months ago (there is no clarity on the exact timeline), but it is apparent that even if it might have solved some of the problems with the last mechanism, minority shareholders of Security Papers feel they have been shortchanged. And they have solid reasons to believe that.

No arm’s length and dependent independent directors

This is the situation we now have. There are two companies in the equation: Security Papers and Pakistan Security Printing. One produces

Earlier, these margins were a result of random mutual agreements between the boards but now there is a very clear justification and explanation; four international companies’ weighted averages of gross profit margins and the weighted average gross profit margin of the PSX listed companies

Imran Qureshi, CEO, Security Papers Limited

Aftab Manzoor, Chairman Board of Directors, Security Papers Limited

paper used to print bank notes and passports and the other buys that paper and prints on it. The former is partially owned by the government, while the latter is fully owned by the government. But at the end of the day both are answerable to the federal government, and this becomes clearer when you zoom in on the shareholding of Security Papers.

The State Life Insurance Corporation (State Life) owns 8.48% shares and Pakistan Reinsurance Company Ltd owns 1.57% shares. Both of these companies’ administrative control is with the Ministry of Commerce. The Punjab Provincial Cooperative Bank, which is governed and managed by the Government of Punjab, owns 7.18% shares. And with the National Investment Trust (NIT) owning 5.67% shares, this brings the government's ownership of the company to almost 63%. Owing to this significant shareholding, the Govt of Pakistan effectively has majority on the board, making Security Papers it a state owned entity (SOE).

There is a vital question and legal definition that underscores this entire story. What is an independent director? According to the guidelines of corporate governance set out in the rulebook for Public Sector Companies, independent directors are non-executive directors who are not government servants. They also cannot be private individuals employed by a government institution.

Remember, this rule is specifically for companies in the public sector. And thus all of these rules apply to Security Papers. The composition of the company’s board, however, paints a rather blatant picture.

Take the example of Muhammad Sualeh Ahmad Faruqui, who is amongst the three independent directors of Security Papers. He is currently serving as Secretary Commerce, Government of Pakistan, However, despite this fact being true, he is on the board of Security Papers as an ‘independent’ director. How can a senior federal government employee in a majority government-owned entity be classified as independent?

The other two independent directors

also face issues of neutrality or competence.

All this would make it seem that despite being an SOE, as classified by the SBP, Security Papers refuses to act like one and additionally stands in violation of the rules set for SOEs, whereby federal government employees are not allowed to hold the post of independent director on the board of this company.

This is not just a technicality. It is the Independent directors that are supposed to make sure and keep a check that nominee directors of major shareholders and the management of the company do not do anything that puts the minority shareholders, the ones that are not involved in the decision making of the company, at a disadvantage.

When Profit asked the CEO of Security Papers, Imran Qureshi, about the allegations against the board for not meeting the criteria of independence, he claimed that the company was in fact moving in a more positive direction, “You know our previous chairman Haroon Rasheed was the Managing Director at the Pakistan Security Printing from 2017 to 2021, during his time as Chairman Security Papers a Pakistan Security Printing employee was on board of both companies. There is no SBP or Pakistan Security Printing employee on our board now, in fact minority shareholders from Iran and Turkey are on the board. This company has an impressive minority representation – only 3 represent the major shareholders and six are from outside, out of the 9 shareholders.”

However, being a State Owned Entity, how independent can this board be when the biggest demographic represented on the board is ‘government employees’ or their nominees.

The good news is that a new SOE Governance law is in the final stages of implementation. The law intends to introduce some specific reforms. It establishes an SOE Board as an oversight body which is supposed to evaluate and monitor the compliance of SOEs. However, for this to work someone needs to make sure that Security Papers and its board knows that they are in fact an SOE.

No disclosures

Guess how we found out that the all important pricing mechanism was recently changed. There was no disclosure in any of the recent financial statements, nor was a notice of material information sent to the PSX and no press release issued either. We got to know about it, very casually, while interviewing company officials for this story.

When asked why the specifics of the pricing policy are not disclosed anywhere, especially to the minority shareholders and why have the profit margins of Security Papers plummeted all of a sudden Aftab Manzoor, Chairman of Security Papers Limited board of directors, said, “We don't need to disclose it, the margins will be clear to you in the end of year financials. Both companies’ management worked on it and presented it to the boards and they have approved it.”.

There is no way of telling from the quarterly or annual reports how this markup was exactly decided nor is there documented evidence of the shareholders having been informed of these decisions. The only way for them to tell that something has changed were the Profit and Loss statements which show that the profit margins have started to decrease dramatically.

Both Aftab Manzoor and Imran Qureshi have confirmed that the newly revised formula was implemented within the last six months. This is a matter of significant concern considering that the company has maintained an average gross profit margin of 40% over the past 15 years. However, starting from the July to Sept quarter of 2022, the gross profit margin experienced a sudden decline. Looking at the latest quarterly report, the margin has plummeted to a worrisome 9.3%. This is at a time when inflation is at an all time high. The drastic fluctuation in gross profit margins caused by the formula's implementation demands a thorough and transparent clarification. Failing to do so would be negligent, especially when the impact is so pronounced.

Once you look at the latest financials, you will see that we have gotten out of mutual funds totally. Because the idea was that we need to de-risk our portfolio, there were some losses, we recovered those losses, it is now totally zero. We invested at market rates in the money market

Essentially, Imran Qureshi is claiming that the original transfer pricing methodology was flawed and the new system allows for adjustments in the final quarter. According to him, all the concerns of the minority shareholders will be addressed when the financial results for the company’s final quarter come out on the 9th of August. The only problem is that minority shareholders or the public at large were never notified of the specifics of the new formula.

Imran Qureshi told Profit that there are two parameters to this new formula: one is the cost, second is the markup which is now evaluated based on the weighted averages of companies listed on the PSX and of international security paper companies. “Earlier, these margins were a result of random mutual agreements between the boards but now there is a very clear justification and explanation; four international companies’ weighted averages of gross profit margins and the weighted average gross profit margin of the PSX listed companies.” But this information was never given to the shareholders directly.

Security Papers' earning per share (EPS), an important indicator of the financial health and performance of any publicly listed company, went down by Rs 8 on a year-on-year basis in 2022. One can accept the typical yet fair justification of such a drop; blaming the fledgling Pakistani economy and its effects on businesses, but with Security Papers, matters are quite different. Security Papers is in a very enviable position, any company's dream: zero competition. Therefore, if its costs were rising due to unfavorable domestic economic conditions such as rising inflation and currency depreciation, it could have simply passed that additional cost on to its guaranteed biggest customer, the Pakistan Security Printing. Instead, it has evidently absorbed most of that cost, increasing prices by a mere 1.7%. This sounds a little absurd.

If the Chairman laments in the annual report about local inflation and the rising rates of the global paper market because of international tensions, why did the company not explore raising the price?

“When our profit margins were consistently high, inflation was around 5-7 %, but in the past year inflation has been on the rise, so naturally this has led to an increment in cost but the end-of-year settlement has not happened yet so the true effect of the price adjustment as per the formula would only be noticed once our annual report is released on the 9th of August,” Qureshi explains.

The exact specifications of the markup and how it is determined have remained elusive in the quarterly and annual reports published by the company. The minimum risk free rate (price setting) that should reflect

the rise in inflation and the subsequent rise in prices should at least accommodate the rate of inflation, and then some.

There is no way of telling from the quarterly or annual reports how this markup was exactly decided nor is there documented evidence of the shareholders having been informed of these decisions. The only way for them to tell that something has changed were the Profit and Loss statements which prove that the profit margins have started to decrease dramatically.

Also badly managed?

March 2023 and March 2022 comparisons show that the company’s earnings per share has been almost halved. More than Rs 2.5 billion were invested in bonds and mutual funds, the company has lost more than 38% to 40% of the principal in the last 6 years and did not make any returns while giving out huge sums in management fees. For a company with a Rs 6 billion market capitalisation, they have lost a lot of money in these bad investments. Aftab Manzoor justified this by saying “Once you look at the latest financials, you will see that we have gotten out of mutual funds totally. Because the idea was that we need to derisk our portfolio, there were some losses, we recovered those losses, it is now totally zero. We invested at market rates in the money market.” The June FY22 annual report shows that out of the total Rs 8.9 billion assets, Rs 3.3 billion have been invested in short term investments. The market capitalization reflects that the market values this company much less than its equity. Out of the total sales worth Rs 6 billion, 80% were made to the Pakistan Security Printing.

The minority shareholders note that considering this level of investment, the company could have earned bigger returns even if they just securely parked it in a savings account rather than making reckless investments which resulted in the company incurring losses. Considering that there are several bankers on the board, it should have been muscle memory for them to not invest in long term bonds (Pakistan Investment Bonds) as opposed to short-term maturity Pakistan Treasury Bills.

In the former type of investment, the interest rate is locked at a certain percentage for a period of 10 years but in the case of the latter kind of investment the tenor is much shorter, a maximum of one year in fact. A combination of investments in both money market products would have offered greater flexibility in taking full advantage of rising or falling interest rates.

For some very odd reasons, the board of directors at Security Papers invested in longterm bonds at a time when the interest rates were low, locking the investment at the same rate for a long period of time.

Solution to the problem

It is necessary to first understand the problem and then think of a solution.

Shareholders are concerned that they are being taken for a ride by a company that, for all intents and purposes, is owned majorly by the federal government. The financial results of the past three quarters do not inspire much confidence; the serious reductions in both the EPS and gross profit margin is a testament to the company’s deteriorating financial health.

Both Qureshi and Manzoor keep on insisting that the full annual accounts that will be released on the 9th of this month will settle all concerns and answer all questions. If that is indeed the case, then the shareholders would be proven wrong, all the hullabaloo and letters to the SECP would prove to be simply a simple case of unnecessary paranoia. However, even then one can not help but blame the lack of disclosures by Security Papers for all the confusion.

However, if the results fail to do this, then there is a very obvious solution to this recurring problem.

The government should simply buy back the 20% shares the public owns in Security Papers Limited and delist it from the PSX. This would take the public out of the equation and no one other than the government would be bothered about ‘pricing mechanisms’ and profits.

From manufacturing the paper for currency and other security printing, to the printing itself, everything would become a one window, singularly owned and run operation. n

The State Bank’s short-lived independence

By Abdullah Niazi

At a conference hosted by a private university in Lahore back in May this year, this correspondent ran into a ranking member of the State Bank of Pakistan (SBP).

The meeting was not quite in the most official of settings and the event was closed to the public. The gentleman, who is a distinguished professional with years of experience on the policy end of the central bank, was there to moderate a panel and the conversation took place in a small break between sessions

over sandwiches and rushed cups of tea. After exchanging pleasantries there was really just one question that was asked — Whatever happened to the State Bank’s hard earned autonomy? “The autonomy is still legally and constitutionally there. I’m not sure what you’re talking about,” he responded with a light chuckle.

The reality of the matter was clear. The State Bank of Pakistan (SBP) Amendment Bill 2021 had made sure the SBP was autonomous and could control inflation targeting. At the time the SBP’s governor was Reza Baqir who fought a long battle to ensure the independence of the central bank from the finance

ministry. But despite the bill being passed in February 2022, the SBP’s autonomy seems to have been short lived. By the time Reza Baqir’s term as governor ended in August 2022, the government of Imran Khan which had passed the SBP autonomy bill had been dismissed through a Vote of No-confidence and the Shehbaz Sharif led coalition government had come to power.

That is when Jameel Ahmad came to power. Meek, not gifted with the same natural charm or communication skills that Reza Baqir had, and much less of a public figure, Jameel Ahmad has operated the SBP from the shadows. During his time as governor, the function-

The central bank is back to the status quo, being run indirectly by the finance ministry

ing of the central bank has gone back to the status quo that it has followed for decades — that the bank is controlled through the finance ministry. This was the real question being asked of the SBP member at the university conference.

“Look, different people have different management styles. Some are more public in their decisions while others like to operate a little under the radar without ruffling too many feathers,” he said when asked directly how Governor Jaleel Ahmad measured up to his predecessor. Just as he was saying this Dr Ishrat Hussain passed. Without stopping or turning to look at us, he simply wagged his finger in our direction and said “let’s not kid ourselves on the question of autonomy here gentlemen” and walked on ahead.

That, more than anything else, summarises the reality of the State Bank Autonomy Bill 2021 that was the topic of fierce debate for months. Despite its passage its implementation is virtually non-existent. And any claims of the hard-fought autonomy still being there in practice are little more than us kidding ourselves.

The origins of autonomy

The autonomy of the SBP was the hottest topic in Pakistani politics at the start of 2022. The equation was pretty simple. The IMF wanted a bill to be passed which made the SBP autonomous and empowered it to manage monetary and exchange rate policies.

“Globally, the majority view is that central banks must be free of government control but must coordinate their work with them. Since bad monetary and exchange rate policies can cause far more and quicker damage than fiscal profligacy, they reside safer with a free central bank focused mainly on inflation,” explains economist Dr Niaz Murtaza. The passage of the bill was one of the earliest sticking points that had made reaching an agreement with the IMF difficult. To put it very mildly, the new amendments in the SBP law made the governor of the SBP independent from the state and not accountable to them either. The only thing the governor would have to wait for was his appointment after which it would be for the governor and the Monetary Policy Committee to determine monetary policy.

At the time, opposition parties voiced their concerns loudly claiming it compromises Pakistan's "economic sovereignty” and gives absolute authority to the SBP to take key economic decisions independently. This wasn’t necessarily a bad thing. Monetary policy should ideally be used to control inflation, especially in a country like Pakistan where it has been the biggest problem for the general population.

Tighter autonomous control over money supply by the SBP, to control inflation also prevents the government from using the SBP to fund runaway expenditure. In short, an autonomous State Bank that works closely with the finance ministry is good for the professional management of the economy. And for a few months in 2022, it seemed we had reached that point. Then the politics came back into it.

How the autonomy was lost

The State Bank Autonomy Bill 2021 is still law. That means under it the incumbent Governor Jameel Ahmad is an actor independent from the state and monetary policy including interest rates can be set at his and the bank’s MPC’s discretion. What we have seen in the first year of his tenure is the very opposite.

In the months he has been in charge, the governor has not once stepped out of line with the incumbent government. In fact, when the recent deal with the IMF was still being negotiated, he called an emergency meeting of the MPC to adjust the interest rate in accordance

with the fund’s requirements — something that was in the interest of the government.

“The environment in the SBP changed overnight after Reza,” says one former high ranking member of Governor Baqir’s team. “I left soon after but you could tell that the new governor was not just in close contact with the finance ministry but was in fact very much taking direction from the ministry on what to do and what not to do. This was back to the old system before the autonomy bill was passed.”

Due credit must be given of course.

Governor Jaleel took over at a precarious time. And while his predecessor had a more outgoing style of management he had a very different environment to manage, including the Covid-19 pandemic. Mr Jaleel has come in at a time when political tensions have been high and toeing the line is the cautious approach.

It is ironic actually that it was originally the IMF which had demanded the independence of the SBP since the government ended up directing the SBP to act in a way that would secure the IMF deal. While his legacy may still change given he has two more years in the job, it will likely not be remembered for preserving the bank’s autonomy. n

Does big tech evade taxes in Pakistan and what can we do about it?

By Taimoor Hassan

Does big tech pay its fair share of taxes in Pakistan? This is perhaps the most relevant question for Pakistan’s tech scene right now. Why? Because tech investment and tech remittances into Pakistan have dropped to their lowest since the ouster of Imran Khan, but some of the bigger tech companies - Google, Meta and ByteDance, which have millions of users in Pakistan - are receiving their share of dollar

outflows from Pakistan.

On the other hand, these companies have not invested much in Pakistan and are alleged to not pay their fair share of taxes like they do in other countries. It becomes a double edged sword - their presence not only widens trade deficit but also the current account deficit in a country indebted to the IMF and other lenders.

As far as taxation goes, these companies do not have full-fledged offices in Pakistan and cannot be taxed as local companies in Pakistan get taxed, all the while turning revenues from Pakistan via payments made

Small operations, undisclosed financials and protection through bilateral treaties makes taxing tech companies difficult.

to these companies by businesses and people using their services in the country. Even without having local offices, the question of taxing these companies on payments sent from Pakistan falls apart because of some bilateral treaties. Here’s what’s exactly going on.

Is there an opportunity to tax these companies?

Abare basic comparison with India reveals much. In India, Google is registered as a full company under the name Google India Private Limited (GIPL) as a subsidiary of Google International LLC, the US-based entity. GIPL provides various services to Indian customers, such as Google Workspace, Google Ads, Google Play, YouTube Premium, and more. As a registered company in India, GIPL is subject to various taxes, such as income tax, goods and services tax (GST), withholding tax (TDS), and equalisation levy, according to a study.

The study reveals that according to the the financial statements of GIPL for the fiscal year 2019-20, GIPL reported a revenue of Indian Rupees (INR) 5,593 crore (about $757 million) and a profit of INR 586 crore (about $79 million) in India. The company paid INR 1,145 crore (about $155 million) as income tax and INR 1,064 crore (about $144 million) as GST to the Indian government. Additionally, GIPL also deducted TDS (tax deducted at source) from the payments made to its parent company and other foreign entities for the services rendered by them.

Furthermore, GIPL also collected equalisation levy from its customers who availed online advertising services from foreign entities. The equalisation levy is a 6% tax imposed by the Indian government on the digital transactions of non-resident companies that do not have a permanent establishment in India.

In Pakistan, Google is not even registered as a company and instead operates through a branch liaison office under the name Google Asia Pacific Pte. Ltd., which is the Singapore-based entity. The branch liaison office provides technical support and consultancy services to Pakistani customers for Google’s products and services. As a branch liaison office, Google is not subject to income tax or GST in Pakistan and only pays a nominal fee per year for its registration, according to the study. Unlike in India, the real numbers of how much Google makes from Pakistan is not even known.

Google is not even the only company enjoying this luxury of operating tax-free. It's the same with Meta and ByteDance.

Can we ever tax these companies? The answer to that is a little complicated.

To begin with, whatever payments are currently sent to these companies from Pakistan, “cannot be taxed because Pakistan is a signatory to the avoidance of double taxation treaty,” according to Sajidullah Siddiqui, former director general of international taxation at the Federal Board of Revenue (FBR).

Under these bilateral treaties that Pakistan has signed with over 60 countries, Pakistan’s domestic taxation laws are superseded by the terms of these treaties. The avoidance of double taxation treaties were signed between countries to avoid taxation of companies or individuals in the country they were doing business in, while they were paying taxes in their home country.

Under these treaties, Pakistan can charge a fee for technical services provided by these companies but the companies instead contend that these services are rather categorised as offshore digital services. The treaties, however, have no provisions for the concept of offshore digital services and therefore cannot be taxed, says Sajidullah Siddiqui.

Pakistan has signed these treaties with the USA, as well as Singapore from where Google manages its Pakistan operations. A similar treaty exists between Pakistan and China where ByteDance has its headquarters. Any move to tax payments from any of the big tech companies will require revisiting the terms of these treaties - an initiative required from the government.

The government has a small tax in place right now on these payments - a 5% withholding tax, which is currently being borne by the local digital media advertisers and not by the big tech companies. This increases the cost of doing business for local companies instead.

However, the question of taxing offshore digital services and tax treaties arises only because none of these big tech companies have full offices here in Pakistan, like they would have, say in India. If that had happened, do-

mestic taxation laws would prevail and these companies would be taxed just like any other Pakistani company.

Why don’t big tech companies have local offices?

Sarocsh Ahmed, the CEO of Karachi-based digital services firm Symmetry Group says that currently, the business of these companies from Pakistan is not fully known but must be small enough that these companies have not considered opening full-fledged offices in Pakistan. A similar assertion was made by Sajidullah Siddiqui who said that the FBR does not have a consolidated data on how much money these companies generate from Pakistan.

There is only an estimate: according to data from Pakistan’s Aurora magazine for FY 2020-21, advertisers spent Rs16.8 billion on digital media in Pakistan. That is theoretically the money that must have been spent on all platforms including TikTok, Facebook and Google. The dearth of data on these companies simply renders us incapable of analysing the potential taxation that could be collected from these companies, which is further complicated by the lack of estimates around what kind of costs are associated with operating in Pakistan as a percentage of how much money these companies make from Pakistan.

But two of the top level executivesone a CEO of a prominent digital marketing firm and other a high ranking taxman - say that these companies probably do not have a business case of opening a full-fledged office in Pakistan and further add to the costs by paying taxes.

In short, they are probably better off doing business like this in Pakistan, without having to pay any offshore taxes, under relevant treaties. n

Mirpurkhas Sugar Mills looks towards paper for profit

Profit report

hat is one of Pakistan’s largest and oldest sugar mills doing entering the paper business? For Mirpurkhas Sugar Mill the numbers speak for themselves. In their latest quarterly report the sugar mill reported that its newly formed Paper Division had made profits before taxation of just over Rs 14 crores and 70 lakhs — that too in just under 50 days of the paper plant being operational.

To put the number in context, the sugar division of the company made profits before taxation of just over Rs 26 crores and 70 lakhs

Wfor the last quarter and that too for a full 90 day period. The entry into the paper division is a part of the continued expansion of Mirpurkhas Sugar Mills and its parent company the Ghulam Faruque Group. The same month as its paper facility started operations (May 12th 2023), Mirpurkhas Sugar Mills also announced that it was acquiring the entire assets of Popular Sugar Mills.

Company background

One of the oldest sugar mills in the country, Mirpurkhas was listed on the stock exchange in 1964 and started sugar production with a

cane crushing capacity of 1500 tonnes in 1966. At the time the sugar mill was operated by the Pakistan Industrial Development Corporation (PIDC). At the time the corporation’s chairman was Ghulam Faruque who took personal control of a lot of PIDC assets in the 1960s including the Mirpurkhas Sugar Mill.

Since then the mill has been operating as a subsidiary of the Ghulam Faruque Group (GFC). The group has a wide range of interests including Cherat Packaging, Cherat Cement Company, Madian Hydropower, Zensoft, Greaves Pakistan, Unicol, and Unienergy, among others. Mirpurkhas is very much a family owned company and its chairman and CEO are Aslam Faruque and Arif Faruque — Ghulam Faruque’s sons.

In less than two months of being operational, the company’s paper plant has proven its mettle.

Over time, the sugar mill continued to increase its cane crushing capacity as the demand for locally crushed and processed sugar increased in Pakistan due to expensive sugar imports.

By 2006, the plant’s cane crushing capacity had steadily risen to 500 tonnes which is when the sugar mill entered into a joint venture with Unicol to start distilling ethanol using the by-products of cane crushing. By 2012 the company had started corporate farming to provide its own sugarcane. The combination of the ethanol production and corporate farming meant that the mill was expanding but did not have many new opportunities within the sugar industry.

There was a ban on establishing new sugar mills as well as a cap on the crushing capacity of existing mills and by 2018 Mirpurkhas had already hit that capacity at 12,500 tonnes. As a result, in 2021, the company decided it would set up a paper plant. One of the main by-products of sugarcane crushing is bagasse which is the pomace from squeezed sugarcane. Its rough texture makes it a good raw material for pulping and papermaking.

The paper that is created as a result is not quite the best for printing but can be very useful for making the kind of paper used for paper bags and the like. The Ghulam Faruque group already had experience and contacts within the packaging industry. Cherat Packaging was founded under the group in 1992 and focused on making paper sacks. In 1992, it started off with one tuber, and one bottomer, which could produce 50 million paper sacks a year. In 1998 it added its second bottomer, and in 2003 it added its second tuber, its third tuber and bottomer in 2006, and in fourth tuber and bottomer in 2009.

Having rapidly expanded its paper sack production to 265 million sacks, the company turned its sight on to polypropylene bags, installing the first such line in 2012. It installed a second line in 2014, and a third line in 2016, with a total production capacity of 195 million bags. Cherat then entered the Flexible Packaging segment (used for food items) in 2017, expanding the capacity to 12.6 million kgs in 2019.

Profitable paper

The immediate rise of the company’s paper division points towards flaws in Pakistan’s sugar industry and the benefits of the paper industry. In its latest quarterly report for the months April to June (the sugar industry operates on a different financial calendar starting in September due to the crop’s harvesting season) the company mentioned how output was lower this year.

During the crushing season 2022/23 that started on November 29, 2022, the plant oper-

ated for 87 days compared to 124 days the previous year due to delay in harvesting and less availability of sugarcane. This resulted in the factory being able to crush 562,641 metric tons of sugarcane to produce 59,325 metric tons of sugar as compared to 649,557 metric tons of sugarcane to produce 70,460 metric tons of sugar during the corresponding period last year. The plant operated efficiently throughout the crushing season.

The Company also produced 28,772 metric tons of molasses during the period compared to 33,080 metric tons produced during the corresponding period last year — which will have affected ethanol production as well.

Overall, during the period under review, the company sold 43,755 metric tons of sugar compared to 44,972 metric tons during the corresponding period last year

And this is where paper enters. The company’s paper plant began operations on the 12th of May 2023. Since financial data is available only up until the 30th of June and not for the current month, we only know how well the plant’s product did for its first 48 days. According to the quarterly financials, the paper division made sales worth just over Rs 1 billion. In comparison, the sugar division performed better with more time but not significantly making sales worth just over Rs 1.6 billion.

The cost of sale for the sugar business seems to have been significantly higher at over Rs 1.3 billion compared to the paper business where the cost of sale was around the Rs 77 crore mark. However, the cost of sugarcane distribution was low at around Rs 1.9 crore com-

pared to the distribution cost of paper which was hovering around the Rs 6 crore mark.

Overall, the sugar division of the company made a profit before taxation of Rs 26 crores and 70 lakhs compared to the very new paper division which already clocked in Rs 14 crores and 70 lakhs. These figures are of course for the last quarter financing costs were higher as well at over Rs 40 crores. The director’s report explains that finance costs increased by 159%, primarily due to significantly higher discount rates coupled with higher costs of sugarcane and other raw materials. A better picture is presented by the overall results of the past nine months for Mirpurkhas Sugar Mills.

According to these, in the nine month period from September 2022 to June 2023 the company made an overall profit of Rs 62 crore compared to Rs 35 crores in the same period last year. Of this profit, over Rs 13 crore is allocated to the newly founded paper division accounting for just over one fifth of profits within the first 50 days of being operational.

According to the company’s quarterly report, the paper plant produced 12,421 tons of paper (including the trial production) to date. “The plant is operating efficiently and achieved all the operational parameters required under the purchase agreement. Due to high inflation and poor economic conditions, consumer spending is on a downward trend. This is directly impacting all FMCGs, including snacks and confectionery businesses, leading to a reduced demand of packaging and corrugated products as well,” reads the directors’ report. n

Expensive energy: Everything you need to know to understand your electricity bill

Profit breaks down the tariff and various government charges that make up your monthly energy cost

By Urooj Imran

Looking at your electricity bill every month can be a daunting task. You may have spent that entire month trying to bring down your electricity use and even though the number of units may be

lower than the previous month’s, the bill still appears to be higher and you are not sure why.

Profit breaks down the different categories in your electricity bills, what they refer to, and how you can calculate your bill yourself. For this story, only the bills of residential consumers under the AR-1 tariff

will be explained.

Bills are divided into two parts — amounts payable to the distribution companies (DISCOs) and amounts payable to the government.

The National Electric Power Regulatory Authority (NEPRA) determines both the tariff for each DISCO as well as a uniform tariff based on the government’s proposals, which also incorporates subsidies and inter-DISCO tariff rationalisation/cross-subsidies — so that consumers of all DISCOs end up paying the same amount irrespective of the cost of electricity for each DISCO.

The authority recently raised the price of electricity by up to Rs 7.5 per unit effective July 1, 2023, after holding a hearing on a motion filed by the federal government.

There are different categories of consumers — protected (lifeline), protected, unprotected and those that have Time of Use (ToU) meters. Residential consumers having a single-phase electricity connection with a sanctioned load of 1 kilowatt per hour (kWh) — you can check your sanctioned load on your bill — including non-ToU consumers who have used less than 100 units a month for the last 12 months are lifeline consumers.

Consumers who use up to 200 units consistently for six months are protected consumers. If the consumption goes above 200 units for even a month and the streak is broken, the consumers will become part of the unprotected category.

Consumers that have a sanctioned load of 5 kWh or higher have ToU meters, which are also known as variable rate meters. These meters have two separate numerical displays — for off-peak hours and on-peak hours (typically during the evenings and nights). Thus, there are two different tariffs for them — offpeak and on-peak, the timings for which differ for each DISCO and season.

The bulk of the charges in the DISCOs section is attributed to the cost of electricity, which you can calculate by multiplying the number of units used with the power tariff.

After this, we have the Quarterly Tariff Adjustment (QTA) and the Fuel Charge Adjustment (FCA)/Fuel Price Adjustment (FPA). At times, the cost of electricity provided to customers by the DISCO is less or more expensive than the amount charged for it. There can be different reasons for this, including a higher cost of power generation due to raised prices of fuel in the international market. In such a case, the DISCO files a petition with NEPRA to recover that amount by charging the customers the difference in a bill for a later month.

So, for example, in your bill for July 2023, you might see that you have been charged a certain amount per unit for the elec-

tricity you used in May. Keep in mind that the FCA/FPA or the QTA is charged for the units you have already used in that month or quarter, instead of your units in the latest month. If you want to check whether the charges are correct, you can go through NEPRA’s decision, which is uploaded to its website.

You may also see additional surcharges, such as the one for Power Holding Limited (PHL) in the K-Electric bill or Finance Cost (FC) Surcharge in the Islamabad Electric Supply Company (IESCO) bill. These surcharges go towards reducing the power sector’s debt servicing and circular debt.

The PHL, which is under the control of the Ministry of Energy’s Power Division, was founded in 2009 to reduce the power sector’s liabilities by borrowing from financial institutions. This is essentially the customer paying for the loan markup.

The government has previously stated that the revenue earned from electricity sales was insufficient to cover PHL loan markups, and hence, it requested NEPRA to impose the additional surcharges. The regulator’s decisions in this regard are also available on its website.

According to NEPRA’s decision, a surcharge of 43 paise for consumers using up to 300 units a month and Rs3.82 for all others, was applicable from March 1 to June 30. It will be charged throughout the current fiscal year (till June 2024) at a rate of Rs 1.43 per unit.

Now, we come to the amount payable to the government, the first of which is the electricity duty. A duty of 1.5 percent is charged on the cost of electricity, the QTA and the FCA/FPA, and distribution margins.

Furthermore, a sales tax of 18 percent is charged on the cost of electricity, the quarterly tariff adjustment, fuel charge adjustment and distribution margins, the electricity duty and the FC surcharge.

Besides this, a flat fee of Rs 35 is charged for Pakistan Television (PTV). The government is also considering imposing a Rs 15 radio fee that would be used to pay Radio Pakistan employees. However, a decision in this regard is yet to be taken.

In case, you are not a filer and your name is not on the Active Taxpayers List (ATL), you will also have to pay income tax. According to the Income Tax Ordinance, you will not have to pay any income tax if your bill is below Rs 25,000. However, if your bill is above Rs 25,000, you will have to pay an income tax of 7.5 percent of the total amount.

Despite the recent increase in tariff rates, the government has stated that 63 percent of residential consumers would not see any change in their electricity bills as it was offering subsidies of Rs 158 arab as well as cross-subsidising by charging those who use more units higher rates.

During NEPRA’s hearing on the federal government’s motion to “reconsider and issue” the new uniform tariff, representatives of the Power Division had claimed that 98 percent of consumers would still be subsidised to differing degrees.

Pakistan’s energy sector is in a perennial crisis with its circular debt — a cash shortfall across the power supply chain that is accrued when power purchasers fail to pay power producers — standing at Rs 2.65 kharab at the end of May.

The government’s move to impose the finance cost surcharge was an attempt to reduce this circular debt as a growing circular debt threatens the viability of the entire energy sector. While the government has increased the uniform tariff, some analysts say that instead of reducing the circular debt, the move may encourage power theft and decrease consumption, thereby affecting the economic output. n