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CONTENTS

08 On the issue of board directors, the SECP may need to go back to the drawing board 12 Despite high profits this company’s share price is low. Can it be intentional?

18 18 Finding meaning in fungibility Fahd Ali 20 With prices on the rise, Pakistan’s employers must go above & beyond 23 Lucky Motors, and Honda might just upend the auto finance market even if it’s just for a few months

28 28 PIA’s long dispute with airplane leasing company seems to have ended

Profit

29 Currency in circulation has declined sharply in 2023’s third quarter. What’s behind the unusual drop?

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) | Sohail Abbas (Lhe) | Malik Israr (Isb) Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk

On the issue of board directors, the SECP may need to go back to the drawing board Election of directors is a problematic issue but SECP is not seeing the real issue at hand By Zain Naeem

W 8

hat does the member of a board of directors do exactly? In publicly listed companies they have many

functions, and they also come in all kinds of flavours. But predominantly the position of director on the board of a company is clinched by the power of nepotism. About 60-70% of the people appointed as directors to the vast array of publicly listed companies in Pakistan are family members of the companies’ majority shareholders, estimates Safdar A Butt, an academic with

years of business experience who is currently a Professor Emeritus of Finance and Corporate Governance at the Capital University of Science and Technology in Islamabad. This is a bit of a problem. You see a director in a company is someone elected or appointed to manage a company’s business and affairs. Every registered company must have at least one director, and most large

companies are run by a board of directors which votes on important matters such as the appointment of a CEO. And since publicly listed companies are owned by different shareholders, a company’s board of directors should ideally represent this ownership pattern. In Pakistan, however, there is a bit of a problem. Because most directors are either relatives or the employees of owners, there is rarely much representation on boards for minority shareholders. On top of this, there is often a conspicuous absence of women and independent directors on these boards. To this end, the Securities and Exchange Commission of Pakistan (SECP) has claimed they are making an active effort to bring local practices inline with international standards when it comes to boardrooms of corporate Pakistan. The Company Act of 2017 made strides in setting laws for a largely unregulated area of the market, and 2019 saw the Listed Companies (Code of Corporate Governance) Regulations being introduced. The question is, have these regulations proven to be effective? Or is the SECP fighting a losing battle by window dressing rather than addressing the real problem?

memo with the CEO’s signature followed to appoint or remove one, things were pretty much as you’d expect. The problem was that these directors treated their job as a family or company appointment because that is what it was for them. “Most of the directors we have don’t know how to do the job” says Professor Butt. “For some reason there seems to be no realisation that as the director of a company, they have obligations towards all stakeholders, and not just their family or friends that gave them the position.” And that is also where the problem exists. “Ethics and the law are not always on the same page” says Butt. “You, as a director, may think you’re doing something moral or just, and in your own mind, you will be completely justified. “But it is entirely possible that you may just be breaking the law in the process. Say you are a director and you think three of your four managers deserve bigger bonuses than the fourth one. Now you may think this is fine, but unless there is some definable criteria for giving bonuses, this is criminal behaviour – no matter your intentions.”

bring in a change in the corporate governance of the companies. By including independent directors and having female representatives on the board, the company gets to gain from the experience and the skills of the independent directors which the company would not have access to previously. “The amendments or changes that were introduced in the (Companies) Act regarding female and independent directors have ensured diversity and women’s inclusion and led towards a more robust corporate governance regime,” a representative of the SECP tells Profit. In the olden days, the board of directors were seen as a formality rather than a necessity and directors were put into place as a way to appease regulators. Now it can be seen that having access to a broader pool of skills and abilities is beneficial for the company as well. Having different perspectives and experiences in the board of directors allows for better problem solving and brings new solutions to the table that might not be considered. What really is the role of the board of directors and how are they important?

The days of company men

Changing times

Why seats on the board matter

t was long understood in Pakistan’s corporate landscape that owners get to appoint directors of their choice. After all, as the majority owners, should the company’s major sponsor get to do as they please? Even if that means appointing younger brothers and son-in-laws with nothing better to do. Now, up until the early 1970s it was practically a free for all. This meant whoever was managing the company’s affairs could unilaterally appoint anyone of their choice to the board. This practice was put to an end by the Companies (Managing Agency and Election of Directors) Order of 1972. The order eliminated the earlier practice and mandated that the companies should carry out elections in order to make the process more democratic. The order was still very much in favour of the major sponsors, but it was the first step towards a more democratised process of electing directors. This was further crystallised in the Companies Ordinance of 1984 which formalised the appointment and removal of directors through due process. For quite some time this was really the only significant legislation regulating how companies in the public sphere were governed. And for the most part it meant that while directors had to be elected and a certain process beyond just a word and an office

t was perhaps this litany of problems that led to the introduction of the Company Act of 2017 which replaced the 1984 ordinance. Even though changes were made to the laws governing companies, the election of directors was mostly left untouched. Many of the powers given to directors were left unperturbed which points to the resilience of the laws made 35 years earlier. The SECP was essentially facing the heat because Pakistan lagged far behind compared to international standards. Because of this, through this new act, the SECP was encouraging companies to move towards independent directors. It asked companies to voluntarily put independent directors up for election with a focus on female representation. To formalise this process, Listed Companies (Code of Corporate Governance) Regulations were brought in 2019 which focused on Corporate Governance. Language was added into the regulation to make it mandatory for companies to be made part of a Board of Public Interest Companies (PICs). PICs, as defined by SECP, are listed and non-listed companies which are operating in the public sector, involved in essential public service or involved in the holding assets in the fiduciary capacity like a bank or insurance company. It also includes non-listed companies which have public shareholders. In essence, these laws are meant to

et’s dust off our old finance textbooks and see why the board of directors are important. It is called the agency problem and conflict of interest. Come on, say it with me. You all know it. The agency problem is that shareholders and managers are at odds with one another as the shareholders actually own the company, however, they do not have the expertise to run a company. Good job everyone. When corporations get too large, the interests of shareholders and managers can diverge. It is in the interest of the shareholders for the company to do well and make them money. The interest of the managers is to run the company which yields the highest amount of vertical mobility and benefits for them. As the interests begin to differ, the best solution is to place a board of directors in the middle. The board of directors act as a bridge which is able to connect the management and the owners of the company together. The board is able to communicate the needs and interests of the shareholders to the management and holds them accountable. The board of directors is elected by the shareholders and is involved in many of the key decision making for the company which have to be implemented by the management. This delegation of authority means that they act on behalf of the owners.

EXPLAINER

From the appointment of the executives of the company to their salaries and benefits and major decision making power, the board gives approval before any significant decision is made. They give this approval after they get the nod from the shareholders at general meetings that are held for the benefit of the shareholders. Shareholders get to vote on these issues which are then carried out by the board. This aligns the goals of the management with the goals of the shareholders. This board is also given powers to create governing documents and put policies in place which the management has to abide by. In essence, they have a supervisory function over the management and they can review the performance of the officers under their purview.

Why you need independents on the board

n such a case, qualified and independent directors become important. Qualified directors are people who actually know the ins-and-outs of the industry or the field the company is involved in. This allows them to provide key insight into its operations. Similarly, independent directors are people who are not related to the company at present or in the past at any point and are coming from outside the company. They see problems being faced by the company with a fresh pair of eyes. When both of these attributes are combined, the company has a board of directors who are able to understand the company and are able to guide them in a better direction without having any conflict of interest. They are not related to the company and have the skills to critique and improve its performance in the future. A balance needs to be struck between executive directors, who are part of the current management of the company and have a view from outside the company to provide a new perspective. Lastly, female representation, in a society like ours, can also provide vital insights for the company going forward. Uptil now, SECP is coming off in the clear with great intention and plan. Wait a little bit and see how they muddle this up.

The process of election

o understand the real issue that plagues the companies is to get to know how the election is actually carried out. The election of directors is carried out for 3 years after which they are seen as being retired and have to be

reelected. Companies can carry out elections in a staggered manner and carry out elections for only the retiring directors, however, most companies have elections for all the seats of its directors. In its initial meetings, the board has to decide the number of members who will be a part of it. This number can be changed later by the board at a meeting as well. Let’s assume there is a company called “Kakkar International Limited”, there are seven directors who are going to be elected. Candidates have to show interest in taking part in the election and have to submit their documents with the company secretary. The company secretary can scrutinise these documents based on the laws and regulations of the SECP and the company itself and then declare the eligibility of the candidates for the election. In our example, there are seven seats and let’s say that seven people show interest to be elected. In that case, all the candidates become directors, the world is perfect and serendipity rules the land. In case eight people are interested in competing in the elections, an election actually does take place on a cumulative basis. This means that each shareholder gets the number of votes equal to his shareholding multiplied by the number of director seats to be filled. Kakkar International Limited has 100 shares that it has given out to its shareholders. This means that a total of 700 votes will be cast. Every shareholder gets a ballot paper and can vote for as many candidates he likes with his seven votes. Even voting for a single candidate multiple times. Once the results are tabulated, the candidate receiving the most votes becomes a director. The next highest voted receiver gets to be the second director. This process continues until all the seven directors are chosen and one candidate loses.

The implications of such an election

he implications of such an election are that, even though the majority shareholder has the most shares, still the minority can band together and combine their votes to vote for a director that they like. In the example that was given, let us suppose that 55% is owned by the sponsors while 45% votes are held by the minority or shareholders outside the company. In such a case, out of the 700 votes, 385 votes are with the sponsor while the remaining 315 are with the other side. If there are 8 candidates, the most votes needed to pass the threshold will be around 88 votes. If all the

directors get 88 votes each, the last one will get 84 votes and will not be elected. This was the methodology that was followed till now which meant that minority shareholders could put up as many of their own candidates up for elections against the majority shareholders. This allowed them to have a voice and have a counterbalance against the majority getting its way.

The flaws of the laws

n such a scenario, the laws were being abused by the majority shareholders. They would look to corner the shareholding by asking for shareholders to hand over their proxies to the sponsors. Proxies are privileges that are given by a shareholder to someone else who can act on behalf of the shareholder. It allows them to take part in elections and general meetings and they can vote with a bigger share of the vote than they actually own. In addition to that, the SECP felt that as there was a tussle of control between the two sides, the spirit of the law was not being followed. Shareholders were not interested in getting an independent director or a female director on the board of the companies which was going against their efforts. In defence of SECP itself, it states that “the laws or amendments therein are always implemented with a view to improving the corporate sector in Pakistan and promoting investor confidence.The laws implemented have brought more transparency, ease of doing business, and investor confidence.” “However, making legislation is a continuous, evolving process that considers changing market dynamics, international trends, and ground realities. SECP follows a consultative process to cater to the viewpoints of stakeholders and stay abreast of relevant developments.”

SECP fixes what’s not broken

n order to address these issues, the SECP looked to codify the elections in the Listed Companies (Code of Corporate Governance) Regulations 2019. In these regulations, they mandated that at least one seat was to be kept for female directors while at least 2 or a third of the board was to be made up of independent directors. This was a way for the regulator to tip the scales in favor of female and independent directors. “The database has made it easier…to identify a pool of candidates for the election of independent directors. The database contains various details about the candidates listed therein, including their education, qualifications and job experience, etc.”

states the SECP which has been aided by the database. Directors who had been trained in relation to the program could be selected and then elected as directors of the company. This strengthened the integrity and the ability of the directors who had been trained under this framework and could provide companies with a source of directors from which to choose from. It had been felt by the regulator that companies were having difficulty complying with the mandatory requirements of the Regulations regarding the appointment of female and independent directors as the candidates did not get a sufficient number of votes to be elected to the board.

The problem is made worse

ecently, the SECP has presented another solution to the voting procedure under SRO 906(1)/2023 dated July 7th, 2023. This ordinance acts as being “ultra vires” the specific provisions of Section 159 and 166 of the Companies Act 2017. They have looked to introduce a separate voting system for election of females, independent and other directors at a company. This has been done under Regulation 7A of the Listed Companies (Code of Corporate Governance) Regulations 2019 where it is mandatory to vote for the three categories of directors i.e. female, independent and other directors separately. This move should have been a step in the right direction. Technical experts brought to light the fact that the SECP was further weakening the position of the smaller shareholders. In the example we used earlier, if one of the directors has to be mandated as being female, the elections will virtually be held between two candidates. One would be nominated by the majority while the other would be put up by the minority shareholders. As it is a head-to-head election between two directors, the majority candidate will always win. Going back to our earlier example of Kakkar International that we had chosen, in that scenario there are 9 directors up for election now and there are a total of 7 seats. One seat has been reserved for female directors where both sides put up their candidates. The winning candidate, from the majority, gets 55 votes while the other candidate gets 45 votes. Now there are 7 candidates left and the votes have decreased to 600 with 330 votes held by majority and 270 by minority. The threshold in the new case is 86 votes. The candidates need to get 86 votes to be elected.

The minority shareholders have barely enough votes to elect three members as they need 258 votes and even a small proxy war can mean that the minority shareholders will not even be able to place the 3 directors that are technically their right.

What is the solution?

his issue is complex in its nature as the situation that exists is problematic. On one hand, majority shareholders hold onto a majority of the shares to make sure their decisions are imposed in the company as the sponsors feel that they funded the company and have a divine right to make its decisions. This is the reason why they keep more than 50% of the ownership of the company. On the other hand, are the shareholders who have invested in the company and feel that their concerns and voices need to be heard as well. The smaller shareholders have invested their hard earned money into the company and deserve some representation in the board. Currently, the idiom of one share one vote is held true which treats every shareholder as equal. Every shareholder gets to vote in the election and get to have their say in the matters of the company. Whenever elections take place, both majority and minority shareholders come together and get to vote on the matters of the company. Negating a vote of the majority shareholder for the benefit of the minority shareholder will defeat the purpose of voting and might even eskew the balance of power towards the minority shareholders where they get to have an equal voice as the majority shareholders. A better solution in this case can be setting up a threshold for election of directors. Every shareholder gets one vote and can vote yes or no for a director. It’s a straight yes or no question for each candidate up for election. In case a director has to be elected, he has to receive a certain threshold above the voting power of the majority shareholder alone. For example, the majority shareholder has 55% of the shares while the minority holds 45% of the voting power. The winning candidate must get 60% of the total votes or a percentage above of sponsors shareholding power. This would make sure that the will of the minority shareholders is considered and they need to go along with the decision of the majority for a director to be elected. This model will not give veto or filibuster power to the smaller side while mandating that the majority side needs support from the minority shareholders before imposing their decision.

A note to the regulator

he issue that needs to be considered by the SECP is not the fact that female and independent directors are not being nominated. Uptil now, every solution that has been presented by the SECP has looked to make the situation better. However, each and every move has fallen prey to the fact that the letter of the law is being followed while the spirit of the law is being defeated. It is true that the corporate landscape of the country has evolved a great deal. From having sponsors appointing directors of their choice, now at least shareholders are getting to have a say through elections. Even today, female directors are put in place who are related to the executives or management of the company and their representation is used as a cosmetic tool to show the inclusion of women in the affairs of the company. The corporate sector can do much better. By opening up their doors to qualified female and independent directors, the company can benefit with the experience and skills of these directors which might be lacking within the company. Within Pakistan, most public listed companies are held by the sponsors which means the rights of the minority shareholders are neglected. In a country like India, sponsors are not allowed to hold more than 25% of their own companies which means the majority does not have the capturing of the board like it does in Pakistan. When asked regarding this, the SECP stated that “the amendments to the Regulations were made with the view that companies can now ensure compliance with the mandatory requirements of the Regulations for the appointment of independent and female directors as well as the protection of the rights of minority shareholders, which may also enable them to have their candidate on the board. The shareholders can allocate and cast their vote in a particular category without the fear of diluting their voting power in other categories. Further, it is the responsibility of all shareholders to play their part in the election of independent directors.” Even though this can be considered a manner to allow companies to comply with the regulations, the spirit of the laws and the regulations are still not being implemented. The core of the issue is not that diversity is not being made part of the board, however, the fact is that majority shareholders are using their power to make sure their people get on the board. This is being done while little care and attention is being given to equip the company with a diverse and well qualified board. Such a board will allow the company to perform better and should represent all the shareholders of the company rather than just the majority. n

EXPLAINER

Despite high profits this company’s share price is low.

Can it be intentional? Towellers, a publicly listed textile export company from Pakistan, is doubling its profits every year, but its boss ladies don’t want the world to find out. What gives?

By Shahab Omer

here are many things that make Towellers Limited unique. For starters, the company is a rare example of a genuine bootstrap success story. Starting from humble origins in 1973, Towellers grew from a small unit of six terry looms to become one of the larger towel exporters in Pakistan’s already densely populated textile industry. On top of this the company is run by a quadfecta of sisters and its chairman and CEO are both women — another rarity in Pakistan. But perhaps most significantly, the company seems to be incredibly modest. For the last three years Towellers has, almost miraculously, been doubling its profits every year, and yet it seems the least bit interested in publicising this information. In fact, if anything, they seem to want to keep this little tidbit of information that would be very interesting to potential investors, hush hush. Most publicly listed companies would issue press releases about such achievements. Some company executives would even pay for media interviews and try to get publicity not just for their companies, but also for their personal profile building. But Towellers is operating on the other end of this spectrum. Not only have they not publicised their achievements, when Profit reached out to the company wanting to cover their success story, without a charge obviously, they asked that the interview be scheduled a full year later. A first for Profit. So what gives? Quite possibly it is because in one particular way the company is not unique at all. In fact, it follows the blueprint of many other Seth-owned publicly listed

companies in Pakistan: A complete and utter disregard for minority shareholders. Why do we think so? The proof, as they say, is in the pudding. And in the case of Towellers it is in the recent trends in their financial results. For one, take a look at what happened to Towellers’ share price on the morning of Wednesday, September 27th, the day the company was announcing its annual results. At 10:00 AM, as the stock market commenced trading, the share price opened at Rs 169. By 12:30 noon, it had risen to almost Rs 178. In fact, for the last few days, the company’s stock was experiencing rapid appreciation in value in anticipation of good financial results. The results were released and showed that the company had more than doubled its profits, from Rs 1.1 billion in 2022 to Rs 2.4 billion In 2023. Similarly the earning per share (EPS), which is the profit attributable to each share of the company, rose from Rs 63 per share to Rs 140 per share. In some part this was because Towellers is an export oriented company that had made bank on the astronomical rise of the dollar. But the profitability of other Pakistani Towel exporters had not increased by as much. There is after all a slow down in the US economy, and hence a suppression in overall demand. Even in the case of Towellers, the sales volume contracted in 2023. But the company was able to double its profit margin from 10% to 20%. In simpler words, whereas other Pakistani towel exporters are making around 5 to 15 cents of profit on every dollar of sales, Towellers has managed to make 20 cents. Clearly the financial results of Towelllers were extraordinarily good. Normally, you’d think this would be good news for the company’s shareholders, and as per the normal mechanics of the stock market, this would result in a rise in share

STOCK MARKET

prices of the company. Especially for a company which had an extremely low share price compared to its EPS. Imagine, Towellers share was trading at Rs 120 on Pakistan Stock Exchange (PSX) in March 2020, the year when each share of Towellers earned only Rs 14. In 2023 EPS has increased tenfold to Rs 140, and yet the share price has increased only marginally to Rs 152. Had the ratio of share price to EPS remained constant, the price of one share of Towellers would have increased to a whopping Rs 1200 per share after the financial results were announced. Except this didn’t happen. Not even close. Instead, as soon as the results were announced the company’s share price started going down, dropping from Rs 178 to Rs 169, which is where it had opened on the 20th of September. The main driver behind this disappointment was that despite having an EPS of Rs 140 per share, the company had only paid Rs 13 out of it in dividends per share, keeping the rest of the Rs 127 per share within the company. This is not necessarily a bad thing for share price. A company can retain profits, instead of paying dividends to shareholders, to invest in expansion, from which it can make an even bigger profit the next year, which should then result in even larger dividends for shareholders in future. But then why, despite the company’s remarkable turnaround, are the investors not impressed? Do they feel they might never see these high dividends? Not even in the distant future? Is it because they have doubts about the company’s future profitability, or is it because they doubt the intentions of the majority owners that are running the company? What instead would the company do with this money then? Some of our answers might be found in the company’s impressive history.

The Towellers’ story

n 1973 Shaikh Obaid set up a small towel manufacturing unit comprising six Terry Looms. Without getting into the finer points of what a Terry Loom is or its output, suffice to say these were humble beginnings. Despite starting off as a small fry in the big, bad, and filthy rich world of textiles, Shaikh Obaid was by all accounts a natural salesman. Even his competitors acknowledge that he was a maestro when it came to marketing and selling his product, particularly to international clients. Now, in the 1970s Pakistan’s textile industry was still very much a work in progress. This was the era when textile producers were bound by the Multi-Fiber Agreement. Under this agreement, Pakistan had a quota to export textiles to European and American markets. However, textiles could only be exported in limited quantities under this quota. This meant there was only room for a few manufacturers to export their product to these prized markets. The quota was actually so highly sought that the Pakistan Export Promotion Bureau would auction the rights to it. But as one might expect, this quota was controlled by a select few people. Most of these were also not manufacturers themselves and outsourced their production but reaped the rewards from the European and American markets. Shaikh Obaid on the other hand had his own production set up. By initially selling to the local market he continued to expand it with an eye on eventually becoming export oriented. Born in pre-partition India, his family had migrated to erstwhile East Pakistan at the time of partition and came back to the mainland after the 1971 Bangladesh War of Independence. This is an important detail because under the quota agreement, since textiles could only be exported in limited quantities by each manufacturer from Pakistan, a lot of the remaining work

was done from Bangladesh and Sri Lanka, where there was not a limit as to the export volumes to the US and European markets. With established connections in Bangladesh in particular, Shaikh continued to export through his second home. For the next two decades Shaikh was flying high. His company grew exponentially and by 1985 the six Terry Looms had turned into an international network of textile factories. Towellers very quickly turned into a Big Kahuna in the world of textile. And despite converting into a public limited company in 1994, the company was still very much a private affair, run by Shaikh Obaid. Shaikh Obaid had five daughters and one son. A progressive man who was passionate about the education of girls (what the GenZs would call a “girl dad”) his children often accompanied him on business trips and were encouraged to learn about the family business, but were too young to get involved. His eldest daughter Sharmeen finished her undergraduate degree in arts in 2002. {Editor’s note: Shaikh Obaid, who passed away in 2010, has left two legacies in Pakistan. The first of course is Towellers which is testament to his acumen as a businessman. The second is his daughter Sharmeen Obaid Chinoy — Pakistan’s first and only Oscar winner. Sharmeen is the only one of the Shaikh’s five daughters that has not been actively involved in their father’s business since his passing}

The turning point

or 32 years Towellers grew and the Obaid family grew with it. Then came 2005 which proved to be a pivotal year for Pakistan’s textile industry, which is when Pakistan saw its highest yield for cotton in history at 15 million bales and business was booming. It was also in this year that the quota system under the Multi-Fibre Agreement came to an end. Insiders report that around this time the company was struggling financially. Some Industry sources say that one reason for the company’s troubles could be the lack of oversight on the company’s operations in Bangladesh. While others attribute it to Shaikh Obaids deteriorating health. On top of this the textile business in Pakistan was about to hit a major point of implosion. Between 2007-08 Pakistan was hit by the global recession. The textile industry faced challenges due to high energy costs, rupee depreciation vis-à-vis the US dollar and other currencies, and a high cost of doing business. As a result, there was a reduction in the number of textile mills operating in the country from about 450 units in 2009 to 400 units in 2019. Shaikh Obaid had generally shied away from diluting his shareholding and raising a lot of money from the public. Instead, the company went to the banks to seek both short term and

long term loans. These were challenging times for the industry on a whole but were exacerbated for Towellers by the passing of their founding patriarch in 2010.

The children’s turn

et us get back to the point with a small digression. What does it mean to be a publicly listed company? Essentially, it means that a certain percentage of ownership in the company is available for purchase by members of the public. People buy these shares in the company and the money is used by these companies to invest further. In return, the shareholders receive dividends if the company has excess cash — essentially their cut in the profit. It is a pretty neat system. You invest in a company that makes big profits and you can expect dividends. This year, as we started this story off with, Towellers has made a bit of a killing. They also netted a big profit in the year prior, which is why perhaps shareholders were expecting to get a decent dividend according to the EPS value. Now, as already explained just because a company makes a profit does not mean they have to pay a dividend. Instead, the company’s management can decide to reinvest the money in the company, make an even bigger profit the next year, which would then result in even larger dividends. The question of whether to pay dividends or reinvest is not one that has haunted Towellers for too long. The company has generally been caught up in the overall downturn of Pakistan’s textile economy. The downturn has mostly been witnessed by Shaikh Obaid’s daughters, who have been running the company since his passing in 2010. He was succeeded as CEO by his daughter Mehreen Obaid Agha in a year when the company was facing a loss. Currently, four out of the five sisters are running

the company, with Mahjabeen Obaid serving as Chairperson, and Hadil Obaid and Sana Bilal serving as Directors (Board of Directors). Interestingly, their fifth sister, Sharmeen Obaid-Chinoy who is the eldest one and has international renown, is not visible in this company, not even as a shareholder. Profit attempted to ascertain Sharmeen’s stance on why she has distanced herself from the company’s affairs, and why she is the only sibling who is not a shareholder, but she too decided not to respond. Even though the company was facing serious issues from 2010-14, consistently reporting annual losses, the most challenging year for the company was 2012 when, despite achieving a turnover of Rs. 2.1 billion, Towellers reported a loss of Rs 60 crores. More importantly due to the losses, the equity plummeted into negative territory, making the company insolvent. In simpler words, the company owed more money than it could raise even if it sold all of its assets, making it a crucial year of financial trouble. Similarly, 2014 also presented a complex financial scenario. Despite sales of Rs 3.4 billion, Towellers grappled with a significant loss of Rs 37 crores. Equity remained mired in the negative at Rs 27 crores underscoring the financial uncertainty surrounding the company. In fact, the company remained insolvent for three full years (2012, 2013, and 2014), finding it difficult to pay its creditors and remain operational. During these years the company had to either default or restructure a lot of its banking facilities. Persistent losses and negative equity obviously meant that after 2009, for many many years the company was unable to pay any dividend to its shareholders. However, after successfully negotiating terms with lenders, and at the same time focussing on the company’s operations, the sisters were able to improve the company’s financial performance significantly from 2015 onwards.

This included shutting down unprofitable business units, a focus on bringing efficiency and getting some of the best international clientele on board. That year, Towellers reported sales of Rs 2.7 billion and achieved a profit of Rs 10.7 crores. This trend continued and going forward the company reported profits every single year, with the last three years being the most profitable. The first major profit came in 2021, when the company made Rs 55.6 crores. Then came the real turn around. In 2022, Towellers Limited achieved a profit of a little more than Rs 1 billion, which meant that EPS was Rs 62.53 per share. Minority shareholders might have started feeling they were due a payout. You see Towellers is very much a family affair despite being a public company. They have a free float of only 20% on the stock exchange which means a maximum of 20% of its shares are available to the public to trade while the rest continue to be held by the Shaikh family. Also remember that while minority shareholders are waiting for dividends for more than a decade, the majority owners of the company that are also its managers pay themselves salaries, benefits, and extract other perks from the company’s earnings. So it would make sense that minority shareholders that had stuck by Towellers through their troubles would now want to get some money.

So why the low dividends?

n the end, despite an EPS of Rs 62.53 in 2022, Towellers ended up announcing a dividend of Rs 10. Still, it was something. And the company had paid a dividend for the first time since 2009, after a gap of almost thirteen years. Perhaps they were looking to invest the profits and make even more earnings the next year? And the company did invest some of that money in expansion. However, a big part of it was invested in short term government securities, through mutual funds. And then we come to this year. The year 2023 marked impressive growth for Towellers which hit a profit of close to Rs 2.4 billion resulting in an impressive EPS of Rs 140.49. Even more impressive was the increase in profit margin to 20%. This Towellers was able to achieve by attracting and retaining brands, as well as institutional customers like hotels, that were more quality conscious than price conscious. But this year again the company paid a dividend of only Rs 13 to its shareholders. The company chairperson, Mahjabeen Obaid seemed to think this should make the shareholders happy, “I am also pleased that the Board has decided to announce a healthy dividend for the second consecutive year. Members truly deserve the same for standing with the management and supporting the Company through all these years for which I am thankful to them. I wish and hope for

STOCK MARKET

the consistent growth and profitability of the company which would be mutually beneficial for all stakeholders.” she wrote in her message to shareholders.

to our emailed question. The other possible answer could be something more questionable, which is that the family that owns the majority of the company wants

This seems logical. That pool of money being built may well be used to do a share buy back at a slightly higher price than the prevailing share price of Rs 150. So instead of distributing Rs 140 of EPS as dividends to shareholders, for which the company does not get anything in return, the company can buy those shareholders out, once and for all by paying slightly more than one year’s EPS. This could also explain why the Obaid family do not want to tell their recent success story to the media, as that could generate investor interest leading to an increase in the share price.

A question of mindset

N With this rise in profits, which is what we started this story with, dividends might have been expected. So why is Towellers shying away from paying its shareholders the dividends they deserve? One answer could be that they are planning on holding on to these earnings so they can expand capacity and grow the business even further. And till that time they are building this pool by keeping the money in interest earning banks saving accounts and mutual funds. However, when Profit requested Mahjabeen Obaid to answer just this one question, as to what they plan to do with the retained profits, she directed us to the company’s Chief Financial Officer (CFO). Not surprisingly, the CFO did not respond to our phone calls, nor

all of the dividends for themselves. And the only way to achieve that is through a massive share buyback. Could this be on the cards? At least one senior analyst at a brokerage firm seems to think so. “You see, if the company starts giving dividends, the share price would grow. And if there is a plan to buy back the shares from the minority shareholders the company would obviously want to be able to purchase these shares at a low price, which explains why the company isn’t paying dividends. Once the company has purchased these shares from minority shareholders, it cancels them and even a bigger part of the company is owned by the sponsors”, he explains with a request not to attribute his comments.

ow this is where things get more complicated. Since 1973 the Obaid family has run Towellers and grown it to great heights. The company has seen highs and lows and throughout all of it they have maintained complete family control. The company currently offers only 20% shares on a free float on the stock market and is more than 80% owned by the Obaid family. Despite being listed (they went public in 1994) it is very much a family business. As such, the company’s owners might feel strangely about offering dividends to small shareholders and have largely been keeping the cash safe. After all they already own more than 80% of the company; their father built this company; they have been running this company without having to pay or answer to any minority shareholder, why would they not consider the company their own? As we’ve discussed above, the company may very well want to keep the stock price low so they can buy back the few shares that are currently held by the public. They will possibly release the dividends after the buy-back which they will get themselves. Remember, when a company is owned by a family they can allocate some of the earnings for things such as salaries, but also perks to board members such as managing their day to day expenses. This then means that company earnings are more like assets for these family shareholders rather than income. There are only really two possibilities. The first is that Towellers has plans to invest these profits further but its management doesn’t want to share its plans with its shareholders. The other possibility, as we’ve discussed, is that the Obaid family wants to initiate a buyback. This would give minority shareholders something to be happy about but might rob them of even higher returns. In both cases, the Obaids are not doing anything illegal per se. But considering they have taken money from public shareholders, what they are is either overly secretive or greedy, both of which cannot possibly have good long-term consequences on a business that wants to be publicly listed and a long-term player in the market. n

STOCKTEXTILES MARKET

OPINION

Fahd Ali ALL THINGS ECONOMICS

Finding meaning in fungibility How foreign assistance fuels much more than just tanks and public sector spending

his is a topic that interests me a great deal. For some time I have been meaning to dive into this but have been preoccupied with other things. It’s been investigated a few times but the best work on it remains to be a paper written by Khilji and Zampelli in 1991! The paper investigates the fungibility of US assistance to Pakistan and its impact on our expenditures. Fungibility here means if resources meant for purpose A can be directed for purpose B. Aid or Foreign assistance received for development purposes can be directed towards military purposes and vice versa. This can happen if external and internal resources are fungible. The paper finds evidence for fungibility of external and internal resources in Pakistan. But that isn’t the only interesting finding of the paper. I think the most striking feature of the paper is another result that has skipped the attention of most (if not all) researchers! Khilji and Zampelli find that: “Pakistan's marginal propensity to spend internal and external fungible resources on public sector goods and services is approximately 0.26 implying that an additional Rs. 1 in fungible resources will raise public spending by Rs. 0.26 with

The author is an economist whose work focuses on macroeconomics and economic history with political economy as a common theme to both

Rs. 0.08 going to defense and Rs. 0.18 to nondefense. The remaining Rs. 0.74 goes into private sector consumption.” This is remarkable. 74% of the additional Rupee raised by the government whether in external or internal resources goes to support consumption of the private sector. Now link it with what I wrote in my previous post on consumption led inflation in Pakistan. The top 20% own 50% of our national income and the top 10% are able to capture 24% of any growth in income in the country. What Khilji and Zampelli findings imply is that the rich seem to benefit disproportionately from foreign assistance as well. Again, it’s something that we all kind of know but it is always good to get some pointers in the right direction. This particular finding in their paper has bothered me for a very long time. I am also surprised that people haven’t really picked it up and we haven’t seen any solid work on it so far. I made a couple of graphs after revisiting Khilji and Zampelli paper. Figure 1 below shows log of four different variables. Don’t worry about Logs - it’s just an easier way of showing/representing large numbers. The four variables are: 1. Average Annual Foreign Assistance Received by Pakistan (logFAssistPKR; includes both loans and grants) 2. Annul Total Expenditure (LogTotExpend), 3. Annual Tax Revenue (logTaxRevenue), 4. Household Final Consumption Expenditure (logHHFCE).

We can see how beautifully the three series move in the same direction. But there is no need to get uber excited. All this shows is a trend in the same direction. This may or may not be interlinked. There is some fluctuation in the Foreign Assistance series, which is understandable. Foreign Assistance to Pakistan would

change from year to year depending on the international situation. We can see these numbers in another way. I took the original series of two of these variables (the ones that were not changed into log form) and scaled it down (another way of saying dividing) by Gross Domestic Product (GDP). The result is shown below in Figure 2.

So before this makes your head spin, let me quickly explain what I have done there. There are two vertical axes shown here. Read the Foreign Assistance Share on the right vertical axis and the HHFCE share on the left vertical axis. This way you can see their movements together easily. Keeping them on one axis would not have conveyed the information that you can see right now. We can see that there are time periods when the two series seem to be moving in the same direction and then there are times when they don’t. Again, we can’t get too excited by it but can still rejoice in the fact that there might be something there. After pondering over this Khilji and Zampelli paper and wondering why everyone seems to have missed the most interesting finding of the paper, I have decided to take this up as my next project. This is the new project that I mentioned in the start of this post. Maybe people didn’t take it up because there was nothing there but I won’t find out without trying for myself. Stay tuned to this space for more updates! n

COMMENT

With prices on the rise,

Pakistan’s employers must go above & beyond With Pakistan experiencing the highest inflation rate in 50 years, employers are confronted with the mammoth task of ensuring that each employee is adequately compensated. Profit therefore provides three simple steps on how this can be achieved By Meerub Amir

he onslaught of Pakistan’s inflation is no longer limited to the debilitating living standards of its people but rather has seen to place all the country’s CEOs at a difficult juncture. Rising prices intuitively signal one prominent problem for companies: as raw materials or inputs become more expensive, the costs of production also increase. With the pressure of compensating employees in time of rising expenses as well as not transferring the burden of costs onto the consumers, the CEO is confronted with difficult decisions. In such circumstances,

the quickest solution would be to increase all wages by the same percentage as the inflation rate. But perhaps the reason why the first lesson in Economics 101 is that of limited resources, is because scarcity is a more pertinent problem than usually perceived. There are two prominent reasons why raising wages by a flat percentage amount is not feasible: firstly, it would pose a tremendous financial burden on companies whose profitabilities are already compromised as explained above, and secondly, it would also not benefit all income brackets equally– which will be explained in detail later on in the article. Hence, a problem unique to inflationary pressures, is the task of determining how to best compensate the workforce.

Pakistan’s Year on Year inflation has grown to 27.55% from January 2022 to January 2023, but the latest Year on Year inflation rate recorded for the month of July stands firmly at 28.31%. This results in some keen glances towards the corporate sector, and nudges all employers to amend their wages and salaries according to the exponentially increasing living costs. But whether or not Pakistan’s businesses have managed to account for all variables in their calculations is up for debate. Imagine this, you’re the CEO of a firm that has two employees: a software engineer and a security guard. They are each paid Rs. 500,000 and Rs. 40,000 respectively. You read a Profit headline that reveals

Pakistan’s Y-o-Y inflation has increased to 28.3%, and so in the quest of being an empathetic boss, to recompense for inflation you decide to increase employee wages by 28% as well. However, as the wave of reality hits, you realize that a 28% increment would add an additional fixed monthly cost of more than Rs. 151,000 which is an unsustainable amount given your limited resources. Additionally, you also realize that a flat increase impacts each income bracket differently such that the engineer would benefit from a higher net increase of Rs. 140,000 than the security guard whose income would only increase by Rs. 11,200 if the increment is implemented. Moreover, each of your employee’s income is also contributing to distinct expenses which take up a different proportion of their income– ultimately rendering such an increase inadequate. To really help paint a picture, if the engineer and manager, with the same original wages stated above, spend Rs. 80,000 and Rs. 15,000 on non-perishable food items, then only their food consumption expenditure should account for 16% and 37.5% of their total income. With an inflation of 28%, however, food expenses would further increase to Rs. 102,400 and Rs. 19,200, and therefore, the proportion of food expenditure to income would also increase to 20% and 48%. The point to note, therefore, is that there is an unequal increase in consumption expenditure for both employees, which means that they are unlikely to benefit equally or sufficiently from a flat percentage increase of 28% since their real wages have decreased by percentages unique to their incomes and food expenses.. What this means is that companies, like Nestle, whose 2022 annual financial report reveals an 18% increase in total salaries, wages, amenities, and training from 2021 to 2022, must take bigger steps to provide a detailed overview of the income increases for each bracket. A collective figure of Rs. 7 billion in wage expenses provides little insight on the potential impact to Nestle’s lowest paid employees. Moreover, it also signals that CEOs require a mechanism to assess how the expenses of their employees have grown relative to their income, and then compensate accordingly. As a result, this is most likely to reduce wage costs than if the 28% increment is applied. This is because, in reality, a firm is likely to hire more than two employees and each employee’s consumption expenditure is likely to include a variety of goods and services other than just groceries. This makes it particularly difficult to compute the effective inflation-adjusted income increase and therefore it is precisely the assistance that Profit aims to provide. Although the State Bank’s Inflation Monitor revealed that Pakistan’s Y-o-Y inflation in April 2023 is the highest rate of inflation

the country has experienced since 1964 with a rate of 36.4%, Pakistan is no stranger to price hikes or its consequences. Wealth and income inequality, as well as the stark disparity in living standards across Pakistan’s socio-economic groups is a topic that has long been explored. But inflation does not only necessitate the revision of living costs and household expenditures; it also impacts wage calculations and labor costs for companies that provide inflation-adjusted incomes. Inflation causes the value of money to depreciate, such that the same amount of income can purchase less goods and services than before. To illustrate using a mathematical word problem, if Person A earns an income of Rs. 50,000 which she uses to buy 10 books costing Rs. 5000 each, then an inflation rate of 36.4% would increase the price of each book to Rs. 6,820. As a result, the same amount of books now cost Rs. 18,200 more– in other words, her real income (actual purchasing power) has decreased to approximately Rs. 31,000. Theoretically, rising inflation causes purchasing power to fall by the amount of inflation on a per-rupee basis. This is a concern for firms as well, particularly those that want to ensure that their employees are not drastically

diture data for a particular fiscal year. In the HIES, all the variables are disaggregated by consumption and population quintiles which means that the population is divided into five groups in order of their incomes with the first quintile representing the poorest 20% of Pakistan’s households. Figure 1, using HIES 2018-2019 data, helps visualize through a Lorenz Curve precisely what the distribution of average income is according to each population quintile in Pakistan. The Lorenz curve is a graphical representation of the distribution of income/ wealth. The curve shows the cumulative share of income from different sections of the population and also draws the line of perfect income equality, which shows the distribution of income if everyone earned the same amount– the poorest 20% of the population would gain 20% of the total income. The poorest 60% of the population would get 60% of the income. Figure 1, therefore, helps us understand the inequality in income distribution as it depicts that the poorest 50% of Pakistan’s households earn approximately only 30% of the total average monthly income, whereas the richest 50% earn and enjoy the remainder. Therefore, since the bottom strata of the

impacted by rising inflation. However, what complicates the situation is that a company consists of not only Person A, rather all letters in the alphabet in each tier of its corporate hierarchy. Therefore, as inflation impacts each income group differently, calculating the effective rate of inflation-adjusted wages can be slightly tricky. Rest assured, the HIES by the Pakistan Bureau of Statistics provides comprehensive data to aid the intricacies of such income calculations. The HIES is the Household Integrated Economic Surveys which is a report by the Pakistan Bureau of Statistics containing household income and consumption expen-

population earns relatively less, it is also disproportionately affected by inflation and price changes. Figure 2 below lays out the data for average household income in Pakistan for each population quintile in 2018-2019 as well as the corresponding average monthly consumption expenditure for the same year. Without accounting for inflation, the poorest households in Q1 spent 47.4% of their monthly income on food expenditure, however, following higher inflation, their purchasing power decreased, resulting in the consumption of food to income ratio increasing to 53%. This was the highest ratio recorded amongst all quintiles, making evident the requirement of customizing

HUMAN RESOURCE

which mandated the national minimum wage to be set at Rs. 32,000. However, prior to this change, for the poorest 40% of Pakistan’s households, the average consumption expenditure– calculated by projecting consumption patterns in the last decade– was exceeding nominal wages. This means that the first two quintiles of the population were most likely in debt as their expenditure was exceeding their income as depicted by consumption to wage ratio (I). Whereas, consumption to wage ratio (II) reveals that when the impact of a 28.3% inflation rate is accounted for, across all population quintiles, consumption expenditure exceeds average monthly income.

inflation adjustment rates according to income brackets. The idea in turn is that the incremental increases in incomes must supersede the increase in consumption expenditure caused by rising inflation.

However, since most data reports on Pakistan’s average incomes, like the HIES, provide a monthly assessment of income breakdowns, the following calculations in this article will be using the year on year CPI inflation rates of 28.3% instead of the SPI.

But, what does this really mean?

Step 2: Organize Data According to Income Brackets

It means that companies, like Nestle, whose 2022 annual financial report reveals an 18% increase in total salaries, wages, amenities, and training from 2021 to 2022, must take bigger steps to provide a detailed overview of the income increases for each bracket. A collective figure of Rs. 7 billion in wage expenses provides little insight on the potential impact to Nestle’s lowest paid employees.

How can we achieve this?

Step 1: Identify the Correct Inflation Rate

closer look into the State Bank’s inflation rate calculation of 36.4% presents two methods of assessing price changes: the Consumer Price Index (CPI) and the Sensitive Price Index (SPI). While the CPI provides a comprehensive computation of retail price changes for a basket of 487 items collected from 40 cities, it is calculated less frequently (monthly basis) than the SPI, which assesses the price movements of only essential consumer items at short intervals (on weekly basis ). According to Pakistan Institute of Development Economics (PIDE), therefore, the CPI is incapable of capturing the price fluctuations which might fade out over the period of a month, while the SPI captures price volatility much better than CPI does, making it a more representative indicator of changes in inflation.

he last Household Integrated Economic Survey carried out by the Pakistan Bureau of Statistics was four years ago which means that the latest data on household incomes and expenditure patterns is from 2019. However, using past data and compound changes in inflation rates between 2010 and 2019, the approximate average household incomes for each quintile in Pakistan can be calculated as well as the Average Consumption Expenditures. This is displayed in figure 3 below. It is integral to note that a government notification was released earlier this month

Step 3: Account for Consumption Expenditure

n circumstances as dire as these, it becomes imperative to ensure that each person earning an income is provided with a level playing field by accounting for his/ her income bracket. For instance, since the real income for the third population quintile reduces from Rs. 37,000 to Rs. 23,723, then not only should their base income increase by 56% to compensate the devaluation but an additional 20% increase should also be granted to ensure that the expenditure to income ratio is maintained at 50%. The values and calculations will differ according to each quintile, which is why a flat inflation adjustment is ineffective. In easier words, for companies to ensure that their employees at each pay scale are less impacted by rising price hikes they must carry out the tumultuous process of assessing the real wages, which means the real value of their incomes post-inflation. Only then can they effectively increase their wages by the percentage difference in real wages and their actual wages, and additionally offer increments or bonuses to ensure that a relatively smaller proportion of their average income is dedicated to consumption expenditure. n

HUMAN RESOURCE

Lucky Motors, and Honda

might just upend the auto finance market even if it’s just for a few months

With nothing to lose and everything to gain, both companies are in uncharted waters with their new schemes By Daniyal Ahmad

ecessity is the mother of invention. Take, for instance, the Ford Model T. It is acclaimed as the first widely affordable automobile in history, and anyone who dared to compete with it would essentially have been confronting the car that revolutionised mobility. Yet, Alfred P. Sloan did precisely that. He forged ahead, and pioneered automotive credit and thereby enabled car buyers to circumvent the need to save for years to purchase the Ford. He had his eureka moment. Pakistan’s automotive industry may be on the verge of its own eureka moment — albeit only for perhaps a few months. In a bid to attract customers, Lucky Motors and Honda have launched their own indigenous financing plans with no interest. Zero. These plans for the KIA Sorento, Peugeot 2008 Allure, Honda BR-V, and Honda HR-V respectively, are unprecedented. This is the first of its kind in the automotive industry. Thus, in an attempt to make sense of the chaos

AUTOMOTIVE

across the industry, the companies have offered customers a bargain. But more importantly, they may have inadvertently created a test case for whether banks can be circumvented from the lending process altogether to go directly to the customers.

A page from the two wheeler market

irect customer financing for vehicles is by no means a novelty in the automotive sector. However, it’s a concept that’s relatively alien to the four-wheeler market. This strategy is, in fact, a cornerstone of the two-wheeler industry — a catalyst for its initial growth and a continuing emblem of its success. It appears that Lucky and Honda have taken note of this trend, seemingly drawing upon it to make sense of the chaos in their respective industries. “The automotive market finds itself in a precarious predicament, grappling with a profound affordability crisis. In response to this, we endeavoured to adopt an innovative and empathetic approach, viewing the situation

through the lens of the customer,” explains Muhammad Faisal, the President of Automotive at Lucky Motors. “Our exploration led us to devise strategies that could offer affordability to prospective customers in a manner that would alleviate their financial burden, shielding them from the exorbitant costs of finance, all whilst requiring minimal equity commitment. Thus, our scheme was born,” Faisal further elaborates. In a similar vein, “The market turbulence has left customers feeling unnerved. Their financial resources have dwindled, prompting us to formulate this scheme with dual objectives — to not only bolster our market presence but also to provide them with tangible benefits,” articulates Amir Nazir, the General Manager of Sales and Marketing at Honda. The underlying rationale for both companies remains consistent. Automotive prices have ventured into uncharted territory at a time when the State Bank of Pakistan (SBP) has clamped down on automotive lending in an effort to stem foreign exchange outflows. Those who dare to venture beyond these factors and contemplate partaking in vehicle

Our exploration led us to devise strategies that could offer affordability to prospective customers in a manner that would alleviate their financial burden, shielding them from the exorbitant costs of finance, all whilst requiring minimal equity commitment Muhammad Faisal, President of Automotive at Lucky Motors

financing are confronted with the harsh reality that Pakistan’s policy rate and subsequently the Karachi Interbank Offered Rate (KIBOR) are at an all-time high. This presents a rather sombre image. However, it’s not just customers who are grappling with the harsh reality of being priced out of the market. The media, including this publication, have been relentless in reporting the record lows automotive companies are hitting each month in terms of sales. Our duo of protagonists have ventured beyond what the two-wheeler industry ever dared to do. “I don’t recall the two-wheeler industry ever offering zero-markup plans. In fact, markups skyrocketing to 40%-50% were far from rare,” explains Fahad Iqbal, Managing Director of Ravi Automobile. “The markups were indeed steep, but the long tenures effectively reduced the instalments to a pittance, which was a major draw for customers,” Iqbal adds. This is precisely what sets this approach apart in the market — its unparalleled singularity.

The savings from the lack of a cost of borrowing

hat do these financing plans offer? Lucky Motors has devised a 12-month and 18-month repayment scheme for the Peugeot 2008 Allure and KIA Sorento respectively. Honda, meanwhile, has settled for a consistent 24-month repayment scheme for both its BR-V and HR-V models. The Sorento demands a 30% down payment, whereas all other vehicles necessitate a 50% down payment. You might be curious as to why these particular models were selected by both companies. This is a valid question, as both have deliberately excluded their most popular models — Lucky with its Sportage and Honda with its Civic — from this scheme. “The Sorento was chosen because we

thought customers would need financial assistance due to the vehicle’s price point, and the higher withholding tax as part of this year’s budget. As for the 2008 Allure, we expected it to generate more volume through the scheme,” Faisal elaborates. Likewise, Nazir remarks, “We had formulated this scheme for a certain number of vehicles as the backorders for both were comparatively fewer than our other models.” Upon closer examination, it seems likely that both companies have surplus inventory that they want to dispose of. There is potential conjecture that these vehicles are lagging behind in sales and perhaps selling at discounted rates in the secondary market — but then again, that is the case for the entire industry. The existing stock of inventory seems to be the most convincing explanation for our protagonists’ choice. However, this article is not about their sales. It is about their savings. The savings from this scheme are

Within the realm of a scenario where a manufacturer can consistently supply vehicles directly to the customer, the delivery mechanism simply cannot operate with a 0% markup. It’s an utter impossibility and, as such, is not practised anywhere else globally Amir Nazir, General Manager of Sales and Marketing at Honda

straightforward: the cost of financing. It’s imperative to explicate this term first, because anyone unfamiliar with car financing might presume that it’s merely the KIBOR you are paying. This is a misconception. The cost of financing for any vehicle encompasses the KIBOR and a rate of profit, known as the margin, levied by the bank. The current minimum is KIBOR+3.5%. This implies that you will incur 25.5% in interest payments for financing any vehicle. So what savings can you anticipate? At the bare minimum, you can expect to save Rs 7.9 lakh, while at the maximum, the savings could reach Rs 17.9 lakh. Lucky’s vehicles command both ends of this spectrum, with the 2008 Allure offering you the smallest savings, and the Sorento 3.5 FWD providing you with the largest. Naturally, your savings could vary depending on the alternative bank financing you are contemplating. In estimating the savings, we formulated an automotive loan that a bank would propose

if you were to purchase these exact vehicles through traditional banking channels. We employed the KIBOR+3.5% rate as our benchmark. It’s crucial to note that this is merely the minimum. While banks will not charge less than this, they will undoubtedly charge more. Furthermore, we considered three distinct scenarios: we assumed there would be no change in the KIBOR throughout the loan duration; we assumed there would be a 1% reduction on successive anniversaries of the loan; and we also assumed there would be a 2% reduction on successive anniversaries of the loan. Regarding anniversaries, we used both loan and calendar anniversaries. The loan we devised commenced in October.” We endeavoured to encompass a broad spectrum of scenarios that a prospective buyer might encounter if they were to finance these specific vehicles from the bank, and that too, immediately. However, we did not factor in the upfront costs associated with the vehicle such as insurance, registration, and the tracker.

While the latter two are standard, your insurance plan will hinge on your bank. Consequently, we focused solely on the interest payments that would have been necessitated based on the portion of the vehicle that the bank would have financed. We operated under the assumption that all vehicles in our calculations had made a standard 30% down payment. For the Sorento, a 30% down payment was not feasible as it exceeded Rs 3 million, hence our down payment for that was capped at Rs 3 million. Our model represents an optimistic, bare-bo loan from the bank that an average buyer would accept without much contemplation. You are certainly welcome to devise your own, but even within our scenario, the savings highlighted earlier are significant. While this strategy appears logical for customers in the market, one wonders if the two companies can successfully execute this without the repossession mechanism typically available to banks?

AUTOMOTIVE

Stress testing the lending

Ultimately, it hinges on the objective of the programme. Do they merely want to evade the cost of holding inventory and generate profits, or do they aspire to create a sustainable model for the future?

aisal and Nazir echo each other in expanding upon their strategies for implementing the scheme. Both strategies hinge on company dealerships and the dealers therein. These dealers will conduct their own rigorous assessment of potential customers, leveraging their networks to identify suitable clients. Moreover, all vehicles will be subject to registration, insurance, and the installation of a tracking device. The reliance on dealers to assess the risk associated with potential customers is reminiscent of practices in the two-wheeler industry. At first glance, this seems reasonable given the industry’s remarkably low default rates and high recovery rates — near perfection in some instances. These achievements are attributed solely to the dealer’s involvement in the lending process. However, it’s important to note that dealers across both segments may not necessarily be identical. “Dealers in the two-wheeler industry are predominantly regional. In many instances, they are influential local figures who utilise their personal connections and patronage networks to sell motorcycles,” Iqbal adds. “They cater to a tightly-knit network, and even today, it remains largely regional. In the industry’s nascent stages, dealers would even station themselves outside a customer’s residence to repossess the vehicle. It’s the personal guarantee of the dealers and their wielded influence that ensure 100% recovery rates,” Iqbal continues. Are four-wheeler market dealers identical to their two-wheeler counterparts? It’s challenging to ascertain. What we do know from our interactions with dealers is that their personal ‘influence’, in relative terms, is somewhat diminished compared to their two-wheeler counterparts. However, this is where additional safeguards such as insurance and trackers come into play. “For an automotive company, insurance

Shahzad Ishaq, Group Head Digital Banking & Chief Digital Officer at MCB

integration offers a safeguard against potential losses or damages. Concurrently trackers significantly bolsters the calibre of collateral — from a recovery and theft risk standpoint — in a remarkable way. Trackers are the reason why motor insurance has transformed from a loss making portfolio to a lucrative venture,” explains Norez Abdullah, former Chief Financial Officer at Hyundai. The vehicles themselves also serve as a form of insurance. With monthly instalments ranging from Rs 1.6 lakh to Rs 4.6 lakh, these are not vehicles within everyone’s financial reach. Only a select group of individuals will be able to sustain cash flows of this magnitude month after month. Cars also represent a distinct type of collateral in the non-banking lending sector. Unlike microfinance loans disbursed for consumption goods whose utility is quickly maximised post-loan origination, vehicles are everyday use-case products. The gratification doesn’t immediately cease, thereby incentivising customers to maintain access to the product. This is further compounded by how vehicles are treated as assets in Pakistan. Read more: The lopsided market structure of the automobile industry Since its genesis in the 1990s, Pakistan’s lending market has evolved considerably, now featuring specialist agencies that manage credit

I don’t recall the two-wheeler industry ever offering zero-markup plans. In fact, markups skyrocketing to 40%-50% were far from rare Fahad Iqbal, Managing Director of Ravi Automobile

collection on behalf of the principals. Furthermore, companies have the option to mitigate risk entirely by enrolling other firms into these schemes. However, this doesn’t imply that such ventures are free from risks. Keeping in perspective the current maturity level of the industry, it’s hard to picture the automotive industry venturing into algorithms for automobile lending — this is an advanced stage of understanding lending, ensuring there are no ‘skip throughs’ or ‘straight skips’,” expounds Shahzad Ishaq, Group Head Digital Banking & Chief Digital Officer at MCB. While automotive companies can avail services of third-party bureaus like DataCheck, they are prohibited from using the SBP’s bureau or any bank’s proprietary one without either complying with the conditions of a formal lender or partnering with a bank. “Lending is a field that requires expertise. It’s not as simple as initiating it, refining it, and assuming it will be fine. No, you need specialists for the process,” Ishaq adds. The automotive companies seem to align with Ishaq’s perspective as there are no indications of this becoming a long-term trend — at least not at present.

The long-term question

onda is very clear about their stance on the matter. Their scheme will come to an end once they hit their desired sales target for their vehicles. So much so, that they emphasise they could cut this off any day. Whilst the urgency may perhaps be a marketing ploy, it also shows that their level of interest (no pun intended) in this is minimal. “Within the realm of a scenario where a manufacturer can consistently supply vehicles directly to the customer, the delivery mechanism simply cannot operate with a 0% markup. It’s an utter impossibility and, as such, is

not practised anywhere else globally,” Nazir proclaims with conviction. Echoing a similar sentiment, Abdullah exclaims, “Predicting and ascertaining the extent of benefit one can reap from such an initiative is exceedingly challenging. There will undoubtedly be a benefit, I harbour no doubts about it. However, whether you attain the desired benefit or not, considering the cost of money involved in dispersing it over 12, 18, and 24 months, remains to be seen.” The magnitude of the discount is not fixed; it fluctuates. To compute the discounted cash flow, we scrutinised the policy rate, the one-year trailing KIBOR, the one and two-year risk-free rates, and the effective interest rates for one and two-year term deposits. We selected these diverse discount rates to consider all potential opportunity costs that the companies might incur. The selection of the policy rate and KIBOR was standard, and these were applied across all vehicles. We adopted the Pakistan revaluation rate as the risk-free rate. We utilised these rates for both one and two years. The former was applied to the 2008 Allure because its financing period did not exceed 12 months. The latter was used for the remaining vehicles whose financing periods exceeded 12 months. We followed a similar approach by taking one and two-year term deposit rates. With the deposit rates, we opted for the effective interest rate rather than the simple interest rate. In discounting the cash flows, we refrained from discounting the upfront payment and the initial cash flow. Through this exercise, we discovered that all vehicles are effectively offered to customers at a markdown by the end of their financing period. When we refer to a discount, we also factor in the price reductions that Lucky and Honda have implemented this October. Ceteris paribus, these markdowns from the financing scheme outstrip the current price cuts. This is also why companies are unlikely to adopt this route long term. While Honda

There will undoubtedly be a benefit, I harbour no doubts about it. However, whether you attain the desired benefit or not, considering the cost of money involved in dispersing it over 12, 18, and 24 months, remains to be seen Norez Abdullah, former Chief Financial Officer at Hyundai

has no inclination to maintain 0% markup rates, we are cautious of Lucky. This is not because they have remained silent on when this scheme will expire but because their pricing strategies are simply eccentric and now that they’ve embarked on this once they could potentially sustain this for an extended period or implement it more frequently. The banks, surprisingly, are more optimistic about automotive companies actually implementing this than automotive companies themselves — albeit with certain reservations. “This is a highly productive and happy development. Moreover, it is a significant and valuable development. It is truly worthwhile to test the waters and see how this entire proposition shapes up,” Ishaq proclaims. “Ultimately, it hinges on the objective of the programme. Do they merely want to evade the cost of holding inventory and generate profits, or do they aspire to create a sustainable model for the future? For the latter, they will require a bank by their side, even if it is in a diminished engagement than the current ones – for instance, a white label arrangement,” Ishaq elaborates. Ishaq’s comments are, in fact, a nuanced

nudge towards the wider automotive sphere, particularly beyond Pakistan. It’s quite ubiquitous for banks to function behind the scenes while automotive firms manage the customer-facing aspects of operations. Such arrangements have been in place for decades in North America and Europe and have gradually gained traction in the Middle East as well. While automotive firms inherently lack the authority to levy interest rates on any form of financing, they are also not bound by SBP’s regulations. One can liquidate surplus inventory, but then one might deplete their running finance. It presents a conundrum. As it currently stands, in merely the pilot stage, both companies are poised to profit and customers stand to gain from discounts. The crux of the matter is what ensues after this. Lending is fundamentally a cyclical business. Interest rates may not plummet significantly in the next six to twelve months, but they are unlikely to remain static for the subsequent twenty-four to thirty-six months either. The question simply is whether these companies wish to capitalise on the insights gleaned during this phase. n

AUTOMOTIVE

PIA’s long dispute with airplane leasing company seems to have ended ECC approves Rs 8 bn financing for reaching settlement By Shahnawaz Ali

he Economic Coordination Committee (ECC) of the Cabinet has approved a Rs 8 Billion bailout for Pakistan International Airlines (PIA) to meet emergent requirements related to overdue payments. Since the last few years, the PIA has been the single-biggest loss making enterprise owned by the government of Pakistan and has been incrementally bleeding billions of rupees every passing year. It faced losses of Rs 97 billion during the calendar year 2022, which is 94% more than its losses in the previous year. The total accumulated losses of PIA have been rising and stand upwards of Rs 500 billion. The Caretaker Federal Minister for Finance, Revenue, and Economic Affairs, Dr. Shamshad Akhtar presided over a meeting of the ECC of the Cabinet, last week. The meeting was held with the sole agenda of PIA, and throughout the meeting the primary topic of discussion were the two A320 aircrafts that the PIA leased from Asia Aviation Capital Limited (AACL) in 2015.

The Story

IA obtained two A320 aircrafts Al -BLY (MSN 2926) and AP-BLZ (MSN 2944) on lease for six years from Asia Aviation Capital Limited (AACL) in

2015.

As per a previous report by Profit, the planes were leased at a monthly rent of nearly $550,000 according to a spokesperson of the PIA – which includes rent for the plane, maintenance costs, as well as insurance. For the next six years, the planes flew as part of PIA’s fleet registered as planes APBLZ and AP-BLY. It is important to note here that most of the planes that are in the PIA’s fleet are older models that have been leased or bought from other airlines. These two A320s were flown for a while as part of AirAsia – the Malaysian multinational air carrier. In the case of airplane lease or rental, the airplane after the stipulated time, needs to be returned (redelivered) to the original owner in its original state. Meaning that any damages to its condition or parts are upon the person who borrowed it. However, in the case of these two air-

crafts redelivery process was not a simple one especially with COVID 19 induced lockdowns and travel restrictions. The process can at times take up to a few months, and until it is complete the airline that leased the planes is expected to continue paying rent for the plane minus its maintenance cost since the plane is grounded. When it was time to return the plane, the PIA asked the company to come and inspect the A320s in Pakistan. Due to travel restrictions, they could not come to Pakistan so the AACL hired a third party company FL Technic for this job which is a global provider of aircraft maintenance, repair and overhaul services, headquartered in Vilnius, Lithuania. The plane was taken to Jakarta, where it was thoroughly inspected. According to our source, the plane did not undergo a C Check before leaving – which is a vital inspection. When it got to Jakarta, it became clear that the plane would require repairs. The plane arrived in Jakarta via Kuala Lumpur on September 19th 2021 via ferry. It was planned that the aircraft will be redelivered in six to eight months after repairs. However, this schedule could not be followed. This led to exchange of claims and

counterclaims between AACL and PIA as to the responsibility for the delay, actual amount of the lease rent, penalties and interest to be paid to AACL. In fact, even till a year later, the plane was neither fixed, nor redelivered. “We had initially asked that the team come to Pakistan to inspect the plane but then because of travel restrictions and security concerns Jakarta was chosen. There is an engineering facility there and we have been paying the rent for the plane but nothing else – the parking fee is covered.” said PIA spokesperson while talking to Profit in June, 2022. So not only was PIA supposed to compensate for the delay, but was also paying the rent for the time that it was grounded in Jakarta. The PIA bled upwards of $5 million just on paying the rent for two planes they were not even using.

What now?

he dispute in relation to the payment of lease rent led to litigation on two previous occasions, in 2019 and 2021, as a consequence of which PIA was forced to pay $12.058 million to AACL. Since April 2022, PIA has extensively tried to reach out to AACL through inter alia visits by senior officials to their headquarters at Kuala Lumpur, but they remained largely unresponsive. However on 11, September, PIA received a Court Notice through AACL’s UK based counsels Herbert Smith Freehills for immediate payment of $ 31.3 million against outstanding rent, redelivery rent, maintenance reserve and interest charges for the two aircrafts. PIA acknowledged the court notice and on its instructions, PIA’s UK-based counsel Norton Rose & Fullbright sought time from High Court of Justice, England and Wales, London to reply to AACL’s claims. Accordingly, the next date of hearing is now for October 30, 2023. At the same time, PIA’s counsels have categorically opined that PIA’s position in this matter is quite weak. They have recommended that PIA may find an out of court resolution with AACL not only with respect to the claimed amounts but also future liabilities with regard to rental payments and redelivery of the aircrafts. The envisaged settlement as revealed by the sources, could be one of the three modes i.e. payment of cash, maintenance buyout or purchase of one or both aircraft. The counsel further stated that since AACL’s claim does not involve factual controversy, it may be decided on a summary judgement for which the case could be heard in around six weeks. It is self-evident that an adverse decision against PIA is likely to result in binding

compulsion to pay the claimed amount and its failure to do so may lead to impounding of its aircraft or attachment of its properties. Moreover, the lease of two aircraft will not end and the rent and other redelivery related liabilities of the aircraft will continue, along with subsequent claims. Taking cognizance of the matter, the PIA board recommended that two board members and the Secretary Aviation should negotiate with AACL for an out of court settlement in the larger interest of the company. On submission of this recommendation, the Prime Minister had allowed the negotiation team to proceed to Kuala Lumpur on 9th October, 2023. After having five rounds of negotiation with the Chief Executive Officer, Air Asia Aviation group and his team negotiation succeeded in convincing them to settle the matter at a consolidated amount of $26 million which includes transfer of titles of two aircraft in two instalments. Sources said that PM approved in principle to conclude the negotiation with the AACL on the loans and placed the case before the ECC for a provision of a grant of PKR 7.3 billion to PIA.

Letter of intent to settle the matter in the above terms agreed between PIA and AACL besides comments of Finance and Privatisation Divisions were invited on 13, October, 2023. Both the divisions have supported financial support of Rs 7.3 billion to PIA. However, the finance division informed that a supplementary grant cannot be granted during the period of SBA with the IMF and advised to arrange financial facility from the market against the balance of guarantee ceiling i.e Rs 7.5 billion. According to the finance division, ECC decided to approve the proposal of Aviation Division for bridge financing through Civil Aviation Authority’s (CAA) resources amounting to Rs 8 Billion for PIA to meet emergent requirements related to overdue payments. It is important to note here that bridge financing is a form of temporary financing intended to cover a company’s short-term costs until the moment when regular long-term financing is secured. This means that the bailout money, in one way or the other will puncture the national exchequer, even if it is not doing so now. The ECC concluded by allowing the Aviation Division to proceed with the bilateral arrangement between the CAA and PIA. n

Currency in circulation has declined sharply in 2023’s third quarter.

What’s behind the unusual drop?

Currency in circulation decreased by 9% QoQ, which according to JS Global Capital is a pace not witnessed in many decades By Urooj Imran

s the world continues to move towards digitalisation in all things, including monetary transactions, cash remains the king in Pakistan. Over the years, the country’s currency in circulation — the amount of notes and coins issued by the State Bank of Pakistan (SBP) that are out of the banking system — has continued

to grow, reaching Rs 7.68 trillion by December 31, 2023. Given the trend, it appeared that this year would be no different. That is, until data shared by the SBP showed the currency in circulation (CIC) declined by 9% quarter-on-quarter in September (according to data analysed till September 22). According to a report by brokerage house JS Global Capital, this pace of decline has not been seen in many decades. After all, in the last

AVIATION

quarter — April to June — CIC grew 11%, a pace that was last recorded 23 quarters ago. And the average historical quarterly growth is 3%. One reason for the decline in currency in circulation is the increase in deposit mobilisation (excluding interbank deposits, deposits of government and foreign constituents). According to SBP data, deposit mobilisation in 2023’s third quarter was up 1.7% compared to the April-June period. The biggest contribution to this increase was by individuals (personal segment), which accounted for 60% of the total new deposits, followed by non-banking financial institutions at 11%, the power sector at 10%, and non-financial public sector enterprises at 8%. For context, almost half of Pakistan’s total deposits in commercial banks are of the personal segment, which include salaried and self-employed individuals, according to the JS Global Capital report. In its report, JS Global Capital said higher savings rates following the central bank’s decision to hike the policy rate by 100 basis points to 22% in June could be among the key reasons for the shift from cash to deposits. It added that other possible factors such as the ongoing crackdown on various segments of the economy, and relative stability in the USDPKR exchange rate cannot be ruled out. Law enforcement agencies had launched a crackdown on illegal foreign exchange trading and smuggling in various sectors of the economy in early September after the rupee fell to record lows of Rs 307.09 and Rs 334 per dollar in the interbank and open markets, respectively. This was followed by structural reforms for exchange companies, which have been directed by the SBP to consolidate into a single category by December this year. Resultantly, the rupee has been recovering steadily — from Sep 6 to 28, the rupee gained Rs 19.24 per dollar or 6.26% in the interbank market and Rs 24

per dollar or 7.69% in the open market. Faizan Kamran Khan, CEO of FRIM Ventures, also said the CIC decline can be attributed to the operation against smuggling and foreign currency hoarding by law enforcement agencies that led to the rupee’s sharp appreciation. “Speculators rushed to sell off their dollars and bring their funds back into the banking system to be safe from investigations into their informal wealth,” he elaborated. Meanwhile, Ahfaz Mustafa, CEO of Ismail Iqbal Securities, said currency in circulation decreased because people regained confidence in the markets and “probably opted to come back into the system and take advantage of higher rates”. “As things improve and fear of bankruptcy subsides, we see people coming and deploying money in the formal sector and taking advantage of higher interest rates,” Mustafa added. After the government managed to sign an agreement with the International Monetary Fund in June, fears of a potential default

were finally put to rest, and foreign exchange reserves nearly doubled to over $8 billion after funds were received from the IMF, Saudi Arabia and the United Arab Emirates. Mustafa said the decline in CIC was a positive development as it signalled public confidence in economic recovery, and could eventually lead to lower inflation. When the currency in circulation is high, it fuels demand, which in turn leads to higher inflation. Pakistan is an import-dependent country, so when demand rises, imports also rise, putting pressure on the foreign exchange reserves. One of the ways that the SBP, or any central bank, seeks to reduce inflation is by increasing the interest rate. This makes it more profitable for people to deposit money in bank accounts and earn interest compared to spending it or investing elsewhere; this way demand is suppressed and currency in circulation reduces, leading to lower inflation.

Will CIC continue to decline?

ccording to Khan, it depends on whether the rupee continues to appreciate. If that happens, speculators may see greater returns in rupee-denominated assets, he said. “If this is corroborated with decline in commodity prices such as sugar wheat etc. then this trend may well continue.” He added, “I still think the crackdown by law enforcement agencies will continue to be the major factor behind bringing wealth back into the formal system and hence, put pressure on CiC. But long term reforms to formalise the economy are needed to bring a sustainable decline in CiC.” Mustafa said as long as the economy — which was plagued by uncertainty and fears of default for at least half this year — continued to improve, more people would move their cash into assets and money would move to the banking system. n

ECONOMY