CONTENTS
10 10 It’s all about the economy, stupid (and a little about fascism) 14 What’s next for Hubco? 18 The business-military link is fraying… and might break 24 Could the KSE-100 hit 60,000 by 2021? JS Global seems to think so
25 25 As it grows, Habib Metro’s compliance struggles to keep pace 27 The mechanics of privatisation Saleem Javed 29 As prices keep declining, furnace oil starts looking more attractive as a fuel
31 31 To privatise or not to privatise? Asif Saad 34 How Pakistan’s Big Tobacco gets away with tax theft 40 If you work out, IGI Life will now give you mobile credit 41 Could the Yaris help Toyota recover from its sales slump?
welcome
A real upgrade Over the past couple of weeks, the government got some good news: Moody’s, the New York-based global ratings firm, decided to upgrade Pakistan’s sovereign credit outlook from “negative” to stable, a move that the government of Pakistan apparently felt the need to point out as a positive development. We are not arguing that this development is not positive, but we do think that the government would be better off if it raised its standards for what constitutes good news for the economy. Let us take a step back and examine what this represents, precisely. Bond credit ratings – sovereign or otherwise – consist of letter grades accompanied by either numbers or a plus or minus sign to further indicate level of strength of the credit rating. A triple-A rating is the highest possible, and a single-C indicates the lowest possible credit rating without actually defaulting. Pakistan currently stands at a B3 (the lowest possible B-rating) with Moody’s and at a B- with both Standard & Poor’s and Fitch, the other two major global credit rating agencies. The outlook, which is what changed in the case of Moody’s, is simply an indicator of what direction that rating is likely to change in when it is next revised. It can be one of three things: stable, negative, or positive. Moody’s had a negative outlook
on Pakistan, the only one of the big three ratings firms that had a negative outlook on the country since February, when S&P changed its outlook to stable. All three firms now rate Pakistan as stable. Of course, it is better to be stable than negative in outlook, but all it means is that we are unlikely to be downgraded any time soon in terms of ratings. It is nothing to celebrate, or frankly, even make note of beyond a small story buried somewhere in the financial press. The government of Pakistan should have significantly higher aspirations when it comes to the nation’s sovereign credit ratings, the most ambitious of which is to earn an upgrade – eventually – to investment grade. We understand that there is a long way to go before Pakistan can even dream of reaching that level, but it will not happen at all if the government does not lift its gaze higher and strive to achieve that goal. For all our disagreements with former Finance Minister and current Planning Minister Asad Umar, we did appreciate that he articulated that as a policy goal for the country to achieve. We hope his return to the cabinet means that the government has not lost sight of that goal.
Farooq Tirmizi Managing Editor
Executive Editor: Babar Nizami l Managing Editor: Farooq Tirmizi l Joint Editor: Yousaf Nizami Reporters: Syeda Masooma l Taimoor Hassan l Abdullah Niazi l Meiryum Ali Director Marketing: Zahid Ali l Regional Heads of Marketing: Muddasir Alam (Khi) Zulfiqar Butt (Lhr) l Mudassir Iqbal (Isl) l Layout: Rizwan Ahmad l Photographers: Zubair Mehfooz & Imran Gillani l Publishing Editor: Arif Nizami l Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk
FROM THE Managing EdiTOR
9
L
et us end the year with a bang, thought Pakistan Muslim League Nawaz (PML-N), over something that everyone can remember. Somehow, the PML-N thought a dry, technical and difficult to understand analysis of the economy was the best way to achieve that goal. Excitedly titled “PML-N Economic Conference” - no, really - the conference was held on December 17 and led by the party’s general secretary Ahsan Iqbal. It was also attended by PML-N’s economic advisory council members, such as Muhammad Zubair, former chairman of the board of investment, Khurram Dastgir, former minister of commerce, and economist Dr Ayesha Pasha.
10
Meanwhile, Marriyum Aurangzeb was doing her best tweeting the conference for media attention. That, she definitely received, as she then called on Prime Minister Imran Khan to rebut the white paper released at the conference “instead of hurling slurs, threats and insults”. In response Dr Firdous Ashiq Awan lashed out and accused PML-N of “shedding crocodile tears”. And then, after decent press coverage, the paper was forgotten, because the very person in charge of that conference, Ahsan Iqbal, was then arrested by the National Accountability Bureau (NAB) a week later over corruption charges, and the conversation changed again. So you are probably asking: why is Profit even bringing up this paper? (Do not worry,
Profit’s managing editor wondered the same). Surely there are bigger fish to fry? There are two reasons for this. For one, the actual contents of this paper, while interesting, are not as important as what this paper represents. For once, the conversation between political parties is not about ideology or establishment sponsorship or the army versus everyone else (disclaimer: incredibly important conversations to be had in Pakistan, no doubt), but instead is about… the state of the current reserves? The Pubic Sector Development Program (PSDP) spending? The take down that PML-N chose to go with, that it wanted broadcast, is basically a reflection of how in the last two years, conversations about the economy, or the International
Monetary Fund (IMF), or taxes, have actually permeated national consciousness in society in a way that it had not before. And that is important because whether you agree or disagree with the premise of the paper, we are all engaging with it at a level unseen before. This is good news for financial journalism, good news for our democracy, and good news for a more informed public. Second: the paper has a whole two slides dedicated to calling the ruling Pakistan Tehrik-e-Insaf (PTI) a fascist party. This cannot be stressed enough. Outside of the liberal twitter chatter, or those in the Pakistani far-left, (and those two camps are distinct), when have you heard of a national party being openly called fascist by an opposition party in Pakistan? Almost all news coverage of the white paper declined to mention how strange - or even frank and bold - that is. And that section, too, deserves examination.
The economy
T
he white paper, grandly titled “Clarion Call, Rescue Economy”, is less of a paper, and more like 11 slides of a Powerpoint presentation. While a significant amount is spent discussing the PTI’s failure with regard to India, the bulk is spent discussing the problem with Imran Khan’s economy. As far as PML-N is concerned, the “Imran Khan government inflicted on 210 million Pakistanis the worst era of governance in Pakistan’s history; marked by catastrophic mismanagement in national security and economic policy; and by condemnable degradation in human development and in constitutional rights of Pakistani citizens.” As for what they are specifically upset about: there are a couple of salient points. First, the size of the economy, as measured by gross domestic product (GDP). According to the paper, Pakistan’s GDP at the completion of PML-N tenure in 2018 was $315 billion, while Pakistan’s GDP at completion of the first year of Imran Khan’s government is $275 billion. As per the paper, the “GDP growth rate plunged to less than 3% under IK compared to 5.8% growth achieved in the last year of PML-N.”
Secondly, inflation has risen from 3.9% in June 2018, to 12.7% in November 2019. PML-N also claimed it had one of the lowest inflation rates at 2.9% in the fiscal year ending June 30, 2016. According to the paper, this high cost of inflation has “massively contributed to the nightmare of the masses”. And worryingly, that high inflation will affect poverty rates in the country. “This has resulted in pushing more than 8 milion Pakistanis below the poverty line within 16 months,” the paper claims. According to PML-N, this means that the national poverty rate will go to 40% in June 2020. Third, as per PML-N, the PTI government posted the highest ever fiscal deficit, at 8.9%. “This is the highest that Pakistan has seen in the last 40 years.” The PML-N paper writers also managed to work in a good jab directed at the Prime Minister’s Finance Advisor and de facto finance minister Hafeez Shaikh, noting the prices of tomatoes twice: “tomatoes have [risen] by an unbelievable 437%”, and “Nothing was more hilarious than the finance advisor’s statement
Every Pakistani government whether it be the Pakistan Peoples Party (PPP), PML-N or PTI, has inherited a mess of an economy. This was true in 2008, 2013 and 2018. A better economic analysis by PML-N, and a more accurate one, is this: “the PTI is not as good at cleaning up our mess, as we were at cleaning up the PPP’s mess”
regarding the price of tomatoes when he claimed the price be Rs 17 as against market prices of Rs 350.” Tomatoes aside, when you look at the numbers presented this way, much of the above information is correct. But the problem is that the PML-N is comparing its final years to PTI’s first years, forgetting a cardinal fact: every Pakistani government whether it be the Pakistan Peoples Party (PPP), PML-N or PTI, has inherited a mess of an economy. This was true in 2008, 2013 and 2018. It is sad but in Pakistan you can not actually judge any party’s economic policy. Instead, you have to judge how efficiently and quickly was the party able to reverse the economic damage done previously. A better economic analysis by PML-N, and a more accurate one, is this: “the PTI is not as good at cleaning up our mess, as we were at cleaning up the PPP’s mess”. On that account, PML-N actually did really well. After winning the general election in 2013, PML-N had to figure out what to do with PPP’s mess. Pakistan’s economic growth was around 3.5%, and forex reserves were around $6.5 billion, their lowest level in 10 years. PML-N policies were able to turn that around. First, they did exactly what PTI did, which is go to the IMF, for a three-year $6.68 billion programme to help the economy. Secondly, they got the ball rolling on the China-Pakistan Economic Corridor (CPEC), which led to an increase in spending on development projects. Unfortunately, that is where the positive
POLITICAL ECONOMY
story ends. As everyone now knows, the PML-N was betting on a consumption-led growth model. This led to an increase in imports, but not much increase in exports since the PML-N was not focused on manufacturing. Most of the low inflation was also helped by very low global oil prices that the PML-N passed on to the consumer. Even the low interest rates that PML-N is boasting about did not lead to a stimulation of the economy as expected, and there was little investment from the private sector. And the worst, and this reporter’s personal pet peeve, was the absurdly pegged rupee. One would assume that the PML-N paper authors would keep the conversation around the numbers mentioned previously and not broach the topic of rupee: yet, bravely/stupidly, they called the devaluation of the rupee from Rs115 to Rs159 a ‘major blunder’. “Devaluation failed disastrously; exports actually fell, boosted inflation and harmed industry using imported inputs.” Later, they wrote: “Despite a massive 40% devaluation of Pak Rupee, exports decreased to minus -1.3% under IK, compared to positive 12.8% growth achieved in the last year.” The rupee’s inability to devalue is one of the major reasons for the PML-N mess that PTI is now attempting to fix. The PML-N in their paper actually answers their own created problem: “The ideal way to improve current account deficit is to increase your exports which unfortunately has not been the case.” Yes, exactly! Devaluation combined with a robust manufacturing sector: unfortunately on that last one, the PTI has also failed to deliver.
Facism
O
ne cannot stress enough how absolutely wild it is that this word is being used in Pakistani political space. For one, we live in a world where our next door neighbor’s government is engaged in policies that have been compared to outright facism (fairly or not), and generally, the world that we live in has seen a rise in rightwing governments across the world.
The actual contents of this paper, while interesting, are not as important as what this paper represents. For once, the conversation between political parties is not about ideology or establishment sponsorship or the army versus everyone else (disclaimer: incredibly important conversations to be had in Pakistan, no doubt), but instead is about… the state of the current reserves? The Pubic Sector Development Program (PSDP) spending? So, obviously, this is a loaded word. Let us first look at the textbook definition of what fascism is: “A political philosophy, movement, or regime that exalts the nation and often race, above the individual and that stands for a centralized autocratic government headed by a dictatorial leader, severe economic and social regimentation, and forcible suppression of opposition.” If you are in the opposition, you could see PTI as a quasi-fascist party, headed by a ‘dictatorial leader’, democratically elected, but Establishment-backed, and of course, the forcible suppression of opposition. Which is why the paper goes on to say: “Media in the first one year of Imran Khan’s government suffered near-total censorship, acknowledged and documented around the world, and repeatedly protested against by all recognised journalists bodies.” As per the paper, channels were taken off air, interviews of PML-N politician Maryam Nawaz, former Finance Minister Ishaq Dar, and former President Asif Ali Zardari were blocked. Maryam Nawaz’s rallies were also blocked from coverage. And more importantly, “trolling at the behest of PTI peaked and threats, intimidation and abuse of honest critics quadrupled.” Why are we at Profit highlighting this? Firstly, because as a publication, it is in our interest to be able to comment openly on the affairs of the country, financial or otherwise. Secondly, whether or not you agree with PML-N on their version of press freedom, it is a
As far as PML-N is concerned, the “Imran Khan government inflicted on 210 million Pakistanis the worst era of governance in Pakistan’s history; marked by catastrophic mismanagement in national security and economic policy; and by condemnable degradation in human development and in constitutional rights of Pakistani citizens” 12
fact that press in Pakistan does have pressures exerted on it by both the Establishment and the government. And most importantly, a climate of uncertainty, or a climate of perceived injustice or perceived media black out, is not good for an economy. Discussion of the economy is not just limited to watching the deficit number go up and down. It is also about, for instance, talking openly about tax evaders, or what is wrong with the abiana tax in our irrigation system, or what is up with our sugar mafia. And that depends on creating an environment of free speech - whether that is PTI or PMl-N or PPP. If a PTI troll, in this case, is holding on steadfastly to an alternate version of an economic narrative, then that is not good over all for the economy or the public.
End
S
o where does that leave us? Well, as mentioned before, less than a week after the release of this white paper, Ahsan Iqbal was arrested by the NAB for alleged corruption in a sports complex. If you are on the side of the PTI, it is just another day in Naya Pakistan, where corrupt politicians are finally being held accountable by the government. If you are on the side of the PML-N, it is just another day in Naya Pakistan, where perfectly reasonable politicians are being hounded by a fascist and Establishment-backed administration. And in the midst of this, the economy is being as a punching bag, where both sides are hoping to outdo one another on whose deficit is smaller. In reality, the two conversations of the ‘economy’ and ‘political freedom’ go hand in hand. Many often divorce the two topics in Pakistan, to the detriment of both. And that is why engaging with even white papers, no matter how obvious, or repetitive, is important for every political party out there, and for every citizen reading. n
POLITICAL ECONOMY
14
WHAT’S NEXT FOR
HUBCO?
With its largest base plant responsible for 80% of its production out of commission, Hubco is looking at big changes ahead. But how will their recently established subsidiary company, Hub Power Holdings Limited (HPHL), help them achieve this
O
By Abdullah Niazi
il-based power production is on its way out. In Pakistan, and what is replacing it is a hodgepodge of coal and liquefied natural gas (LNG) based power plants that have taken over in the past few years in an attempt to get out of the rut of oil based production problems such as fluctuating prices. Earlier this month, Profit’s cover piece explored the dimming stars of the Hub Power Company (Hubco), Pakistan’s largest independent power producer (IPP), and a company that has traditionally used oil to fuel its power production. With its largest base plant, which accounts for 80% of its production capacity, effectively shut down, Hubco has a lot of introspection to do. But it seems that the company had seen this coming down the road some years ago, and had been planning their next step for whenever the inevitable happened. Hub Power Holdings Ltd (HPHL) was established in 2015 as a wholly owned subsidiary of Hubco to invest in its future growth initiatives like recently commissioned China Power Hub Generation Company Ltd. With the changing times, the HPHL is looking towards other avenues to make up for what are going to be hard times ahead in the power production sector. And while the natural impulse or assumption would be that Hubco is or should move towards operating on a different fuel source such as coal or LNG, there might be an even bigger change on the cards. Since its inception, the HPHL has been actively pursuing an aggressive growth plan for the water and power portfolio of Hubco. With so much on the line and some change or the other definitely in the offing, Profit spoke to Mr Ruhail Muhammad, the CEO of HPHL, to find out what in the world is Hubco planning next.
Terrifying numbers
T
hey are still not easy to digest. As Profit pointed out last month, it is a hard sell saying a company that made Rs11.9 billion in profits last year is struggling. But the future is full of existential questions for Hubco, with their base plant effectively shut down operating at 1.3% of its capacity. Hubco’s bane has been oil. Traditionally, the company has focused on efficiency to stay on top, taking great pride in their top of the line technology from the likes of General Electric rather than the cheaper Chinese options that a lot of companies end up using. But has oil-based power production become unsustainable even for efficient companies like Hubco?
ENERGY
“We are the only IPP in Pakistan with four growth projects listed in CPEC [China-Pakistan Economic Corridor]. Two of these growth projects, the 2x660 MW imported coal power project at Hub and First Phase of the Thar coal mining project, have already started commercial operations. Coal is supposed to be the cheapest fuel among all other sources for the base load and hence the newer projects that we are doing are all based on coal” Ruhail Muhammad, CEO of Hub Power Holdings Ltd Ruhail Muhammad recognises the trouble that Hubco is in, and the company seems to have been aware of the impending doom and gloom. Government policy had clearly been changing soon after the Nawaz administration came into office in 2013, and the most significant change to that had been in attitudes towards the fuel mix. The type of fuel being used was the biggest factor in the high energy prices, and with most of the base requirement being fulfilled by power producers that used oil, matters became even worse because of just how volatile oil prices were. Because of this, the latest additions of power plants that came after 2013 were mostly consuming coal, LNG as well as hydroelectricity rather the more expensive fuels like refined furnace oil (RFO). Most of these plants are now contributing to the national grid, and at the cost of record breaking smog levels and the country’s largest province unable to breathe, the capacity has become sufficient. But needless to say, with the current trend, RFO-based plants will be used less and less, and their only role will be for peaking in summer, rather than being used as the base load as they once were. With this clear change in trend, Hubco had set up the HPHL, in part to tackle the problems of the future and chart the path the company would eventually take to invest in its future growth initiatives. “In the past two years, we have witnessed the addition of more than 10,000 megawatts (MW) generation capacity in the national grid. These include thermal as well renewable power plants. The thermal plants include coal and RLNG [reliquefied natural gas] based plants which not only use cheaper fuels but are also based on the latest technology and therefore offer significantly higher efficiency,” says Ruhail Muhammad, CEO of HPHL. Hubco’s RFO plants based at Hub and Narowal continue to be amongst the most efficient plants in the country, beating out other
16
power producers. “This is why our Narowal Plant was dispatched sporadically in the August-September (during a time when demand was at its peak). However, since demand has not increased in line with the capacity additions, none of the RFO plants are getting regular dispatch,” he says. But this is not the end of the story, because an additional problem is transmission and distribution (T&D) that the government needs to give some thought to. The country’s T&D infrastructure is in dire need of upgrade if the government wants to ensure that the potential demand is met through maximum utilisation of available generation capacity. This would also lead to improvement in grid stability which should motivate industries to switch from captive power to the national grid, thus increasing power demand while making cheap local gas resources available to more efficient uses.
The alternatives
G
etting gas, would of course, be a natural boon for Hubco. However, for now they seem to be looking towards coal while trying to keep their clean, efficient image. According to Ruhail Muhammad, Hubco is leading the country’s generation capacity expansion by undertaking growth projects worth more than $4 billion. “It is pertinent that we are the only IPP in Pakistan with four growth projects listed in CPEC [China-Pakistan Economic Corridor]. Two of these growth projects, the 2x660 MW imported coal power project at Hub and First Phase of the Thar coal mining project, have already started commercial operations” he says. “Coal is supposed to be the cheapest fuel among all other sources for the base load and hence the newer projects that we are doing are all based on coal.” But even with this, he insists that the company is going to keep its operations smooth
and clean, working on the efficiency ethos that has got it so far up until now. “Efficiency and engineering excellence are at the forefronts of Hubco’s operations. That is why Hubco has long been partnering with the most technologically advanced companies like GE, MAN, Ansaldo, ABB, etc. to institute technological initiatives at its base plant” he explains. “These include implementation of Predictive Enhancement and Performance Improvement (PEPI) Solutions of GE at Hub plant which has led to 3.5%-4% improvement in efficiency of its generating units. A similar initiative of GE for predictive maintenance, Advance Performance Management (APM), was implemented at the Narowal plant. On the other hand, Hubco has selected the state-of-the-art equipment for its growth projects as well. Our coal-based growth projects utilise the latest supercritical / subcritical technology and highly efficient European boilers.” Seeing the cards, the government had already offered to convert two units of 300 MW each into coal power units for Hubco. There was talk of using supercritical and GE technology to make the plant as viable and efficient as possible. “With the current trend in the demand and supply, the RFO based plants like Hubco are not likely to be dispatched until 2027. However, the government will be paying us the capacity charges so we offered that the Hub Plant shall be used for a national cause. Hence we initiated proposal first to K-Electric and then to the federal government to convert two units out of four i.e. 600MW to coa,l” Ruhail Muhammad explains. “We will only have to convert the boiler to the coal base and the rest of the plant including the turbines will remain the same. Using coal as the fuel will keep the cost of electricity generation significantly lower as compared to any other fuel and hence Hubco and KE have signed an MoU to further the feasibility of the project.” As per Hubco, this would be a win-win
Shuttered plant
1.3%
The proportion of the main power plant at Hub, owned by Hubco, that was utilised for power generation over the past quarter, according to the company’s financial statements
situation for everyone. Indeed, the state-owned monopoly buyer of electricity from power plants, the National Transmission and Dispatch Company (NTDC), would be relieved on making capacity payments for two units for at least 5 years. which would end up saving around Rs50 billion. Meanwhile, KE will get a cheaper source of electricity, and the government will spend less on importing new plants rather than retrofitting an old plant. “We are right now in the process of preparing feasibility and in parallel getting approvals from NTDC for the conversion process. For the remaining two units we have started to assess the possibility of converting one unit into a sea water RO plant to address the water scarcity. However we are yet to work on the economics and formal approvals of this proposal.”
Capacity payments
T
his of course raises the question of what exactly these capacity payments that would be relieved from the NTDC are, and whether Hubco and other power producers depending on them is a sustainable or healthy business model in the first place. Capacity payment is a critical feature of an IPPs business model. The business model of an IPP is that a custom-made plant is setup for the only buyer in Pakistan which is NTDC. Hence there is no other option for all IPPs but to rely on capacity payments. This was embedded in the policy made by the government during the 1990’s and after which was followed for all the IPPs . But this is something that the company eventually wants to wean itself off, especially since the government has since the very beginning has not been a particularly reliable partner. Hubco’s management and board have also told Profit, that they have been proactively seeking and venturing into new opportunities and made timely decisions to invest into projects in hydroelectricity and other lower cost of fuels and diversify into B2B models, water projects and other industrial sectors. But despite volatility in government policy, Hubco is still hoping that the current
Unaffected profitability
Rs11.9 billion
government will end up somehow improving the sector. Their hope is that the power sector reforms initiated by the new government will start producing results during the ongoing fiscal year over the flow part of the equation i.e. the gap between the receipts and payments. “Measures such as curbing power theft, improving recoveries, increasing end-consumer tariff and improving the share of renewables and indigenous fuel in the generation mix, are expected to address the root causes of circular debt and will ultimately benefit Pakistan’s energy sector on a sustainable basis,” says Ruhail Muhammad, going on to explain that “the power sector circular debt stands at historically highest level of approximately Rs900 billion at the start of December 2019.” “This situation is severely constraining the sector’s liquidity for which the government had planned to inject a sizeable amount of Rs600 billion through issuance of Energy Sukuk in 3 tranches to ease the liquidity of the sector. After the first tranche of Rs200 billion in March 2019, the remaining two tranches have been considerably delayed mainly owing to IMF program. However, we are hopeful that after the recently concluded IMF review, the work on Energy Sukuk will speed up and the next tranche of Energy Sukuk would be issued soon.”
The company’s image
C
oal is bad. That much humans have been able to figure out. As cheap and reliable fuel source as it may be, it is limited and causes irreparable damage to the environment. But then again, it is cheap and reliable, which seems to outweigh all the nastiness. At a recent lunch hosted by Hubco senior management, there was a lot of talk about critical and supercritical technology that would provide ‘clean’ coal energy. However, despite all of this, the bottom line was that coal is still the most used fuel source in the world, and if that is where Pakistan’s government policy was taking power production, then there was no other choice. Ruhail Muhammad had the same take on this issue. He did not really say whether or
Hubco’s net income over the 12-month period ending September 30, 2019; a level of profitability the company is able to maintain because of capacity payments
not the company’s image would be hurt, but he did try and give reassurance that they would maintain what they see as their standards of efficiency and cleanliness. “All our coal projects are approved by the respective provincial Environment Protection Agencies (EPA). Further, the projected emissions of all plants comply with the National Environment Quality Standards (NEQs) and IFC Standards and the emission levels are well below the limits prescribed by such standards,” he says. “Unlike the common perception that coal plants emit black smoke, smog or particles, one has to know that the Supercritical Technology does not emit any particles or negative emissions. You can visit the new coal-based plants at Port Qasim or Hub and see there is no such issues.” “It is also important to mention that Pakistan’s carbon footprint is one of the lowest in the world and the overall emissions level on absolute and per capita basis are still far less than many countries including US, UK, China and India.” He also pointed towards a recent study published by John Hopkins University, which oddly enough seemed to claim that countries like Pakistan might just benefit from a larger carbon footprint. The research paper argues that development will require a substantial increase in greenhouse gas emissions and water used for the country’s population to achieve a nutritious diet. In order to get countries such as Pakistan to a place where they are not experiencing chronic undernutrition, they will need to eat more, and accordingly, will need to increase their carbon footprint. “Hubco has also made significant investment in the latest available technological intervention to control the environmental impact of emissions at all its plants including coal projects,” adds Ruhail Muhammad. The claims are tall ones, and at moments dubious ones. Coal, no matter what you do, is still going to mess up the environment. But that seems to be a cost that the world is willing to pay, and Pakistan and its power producers are not going to be the ones to make any revolutionary changes. n
ENERGY
18
POLITICAL ECONOMY
W By Farooq Tirmizi
hen was the last time you saw a conglomerate advertising not its consumer-facing or even industrial products but itself – its own reputation as a responsible corporate citizen? Probably last night, if you live in Pakistan and watched the news on just about any major channel, with Engro Corporation’s ads about its various business lines and their positive impact on Pakistan’s economy and society. Of course, Engro being among the most sophisticated locally owned conglomerates in the country, at least part of the reason is likely just corporate brand-building: Engro wants prospective suppliers, customers, employees, financiers, and business partners to view the company favourably. But it probably is not entirely a coincidence that the company’s activities – and, more recently, its chairman and largest shareholder Hussain Dawood, along with his son and Engro board member Samad Dawood – have been named in inquiries currently being conducted by the National Accountability Bureau (NAB). At least part of the reason for the ads, then, might simply be Engro turning to the court of public opinion to help counter the near-hysterical theatrics of reporters who appear to have convinced themselves – without any substantive evidence to date – that Engro and its officials must be guilty. They are just not sure yet of what crime. While most viewers probably did not pay much attention to the ads, they represent an interesting – and important – shift in power dynamics in Pakistan. It is highly unusual in the country’s history for a large, well-capitalised, highly influential, and generally well-regarded company like Engro to be turning to public opinion directly rather than engaging in a more quiet lobbying campaign with the government to ensure that its side of the story gets a fair hearing. The reason why Engro is doing this is extraordinary. For the first time since at least the late 1950s, there is no longer a straightforward answer, at least as far as the business community is concerned, to the following question: who is in charge of the government of Pakistan? Political scientists – both inside Pakistan and abroad – refer to governments like those currently in office in Pakistan as a “hybrid regime”, meaning it has elements of
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both democratic civilian and autocratic military rule. And the presence of that duality is causing confusion among leading businesses in Pakistan as they have undergone an extremely aggressive – and heavy-handed – prosecution campaign by NAB, which has rendered it virtually impossible to figure out what the government considers acceptable. And while the government announced on December 27 an amendment to the law that curbs some of NAB’s worst powers, in effect promising relief from that aggressive campaign, the question that will continue to puzzle the business community is this: who should they turn to when they have a problem? Who is in charge in Pakistan today? And what does it mean for their future and that of the Pakistani economy? For this story, Profit spoke to several current and former senior officials inside large companies that have been targeted by NAB for prosecution, as well as other officials who have familiarity with NAB prosecutions. So total is the fear of what NAB might do – and how vindictive its investigating officers have become – that none of them were willing to speak on the record, with their names published. What they describe, however, is an environment both inside the government and inside companies that frequently do business with the government that was paralysed in terms of decision-making. Officials were terrified of signing routine contracts for fear of having that signature be used by NAB as the basis of an arrest warrant and prosecution. Planning for long-term projects that need government collaboration or even approval came to a grinding halt. And several major investment projects had been put on hold, including additional LNG projects. Indeed, Iqbal Z Ahmed of the Associated Group was arrested by NAB from his offices while he was in a meeting with foreign investors to raise capital for additional energy sector projects. Uncertainty itself is not extraordinary in Pakistan. Governments frequently change policies which can make it difficult for companies to navigate new laws and regulations. What made the situation extraordinary is the fact that this was happening even to businesses that supposedly had assurances from the senior military leadership that they would not be harassed by the unusually eager investigating officers at NAB. For the military leadership to promise protection and not be able to deliver, at least until this past week, is almost without precedent in Pakistani history. And it happened because the Imran Khan Administration is unlike anything else we have ever seen before.
A brief history of business-military relations
W
hile the military and large businesses in Pakistan may have had informal social ties before, the relationship between the two took off in earnest when General Ayub Khan took power in a military coup in October 1958. The Ayub Khan administration had a significant focus on private sector-led industrial growth in the country as the cornerstone of its economic policies, and hence understanding the concerns and hindrances faced by large businesses in setting up and expanding their industrial operations was a key priority for the government. The positive impact of this prioritisation was that it was very easy for business leaders of large conglomerates to gain access to key decision-makers and influence policymaking in a manner that allowed businesses – and ultimately employment – to grow rapidly during the 1960s. The downside, of course, was that the government was far more responsive to the needs of businesses and not necessarily to those of its citizens, which resulted in policies that dramatically exacerbated income and wealth inequality in the country, culminating in even the architect of the Ayub administration’s economic policies, Dr Mahboobul Haq, to decry in 1968 that the vast majority of the country’s private wealth was owned by “22 families”. One thing, however, was clear: if business leaders had a problem, they knew who to turn to. President Ayub Khan was the ultimate decision-maker and those whom he had empowered to speak on behalf of the administration really did have the power to make credible commitments on the part of the government of Pakistan. The Yahya Khan administration did not really matter much since it was consumed almost entirely with the lead up to the 1971 war that led to the independence of Bangladesh. And then came the administration of Pakistan’s first democratically elected leader, Prime Minister Zulfikar Ali Bhutto. Given his policies of nationalisation, Bhutto was universally reviled by the business community. The Bhutto administration did not lend a sympathetic ear to any complaints from business leaders, and had no qualms about treating many of them very badly. But given the political weakness of the military for much of the Bhutto administration, there was not much recourse either. Bhutto was in charge, and what he said was what mattered in terms of government policy. After the Bhutto administration, one would expect that whoever came next would be a welcome relief for Pakistani business, but the reality was that the Zia Administration ended up not being a return to the “good old days” of the Ayub
era and more of a remoulding of the business elite into the image of what the establishment – both civilian and military – wanted. The Ayub era elite consisted largely of people who had money before Partition. The Zia era introduced a new elite which was dependent on – and, to some extent, created by – government largesse and political connections for access to coveted assets (in the form of re-privatised industries) and financial resources (in the form of loans from the still-state-owned banking system). One day we will be able to name names of who got wealthy in that era due to shady political connections. [Editor’s note: That day is not today.] Then came the ‘decade of democracy’, lasting from 1988 through 1999, where the relationship of the economic elite with the government was somewhat complicated. Both the Benazir and Nawaz administrations pursued policies that created wealth tied to political largesse – Nawaz with his pursuit of re-privatisation, and Benazir with the creation of the independent power producer (IPP) policy and aggressive pursuit of the politically motivated lending by state-owned banks. But both also created camps where businesses were effectively forced to pick sides: if you were friends with Nawaz, the Benazir government would come into power and go after your businesses with prosecutions, and other forms of harassment. And likewise with friends of Benazir in the two Nawaz administrations. For example, Sultan Lakhani – a major shareholder in the Lakson Group and a senator under the Benazir administration – faced prosecution and was imprisoned under the Nawaz administration. Likewise, Mian Mansha, believed by some to be friendly with Nawaz back then, faced significant harassment under Benazir’s administrations. During this time, some of the wealthier business leaders kept their links with the military alive, and were often among the groups of ‘concerned citizens’ who would frequently visit the then Army chief practically begging him to conduct a coup. So, when the Musharraf administration came into power through a military coup in October 1999, the business community, by and large, was somewhat relieved. And the Musharraf administration absolutely did not disappoint. Indeed, in terms of access to the corridors of power and receptivity to the concerns of businesses, the Musharraf administration was far more democratic than the Ayub era. “Back in the Musharraf days, if you were the CEO of even a mid-sized company, or a partner at a Big Four accounting firm, you could get an appointment with [then-Finance Minister] Shaukat Aziz in a matter of a week or two,” said one partner at a Big Four accounting firm who wished to remain anonymous. “And they would
In the Musharraf era, if you had a bit of money, you could get time with the person whose word counted the most when it came to economic policy matters: Aziz, who had solid support from President Musharraf, the person who ultimately called the shots. Aziz would listen to you. He would take you seriously. He would try to help to the extent possible. And if he could not, he would be honest enough to tell you why genuinely listen to what you had to say and at least tell you what they could or could not do for you.” The laissez-faire ideology of Shaukat Aziz, the administration’s boss on all matters economic, meant that the government tried not to play favourites. And, somewhat shockingly, they largely succeeded. Virtually every major conglomerate expanded manifold during the nine years of the Musharraf administration, and the ones that crashed afterwards (the Dewans, the KASB Group, et al) were not because of government policy but rather more traditional reasons for business failure: over-borrowing, bad timing, and poorly executed strategy. In short, in the Musharraf era, if you had a bit of money, you could get time with the person whose word counted the most when it came to economic policy matters: Aziz, who had solid support from President Musharraf, the person who ultimately called the shots. Aziz would listen to you. He would take you seriously. He would try to help to the extent possible. And if he could not, he would be honest enough to tell you why. Needless to say, that party had to end in the opposite coming to power. When President Asif Ali Zardari took over the reins he was referred to in most circles as “Mr 10%”, a title alleging that he would ask for 10% of your wealth to be left “We raised an investment fund once, and got an actual call from a man whom we know for sure was acting at the behest of the party leadership because he said so quite plainly,” said an executive at a major financial institution in Pakistan who wished to remain anonymous. “And they actually wanted 10% [of our assets under management]. Their logic was ‘you were able to raise this fund because of the policies of this government. Please give us [an amount exactly equal to 10% of the fund’s assets].’” The PPP government was, in a way, egalitarian about its harassment: everyone was fair game, unless they were friends with the decision makers in the party or unless they were somehow able to continue doing business with little need for help from the government.
It worked in different ways, but one of the most common methods was this: if you wanted the government to do you a favour, or stop harassing you, you would reach out to someone with access to the party leadrship to intercede on your behalf. The friend would arrange for a meeting, and ‘parenthetically’ mention a business opportunity of their own in which they wanted you to ‘invest’. You would never be asked for money personally in your meeting, rather the common acquaintance would almost always structure the transaction to make it look like a normal investment or asset sale. But if the deal went through successfully, so would your transaction or request with the government. And if you were lucky, maybe it was a price you were willing to pay, or an asset you were willing to lose. You could ask the military for help, but they had other concerns: an actual war on the home front, and the bruising their reputation had taken politically under Musharraf. In rare cases, you might persuade some senior officer to put in a good word, and that might have been honoured, but the Army largely did not pretend like it had any sway over the government beyond its own policy priorities. The third Nawaz Administration was, in many ways was a civilian replica of the Musharraf administration as far as relations with business were concerned, with two major exceptions. The first was that, unlike Musharraf, who largely drew economic policy from what business leaders wanted, the Nawaz administration came in with their own agenda (expand power generation) and so had more internal reasons to say yes or no. And the second was that the top man himself was the one in charge: Nawaz. The textile lobby learned this the hard way when they first decided to approach Finance Minister Ishaq Dar for favours. Dar was dismissive of them. Then they discovered that, while Dar had the PM’s confidence in many respects, it was not absolute and that Nawaz was more than willing to overrule his finance minister. During this era, almost nobody sought to persuade the military to lobby their case. Business leaders figured out quickly that Nawaz was the man in-charge and the only key deci-
POLITICAL ECONOMY
sion-maker. And his relations with the military were famously frosty.
The chaos of the ‘hybrid regime’
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his brings us to the Imran Khan Administration. Given the visible levels of amity between the Imran Khan administration and the senior military leadership, the business community initially assumed that the two were almost completely in harmony over all key policy matters, and certainly the ones that pertained to the economy. They also assumed a relatively pro-business attitude, given the rightward ideological tilt of the ruling Pakistan Tehreek-e-Insaf (PTI). And they assumed that Finance Minister Asad Umar would have the full confidence of the PM on all matters economic and would serve as the point-man on the economy. All three assumptions turned out to be completely wrong. The first to go was the assumption of a pro-business administration. That illusion was shattered when the government set NAB loose, almost indiscriminately, on just about any company that had done significant transactions with the government under the Nawaz administration. These include – famously – the case of Engro Elengy, the subsidiary of Engro Corporation that set up Pakistan’s first liquefied natural gas (LNG) import terminal and had the temerity to enter into a sale agreement with the state-owned Sui Southern Gas Company. Its CEO Imranul Haq was thrown in jail by NAB, including 49 days of solitary confinement. And the company’s chairman and major shareholder Hussain Dawood is also named as a defendant in the NAB investigations. There is also the case of KSB Pumps, the German engineering company whose Pakistani subsidiary supplied water pumps and filtration equipment to the Punjab government’s Saaf Paani projects during the tenure of former Chief Minister Shahbaz Sharif. The CEO of KSB Pumps Pakistan, Mohammad Masud Akhtar, was arrested by NAB and kept in confinement for over eight months. And while the KSB Pumps case had begun before the PTI government came into office, NAB investigators and prosecutors appear to have significantly increased the zeal with which they were pursuing the case. Once they lost the case in the Lahore High Court in February 2019, they continued an appeals process, despite having completely failed to prove their case. And, according to some executives who have experienced NAB interrogations, it appears that the strategy being deployed by NAB officers was not one of a diligent prosecution of white-collar crime based on evidence they have managed to collect. It was instead one based on harassment of individuals in the hopes that they
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While Gen Bajwa has been unwilling to commit to a full repeal of the law, he has committed – at least in private – to executives that the military would help intercede on their behalf to curb its excesses. At Gen Bajwa’s suggestion, the government has created a committee comprising both government officials as well as private sector individuals to help create mechanisms that could curb those excesses will confess to something – anything – that can be criminally prosecuted for. “The NAB IOs [investigating officers] did not seem to understand how business works,” said one person who has been interrogated by NAB. “They are not willing to do the legwork. You see, prosecuting a white collar crime is hard work. You need to patiently build up a case over months before you confront people with evidence you have collected. And you need to understand what you are doing.” Then came the shocking revelation of the ignorance of NAB investigators: “These IOs did not understand the difference between revenue and profit when calculating how much money we were making in our contracts with the government. They kept quoting the revenue number and calling it an inflated profit. They completely did not understand the concept of operating costs, let alone complex things like IRR [internal rate of return, a measure of profitability]. And even then, they had no way of benchmarking what constituted an abnormal rate of return and what was illegal about our contract.” The strategy appeared to be to intimidate people who have never seen the inside of a jail cell and hope they confess to something. “Why are you putting people in jail who are cooperating? These are private sector employees who would be scared of fleeing. They show up whenever you call them. They cooperate, they provide whatever you ask of them. Why are you arresting them? Just because you aren’t willing to do the hard work and hope they confess?” said the executive who had been interrogated. The result of all of this is that executives at practically every major energy company in Pakistan that did business with the government were, until just last week, spending a substantial portion of their day preparing responses to NAB queries rather than planning the future growth of their businesses and, by extension, the country’s energy supply. Even now, it is unclear just how real the relief announced by the government will be. At first, it looked as though Finance Minister Asad Umar might be able to help. In meetings with executives, he was certainly understanding of their perspectives. But he never seemed to be
able to do much, and was frequently contradicted in public by the prime minister. Then came his ouster in April 2019, and the illusion that he was the point man on the economy – already on the brink of collapse – was completely shattered. Along with it went the notion that the civilian government was operating in collaboration with the military. Nobody – absolutely nobody – in Pakistan’s business community believes that Prime Minister Imran Khan would have chosen Abdul Hafeez Shaikh as his de facto finance minister. It is abundantly clear that he is in his office because of his cordial relations with the military. Hafeez Shaikh’s appointment confirmed – at least apparently – what had already been a hypothesis swirling among Pakistan’s business leaders: that the way to get anything serious done was to bypass the civilians and speak to the military leadership directly. When it came to their money, then, business leaders began operating under the assumption that the ‘hybrid regime’ was really just a military government in a civilian dress. Here is the problem with that hypothesis: it does not hold true. Several business leaders known to have very strong social ties with the military leadership – including Chief of Army Staff General Qamar Javed Bajwa – had appealed for his help in fending off the worst of NAB’s overzealous prosecutions, and had received assurances from him of support, and found those assurances to not have resulted in any slackening of the pressure from NAB for several months. Take, for instance, the case of Engro. In December 2018, the company’s management helped conduct a tour of the Thar coalfields by Gen Bajwa, a tour that was publicly disclosed. Sources familiar with the matter tell Profit that Gen Bajwa assured the company’s leadership of support which, at least sources familiar with the management’s interpretation of events, took to mean that he would request the civilian government to get NAB to back off the aggressive inquiry into Engro’s energy projects, including the LNG terminal. Needless to say, that is not how things turned out because the most aggressive stage of the prosecution came after that visit to Thar by Gen Bajwa. It is certainly possible that Gen Bajwa
did not promise anything explicit to Engro. But there are others who had received far more public assurances from the chief and gotten quite the opposite in return. Business leaders have been seeking Gen Bajwa's help directly throughout all of 2019. The formal structure for this was created in July, when the army chief was named a member of the newly-created National Development Council, a body ostensibly put together to help coordinate the country’s civilian and military leadership’s efforts in stabilising the economy. This kind of direct, formal role for the army in economic decision-making during the tenure of a civilian government is highly unusual. According to reporting by Faseeh Mangi at Bloomberg, at least three meetings with senior business leaders had taken place by October 2019. The last of these three meetings, which took place at a military building in Rawalpindi, was very well publicised and seen as publicly undermining Prime Minister Imran Khan, because it included members of his cabinet and administration appearing in public as supporting speakers, not to the PM, but to the army chief. Initial reports even suggested some tension in the room, though those were quickly downplayed by some business leaders who participated, according to reporting by Khurram Husain at Dawn. And while the subject of other economic reforms came up, a recurring theme in all of these meetings was NAB’s aggressive prosecution and the insistence of business leaders that the government fulfil its promise to repeal the 1999 National Accountability Bureau Ordinance, which gave NAB its draconian powers, which include almost indiscriminate authority to arrest anyone for up to 90 days. While Gen Bajwa has been unwilling to commit to a full repeal of the law, he had committed – at least in private – to executives that the military would help intercede on their behalf to curb its excesses. At Gen Bajwa’s suggestion, the government created a committee comprising both government officials as well as private sector individuals to help create mechanisms that could curb those excesses. However, that committee appears to be powerless, with sources telling Profit that some private sector members of that committee learning of their appointment via the news, and having yet to be informed of the parameters of their participation. And far from going away, NAB’s prosecutions in the aftermath of the meetings only appeared to grow more aggressive over time, with several participants of those meetings with the military leadership continuing to face harassment from NAB even after meetings with Gen Bajwa, where, according to sources familiar with the meetings, they came away with the impression that the Army chief was sympathetic to their position would intervene to help them.
“The NAB IOs [investigating officers] did not seem to understand how business works,” said one person who has been interrogated by NAB. “They are not willing to do the legwork. You see, prosecuting a white collar crime is hard work. You need to patiently build up a case over months before you confront people with evidence you have collected. And you need to understand what you are doing” These businessmen include several of the largest real estate developers in the country (yes, we mean Malik Riaz of Bahria Town, but also others.) It is not clear if Gen Bajwa had the same recollection of these meetings.
Some movement, but will it be enough?
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ll of these developments came to a head on December 27, when the government announced that it had proposed some changes that would potentially restrict the jurisdiction of NAB in certain cases. NAB, for instance, would not be allowed to prosecute civil servants in cases where a departmental inquiry was already underway. And NAB’s jurisdiction over the private sector would be curtailed, with existing enforcement mechanisms available to the Federal Board of Revenue (FBR), the Securities and Exchanges Commission of Pakistan (SECP), as well as local Building Control Authorities (BCAs). If the reforms succeed in reducing the scope of NAB’s activities, that may end up being enough to restore the economic elite’s confidence in the military’s ability to advocate on their behalf. However, this is not the first time the government has looked like it was beginning to take action to curb NAB’s powers before changing their minds again. If this ends up being more of the same, it will be back to square one all over again. For now, though, Gen Bajwa can say that he delivered on his assurances to the country’s economic elite: he did not promise an end to NAB, and he did not give them that. But their impression that he would do something to curb NAB’s worst elements turned out to have been accurate, and he has delivered what they assumed he had promised them.
Democracy to the rescue?
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onetheless, there remains a big question: is Gen Bajwa – or whoever eventually succeeds him as Army chief – really in charge of this government, or is he simply one among many parties that has
influence over the government, but not a veto, and does not direct policy? It also raises more uncomfortable questions: if the civilian prime minister and cabinet do not have final say in economic policy, and neither does the military – at least on some of the most pressing concerns – then who does? None of the sources we spoke to had specific answers to that question, though everyone had a theory. The most common one is that, in the absence of a clear chain of command due to the hybrid nature of the administration, the civil servants at NAB had nobody to check their power. However, the flaw in that explanation is that while it explains how NAB got started on its prosecutions, it does not explain why nobody stopped them for so long. Unfortunately, that is a question that is difficult to answer since the government’s statements on the matter did not appear to offer any clarity. The opposition Pakistan Muslim League Nawaz (PML-N) believed, however, that NAB’s excesses were no accident, and were being used by members of the ruling PTI as a means of score-settling against political rivals, and against businesses that had previously done transactions when the opposition was in office at the federal and provincial levels. We do not mean to exaggerate the effects of what we are reporting here: the confidence of Pakistan’s economic elite in the Pakistan Army and its ability to manage the country effectively had been shaken, but not broken. And the events of last week, where the economic elite’s biggest demand appears to have been fulfilled, at least on the surface (though it is too early to definitively say), suggests that the confidence may well be restored. The military remains hugely popular with the nation’s wealthiest business owners, but the hybrid regime’s recent failures in addressing some key concerns suggests that business leaders may have to rethink their views on whom they trust with the management of the economy. hich brings us back to those Engro ads: is it possible that Pakistan’s economic elite will have to rely on public good will, manifested in democracy and the rule of law, as their best guarantor of protection? Who knows? But one can certainly hope.n
POLITICAL ECONOMY
Could the KSE-100 hit 60,000 by 2021?
JS Global seems to think so Leading investment bank issues strongly bullish market outlook for the coming year and believes the equity markets have truly turned a corner
G
iven the recent beginnings of the economic recovery in Pakistan, what can investors in the equity markets expect as far as returns over the next two years or so? If the analysts at JS Global Capital, a leading investment bank, are to be believed, returns might approach close to 50% over the next two years. JS Global’s recently released Pakistan Market Strategy is so optimistic, that the reader could be forgiven for thinking that perhaps the analysts are letting the animal spirits get the better of them. The report is not only practically joyous in its outlook, but also grandiose. Consider the opening sentences: “What is to stop the equity market from reaching out for the stars once the dust settles? The quintessential behaviour of Pakistan’s equity market has time and again exceeded the wildest expectations of those who have dared to dream! So why not take this opportunity to
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pluck the fruit while it is still ripe?” The hyperbole notwithstanding, the report is interesting for a few reasons. For one, it claims that the preceding two IMF programs had been checkpoints for Pakistan equities. “The bottom that the market has made post IMF-entry has not been revisited.” the report says. The report has also claimed the benchmark index could hit 60,000 by 2021. How did JS Global reach this conclusion? First: “With regards to valuations, Pakistan’s market capitalization to GDP and free float to M2 ratios are both well below their 10-year averages. A simple mean reversion would land the benchmark index at 50,000! Coincidently, real returns that the index would provide at this level match the 20-year-averages.” Gross domestic product (GDP) is a measure of the total size of the economy. Market capitalisation represents the total value of all
shares listed on the stock exchange. M2 is a measure of money supply, and generally refers to physical cash, plus bank deposits. Free float refers to the proportion of a company’s shares that are available for trading, which is to say, not held by investors who have management control. Secondly, “While the market cap to GDP and domestically held free float to M2 ratios both present strong cases for a 50,000 target under a mean reversion scenario, is it not fascinating that our Target Price-based methodology computes the same index levels?” What the analysts are referring to in this sentence is the level of the benchmark KSE100 index, which, as of the close of trading on Friday, December 27, 2019 was at 40,848.53. A rise to 50,000 by the end of calendar year 2020 would mean that investors in the stock market, on average, would make a return of 22.4% over the course of a single year. The inflation forecast for next year, according to most analysts, is in
the range of 12% or so. “We think not. The weak earnings we have seen, particularly with regards to cyclical stocks, have come alongside falling prices on the bourse. As a result, the net effect on the Price to Earnings ratio has been largely off-set. Nonetheless, the market trades at a discount to its 10 year average P/E providing (yet again) potential to reach an index target around the 50k mark. In such an environment, we find it more prudent to value stocks based on the Price to Book ratio to filter out the impact of fluctuating earnings. Here we find that if the multiple were to revert to its 10-year average, the index could potentially reach 60,000 levels!” If the KSE-100 index reaches a level of 60,000 by the end of calendar year 2021, that would mean that investors who remain
invested in the stock market for the next two years, would stand to earn an average return on investment of approximately 21.2% per year, during a time when inflation is expected to average closer to 10% per year. While those numbers may seem outstanding, investors in the Pakistan Stock Exchange who have remained invested and not engaged in panic selling during downturns have earned substantial returns over the past two decades. Between June 30, 1998 and June 30, 2019, the benchmark KSE-100 index – which represents total returns on stocks listed on the stock exchange – rose by an average of 19.0% per year. In inflation-adjusted terms, investors earned a return of 10.85% per year during that same period. Yet to say the phrase “on average” hides
considerable variation. During calendar year 2008, stocks declined by 58.3% in a single year. In calendar year 2002, however, stocks rose by 112.2% over the course of a single year. Average, in other words, hides real substantial variation. The key to stock market investing, then, is patience: not selling when the market crashes like it did in 2008, and not overzealously buying when the market reaches its peaks. The report did have some concerns, all thrown on to one page of 91 pages in the report. These include the FATF blacklist, a potential war with India, hike in oil prices, and ‘anti-government squabbles’. “Recent events such as … the verdict regarding an ex-President-cum-Army chief... they have proven to be essential ingredients in brewing market volatility.” n
As it grows,
Habib Metro’s compliance struggles to keep pace The bank has seen impressive growth in its deposits, and profitability, but management has struggled to improve its compliance systems in order to be acceptable under SBP’s new tighter regulatory regime.
I
t is the most cliche of cliches, but it is so widely cited exactly because it has a point. Getting to the top is not the hardest thing, it is staying balanced on the precarious perch that is the real challenge. Habib Metropolitan Bank (HMB) has managed to make the ascent, but just as they were planning on getting to a place they could cosy up in, it seems that the State Bank of Pakistan’s (SBP) new regulations are already giving them a bit of a woozy. At a recent analyst briefing delivered by the bank touted impressive numbers for 2019, with HMB’s deposit base increasing by 18% year-overyear during the first nine months of 2019. And unlike most other banks, it has been able to profitably deploy those rising deposits into loans. The bank’s loan book grew at an average annual rate of 33% as of September 30, 2019, compared to the same period last year. The banking sector as a whole saw its loan book increase by just 6% during that time. And the rapid growth in deposits is not the result, as in the case of some other banks, of a strategy of raising expensive deposits from corporate or high net-worth individual accounts. Current accounts at the bank, which are the cheapest possible source of funding for a bank since they carry a 0% interest rate for almost all customers, rose by 24%, higher than
the overall growth rate in deposits for the bank. That means that the proportion of the bank’s deposits that come from cheap current (checking) accounts rose over the past year. In other words, the bank is able to organically grow its deposit base at 18%, faster than the banking industry (which grew by just 7.6% during the same period), and it is able to profitably deploy those deposits into private sector lending. Nonetheless, while the bank was able to grow its loan book, a substantial portion of its deposit increases went into government bonds. The bank’s loan book grew by Rs33.8 billion during the first nine months of 2019, while deposits grew by Rs57.7 billion. The bulk of the difference between the two is accounted for an increase in the bank’s investments into government bonds. The management had a targeted growth strategy, which led to expansion in the bank’s loan portfolio in the recent past, restricting dividends to manage adequacy ratio requirements. That has helped the bank improve its capital ratios. “The bank’s Tier I capital ratio currently stands at 13.3%, while Tier II stands at 13.86% (minimum requirement is 12.5%), slightly lower than the management’s comfortable buffer of 1.5% above the Tier II capital ade-
CAPITAL MARKETS
quacy ratio,” wrote Amreen Soorani, the deputy head of equity research at JS Global Capital, in a note issued to clients on December 17, 2019. Despite the impressive numbers, however, the current topic on everyone’s mind at HMB is regulatory compliance and controls. While it may have been a good year for the bank, all of their spoils may easily be washed away if the SBP is miffed, and the SBP looks in a stingy mood. At the analyst briefing, management stated that they are taking key steps to further upgrade compliance and controls by means of relevant human resource induction, software up-gradation etc. The bank claims that their focus on the trade finance business, where they are already market leaders in the export business, would continue despite competitive margins. However, the current headache is clear, and if they are to achieve their target to accumulate the stock at prevailing market price, then they will have to get their heads down and get complying.
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The problem for HMB, along with every other bank in Pakistan is that the Financial Action Task Force (FATF), the multilateral global group dedicated to fighting money laundering and terrorism financing, has a strong focus on compliance at Pakistani banks, with a particular focus on ensuring that the banking sector does not serve as a conduit for terrorism financing. For trade financing banks like HMB in particular, where they frequently move money across borders for their clients, the level of scrutiny is even greater, particularly in light of the compliance troubles at Habib Bank, which was forced by the New York State Department of Financial Services to shut down its operations in the global financial capital for failure to improve its monitoring of suspicious transactions. While HMB does not have a branch in New York, it is a subsidiary of Habib Bank AG, the Switzerland-incorporated parent company of the group. (Habib Bank AG has no current relationship with Habib Bank Ltd, the largest
bank in Pakistan.) And Swiss authorities have been collaborating quite closely with financial regulators in the United States to crack down on money laundering, tax evasion, and other financial crimes. Habib Metro is the smallest among the three “banks named Habib” in Pakistan, named after Habib Esmail, the founder of Habib Bank Ltd, the bank that is now the largest in the country. It is majority-owned by the descendants of Habib’s third son, Mohammedali Habib (as opposed to Bank AL Habib, which is majority-owned by the descendants of Mohammadali’s elder brother Dawood Habib). All of the Habibs are now Swiss citizens, but their banks in Pakistan remain among their biggest assets. If the Swiss authorities decide to crack down on those banks, or else create regulatory issues in Switzerland for them, that could make life quite difficult for the owners of the bank. Hence, it is not surprising that, despite the stellar numbers, the bank’s management is focused on reducing that risk. n
BANKS
OPINION
Saleem Javed
The mechanics of privatisation
complicated matters have taken center-stage in the policies adopted by the PTI’s economic team. The current regime has prioritized increasing its foreign currency reserves as a key policy initiative aimed towards the economic overhaul of the country. And as the rupee continues to be obsessively devalued, the resultant sharp interest hike to curb industry demand and improvement in balance of payment numbers is being watched greedily. Whether these recent measures are aiding or detrimental to our economy is Restructuring of state assets prior to any perhaps a discussion for another time. The more immediate concern is sale consideration is critical to a Pakistan’s need to improve its access to foreign reserves on an ongoing basis, and achieving it in a fashion that does not curb, but rather successful privatisation program encourages economic growth. We are a dollar starved economy. The nation is continually torn between balancing its external finances and meeting the fiscal requirements of its government and people. A clearer path to help e hear the same things over and over ameliorate this dollar shortfall is through maximizing the value of again. You can open the headlines from both listed and privately held state-owned assets via sale to strategic half a century ago and they will scream or financial investors. of the same few plagues. It is trade This mechanism, if executed correctly, can generate value for deficit this, devaluing rupee that, and the state by creating national wealth, both in the form of ownership some panic about the balance of payinterests sold to external investors as well as the improved valuation ments or the other. For its 72 year existence, Pakistan has, for all of the residual ownership retained by the State. intents and purposes been unable to conquer these two or three Privatisation efforts in previous regimes did not achieve the succore issues that seem to grow more alarming with every passing cess expected of them. There is a plethora of reasons one can point to day that they are not brought to heel. for this outcome but the crux of it can be distilled into a few key facts. With the direction that the current government has taken First, is the inability to restructure a majority of these assets from an since it came to power in 2018, these loaded and somewhat operational and financial perspective. Second, investors, specifically foreign institutions, have not effectively been communicated the true value of these state assets. Lastly, there is an incomplete understanding of the availability of in-country liquidity available towards monetization of these assets. Each of these issues warrants a closer look. As a first order concern, almost all state-owned assets are in dire need of financial and operational Saleem Javed restructuring. Without optimizing corporate efficiency, balance sheet issues, profitability and goveris an investment banker nance, the prospects of attracting serious investor interest in such assets will continue to remain low. based in the US Restructuring of such assets falls beyond the purview of existing management teams. Rather, it requires the assistance of sophisticated advisors that specialise in this area. Any privatisation program, to date, has seen the omission of such advisors. Another key impediment to maximizing value of state-owned assets has been the fundamental misunderstanding of how international capital markets view Pakistan as an investment destination. The global investment dollar is highly mobile in that it seeks the best risk-reward available to it. It tends to be geographically agnostic for the most part.Most importantly, the investment dollar seeks confirmation bias, that is, it seeks evidence that other investment dollars have been deployed and extracted
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return successfully. Without this confirmation bias, the investment dollar moves seamlessly elsewhere. This is precisely what has transpired with Pakistan over the years, especially in relation to other regional economies of similar or lesser investment attributes which have attracted significantly higher amounts of foreign capital. The first step to alleviating the above mentioned ailments would be to appoint a panel of restructuring experts to comprehensively evaluate and restructure state owned assets along operational, strategic and financial lines. They must be empowered to make the necessary realignments needed within ailing companies to effectively make them attractive to investors globally. To be clear, these experts are not be confused by transaction advisors, typically investment bankers serving as marketers in any said transaction, and which have been hired by the government periodically in the past. These are firms and individuals that specialize in fixing inefficient operations, upside down balance sheets and a host of other corporate ailments that prevent businesses from achieving their true potential. The government should also strive to create the conditions necessary to result in a successful investment, and eventually a timely and profitable exit by investors in any privatisation deal. A combination of cleanly restructured as-
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sets, clear legality, sovereign financial support (where applicable), and reasonable valuations are all examples of measures the government can introduce and leverage to show investment success and ultimately the confirmation bias global investors seek. The ongoing privatisation of SME Bank is a relevant example to illustrate the arguments made above. This is a bank marred by financial losses that effectively make it insolvent, an inflated operating cost base and the absence of a scalable platform. These ingredients guarantee that a sale of the bank will not fetch the government proceeds anywhere close to what would be a desirable outcome, assuming it attracts any serious bids at all. A more viable approach might be to clean up the balance sheet to a full provisioning of the toxic loan book, fresh injection of liquidity in terms of equity or a low interest loan by the government and restructuring of the cost base in line with the bank’s earning capacity over the near to medium term. Only then, would serious investors view SME bank as an operational platform rather than the purchase of a commercial bank license from the government. What the privatisation regimes of the past have lauded themselves for, are in reality, sales of shares of already listed companies where the government happened to own a stake. These sales hardly qualify as true privatisations and unfortunately have been made at
significant discounts to the intrinsic value of the companies involved. Sale of non-listed public sector companies have been non-starters given the structuring complexity around such transactions and the lack of expertise needed to execute them. This is where the government needs to change their approach this time around. To wrap up, there are significant pools of untapped investment capital within Pakistan, which can and should be investing in stateowned assets prior to participation from foreign investors. These pockets of capital within Pakistan can and should be incentivised to participate in the initial stages of the rehabilitation of state-owned enterprises. Assuming the assets have already been restructured, and the government has provided the conditions for investors to believe they can earn a market return on their investments, local development financial institutions (DFIs) as well as other private capital can be galvanised to rotate their funds from government securities and mutual funds to such state-owned assets. Currently these firms tend to be invested in mutual funds and liquid securities, reflecting their level of risk averseness. There is no reason why with attractive and actionable opportunities in restructured state-owned assets, these players cannot serve as early and therefore profitable investors in state-owned assets. n
COMMENT
As prices keep declining, furnace oil starts looking more attractive as a fuel
Global prices for the fuel keep declining even as other types of oil remain steady; a continued decline could render oil competitive to natural gas
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lobal prices for high-sulfur furnace oil (HSFO) have been tumbling this year, and analysts believe that if the slide continues, it would make the fuel – previously thought of as one of the most expensive fuels for generating electricity – almost competitive with natural gas, ordinarily thought of as among the cheapest hydrocarbon-based sources of power generation fuel. HSFO prices have declined 44.6% since the same time last year, even as crude oil prices
ENERGY
have remained relatively stable and even risen. The reason or the decline in furnace oil is a decline in demand specifically for that fuel, even as other oil-based fuels have held up in terms of demand. As a result, the HSFO ‘crack’ relative to crude oil – or the discount that refiners sell furnace oil at relative to crude oil prices – has risen to 43% of the price of crude oil, or about $29.30 per barrel. Unlike most other refined fuels, and unlike most other products in general, furnace oil sells at a price below its raw ingredient, crude oil. The reason for this is that furnace oil has a
lower energy density relative to other oil-based fuels and commands lower demand. Refineries need to sell it at a loss in order to avoid it going completely to waste. Nonetheless, furnace oil has historically been an important fuel in Pakistan for electricity generation, and many power plants remain set up to be able to function on both furnace oil as well as natural gas, and can switch between the two fuels depending on which is cheaper. That means that the relative price of natural gas and furnace oil can have a relatively rapid impact on Pakistan’s aggregate energy fuel mix.
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“Any continuation of this slide in the HSFO benchmark would make it more competitive as a source of energy production, where captive power plants operated by industry (particularly textiles, glass, paper and board and some cement manufacturers) are already competitive (versus captive gas power tariff and industrial tariff on grid)” Ali Asghar Poonawala, research analyst at AKD Securities “Any continuation of this slide in the HSFO benchmark would make it more competitive as a source of energy production, where captive power plants operated by industry (particularly textiles, glass, paper and board and some cement manufacturers) are already competitive (versus captive gas power tariff and industrial tariff on grid),” wrote Ali Asghar Poonawala, a research analyst at AKD Securities, an investment bank, in a note issued to clients on December 20. The fall has been so extreme that in fact, it has largely overridden the higher costs usually associated with the devaluation of the rupee. According to October 2019 data on grid generation, this steep decline in furnace oil prices could make the difference between the cost of electricity generation from furnace oil and natural gas much smaller, especially considering the fact that an increasingly larger proportion of natural gas supply in Pakistan comes from imports of liquefied natural gas (LNG). Cement companies like Lucky Cement, DG Khan Cement and Cherat Cement are expected to benefit, as well as Attock Petroleum and Pakistan State Oil, which already have steady furnace oil industrial supply arrangements with major power plants. So, why is this steep decline in furnace oil happening to begin with? The International Maritime Organisation (IMO) has put a sulfur cap on marine fuels, from 3.5% currently, to 0.5%. These restrictions come into play on January 1, 2020. That means there is rising demand IMO-compliant products, such as very-low sulfur fuel oil, and a corresponding decline in high-sulfur variants of furnace oil. This decline in furnace oil stands in contrast to pretty much every other petroleum product, including both motor spirit (petrol) and high-speed diesel. In terms of other products, motor spirit and high speed diesel were trading marginally higher, showing a 0.2% and 4.1% increase month-on-month in December. In addition, global prices for crude oil are also expected to stay stable, as the US and China have delayed their tariffs (and potential
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trade war) for the time being. “Calm on this front is likely to act as a catalyst for physical crude draws with early-December OPEC+ agreement adding further impetus to bullish expectations,” wrote Poonawala.
Rising gas prices
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n the other side of the oil versus gas equation, prices of natural gas in Pakistan are expected to rise substantially after the Oil and Gas Regulatory Authority (OGRA) recently approved substantial rises in gas prices for nearly all categories of gas consumers. Prices for domestic consumers will rise on a weighted average basis by 29.3%, for industrial users (including captive power plants at industrial units) by 31.6%, and for the feedstock for fertiliser manufacturers by 135.6%, with the increases set to go into effect next month. The rise in gas prices comes as an increasingly larger proportion of Pakistan’s natural gas supply is dependent on imports, which are both more expensive owing to transportation costs of LNG, as well as paid for in dollar-denominated contracts, which means that the recent plunge in the price of the rupee has raised the rupee-denominated prices of imported LNG. The government is allowing for a rise in gas prices so that the state-owned natural gas distribution monopolies – Sui Northern Gas Pipelines (SNGP) and Sui Southern Gas Company (SSGC) – would not get embroiled into the same kind of circular debt problem that plagues the country’s electricity grid. The government has been informally subsidising the price of natural gas for consumers even as the weighted average cost of gas goes up with the share of imported gas relative to domestically produced natural gas. Given the government’s promises to the International Monetary Fund (IMF) to control the budget deficit, the government needs to reduce the amount of money it spends on those subsidies, hence the rise in the price of gas. Yet despite the populist hysteria that
accompanies every increase in the price of utilities, the expected impact in terms of inflation is relatively muted. Analysts at AKD Securities estimate that the impact on the consumer price index (CPI) is expected to be no greater than 0.19% for most consumers, and a virtually non-existent 0.02% for ‘lifeline’ consumers, the poorest consumers who have relatively low domestic usage of natural gas. The downstream effects of the price hike might be somewhat more substantial, with the prices of fertiliser and cement expected to see significant increases, given the relatively high proportion of the cost of these materials that comes from the price of natural gas. The impact on steel is expected to be somewhat more muted since the steel industry in Pakistan has a relatively low usage by most companies of natural gas relative to other fuels.
Meanwhile, coal marches on…
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he interplay between oil and natural gas notwithstanding, Pakistan’s energy grid continues to use an increasingly larger share of coal-fired power plants as a source of electricity. During October 2019, the latest month for which data is available, coal-based electricity generation increased by 111% compared to the same period last year, according to data published by the National Electric Power Regulatory Authority (NEPRA). Coal continues to rise as the fastest growing portion of Pakistan’s energy mix. As recently as fiscal 2016, coal accounted for just 0.1% of Pakistan’s electricity production. In fiscal 2019, it accounted for 13.3%. The change in Pakistan’s energy fuel mix that has taken place over since 2013 has been two-fold: oil, which was the dominant fuel for Pakistan’s electricity generation as recently as 2015, has slowly been displaced by two competing forces: natural gas in the form of liquefied natural gas (LNG) imports into the country, and coal-fired power plants set up as part of the China-Pakistan Economic Corridor (CPEC).
ENERGY
OPINION
Asif Saad
To privatise or not to privatise?
and devised clever pricing and tariff structures which would allow the private sector to earn attractive returns. However, after almost 40 years and amidst accusations of poor service and generous payouts to shareholders, UK citizens seem to be suggesting that they do not mind some of these utilities to be renationalised! Despite Labour’s defeat in the general elections a few days back, the support for renationalisation is unlikely to reduce. I am elaborating the situation in the UK of course because to privatise or Despite reticence on the part of the not seems to be a question faced by many countries, including our very government, the long-term benefits of own. The underlying consensus between the right-aligned political privatisation cannot be taken for granted parties as well as the powers that be in Pakistan seems to be staunchly in favor of privatisation. One commonly hears that the only solution to the umpteen issues of managing state corporations is to privatise. You n a recent trip to London, I could not help but hear about PIA, the state utilities (electric and natural gas), railways follow the media coverage of the upcoming genand many more as being major drains taking hundreds of billions to be eral election in the UK. The Labour Party, which kept afloat. has since been soundly defeated, was campaignWhile the immediate drain to the public exchequer is possibly ing on an agenda to increase public spending on plugged through privatisation, it is important to learn lessons from the health and education. It was also proposing to experience of other countries. In the UK, years of inefficient operanationalize some of the previously privatised public organisations. tions and rising bills have eroded the consensus that private sector can Foremost amongst these are the utility companies supplyrun these organizations more cheaply and efficiently than the state. ing electricity, gas and water to British citizens. Most of these The questions which come to mind, largely from a public interwere privatised during the Thatcher era in the early 1980s and est perspective in Pakistan are the following; first, is it an ownership were later accepted as the norm by all sides of the political divide. issue? Can the regulators treat both privately held utilities as well as At that time, the UK was the world leader in selling off utilities state-controlled ones at par? Who can raise the capital to invest and will have lower cost of capital? who can execute infrastructure projects more efficiently and take better care of these investments? Answers to these and many other similar ones need to be found before we decide which direction is better for us. The UK experience seems to suggest that the country still ends up paying more with the cost of inefficiencies in the public sector partially converted into private sector profitability and nothing Asif Saad more. is a strategy consultant Does this mean we should not privatise? Not necessarily. But privatisation must be preconditioned who has previously worked with two things; first, markets must be opened to competition to provide a level playing field and disat various C-level positions courage a rentier economy and second; there is a dire need to build the capacity of the various regulators for national and to enable them to truly play the watchdog role in their respective sectors. multinational The first condition is easy to see in Pakistan where rent seeking has been the basis of growth and corporations profitability in many sectors. Transferring a public organization to the private sector while keeping its monopoly intact is against the principles of fair competition and should only be done under dire circumstances. I believe businesses have the ability to bring operational improvements and we have seen examples of this but the private sector is efficient and runs streamlined operations mainly because it tries
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to do better than the competition. That is how businesses improve and benefit society by sharing the benefits of these improvements with its customers. Businesses should not benefit from creating bigger problems. The current regulatory structure in most public utility sectors in Pakistan is copied from the original pricing and investment formulas devised during the Thatcher era in the UK. These formulas incentivize overinvestment and allow utilities to pad up costs. There is a contradiction between the regulators requirement for utilities to generate cash for investment and its duty to protect consumers from overpricing by utilities. If the private sector organisation has little incentive to improve operations and remains dependent on government subsidies in the long term-there is something inherently wrong with this business model. Less competition leads to higher prices and lower productivity which ends up hurting the consumers eventually. The second issue is regulatory capacity i.e having the skills to make correct decisions and the ability to get these decisions implemented. These may even be a bigger threat to the system than the questions about utility operations themselves. Time and again, our regulatory bodies have failed to act wisely and bring needed
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reforms. Even when they did, no one, including the various federal governments have taken them seriously. Apart from tariff structures, utilities resist following the directions given by the regulator simply because they know that the regulator has very little capacity to penalize them. Even when penalties are imposed, these are usually challenged in courts and held in abeyance till eventually decided years later. No utility, to my knowledge, whether public or private, has ever been seriously threatened about their license being revoked and unless the regulators become capable of taking meaningful action their overall impact will remain negligible. It is interesting to note that some of our neighbors have different regulatory structures in place. India, for example, has successfully brought reforms in the electric utility space via the state or provincial regulators instead of the federal one. Provinces have been encouraged to build their own capacity and being closer to their citizens, they have responded to the needs of consumers in a better way. In Pakistan, sadly provincial regulators for utilities do not exist and all the powers are with the federal regulators. One of the reasons for this is to maintain uniform pricing throughout the country
although it remains to be seen whether that in itself is good for the country. In any case, provincial regulators should be created and empowered to become more effective bodies able to respond to public needs. Only a handful of developed countries have followed the UK example of selling utilities outright to the private sector. However, this has been followed by the underdeveloped world where the state is strapped for cash and cannot fund the necessary investments in infrastructure. In Europe, the model has been different. They have separated assets from services and allowed the private sector to offer services. This helps in controlling prices as arguably a publicly owned utility will not be required to deliver the returns demanded by the private sector. This model ought to be seriously explored in Pakistan. Unfortunately, for a country like Pakistan, there are no easy answers. What this subject requires is careful deliberation and a government which is able to absorb ideas from diverse set of people. The simplistic approach of selling public assets to provide immediate relief to a cash starved government is a short-term fix which can have serious long-term implications and hence the rush to privatise must be resisted. n
COMMENT
By Syeda Masooma
T
hey are called loosies in the United States. A single cigarette that is purchased and sold, usually in areas that are low-income and predominantly African-American.
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It is the lowest rung of dealership, and what can at best be called a ‘side hustle.’ But nothing seems to ruffle the feathers of the Goliaths at Big Tobacco more than a few loosies being sold on the streets and in department store parking lots. Ask the tobacco companies, and they will holler and howl over how the the high
taxation on their products result in smuggling, the proliferation of loose cigarettes, and what they claim is resultant criminal activity. Pakistan does not have a problem of cigarettes being sold out of trench coats on street corners and down dark alleys, but the tobacco industry still has the same complaints: high taxes and smuggled products.
Econ 101
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n very plain, A-level, Economics for-Dummies terms, tobacco is a demerit good. It harms the health of the consumer, it is addictive, it harms those that do not smoke as well through passive smoking and its use should be discouraged by government. This discouragement can be carried out through health warning labels and curbs on advertising, but most importantly, through taxation. But of course, where the taxation is supposed to help wean people off cigarettes, the addictive nature of the good means its demand is inelastic, and the government just ends up making a pretty penny out of taxing cigarettes. The contribution that the industry makes to Pakistan’s national exchequer every year is quite significant. The tobacco industry in Pakistan is an imperfect market, with two players taking up 90 percent of the market share, their contribution to taxes in the form of Federal Excise Duty (FED) and General Sales Tax (GST) is enormous. These two players are Pakistan Tobacco Company (PTC) and Philip Morris Pakistan Limited (PMPK), and together they paid Rs 117 billion in taxes in the fiscal year ending June 2019. Since then, in the third quarter of the calendar year 2019, PTC has further contributed Rs 14.5 billion in excise duties and Rs 4.2 billion on sales taxes, while PMPK has added Rs 2.76 billion in excise duties and Rs 820 million in sales taxes. Despite such significant numbers – nearing 3 percent of the total tax revenue for the government – so far the Tobacco industry has been paying taxes on what it declares it to be the final production and sales. In terms of taxation, FBR relies on “self-assessment” by the manufacturers. According to a report released by Social Policy and Development Centre (SPDC), “Quantifying the Potential Tax Base of Cigarette Industry in Pakistan”, the problems in the tobacco industry reach far beyond smuggling, and expands in the myriad of ways that the industry is underreporting production and sales, while it may also be adding new accounts in their financial statements to cover up some of these underreported profits. This self-assessment has led to an approximate loss of Rs 15-20 billion per annum for the national exchequer, and that too for an industry that continues to poison its customers. but the industry players seemed to have had their interests protected so far. For one, they have their representatives in the legislature, and by that we do not mean lobbyists, but parliamentarians that have stake in tobacco. The former KP Health Minister, Sharam Khan Tarakai, comes to mind, whose family are some of the biggest names in the country’s
“The problems in the tobacco industry reach far beyond smuggling, and expands in the myriad of ways that the industry is underreporting production and sales, while it may also be adding new accounts in their financial statements to cover up some of these underreported profits” Report by the Social Policy and Development Centre (SPDC) tobacco industry. At the launch of this report by SPDC, FBR’s Member Inland Revenue policy Dr Hameed Ateeq Sarwar said that the tobacco industry has representatives within the National and Provincial Assemblies which makes it harder for the tax collection authority to implement stricter laws. It could be coincidence, but in June 2019, it was feared by farmers that a Rs300 tax per kilogram on tobacco by the Federal Bureau of Revenue (FBR) would render a large number of farmers and industrial workers jobless, and bring huge losses to the growers and those associated with this cash crop in Khyber Pakhtunkhwa. When the farmers complained, Tarakai was part of the high power government delegation that assured them that the FBR would impose the tax on smokers, according to Abrarullah, President of the Mehnat Kash Labour Federation. But when the tax was finally implemented in the budget, the weight was falling on the farmers again. It was a neat situation for the tobacco companies and the government alike. The former did not see a dip in demand due to high prices, and the latter still got their cut in the war of taxes. The ones to suffer were the farmers, who claimed that a well-organised effort is being made by influential people in the country to force the farmers in KP to either stop growing tobacco or sell the produce to two multinational tobacco companies in Pakistan. The News International, even went so far as to reporting that the government added Rs300 tax on tobacco after senior officials of the multinational tobacco companies met some top officials a day before the budget.
Smuggling is bad, what is being done?
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hile the government and the tobacco industry might bicker, and maybe even collude on and off, on taxation issues, the one thing that both agree about is that smug-
gling is a big no. Smuggled product cuts into the tobacco companies’ market, and means tax free cigarettes rob the government of revenue, and promote lawlessness. But again, does Pakistan really have a loosies problem? After years of complaining and persistent badgering from Tobacco companies to crack down on smuggling coupled with Pakistan’s continued failure to implement the World Health Organization’s (WHO) obligations from Framework Convention on Tobacco Control (FCTC), the FBR has introduced a new Track and Trace system. The new system looks to eliminate smuggled cigarettes, and the FBR has also licensed a consortium including National Radio Telecommunication Corporation (NRTC) for a mobile app that will monitor production and transportation of cigarettes. But this new effort is trying to do something far more important than curbing the less pressing problem of smuggled cigarettes, and also looking into the production side of the tobacco companies. The FBR’s new policies track and trace system will be aiming directly at finding out the actual output of tobacco companies. However, even with that it might not be possible reveal and capitalize on the full tax potential of tobacco industry. For starters, a few players have already moved their operations to one area where track and trace system does not exist – Azad Kashmir (AJK), to escape the writ of FBR, as was told by Dr Ateeq himself, not to mention the erstwhile FATA areas have also been used for the same purpose. The earlier mentioned SPDC report highlights just that, as it also identifies correlation in certain trends in reported production and the addition of new headings in the financial statements of both companies – which might as well be a coincidence – to the changes in FEDs as applied by the government. SPDC claims that unless an integrated information system is put in place that monitors the process of tobacco industries at all three stages – production, wholesale and retail – the room and incentives for tax evasion are likely to continue.
CONSUMER GOODS
The state of affairs
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o begin understanding the situation, let us look at the problems identified by the report, the evidence available otherwise that corroborates the report, and the proposed and actual measures being taken by the government in this regard. As per, Oxford Economics – a global forecasting and quantitative analysis company, and Euromonitor International – London-based marketing research firm, approximately 37 billion non-duty-paid cigarettes are consumed in Pakistan each year, out of which 27 billion are produced domestically. This ratio suggests that the underreporting, or perhaps non-reporting, cigarette production is at least 2.7 times a bigger issue than smuggling. As per Euromonitor’s finding, approximately 34 percent of cigarettes consumed in Pakistan in 2018 were non-duty paid. [To put this in perspective let’s say that every year an average 30 percent of production goes unreported. By this number, the Rs 117 billion collected in the fiscal year 2019 would be only 70 percent of the total production, meaning an approximate loss of Rs 50 billion annually. Since, if the total production was reported and taxed, the collection would be approximately Rs 167 billion.] There is enough data in usual newspaper reports that such underreporting is occurring in the country, sometimes blatantly, sometimes through loopholes, and sometimes by influence. In 2017, Business Recorder reported detection by a Rawalpindi tax office of tax evasion by Phillip Morris. In December 2018, Policy Institute of Development Economics (PIDE) released a report “Economics of Tobacco Taxation and Consumption in Pakistan” that substantiated a loss of Rs 36 billion in fiscal year on account of moving from a two-tier FED regime to a three-tier regime. As opposed to outright eliminating of reporting production, this instance is one of a legal loophole, since the tobacco companies moved their bestselling brands to the lowest tier to avail a 50 percent cut in FED. 2019 saw another episode where the tax evasion went right to the roots of tobacco, literally. This was the FBR imposed adjustable tax of Rs 300 on green leaf processing mentioned earlier in the story that had farmers complaining left, right and center. This was supposed to be a corrective measure to the estimated non-documented 40 percent tobacco leaf purchases in Pakistan. However, coming full circle the parliament voted it as a move against poor farmers and therefore a month later, in June, the move was reversed. The instances mentioned above are fairly recent but the problem and its realization are much older. As far back as 2005, FBR had tried
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to stamp each cigarette pack to monitor sales from the formal sector but due to the severe opposition from the industry it never got down to implementation. Likewise, System of Electronic Monitoring of Production (SEMP), not much different to the current track and trace system, was also proposed in 2014 by FBR, which also saw the same fate as their 2005 initiative. Since 2017, FBR finally buckled down on T&T which is now finally in its final stages of implementation, but its results are yet to be seen.
The numbers
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he SPDC report has taken time series data from 2004 till 2018, for PTC, PMPK, and a third company, Khyber Tobacco Company (KTC) to evaluate how the reported production and corresponding profits have changed for these players over
time, and how the foremost claims of rising cost of sales from these players might not be as significant for their revenues as these companies would want the regulators to believe. One of the trends spotted by the report through this data is the four-fold increase in the size of the industry from 2004 to 2018, with the turnover of both market leaders dropping in 2017 for the first time in a decade and a half. As the report also mentions, while this may be a coincidence, it does have a direct link with the rates of FED. During the same time, PTC seemed to have added 19 percent to its market share, from 56 percent in 2004 to 75 percent in 2018, taking all of it from PMPK. Moving on to the cost side analysis, all three companies showed nominal increase in the cost of sales but it continued to fall short of the increase in the turnover reported by all three companies. the notable point however might
of PMPK and KTC were at a higher level, and PTC’s did not drop significantly,” the SPDC finds.
Tricks of the trade
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be the steepest rise in cost of sales in the year 2018, which was attributed to the deteriorating Pakistan Rupee in the international market – thereby signaling a heavy dependence of these companies on imported inputs. Another factor highlighted by the report is that while the year 2017 saw falling revenues as well as scaling down on its workforce, the cost of sales for both PTC and PMPK went up. Interestingly 2017-18 was also the time when FED on several brands of cigarettes was reduced from Rs 32.98 to Rs 16. To look into FEDs in depth, the structure of the FED on cigarettes has historically been a complicated mix of a specific tax on low-priced brands, an ad valorem tax on highpriced brands, and a combined specific and ad valorem tax on mid-priced brands. In 2013, the ad valorem tax was withdrawn, and a two-tier structure of specific taxes based on the range of retail prices was introduced. Changes have been made in the tier structure and tax rates since then. These tax policy interventions have often generated debates about whether the objective of taxation on cigarettes was achieved or not. A table from PIDE’s report is also attached for further clarification on changing FEDs in the past few years. Taking another excerpt from the SPDC report, one might gauge the tobacco companies’ claim of higher FEDs causing reduction in their sales and therefore profitability. The picture that the numbers paint, however, shows that profit margins seem to stay the same and even increase with higher FEDs and somehow with lower sales as well. “For instance, during 2010
to 2014, the profit margins of PTC, PMPK and KTC hovered around 32 percent, 28 percent, and 26 percent, respectively. However, profit margins substantially increased afterwards. In fact, in 2017 – a year of substantial decline in production – profit margins were 47 percent, 36 percent, and 38 percent for PTC, PMPK, and KTC, respectively. Even in 2018, profit margins
ertain things, however, may be ‘hidden in plain sight’. This method of tax evasion by the PTC and PMPK involves the addition of new headings in financial statements. While one may brush this off at first glance, a deeper look into how these values are calculated is enough to raise suspicions. The report highlights, PTC has introduced a new category named ‘Severance Benefits’ in 2015. Severance benefits refer to an amount paid to employees who leave employment unwillingly. This category is in addition to the category, namely, salaries, wages including benefits. It is very unlikely that the company did not pay severance benefits prior to 2015. Whereas, it is probable that severance benefits were clubbed into wages and benefits and the new category could be an outcome of improvements in financial reporting of the company.” There was a drastic reduction of 26 percent in the company’s work force in 2012, but severance benefits are not mentioned. After 2015, severance benefits are shown as a regular expense with varied amount. For instance, even in 2018 when the company’s workforce grew by almost 8 percent, company paid Rs 172 million under severance benefits. The report says that this category is also important because the esti-
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mation of this number is based on financial data of more than two decades, which means that even if these were part of salaries and wages prior to 2015, then ignoring this cost after 2015 would mean that even the extent of under-reporting has been underestimated. On PMPK side, the new category that raised its head in 2015 was ‘Trade Discounts. Before this category was part of the company’s financial statements the net turnover simply turned out to be the difference between gross turnover and taxes, but now this number is also subtracted from sales in addition to FEDs and GSTs. The fact that from Rs 244 million in 2015 these trade discounts exceeded Rs 1 billion in 2018 is, at the least, a cause for wonder. So one might take three points from this discussion: 1) Lower FEDs do not necessarily mean higher sales, as lower sales also do not mean lower profit margins. 2) Cost of sales might not have a lot of impact on net sales. 3) Two major companies decide to add new categories to their financial calculations in the same year. Now moving on to the exact, possible relationship between FED and the production/ reporting of cigarettes as identified by SPDC in their report. One cursory look at the numbers would show that the increase in FEDs did not lead to a corresponding increase in the final prices. While this may be explained through the possi-
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bility that the cigarette manufacturers absorbed some of these increases, the changes in the reported production are less easy to explain. The report explains that “with the exception of 2008-09, the production of cigarettes remained fairly stable between 61-67 billion sticks until 2014-15. However, massive fluctuation in production is evident in the last three years. Declared production reached the lowest level in 2016-17 with massive decline of 36 percent. In absolute terms, the production of the industry decreased by 19.2 billion sticks in one year. This decline can be attributed to the consistent increase in prices of cigarettes largely due to the increase in the FED rate. In 2017-18, the federal government introduced a three-tier FED structure – with a new tier for the low-priced brands. The effective FED rate was slashed by 41 percent, which resulted in a 22 percent reduction in the prices of cigarettes. Interestingly, this decline in prices corresponded with a massive growth of 72 percent in production of cigarettes. In absolute terms, production bounced back to almost 60 billion sticks. This peculiar trend in production of cigarettes coinciding with the variation of the FED raises concerns over the validity of declared production.” Based on the above trends, and after running the financial data through a supply side and demand side econometric functions, the SPDC report, suggested the following: Link the FED with multi-stage taxes, link financial
“A well-organised effort is being made by influential people in the country to force the farmers in KP to either stop growing tobacco or sell the produce to two multinational tobacco companies in Pakistan” Abrarullah, President of the Mehnat Kash Labour Federation data with production, and reduce seasonality in production. This last suggestion comes in the wake of the trends observed that the projected quantities of cigarettes produced shoot up right before the federal budget, perhaps because of the sole reason of uncertainties associated with tax policies. A medium-term tax policy might also serve to reduce such underreporting. As with the current mechanisms being put in place, FBR hopes to collect around Rs 200 billion from the tobacco industry in the next three years with a single tier of FED. While the tax collector might want to keep tax collection tier-free, there is a possibility that the rate of taxes will be increased. However as per Dr Ateeq, that decision is put on hold as not to scare the formal sector. At the same time, while the track and trace system might be able to provide a better insight into production volumes, the data from smaller units, especially those who have already relocated out of FBR’s writ might be difficult. It also poses a threat of larger companies starting operations from smaller factories – which if happens will not be a new practice, as several such units have been uncovered over years still operating after they were formally reported to have been closed down. The Rawalpindi incident with PMPK was of the same nature. At the end of the day, the implementation of GST collection at several levels might be the ultimate solution to the problem of underreporting and tax evasion. At present FED is collected at factory level on declared production. If the FED is linked with GST and then GST is collected at three stages – factory, distributors, and wholesalers/retailers, coupled with track and trace system keeping in view the production and transportation from the formal sector, it might bring an end to this decades long practice of tax evasion. n
CONSUMER GOODS
If you work out,
IGI Life will now give you mobile credit
The insurance giant has partnered with a US-based technology platform to help it offer differentiated pricing to its clients based on lifestyle factors
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GI Life Insurance, one of the subsidiary companies of IGI Holdings has decided to become part of a growing ‘active’ insurance model, by collaborating with US-based Vitality Group. “This is first of kind active life insurance which provides weekly, monthly and yearly rewards which includes mobile top-up, food voucher and etc. just for staying active and healthy. Management believes that this will improve client retention significantly.” wrote Syed Noman Ahmed, a research analyst at Insight Securities, a securities brokerage firm, in a note issued to clients on December 20. The company raised the capital required to launch this project through a Rs1 billion issue of warrants in August 2019. A warrant is a derivative that gives its bearer the right, but not the obligation, to buy shares at a specified price within a specified period of time. IGI Life is planning to sell the product through its network of 22 sales branches across Pakistan, and around 200 direct & 400 indirect staff members. The company has also set-up an in-house training institute for to sell the above products. The Vitality Group, headquartered in Chicago in the United States and founded in 2005, has a presence in 19 countries. International partners include Generali in Europe, SoftBank & Sumitomo Life in Japan, Ping An
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Insurance in China, AIA Group in Asia and Australia, Manulife in Canada, and John Hancock Financial in the United States. Vitality, and its partners, pioneered something called ‘Shared Value Insurance’. What this means is that it is in the interest of insurance companies to make sure their clients are healthier, and to do that the insurance com-
panies themselves will change the behaviour patterns of their clients. They do this in order to promote a ‘healthier society’. But the way that these insurance companies go about it, may create concerns around issues of privacy. For one this model relies on data tracking. “Every single minute this platform tracks
roughly a 1,000 activities and picks up about 50 biometric readings,” according to IGI Holdings corporate briefing. Vitality, for its part, appears to largely ignore concerns around data collection and privacy. One Harvard Business Review article, “Can Insurance Companies Incentivize Their Customers to Be Healthier?”, (promoted on Vitality’s website), reads: “What makes prevention today different from past efforts is how it can be done. First, a wide range of new technologies and data analytics allow tracking who and what is changing, making it possible to establish individualized targets, remedies, and incentives.” That same article also suggests that because of these methods: “Vitality members generate up to 30% lower hospitalization costs and live from 13 to 21 years longer than the rest of the insured population.” Vitaliy is an early adopter of technology. It has more than 150 patents and even has a rewards program with Apple Watch. This aligns well with its stated goal of “the integration of wearable and mobile technologies into wellness programs”. This kind of ‘fitbit insurance’ is tried and tested in developed countries with higher adoption rates of technology across the population, but not so much in places like Pakistan. IGI Life’s bet on a tech-based rewards system working perhaps signals how it views its changing client base, and whether that base is ready to adopt this kind of behavioural monitoring. There is still great potential in the insurance business in Pakistan, with the country’s insurance penetration rates being significantly lower than those of other countries. Insurance premiums in Pakistan constituted only about 0.89% of the total size of the economy, as compared to an average of 2.24% in the region as a whole. Yet over the last decade, the insurance industry in Pakistan has grown relatively rapidly, largely as the result of the efforts of the private sector life insurance companies, which have sought to break the near-monopoly enjoyed by the state-owned State Life Insurance Corporation of Pakistan. That rapid growth, in turn, has led to stiff competition between companies as each seeks to differentiate itself from its competitors, whether it be through making it easier to shop for insurance and getting a quote online, to paying premiums with the convenience of an online payment, etc. IGI Life appears to be the first to be seeking to take advantage of the relatively recent trend among upper middle class Pakistani consumers of fitness gadgets and apps, which has been combined with an expansion in the
number of gyms across major cities in the country as well as an increased awareness of healthy eating habits. Yet it is unclear how many Pakistanis might be willing to share such intimate details of their life as their health information, along with other markers such as where they might be at any given moment in time, with their insurance company, all for rewards such as mobile credit and coupons for restaurants. While the conversation in Pakistan around data privacy has not really taken off yet, it may also be because no company has tried to collect any more data than it needs to
for its basic business operations. The IGI Life experiment may yield useful information about attitudes among the relatively affluent, better educated portions of the Pakistani population: are they willing to exchange their private data for monetary gain? While analysts certainly seem intrigued by the innovation introduced into the Pakistani market by IGI Life, and sound optimistic that it will help the company gain market share with consumers of financial services, there is still reason to be sceptical that such a collaboration will yield anything more than just a little bit of buzz around the gimmick, and nothing more.
Could the Yaris help Toyota recover from its sales slump? New sedan model’s introduction into the Pakistani market could allow the auto giant to widen its product range and offer a cheaper alternative to the corolla
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he financial fortunes of Toyota – the company best-known in Pakistan for its production of the country’s leading sedan, the Corolla – may end up becoming more reliant on another sedan. The launch of a new model, the Yaris, could end up help turning around Toyota’s fortunes, which have taken a dive in recent months with declining sales. The Yaris is the latest offering in the competitive 1,300+ cubic centimeter engine sedan category, and is expected to be launched in the third quarter of the fiscal year ending June 30, 2020, with sales commencing in the fourth quarter (the second calendar quarter of 2020). The Yaris is expected to have five variants (ranging from 1.3-litre to 1.5-litre engines), and will be priced between Rs2.3 million and Rs2.9 million, making it significantly cheaper than the Corolla, which currently retails between Rs2.5 million and Rs3.7 million. According to a note issued to clients by AKD Securities, an investment bank, the sale of 30,000 to 50,000 units of the Yaris could push annual profits for Indus Motors – Toyota’s Pakistan subsidiary – by between 5% and 31% over the course of this financial year. So far, Toyota had been relying on its core brand, the Corolla, which is the dominant sedan in Pakistan, making up on average 61% of the 1,300-cc segment in the last decade, and contributed on average around 75% to Toyota’s gross profits over the last 5 years. This over reliance on the Corolla has been a pain point for Toyota, since the average car model is only meant to last around two years. The long overdue Yaris could help revive sales. “On price rise frequency and cumulative hikes amongst the three major OEMs [original equipment manufacturers] through the CY17-19 devaluation led pricing escalations, Indus Motors has the highest cumulative price rise for its Corolla variant, with higher price rises sooner, confirming our case for Indus continuing this trend to preserve margins,” wrote Ali Asghar Poonwala, a research analyst at AKD Securities, in a note issued to clients on December 19.
FINANCIAL SERVICES
Toyota is well positioned for this new launch. According to AKD Securities, Toyota’s augmented capacity allows the firm to meet any demand spikes with relative ease. It also has a successful track record of riding the new-model effect sales bump. Additionally, there is little competitive pressure, since a Honda City upgrade is not due until 2021, and KIA or Hyundai have not announced any new entrants in the same segment. Car sales in Pakistan are driven in large part by increases in personal disposable income. While that does not necessarily always go down for a substantial part of upper middle-income households in Pakistan – the kind of people who can afford to buy a car – during an economic slowdown, a slowing of economic activity nonetheless does make people want to conserve their cash more, and hence be less inclined to make a large purchase like a new car. This year, that slowdown is being exacerbated by a new problem: the requirement imposed by the government that people be able to prove that they have filed their tax returns before they can buy a new car. Most people in Pakistan do not file their tax returns and fear doing so because they think – not without rea-
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son – that they will be harassed by the Federal Board of Revenue (FBR) if they disclose to the government how much money they make and what their source of income is.
Auto financing
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second major factor that drives new car production in Pakistan is the availability of car financing from commercial banks. It is not clear just what proportion of cars in Pakistan are bought on auto leasing, but it is clear that the volume of auto loans available to consumers is directly proportional to the number of new cars sold and produced in the country. The total amount of new loans to consumers has been steadily increasing over the past six years, though the pace of increase over the past 12 to 15 months has dropped considerably. The total volume of loans outstanding declined in June 2019. Banks are increasingly uncomfortable with the idea of loaning money to consumers at a time of rapidly rising interest rates. The State Bank of Pakistan has more than doubled the benchmark discount rate at which it lends to commercial banks. The discount rate was 6.0% as recently as January 2018. It has since risen to
13.25% in just over 18 months. Commercial banks are particularly afraid of a repeat of 2008, when they had been lending to consumers at a rapid clip for about five years, and then suddenly saw a sharp rise in interest rates, which affected the ability of many of their borrowers to pay back their loans. As a result, defaults at commercial banks on their consumer lending portfolios rose sharply and they faced heavy losses on their balance sheets. The decline in auto lending is unlikely to be as sharp or as prolonged as the one that followed the 2008 financial crisis. For one thing, interest rates are unlikely to hit 20%, which is what happened in the aftermath of that recession. Most analysts believe that the State Bank of Pakistan is unlikely to raise interest rates any further than they already have. And secondly, banks appear to have been far more prudent in their lending practices during this boom cycle compared to the last one, which suggests that loan losses are unlikely to be as high as they were the last time, when over a quarter of all consumer loans went into default. That number is likely to be significantly lower this time around, which means that banks are unlikely to completely abandon consumer lending like they did in the aftermath of 2008.
AUTOMOBILES