Editor
This
article was published in Business Recorder, the Leading Pakistani
Business Newspaper in September 1997. Wharton Partners explained
why Pakistan's economy was not responding to the governments efforts
to revive the stagnating industrial sector in Pakistan
The
attempt to revive sick units very likely to fail
KARACHI
(September 11): A
major problem facing this nation is a lack of production of exportable
goods compounded with living way beyond our means. It is now recognised
that the industrial sector of Pakistan is in serious trouble and
attempts are being made to revive the sick industries. Increased
industrial production is the only practical way to cope with the
trade and budget deficit problems.
In the past few years policies regarding taxation and debt structuring
were instituted which resulted in almost inevitable default and
sickness of the small and medium size industrialists. Those who
survived this credit crunched environment were some large industrial
groups who were able to refinance debt with other debt. Even these
faced very low profitability. The proof of the destructive effect
of this structuring problem is so mathematical that their can be
no real argument made against it.
Wharton Partners believes that the current approach of setting up
committees for the revival of sick industries is almost certain
to fail. We believe the constitution of the sick units committees
is such that generally it will lack certain specific skill which
are necessary for project appraisal. These skills will be necessary
to decide the future viability of the industrial units.
The committees have a chairman (appointed by the State Bank) of
the committee, a chartered accountant, a legal expert, a representative
of trade/industry, representatives of the bank and the concerned
parties and FPCCI representatives etc. The problem is that none
of the members of the committees have the following necessary skills:
Fixed income security analysis and mathematics: This is the requisite
knowledge for understanding the structure of loans. The structure
of loan i.e. how principal and interest payments will be made is
crucial to the survival probability of the industry. The structure
of project finance loans in Pakistan is such that default is imminent
for the vast majority of industries if they cannot refinance their
loans. The bankers and chartered accountants are not trained in
this discipline. This is evident from the fact that such a devastating
structure of debt was used so widely in Pakistan without any expert
questioning it. The chartered accountants who were part of industrial
revival attempts in the past and also feasibility experts never
realised the structuring problem.
International asset returns: Investment strategists are familiar
with asset returns data in the various economies of the world. Business
Week also prints annual results from various countries. Efficient
market theory and the capital asset pricing model imply a great
deal about how returns on investment will be distributed based on
investment risk. These areas mentioned are essential not only for
an investment analyst but also for project finance specialist. Had
our chartered accountants and bankers been aware of these aspects
of international financial markets and financial theory, this widespread
destruction of industry may have been much less severe. The reason
being the project finance specialist would have realised that the
structure of debt being used would have been impractical in almost
any country in the world. Our CAs and bankers would have realised
that the Pakistani banking system applied to the US would result
in most industries failing. Similarly our system applied to 60 other
countries would result in similar disasters. (Assuming the same
difficulty in restructuring and refinancing debt).
Competitive strategy: Knowledge of this aspect of management theory
and exposure to ideas of the top investors of the world such as
Warren Buffet or Peter Lynch, would have resulted in very different
decisions regarding project financing in Pakistan. Value-added projects,
engineering industry and export oriented projects would have been
stressed even though the domestic market provided higher returns
in the past. This was absolutely crucial. If there were people with
good expertise in this area, the cement and textile industry in
Pakistan would not be in such a bad shape. For the ACCA trained
accountants, better training in this field is done than the regular
CA training in Pakistan.
The unfortunate thing is that neither the chartered accountants,
nor the bankers, nor the State Bank of Pakistan, nor the FPCCI has
the above mentioned expertise. Without a good understanding of all
the above mentioned expertise, any attempt to try to figure out
the viable versus enviable units will fail. The fact is that thousands
of industries are in severe financial distress if not outright closure.
The State Bank was on watch while this systematic process of deindustrialisation
occurred. They were unaware about the debt structuring problem.
They lacked the expertise mentioned above. Same holds true for the
chartered accountants.
SOME PREDICTIONS Wharton Partners wants to make the following predictions.
Unless experts are brought with the above mentioned expertise, this
current attempt to revive industry will fail. Secondly, if our analysis
is correct, the new scheme of principal + X% will fail for the more
recently put up industries, as the real problem is the structuring
of the debt. Thirdly, since the industrial crisis is due to structuring
of debt and taxation problems, we believe the governments attempt
to recover 1/3 of the defaulted loans quickly will fail. Fourthly,
if an attempt to liquidate a significant portion of industry is
made, this will have the same results as the debt retirement scheme.
The fact is that Pakistan has accumulated our debt over decades.
It was not logical to assume that the debt retirement programme
would raise capital on the order of the national debt (especially
in view of the fact that we have been running trade deficits for
decades and there is no real creation of wealth). The same applies
to liquidation of industries, a glut will be created in an environment
where industries set up over a long time is liquidated. Both the
excess supply of industry and the low Net Present Value of industry
due to bad economic conditions will result in recovery of only a
small percentage of the defaulted loan for the industry. Lastly,
the quicker the attempt to recover money is made, the lesser the
amount recovered will be and the industry sickness will increase
proportionally.
Mian Sahib must get the credit for understanding the importance
of industrial production for the economy. In this new environment
with a widening trade deficit and lower net transfer of debt, it
is absolutely essential to increase industrial production. However,
he must understand that the necessary expertise is lacking in the
people responsible for the industrial revival. Pakistan must get
the expertise it can find. The autonomy of the State Bank is a dangerous
development since they not only lack the above mentioned expertise
but are unwilling to admit the dangerous mistakes they made. In
a country with limited expertise it is essential to share whatever
good resources you have. In that view if there is a debt expert
in company X, both the State Bank and Ministry of Finance must use
it.
In order to avoid a repeat failure Pakistan needs to get the above
mentioned expertise. It may be in the form of its sons abroad such
as Mansoon Khan, Arif Sarfaraz, Ali Asghar, Omar Khayyam Sheikh,
Mansoor Siddiqui, Nadeem Babar, or may be in the form of companies
such as McKinsey & Co, Goldman Sachs, Morgan Stanley, Merril
Lynch etc. The time is now. Lets not make our children pay because
our vanity does not permit us accept our lack of expertise in debt
project finance related areas.
(The writer has worked with Goldman Sachs in New York on debt issues
and is presently operating Wharton Partners).
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