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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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