Pakistan Steel Mills Corporation

KARACHI: Origins

The government never realised how much money a project as enormous as the Pakistan Steel Mills Corporation could bleed from the country if left in inept hands.

The government established the Pakistan steel mills corporation thinking that that economic growth would not be possible without a self sufficient iron and steel making plant.

They believed that depending on imported steel would cost the country too much. How wrong could they have been? They would never have believed that it would come to such a point that the Steel mills would ask for steel imports to be banned so that it could sell its steel at a higher price.

In May 2006 Pakistan Steel Mills was privatised. This could have been one of smartest things that the government of General Musharraf could have done.

The consortium involving Saudi Arabia-based Al Tuwairqi Group of Companies submitted a winning bid of $362 million for a 75 per cent stake in Pakistan Steel Mills Corporation (PSMC) at an open auction held in Islamabad. Rs21.6 billion or $362 billion was paid by Al Tuwairqi, Russian Magnitogorsk and local brokerage Arif Habib securities to take control of Pakistan Steel mills. This amounted to Rs16.8 per share.

We could have been saved but justice had to prevail. The privatisation was reversed. This happened after a wide spread hue and cry for action from everyone; mainly steel mill employees and unions who feared they would be fired because the new management would figure out that they were of absolutely no use.

The verdict was delivered on August 8, 2008. They said that the selling process of the Steel Mills was hasty and ignored profitability. But then again hindsight is always 20-20. The scene was set and the $362 million transaction with the Russian- Saudi-Pakistan investors was no more.

Privatisation

Nobody ever bothers to verify numbers because numbers don’t lie. The argument against the sale of the steel mills was that it was being sold too cheaply there were also rumours that people were benefitting on the side from the transaction.

Opponents of the sale claimed that market analysts had estimated the price of a 75 per cent stake in the mill to be much higher than the Rs21.68 billion, that it was eventually sold for.

They never bothered to take into account the companies liabilities, the kind that are imminent when the management is completely government appointed, the kind that bring about losses every year.

Analysts said that realistically the value of liabilities for the mill at the time must have been huge because the mill has been incurring losses and hemorrhaging money, tens of billion rupees of it, for many years.

The money that would have to be put into the Steel mills to make it viable again was never taken into account. They never considered the economic benefit of a non-government firm putting money into the mill to run it in an efficient way so that it could stop incurring losses and produce more steel. Even if it did not benefit the government monetarily, the industry would still benefit from the increased steel production.

So far the government has not been able to stop the steel mills from being a white elephant. There is no way that the government would be able to spare the money required in its current financial position to fix the steel mills problems.

Pakistan’s fiscal debt went through the roof long before the privatisation transaction of the steel mills and still nobody thought to question the economic viability of not privatising such a large hole in the government’s pocket. The most basic of benefits of such a deal would have been that it was foreign investment and it could have attracted more.

It would have made the public steel mills monopoly private. Then the competition regulating body of Pakistan would not have as much trouble dealing with because it would not have belonged to the government and vested interests would have been fewer.

Losses

Pakistan Steel Mills Corporation (PSMC) has lost and cost the government a huge amount of money so far.

Its annual losses stood at Rs9.33 billion and it needed to pay back Rs19 billion worth of loans up till 1999.

Then it suffered a net loss of Rs19.5 billion in 2008-09. In just six months, it lost Rs5.622 billion during the July 2009 to January 2010 period.

The ECC was forced to approve a Rs10 billion bailout package for Pakistan Steel Mills in January 2010 to overcome its “acute financial crunch”. Pakistan Steel Mills said that the Rs10 billion was ‘adjusted in the loan repayment.’

Now PSM wants Rs25 billion more, and has again requested the ministries of industries and production and finance for a bailout package for running the mill efficiently and help it overcome its financial liabilities. They say that the mill is currently running at 30 to 35 per cent production capacity. In lieu of this the privatisation back in 2006 just keeps on getting more and more attractive.

Despite all its problems, the mill is a paradigmatic employer and would rather see itself run into the ground than mistreat its long standing employees. In the midst of all the troubles that it is facing, the mill started issuing letters confirming their jobs.

But these are just the workers; other employees of the mill take house rent from the company worth billions of rupees while residing in the official residences that the organisation provides. The double benefits on accommodation were enjoyed by many people from the chairman to officers at junior posts according to the Public Accounts Committee (PAC). The former PSM chairman also took Rs2.886 million house rent while using his official residence.

Apparently there were some serious financial problems other than the ones that had always been plaguing the company. It was discovered that the Pakistan Steel Mills was in serious trouble after the Competition Commission of Pakistan (CCP) undertook a detailed investigation of it in 2009.

The organisation was left in serious debt up to Rs22 billion, possibly more. The CCP discovered that the Pakistan Steel Mills had run its factories into debt by selling exclusively to the Abbas Steel Group at well below the market price while other competing vendors were not sold to at all.

Initial allegations accused the, then Chairman of Pakistan Steel of having a strong bias towards the Abbas Steel Group (ASG). They were accused of allocating all the billets being produced by Pakistan Steel Mill to be sold exclusively to the Abbas Steel Group at rates well below the market price while other vendors, who had actually made complete payments in advance at the official market price, were left stranded and ended up literally running their factories into debt and ultimate closure.

Pakistan Steel gave Abbas Steel exclusive rights to all its production and discounted prices after Moeen Aftab Sheikh was appointment Chairman of Pakistan Steel by the Pakistan Peoples Party.

The CCP’s detailed investigation found that the owner of Abbas Steel Group, Riaz Lalji was responsible for the Steel Mill crisis.

Domination

Pakistan Steel Mills does not sell its own steel: it outsources that task to steel dealerships that then go on to distribute the steel throughout the country. The commodity mill has strict guidelines on how much steel it can sell to each dealership.

In theory, at least, the mill is supposed to sell roughly the same amount of steel to each dealership. It does so in order to avoid giving a single player monopolistic power to corner the steel market. But, according to informed insiders, that is not how the system works in reality.

According to a steel dealer familiar with the matter, several enterprises register multiple dealerships under the names of their relatives and friends and then bid for steel through multiple licenses, in effect circumventing the rule designed to prevent the rise of monopolies. The mill makes no effort to regulate this sort of behaviour and generally shrugs off the responsibility of ensuring that rules are followed.

“Since these people have virtual control of the steel production in the country, they can charge whatever they want for their wares,” said one dealer. “They can hoard it in bad times, they can benefit by selling it to one person over the other.”

The rate at which the steel mills sell to the dealership is usually stable and fixed but the dealerships are free to sell at whatever price they want, constrained only by the economic forces of supply and demand. Given the fact that the demand for steel in Pakistan outstrips local supply by a factor of five times, the dealerships have enormous market power.

Nevertheless, according to industry experts, Pakistani steel prices do tend to fluctuate with international prices, since most of the steel used in the country is still imported from abroad. When steel prices fell over the last few months, dealerships began hoarding large amounts of steel in order to sell once prices have recovered.

Some observers feel that the decision by the steel mill to outsource its marketing and distribution to dealerships creates an unnecessary middle-man that only serves to act against the public interest.

Pakistan Steel (PS) has requested the Ministry of Industries and Production and the Ministry of Finance to arrange a bailout package of Rs25 billion to help the mill run efficiently and overcome its financial problems.

“The management of Pakistan Steel is striving hard to harness each and every source to enhance its production capacity and sales of its products at competitive prices to the international market,” said the PS in a press release on Friday. The PS said that in the last few months it has stepped up procurement of iron ore and coal which are essential for iron and steel production. “The supply line has been restored,” it said. Over the past month, the PS said, it has received two shipments of coal and one shipment of iron ore.

Another shipment of 50,000 tons of iron ore is expected to arrive in three to four days. “With this encouraging stock of iron ore and coal and putting in place of a comprehensive business plan, we expect to take production capacity to 70 to 80 per cent in two months,” said the PS. “With the business plan coupled with a bailout package in due course of time, we are confident of becoming a profitable organisation again,” it said. The PS stressed that the mill was neither being closed nor priVATised and there was no truth in such reports.

It is unclear why the government has not followed up on its plan to exploit substantial iron ore deposits in Kalabagh and has delayed its proposal to set up a steel mill there despite plans to do so in 2002, say analysts.

According to the Geological survey of Pakistan, Kalabagh (Mianwali district) holds substantial iron ore reserves at an approximate 9,300 million tons. Given this, the idea of constructing the second largest steel mill at Kalabagh was explored by the Musharraf regime in 2004.

However, reasons as to why no government has been able to tap into the resource remains a mystery. Local raw material procurement would be a blessing to the country’s national exchequer and those who painstakingly import raw materials from countries such as India, Iran and Turkey.

The withering ship-breaking industry, a source of scrap at Gadani, is costing the national economy much more than lost taxes as hundreds of steel rerolling and re-melting mills owe their very existence to the ship-breaking industry. However, many steel re-rolling mills have now resorted to importing steel billets or utilising local and fragmented suppliers that provide them with timely and hassle-free supply of items.

These steel reinforcement bars are in turn consumed by the construction industry in the country. But there remains a dearth of quality steel products being manufactured locally. The per capita consumption of steel in Pakistan is 38 kg per annum as opposed to a global average of 198 kg per annum.

This demonstrates the immense potential that Pakistan has to first become self sufficient in steel production and then focus on exporting quality steel products to the world on a similar model to that utilised by China and India and as a result increase its per capital consumption of steel which is a good indicator of meaningful infrastructural development.

One would have thought that the role of the steel industry would grow as Pakistan modernises as a result of steel structures replacing traditional masonry work in construction activities. However, the industry remains highly fragmented with an estimated 598 manufacturing units operating throughout the country.

Pakistan Steel Mills (PSM) remains the largest industrial unit in the country with an annual production capacity of 1.1 million tons. PSM recorded a loss of Rs5 billion in the first 6 months of the current financial year. The company is beset with allegations of rampant corruption, bribery and the latest findings by the Public Accounts Committee state that PSM employees avail a facility reported as “house rent” in addition to residing in official PSM quarters.

Such fringe benefits are leading the state-owned entity to near bankruptcy. As a result, downstream industries are suffering presently due to PSM’s year on year trend of inefficiency and recorded financial losses. The government should focus on developing and supporting mini steel mills which require less capital investment and based on supply from local iron ore deposits in Punjab, Khyber-Pakhtunkhwa, and Baluchistan, say observers.

These state of the art mini mills prove to be more cost effective, require less capital investment and are easier to modernise instead of revamping PSM which has out-dated technology and worn-out machinery. But there are many hurdles to cross including importing under a clear and transparent scheme.

There are different rates of duty for almost similar items of flat rolled products such as 10 percent on prime and 20 percent on secondary products. There is also harassment from the customs authorities and government departments which create problems for steel importers so that they can also make money.

A unified duty on iron and steel items should be implemented by the government, say observers. Insiders say that shipping companies have formed a mafia whereby they are charging irrational freight costs. This results in hampering the already fragmented steel sector from doing good business, say many.

To import raw material, the State Bank of Pakistan (SBP) should also allow forward cover on foreign exchange for import of steel products and raw material due to the volatility of the rupee against the US Dollar. This would in turn encourage importers of steel products in an industry where there is a shortage of local sources of coal and iron ore and the end-users are unregulated.

The federal government has excluded Pakistan Steel Mills from the privatization list.

The decision was taken at a meeting held under the chairmanship of Federal Minister for Industries, Mir Hazar Khan Bijarani on Thursday in Islamabad.

The ministry is preparing a summary for the prime minister’s approval on this decision.

The government previously tried to privatise Pakistan Steel Mills during the regime of Pervaiz Musharraf, but the Supreme Court ruled against the move.

The federal government has excluded Pakistan Steel Mills from the privatization list.

The decision was taken at a meeting held under the chairmanship of Federal Minister for Industries, Mir Hazar Khan Bijarani on Thursday in Islamabad.

The ministry is preparing a summary for the prime minister’s approval on this decision.

The government previously tried to privatise Pakistan Steel Mills during the regime of Pervaiz Musharraf, but the Supreme Court ruled against the move.

Poor supply chain management, it appears, are largely to blame for the colossal losses mounting at the state-owned Pakistan Steel Mills, the largest steel company in the country, a firm that has requested three bailouts over the last three financial to years and is unlikely to be able close the current year without substantial financial support.

A comprehensive investigation into allegations of financial malfeasance at the company, conducted by the Federal Investigation Agency, concluded that the company’s antiquated method of purchasing raw materials – primarily iron ore – was responsible for the massive increase in losses that occurred after the close of the financial year ending June 30, 2008.

The findings of the report were made available to PSM’s management in August, which was then asked to comment on it before it will be forwarded to the Supreme Court in the next few weeks, said one official at the Steel Mill.

The PSM management, however, appears to have yet to come up with solutions to the problems alluded to in the report, including the inefficiencies in its procurement and supply chain management policies.

“The biggest problem facing Pakistan Steel is a raw material shortage,” said one high-ranking official at PSM who wished to remain anonymous.

PSM had a policy of setting annual contracts for its purchases of raw materials – primarily iron ore – from its suppliers, a policy that hit the company’s finances badly as international commodity prices fluctuated wildly during 2008 and 2009. Because the steel mill had often locked in contracts for supplies at higher rates, its production costs often did not match the prices it could command for the finished product.

The company faced massive losses in fiscal year 2009 of around Rs26 billion, though those were reduced to Rs11 billion during 2010 and were projected in April to be about Rs5.6 billion during the fiscal year that ended June 30, 2011. Despite being a state-owned company, PSM does not make its financial statements available online.

PSM has since switched over to a quarterly procurement policy, which balances the company’s needs for stable prices with relative nimbleness in its ability to take advantage of fluctuations. (Iron, unlike most other metals, is not traded on commodity exchanges, thus making it difficult to hedge against price movements.)

The management of the company, however, did not elaborate on why PSM has trouble in procuring adequate supplies for its operations other than to say that they have not been able to import raw material from Iran, owing to reluctance by banks to finance the transaction due to US sanctions on Tehran.

To a large extent, however, Pakistan Steel Mills appears to be a victim of its own inability to adjust to a changing competitive environment. When it was set up in the early 1970s with the financial assistance of the Soviet Union, PSM was the only steel mill in the entire country, a monopoly it enjoyed for over two decades.

In the early 1990s, however, it began to see more competition emerge from the private sector, as the more free-market-friendly policies of then-prime minister Nawaz Sharif allowed more investment in the industrial sector.

PSM has since sunk from a virtual monopoly two decades ago to a 20% market share today, which has substantially reduced its market power in buying raw materials. It is unclear, however, whether the company’s management has adjusted to the new reality.

The company is currently producing at only 20% production capacity, well below the 70% it needs to produce at in order to remain financially viable, according to PSM insiders.

“I can assure you that we can produce at 70% capacity in a matter of days if we get the right amount of raw material,” said one source at the company.

The government has decided to enhance production of Pakistan Steel Mills (PSM) from 1.1 million tons to three million tons per year.

A meeting held here on Tuesday discussed balancing, modernisation, revamping and extension of the mill with technical assistance from Russia.

Federal Minister for Industries and Production Mir Hazar Khan Bijarani and Russian Ambassador to Pakistan Andrey Sergeevich Budnik, who were present in the meeting, decided that a proposal should be worked out to expand the steel mill’s production capacity to three million tons per year.

The Ministry of Industries and Production will finalise the proposal within two days after consultation with other public sector stakeholders. The Russian ambassador also gave suggestions in this regard.

The two governments will finalise terms and conditions of technical and financial assistance offered by Russia.

If both the governments agree on the proposal, a memorandum of understanding will be signed by the Ministry of Industries and Production and the Russian Economic Development Ministry during President Asif Ali Zardari’s visit to Russia next month.