'Garment sector faces severe liquidity crunch due to pending refunds,' CEO Ashraf Industries

BR Research recently sat down with the CEO of Ashraf Industries, Mr Ijaz Khokhar. Ashraf Industries is the leading marital art uniform exporter in the country and Mr. Khokhar has been instrumental in growing the company from its humble origins to its current scale. Ijaz possesses vast experience in the garments sector and has also headed Pakistan Readymade Garments Manufacturers & Exporters Association (PRGMEA). We discuss various financing and export related issues being faced by the garments industry. Below are edited excerpts of the interview.
BR Research: Please tell us the journey behind Ashraf Industries and its subsequent success.
Ijaz Khokhar: My grandfather possessed considerable experience in stitching and catered to orders from a royal family in the Gulf region so our family has been associated with the garments sector for generations. Ashraf Industries was set up in our native town of Sialkot with some savings my father had done during his time in the Middle East. Although the eventual goal was to become an export oriented firm, in the early years we used to stitch uniforms for the army. We got a breakthrough in the early 1970s upon receiving an order from Japan for making martial arts uniforms. That changed everything and eventually transformed Ashraf Industries into the leading martial arts uniform exporter from Pakistan. Currently we supply to every major brand and martial arts club in Europe, United States and Japan.
BRR: How much is your annual turnover and employee count?
IK: Our turnover is roughly Rs 500 million and we employee about 500 people.
BRR: Given you vast experience in the garments industry, how effective do you consider the exports package announced by the government?
IK: The package itself is not practical so far and there are reasons for this. There has not been any payment of refunds and the State Bank of Pakistan (SBP) hasn't started the disbursement yet. Firstly, a minimum of 90 days are given for the shipment. If you've done the shipment in January, then your payment will arrive in March and April. Sometimes it can be as long as six to nine months depending on the kind of product. For example, football's payments arrive in six to nine months.
The main problem is the liquidity crunch these days, and because of that the exports have been suffering. We prefer receiving cash in hand instead of the incentive. Cash in hand is your liquidity which is what you get in the form of sales tax refund. That would have benefited us more than this package. Our previous refunds would have been received.
BRR: So yours refunds have not been cleared yet. How about the cash incentive on the incremental new refunds? Is that helpful?
IK: Yes, but less than 5 percent entrepreneurs are gaining from it. Only the big vertical units are experiencing growth due to this, not the small and medium enterprises (SMEs). That is a reason behind the decline in the overall exports. There are two packages running parallel right now. One of them is the one with a 4 percent incremental percentage on 10 percent growth of exports.
You get 7 percent on the FOB value of exports from the other package that is from 1st January to 30th June, 2017. This is not on an incremental basis right now, but it will be levied on incremental basis after six months. So the rate which was higher than 10 percent last year will continue. Those who cannot increase their exports in line with this will be unable to take benefit from this.
BRR: What are the constraints behind expansion for the companies operating in the garments sector?
IK: Nobody has enough capacity to go into expansion right now, because expansion is based on your cash in hand which we don't have in sufficient amounts currently. When we will get cash in hand, we will pay our vendors before anything else; our businesses run because of them.
For example, in garments industry, 70-80 percent cost is that of raw materials which is the foundation of our business. If I will not get cloth, I won't be able to produce anything. Because of previous liquidity problems, we have faced blockages since the vendors have cut their supply short. The solution is that you pay your vendors first in cash. If you have Rs 1 million you can run the cycle three times for up to Rs 4 million but when the money running in that cycle gets blocked it is then that the problems arise. This has happened with us for more than two years. When this happens people start making excuses that they will pay later. This is one of the basic reasons why vendors close supply of raw material to us. Since there is not enough financial cash flow the problems become worse.
Now the government should have launched this incentive in 2013-4 when the exports were declining so exporters could have benefited. Even right now when the package has been launched, there still have not been any disbursements. They are still in the process of collecting documents. So we won't be able to see any impact of this incentive till at least June and it a long shot even then.
Looking at the fiscal deficits, we are not expecting any cash receivables from the government. Their target for collections is in decline. So, now the government is trying to come up with new plans such as collecting income taxes in advance. Even if they will collect income taxes in advance, they will keep that money as a reserve to maintain financial levels. Exporters don't see any green channel that could help them right now. Secondly, this local situation has also blocked our overseas markets. And because of this liquidity crunch, we cannot pay our vendors on time and thus lose our credibility.
There are also some disadvantages of expanding factories by borrowing money. I am satisfied with the organic growth that my business is experiencing. The spinning sector borrows money from the bank to expand. Export refinancing is suitable for them. But value added business have a very tough competition from all over Asia and so to stay competitive they don't borrow from the banks. Bangladesh is very competitive and this is why their garments exports have crossed $27 billion, plus their policies are implemented properly. Unfortunately the same cannot be said for Pakistan, where policies are not even implemented properly. So my advice is that in order to survive for long term, try to depend on your own resources instead of borrowing from the bank.
BRR: Why don't you avail bank financing as an option to ease your liquidity crunch?
IK: Banks are already financing the big players in the textile sector. So if I go and borrow from them they will lend me the money since my credit history is clear. But generally, since SMEs are short of collateral most of the times, it gets very hard for them to borrow money.
There was a certain overdraft limit set for the SMEs and they could borrow up to that amount. But banks are not following that, because they are demanding collateral to pledge against that loan. They aren't even giving them the running finance facility. They also said that SMEs will get the personal guarantees, but for that the individual guarantor is personally responsible if the business is unable to pay its debts. So no one in the SME business will get that easily. So SMEs are just used in slogans and there hasn't been any work practically done for the development of this sector.
BRR: Letter of Credits (LCs) used to be higher five years ago but now the trend has declined. What are the reasons behind this?
IK: The LC is usually opened when you are dealing with a new customer. New customers are given two options. First is LC which involves a lot of formalities. The bank might also ask the buyer for a guarantee or a cash payment to open an LC account. If the buyer has an established business, the bank might open his LC on a 10 percent margin.
LC financing is at 5 percent today, but 10 years ago it might be equal to 20-30 percent. There's a declining trend because the export market has generally become competitive. The market has become a buyer market and due to that you had to divert to compete with your regional market trend. Because the market trend in that region was that sometimes people used to take advance payments.
There are two conditions of LC. The LC at sight is the one including advance payments. The other one is DA (Deferred Account) which accepts deferred payments.
BRR: In an open contract, you have a surety that you'll get export proceeds after a certain period of time. Do banks lend you on that?
IK: It does up to 60 percent of the total amount. But then it demands collateral for security, because LC is just a piece of paper. The overdraft limits have to be first sanctioned by the State Bank; they will take permission from the State Bank and then give out the loan.
Let me tell you one more thing about LC. There is a difference between us and Bangladesh. Here we don't have the concept of back to back LC. Bangladesh's growth has been 90 percent due to back to back LC. This means that if I get a LC of Rs 10 million and I have to buy cloth from different vendors and my basic material costs me 60 percent, then I will go to the bank and ask them to open my LC account and loan me up to 60 percent amount without collateral.
When I will export those goods the bank will give me the amount due to me and everything will be clear. This is the ideal system which doesn't exist here. We have told the government, recently in the budget, that if they really want to promote the exports and solve the problems of liquidity crunch in the country they should introduce this back to back system of LC on the pattern of Bangladesh.