'Atmosphere of accountability negative for investor sentiment' an interview with Chairman Nishat Chunian Group, Shahzad Saleem

BR Research recently sat down with Shahzad Saleem, Chairman of the renowned Nishat Chunian Group. Shahzad holds an MBA from the Lahore University of Management Sciences (LUMS) and was amongst the second batch of the university's MBA cohort. One of the best success stories around, Shahzad has been a role model for entrepreneurs looking to make it big in Pakistan. In a candid discussion, Shahzad gives his views on the entrepreneurship culture in Pakistan, the problems in the power and textile sectors of the country and the role of the government in private sector affairs.
Below is an edited transcript of the interview:
BR Research: You are one of the top entrepreneurs in Pakistan and are a great example of how to make a successful business from scratch. Entrepreneurship in the country is still weak and there are limited examples of flourishing businesses. What are the impediments to entrepreneurial growth in the country?
Shahzad Saleem: This is a very important question. For entrepreneurship to flourish, it is extremely important that you have an enabling environment. The most important aspect of entrepreneurship is failure. However, in Pakistan you do not have the option to fail. That is a fundamental problem. We consider failure to be a cultural taboo. In America, which is considered the hub of entrepreneurship, almost 98 percent of businesses fail. Failure is an accepted norm there, and there is no witch-hunt.
By definition, an entrepreneur is a risk taker. So, getting rid of this taboo will help develop entrepreneurship. India's software industry has also moved beyond this taboo. Angel investors are there in big numbers and they are aware that investing in 100 companies will only yield two to three successful companies. The laws also have to be supportive of people exiting businesses. You cannot haunt them for 30 years. Accountability should be there but not like the way it is being done here.
BRR: Please elaborate on how are laws not supportive for businesses looking to exit.
SS: Bulk of my time is spent managing operational affairs and relationships with government and semi-government departments and looking at the laws. The laws should be made simple to facilitate business owners.
I will give you an example. In the textile industry, a lot of factories went bankrupt. If these companies were bought ten years ago when they declared bankruptcy, they could have been turned around or at least their machinery would have been worth something. But our legal system does not permit us to acquire them in a timely manner. Eventually it took us ten years and the machinery was sold as scrap. We have created an asset trap.
The property market is another example. In Lahore alone, 10-15 percent of the urban property market is stuck in litigation. If these are resolved, the supply will increase and the rates will automatically come down.
Banks are not willing to take risk in lending because if something adverse happens, the laws are not there to support them. This has resulted in bank financing only limited to top tier clients or the government. The aim should be to decrease societal risk. The prices of everything will fall automatically because the reward will be lessened.
BRR: You mentioned accountability should not be done the way it is done here. Many other people in the business community have also raised this issue. What needs to be improved in this regard?
SS: This atmosphere of accountability that has been created is a big negative for overall investor sentiment. This is increasing the risk factor for doing business. People do wrong things across the world. What matters is the appropriate reaction by the state.
Here, thousands of cases are being dragged for more than decades. Summonses are made every day and unfair media trials conducted irresponsibly. When someone is called by NAB, it makes news. But when it turns out there was nothing there to begin with, that is not reported by media channels. However, what it does do is increase the risk for people looking to invest in Pakistan as an atmosphere of fear takes over.
The premise in Pakistan is the other way around. Instead of being innocent until proven guilty, here the onus is on the person to prove that they are not guilty.
BRR: The power sector in Pakistan has been riddled with problems. You operate in it as well through Nishat Chunian Power Limited (NCPL) and have a long association with the sector. One point that consistently comes up is the high return given to IPPs which constrains investment in other sectors. These exuberant returns have been blamed for eventually driving up the price of electricity as well. Is there any merit to this?
SS: I disagree with this argument. The returns are not exuberant. In the 1994 Power Policy, if the returns really were so excessive, then why did the same investors not invest in the power sector again? The returns look lucrative on paper but the situation is different in reality. It remains a mystery as to who is getting these lucrative returns in reality.
Another power policy was rolled out in 2002. New investors came in and we were amongst them too. Again, there were amazing returns on paper. But since then we have not made the mistake of investing again in the power sector. Why was that? Because we are scared that our payments will get stuck. We are also scared of the fact that the subject of accountability never ceases in this country.
Most the world has moved on to reverse bidding auction mechanisms for determining tariffs. Why are tariffs still being decided by Nepra in Pakistan? The government can decide the location, technology and the size, but it should leave the tariffs to the market. Therefore, the reason the returns are so high is because the risk has increased so much. If the risk comes down, the return will automatically come down.
BRR: How can risk be reduced in your opinion?
SS: The first step should be to abolish the tariff announcement strategy by the government. Even if the government is the sole buyer, reverse bidding should take place. This will ensure transparency and the tariff will be set by market forces rather than the government. We are still going ahead and announcing tariffs when the world has moved on to competitive bidding.
BRR: Should the electricity market be deregulated?
SS: There is no solution except deregulation in this case. All distribution and generation companies should be privatised and a merchant market should be created. When this is done, the efficiency of the overall sector will increase as the buyers will invest to enhance their returns.
BRR: But plans for deregulation have been there for quite some time now yet the execution has failed to materialise. Why do you think that is?
SS: There is strong opposition from people who work in these companies who feel that they will lose their jobs. It is quite a powerful lobby.
BRR: Why is electricity so expensive in Pakistan compared to India, Bangladesh and other regional peers if the returns are not the reason as you said earlier?
SS: Tariffs are a complicated subject. One reason for electricity being more expensive here is that the tariff is for 25 years but the loan repayment is spread over the first 10 years and 80 percent is debt financing. So the majority of the cost is incurred in the projects earlier life. You do not have a 25-year bond market. If there was one, the debt schedule would have been spread over 25 years and the cost would have automatically come down.
BRR: Do you think setting more renewable plants will help in bring down the cost of electricity?
SS: In my humble opinion grid based renewable energy is not a solution for Pakistan right now. Rather, it is off-grid renewable solutions that will be helpful. These should be used by hospitals, private homes, office buildings or for remote areas that are sparsely populated like Baluchistan.
Around the world, electricity is predominantly produced by gas, coal or furnace oil. Renewable still hold a paltry share in the overall global energy mix. We only produce 4 percent of our energy from coal whereas America produces more than 50 percent. Granted, it might not be good for health reasons but coal powered generation is still the cheapest. For a developing nation like Pakistan, cheap energy is a prerequisite for any meaningful industrial development.
BRR: Let's move on to the textile sector, which is your forte and one of the most discussed sectors in the economy right now. Do you think subsidies in the form of reduced electricity and gas prices are a good way to help the textile sector out?
SS: I think it is a good step but let's look at the flip side of the coin. If the government instead of giving us subsidies makes a law that the industry's refunds must be processed within 30 days and exporters receive their money, it would be far better than giving subsidies. Many textile companies who were profitable have had to shut down because of a liquidity crisis as their refunds were not processed for a long time. Even Nishat Chunian Limited's pending refunds run into billions of rupees. The same is true in the power sector where IPP receivables keep piling up.
BRR: The currency has been devalued by almost 30 percent now. Yet, critics say textile exports still have not risen. How would you respond to them?
SS: I think it is a lack of understanding on behalf of people who are making these statements. Simply, look at the difference in local and international interest rates. This is basic economics. The difference between KIBOR and LIBOR has to be devaluation otherwise your currency will be overvalued.
We should be thankful that our exports have actually not decreased let alone increase. For the past five years there was no devaluation, which was automatically making our exports uncompetitive. Moreover, there should be a realisation that currency is just one aspect and there are many other factors for why textile exports have not increased. There are liquidity issues due to pending refunds and over-regulation. I would say that micromanagement on the part of the government has also been a big problem. The state should instead focus on macro management.
BRR: Are you looking to expand now in light of the positive triggers for the textile sector including the currency devaluation and the government subsidies in input costs?
SS: I am optimistic about Pakistan's export prospects and the government has a macro-level interest in promoting exports. We are looking at various options and expansion should definitely happen. For us, business expansion viability includes government refunds, which are a major issue in deciding to go ahead with any expansion. We have to see how much more money will end up getting stuck with the state as refunds. That is how we make a decision.
BRR: Do you think textile value added segments in general will expand?
SS: I think if the liquidity issues of the industry persist and the focus only remains on subsidies, then it is hard to see any expansion.
BRR: Pakistan is the fourth largest cotton producing country in the world. Yet, our cotton production is still well below our industry demand and the area under cultivation has been going down consistently. What are your views on the matter?
SS: This is again flawed policy making. As you pointed out correctly, the local production meets only a part of the industry demand. The crop is not being increased and there are duties imposed on imported cotton. To give an example, for climatic reasons long staple cotton cannot be grown in Pakistan. But duty was also imposed on import of this type of cotton. Therefore, government interference should be kept to a minimum or it will result in distortions for the textile industry.
Another related matter I would like to highlight is that there is illogical opposition to the spinning segment. The textile industry' base in Pakistan is the spinning sector. I am not saying value added segment should not be promoted but at the same time spinning should not be vilified. There should be a level playing field provided to spinners as well and the import of cotton should be allowed without any duty imposition.
BRR: Spinning margins have taken a hit recently. What is the reason and where do you them levelling out?
SS: The spinning market crashed recently due to the imposition of tariffs on China by the US. This led to a slowdown in the Chinese industry and as a lot of our yarn was being exported to China, it put downward pressure on margins. Spinning margins have declined by almost 10 percent in the past three months alone. I cannot really make a prediction about where they will level out because it is an extremely volatile market.