'Government needs sectoral experts to design import policy' an interview with Hadi Akberali, COO Amreli Steels

As the PTI government sets the wheels of austerity in motion, the economic slowdown is palpable, manifesting in dampened demand and reduced business activity. The steel industry is in the thick of it, particularly true for long steel manufacturers who rely on the demand coming from housing and commercial real estate development and government-led infrastructure projects. To determine the exact impact of austerity on steel, BR Research spoke to Hadi Akberali, who is the Chief Operating Officer- Strategy at the family-owned Amreli Steels, the largest long-steel manufacturer in the country. We discuss the implications of the budget 2019-20 as well as the measures this government needs to take in the mid and long term to promote business confidence and investment in industrialization, particularly in context with the steel industry.
Hadi has studied industrial engineering from Northwestern University, USA and has an MBA in Finance and Strategy from INSEAD, France.
Following are edited excerpts:
BR Research: The steel industry has added a lot of capacity recently, given the demand prospects in the construction industry that were presenting during the PML-N regime. But they may regret it now since the off-take is not as high. Historically, Pakistan's growth rates have oscillated in a boom-bust cycle. Did you and other industries see the current bust coming?
Hadi Akberali: I think the industrial sector was expecting some sort of correction in the market after the PML-N regime because some of the past policies were not sustainable. The balance of payment crisis was in full bloom, rupee was overvalued, public debt was ballooning and the real estate prices reflected a bubble. However, we did not see this much contraction.
Currently, the major contributor to the worsening economy is massive cost-push inflation. Costs are up because of devaluation, hikes in gas and electricity price, and rising taxes. These costs cannot be passed onto the consumers entirely because wages are flat and this is causing huge pressure on margins. Some of the impact is passed on which is causing inflation, not just for steel but for nearly all goods and services. As a result, demand is down, and our margins are taking a hit. When that happens in a sector, industries and investors start to reevaluate their investment and growth plans. It is a vicious cycle and we are watching the economy now coming to a virtual halt. Did we see it coming? Not at this level and stake, no.
BRR: What is the capacity utilization for your recently-expanded facilities and what was the demand forecast at the time when you launched your expansion project.
HA: We commissioned the new plant in July 2018, almost a year ago. It tripled our capacity, and now we are at about 50 percent capacity utilization. We thought we would be able to ramp up capacity utilization a lot faster, but that hasn't happened due to the sudden slowdown in the economy.
During 2013 and 2018, we saw steel demand and production grow by a couple million tons. There were times in the past five years where the annual growth was 20 percent and steel was the fastest-growing segment in large-scale manufacturing. This is why our average growth forecast was around 6-8 percent for the upcoming years. And it may as well have been understated, given what we thought were long-term, massive plans in infrastructure development and the housing market. Our expectations were based on a realistic outlook on demand and even an impending correction. However, we are now facing a contraction in local steel output and demand rather than growth.
BRR: What is the business sentiment about the new government? Is it on the right track?
HA: The short-term measures being taken under the new government are right. Given the glaring fault-lines in our economy, the government has moved away from unsustainable policies by allowing the rupee to come to a realistic value, removing concessionary and subsidy-based regimes, addressing circular debt, overhauling the taxation system and widening the tax net. These measures were inevitable and will be painful for consumers and producers alike as we try to address the structural issues of our economy. Moreover, due to the IMF programme, these measures are all being enacted at once which has jolted the economy and business sentiment rather than taking a soft-landing approach. The next couple years will be difficult for business.
However, what this government needs to do immediately is to carve out a short and medium term plan to let industries and stakeholders know about what levels they aim to settle the currency devaluation, interest rates, and tariffs/taxes. This would provide some indication into the market of where we are headed as an economy, which will start the adjustment process to absorb the current reforms.
BRR: The budget 2019-20 has brought about some changes to the tax regime for the steel industry. Explain to us what that is and the implications of it.
HA: The only major change has come in the sale tax regime. We were governed under a special sales tax procedure where our sales tax was charged under the electricity bill. They have normalized the sales tax regime and brought the steel sector under a regime similar to the ad valorem GST regime that is taxed at 17 percent.
Under the special procedure, the estimated GST was 14-15 percent, but now our sales tax liability is higher, which once again adds to our cost.
BRR: There is some contention that the new regime will simplify the tax procedure and also discourage those industries that are under-reporting their sales. Is that true?
HA: Not really. The special procedure allowed the government to collect maximum sales tax because collection was done directly from the utility bill. After removing the industry from the Sales Tax Special Procedures, the onus really lies on the government to ensure they collect tax from a very fragmented industry that has units spread out across the country. It is good that they have retained a formula to declare minimum production based on consumption of electricity as this will deter tax evasion.
BRR: What were you expecting from the budget?
HA: We were expecting some relief in the budget. Our costs have been continuously going up, and passing them onto the customer is inflationary, which in turn is discouraging demand even further. We are unable to pass on many costs due to the depressed economic situation and that takes a huge hit on margins as well as investment sentiment.
Regarding the budget, we were expecting reduction of duties and taxes on our raw material to counter the many other cost increases the industry has had to face in the past few months on account of currency devaluation, rising energy prices and higher interest rates. Steel scrap, a primary raw material, was taxed at 10 percent (3 percent customs duty, 2 percent additional customs duty and 5 percent regulatory duty) before the budget. We had suggested that all duties and taxes be abolished on the primary raw material to reduce the inflationary pressure on the consumer and provide some breathing room for the industry.
Cost increases have caused margins to plummet in the industry which means further investment in the sector is unlikely. The government wants to promote the exporting sector but it is not providing the regulatory environment to do that.
BRR: So you would like no duty on raw material, and continue with the current duties on intermediate and finished goods? Walk us through the ideal import policy that you see for the steel industry in order to make local industry competitive.
HA: The tariff structure is critical in promoting industrial production and providing a level playing field. Technically, there should be no duty on primary raw material in order to keep domestic industry competitive. There should be a cascading structure where as you do more value addition, you get more protection.
One of the biggest anomalies which we have pointed out to the government is that while there is a 10 percent duty on primary raw material, the duty on the intermediate good - re-rollable scrap - has been slashed down to zero. Re-rollable scrap is generally used to make lower quality rebars.
There are two processes by which rebars are made. The steel-melting industry imports melt-able scrap to make billets, which are used to make rebars. Alternatively, re-rollable scrap is imported, as a substitute product of steel billets, by small, often undocumented firms to directly manufacture rebars. This makes steel billets and imported re-rollable scrap interchangeable intermediary goods. Due to this tariff anomaly, there is no level playing field in the industry and the documented sector that pays the majority of tax in the steel sector, makes quality products, and observes environmental compliance is getting hurt.
The steel-melting industry has over 200 operating units, employs thousands of people and contributes billions to the national exchequer every year. Moreover, even the ship-breaking industry, one of the largest industries of Balochistan, is also getting severely affected due to this tariff anomaly. Most importantly, the practice of using re-rollable scrap to directly make steel bars is not a global practice and often results in a sub-standard quality that is not acceptable internationally.
The solution is to equate the tariff on re-rollable scrap to that on steel billets as they are both intermediate products used to make the same finished good. This would provide a level playing field to all stakeholders.
BRR: One begs the question: does the government have the capacity to determine which product lines need concessions, and which need a higher duty structure. When the previous government was imposing regulatory duties, it became a huge bone of contention as some manufacturers were dis-incentivized and others incentivized. Any large association can steer them in their direction given the right kind of lobbying influence.
HA: They don't have sectoral experts and they need to bring them on board immediately. All businesses have their own vested interests and it should be sectoral experts who would analyze and determine what the import policy should be for any industry.
BRR: Do you believe steel can be an exporting industry in Pakistan?
HA: Not in the short term, but definitely over an outlook of 5-10 years. We can export regionally to Sri Lanka, Afghanistan, and the Middle East. Our problems right now are costs, which are not as difficult to tackle, but prohibitive enough to make us uncompetitive abroad. In fact, some sectors within the steel industry are already exporting.
BRR: The last time we met in 2016, we discussed the sub-standard steel products being manufactured across the country and no quality control body forbidding it or impeding its growth. Has that changed at all since then?
HA: The situation has possibly worsened, especially in Punjab where they have no quality parameter or regulation. Under law, the minimum strength that steel rebars need to meet is 40,000 psi. Under this strength, the steel is not safe for consumption in any application. A lot of the steel being produced in Pakistan does not meet this criterion due to poor processes. A lot of steel-makers are not following internationally-acceptable practices and there is no regulation to keep a check on them. Plus, majority of these steel producers do not have testing facilities.
Additionally, quality control cannot be done without a chemical testing lab. In terms of environment, more than 95 percent of the industry does not have appropriate pollution and climate control systems. The Pakistan Safety and Quality Control Authority (PSQCA) does not seem to have the capacity to bring these low-quality steel producers to task. This is a major national risk because sub-standard steel is being used in our infrastructure and housing, which leads to tragic instances of collapsing buildings and deaths.
BRR: Suppose that these quality standards are instituted, and sectoral experts are brought on board to decide on the import policy going forward, do you think it would drive out a lot of small steel manufacturers who as you said are not producing the required quality of steel? Is that even desirable?
HA: It cannot be done overnight. They need to give these manufacturers a timeline to bring their quality up and invest in their facilities to be compliant with environmental laws, health & safety laws and Pakistan quality standards. If they are unable to upgrade, they will have to stop producing. There is no other way because ultimately, it is the government's job to regulate industries and safeguard consumer welfare. Low-quality steel is hurting the end consumers.
BRR: There is a lot to unpack in the Pakistan Steel Mills (PSM) potential revival which may or may not happen. Do you think that if the government is unable to revive PSM, the private sector can bring about those much-needed investments to build facilities at that scale?
HA: If Pakistan Steel is run effectively, because they have scale, they can provide cost-effective raw material solutions of the steel industry. However, if it is not revived, we could make a case for large-scale steel manufacturing plants run by the private sector and producing different products in the long and flat value chain at a significant capacity comparable with other plants in the region. But in the existing boom-bust economic climate, we need certainty and a set of strong, pro-business policies across a period of 10 years so these investments can be successful. There are a wide range of issues from energy pricing, to regressive duty regime to exorbitant industrial prices which need to be tackled on a sustainable basis.
BRR: Let's talk a little about your business. What is your current focus on from the demand side? Which segment (government infrastructure projects, consumers, developers) do you sell more to and intend to grow into?
HA: The way we divide our customer base is: corporate sector, builders and real estate developers that deal in commercial and big housing projects, government projects and individual homeowners. We prefer to balance these segments in our sales-mix so that we are not overly reliant on any one segment. Recently, we have been focusing on our presence in the retail market across the country.
BRR: You have also increased your marketing expenditure a lot. How do you brand a commodity like steel?
HA: There is a very good case for branding it. We are trying to brand it to differentiate ourselves from the many small and fragmented players that severely lack quality and may even be producing unsafe and hazardous rebars. Steel is a technical product and awareness is missing, so consumers going to purchase construction material may not be able to tell the difference. This also makes them vulnerable to contractors or steel middlemen who may push one product over another. By marketing our products, we make some brand promises to our customers in terms of quality or tenacity. For instance, our rebars meet international standards and are suitable for use in earthquake design.