Steel shortage in offing: Pakistan's construction sector under threat

The ongoing shortage of dollars and the industry's inability to secure Letters of Credit (LCs) for import of raw materials is expected to hit the profitability of the construction sector and may lead to a country-wide steel shortage in the coming days, said Arif Habib Limited (AHL) in a report on Tuesday.

The brokerage house highlighted that given the short supply of US dollars in the country, amid external repayments and delay in the International Monetary Fund (IMF) programme, the State Bank of Pakistan (SBP) took various administrative measures including limits on LC opening, ban on certain imports and curbs on dollar repatriation to keep dollar outflows in check and minimise current account deficit.

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“Although the ban on imports has been eased as per a circular of the SBP, it is not being fully implemented in spirit,” said AHL.

“Although we expect the SBP to gradually loosen administrative measures going forward, they currently pose headwinds to the local construction and allied industry in the near term,” it said.

The domestic steel industry, especially the graded steel (high quality) industry, which heavily relies on the imports of scrap (for the production of long steel) and HRC (raw material for flat steel), remains highly vulnerable.

“Therefore, the restriction on LC opening poses dire consequences for the availability of steel going forward,” said the report.

AHL said that as per its checks local players will run out of steel raw material and become forcefully non-operational if no LCs are opened within the next 30 days.

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“This will have a multiplier effect on the domestic construction industry; without steel rebars in the country, construction activity will face hurdles, slashing demand for cement and 40 other industries (such as glass, tiles, cables, PVC, pipes, appliances, wood and furniture, clay, bricks etc.).

“While we were already expecting a decline in cement (-10% YoY) and steel rebars (-20% YoY) dispatches in FY23, this poses further downside risk to our projections,” it added.

The report highlighted that the loss of manufacturing output will exacerbate the LSM output, which has a nearly 13% contribution in the annual GDP. “Moreover, it may also trigger NPLs in the banking industry (PKR 195bn advances to the construction sector as at Oct’22), and potentially harm the government’s revenue collection (lower corporate profitability),” it said.

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“Therefore, in order to avoid an impending fallout in the housing and construction supply in the country, we believe that these industries should be allowed to open LCs on a quota system, based on the offtake of the prior year.

“Whereas for exporters, LCs for import of raw materials should be adjusted against export proceeds,” said AHL.

On the IMF programme, the brokerage house expected the government to fulfil pre-requisites of the lender, such as additional revenue commitments, an increase in PDL and GST on petroleum products, and a hike in electricity and gas tariff, so as to resume and complete the 9th review.

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The resumption of the IMF programme would fetch in a $1.2 billion tranche as well as provide confidence to bilateral and multilateral partners to support foreign exchange reserves.

“Once new flows come through, we believe restrictions on LC issuance will ease off in a gradual manner. Until then, risks appear over shortage of steel in the country in the upcoming summer 2023 quarter and hence, curtailment in construction activity,” it said.