Article Link: Business Recorder

“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” Alice in Wonderland.

A common gripe in Islamabad is that these manufacturers/exporters, call them entrepreneurs, more specifically textile and apparel entrepreneurs, are failed subsidy hogs. They cite:

State Exhibit No 1: There has been no quantum increase in textile exports, and

State Exhibit No 2: No new products in the export portfolio and so on.

Such uninformed fusillades are nothing but old wives’ tales, factoids and more ominously reflections on the poor understanding of how businesses invest.

Generally, an existing business invests by borrowing all or major fraction of the required capital expenditure, capex, needed to set up/restore/enhance capacity.

Depending upon the context, investment is generally of two types: BMR, Balancing, Modernization and Replacement, meant for debottlenecking and restoring/maintaining generally its current capacities and efficiency as old machines consume more energy, and may not produce in line with current trends. This capex may or may not increase output significantly.

The other kind increases the enterprise’s capacity from, let us say, 50,000 T-shirts (Tees)/day to 75,000 Tees/day. It may use up some existing slack or could simply be a new line. This is where production goes up meaningfully, exports go up, more revenue, more contribution and hopefully more profit after absorbing the incremental operating expenses and full capex cost. These are routine business decisions.

There is, however, another kind of sinister capex, endemic to Pakistan. This kind does not necessarily increase the production capacity, does not reduce costs; actually increases them. It forces the entrepreneur to finance power producing equipment by borrowing, recently at as high as 22.5 percent + spread, that his international competitors do not have to. He has no choice here. If he does not invest in these non-core assets, production will plummet. Such investment diversions to non-core assets have happened one time too many.

When the Tee manufacturing facility was set up, a DISCO / KE had energized it-KE landscape is tougher. Then the grid ran aground, the Tee-wala was forced to go for gas-fired generation, bought engines/turbines, paid for a pipeline, a CMS, coughed up collaterals for the respective Sui gas. The Sui gas then discovered the gas deficit and made the Tee-wala wean off gas, forcing him to go for RFO-fired engines, storage tanks, etc.

Now he has a three-layered defence, aka stranded assets with carrying costs, against an enemy, energy shortage, which he was not supposed to have. He was supposed to build and paddle his Tees, which he knows quite well. This investment diversion to non-core assets is on account of infrastructural failure by the public sector at a colossal level. Exporter’s trial is, however, not over yet.

His international customers then tell our exporter to decarbonize. Dutifully, he finds extra funds, debt and equity, and invests in renewables, biomass boilers, solar and in some case even wind power.

With a Jurassic World of non-core energy assets, he must wonder about the new business that he is now in. He was good at Tees and wanted to make more of them, but was forced to divert investible funds into assets and businesses, which were never his wont. His competition abroad does not have to carry such deadweight on their balance sheet.

He must not be producing his own power-5 or more different debt-financed energy platforms-yet he has to. He is not supposed to truck in its own water, but cannot do without. Not supposed to have own security, own transportation. No choice for him here, as well. He just wanted to sell Tees. He is but an IPP, a security company, a transport contractor who also happens to build and sell Tees.

“Energy assets, as a percentage of total fixed asset base, could be as high as 20-25 percent. How can one make a business grow with such a high percentage of expensive capital trapped into these dead, non-core assets? Collective and continuous failure of various Blocks at Pak Secretariat, Islamabad, forced exporters to fend for themselves.”

They had to divert expensive, scarce capital and foreign exchange to “unproductive assets” to maintain their current levels of production. “All the running he can do, to stay in the same place.”

Islamabad must realize it is solely culpable for these increased costs and management drag for exporters and must atone by providing them with 20-year loans to cater for these non-core assets, to lighten the cash flowload off them. And after doing all this by themselves, the following is what they get in return:

As the Tee-wala receives its export proceeds, the P-Block deducts 2.25 percent of its export proceeds, 2 percent of which go to prepay his, as yet undetermined, final tax liability at 39 percent of it taxable income. I mean, come on.

USBC issues LEED certifications, Gold, Platinum, to qualified factories, signifying their success in meeting certain environmental and green standards.

Now this investment, hundreds of millions rupees per factory, does not confer immediate revenues and profit streams. In a leading textile exporting nation, the taxman reduces the tax rate by 2 percent, from 12 percent to 10 percent, for such LEED certified factories, acknowledging perhaps the argument this scribe made in the lines above.