Abstract
The steel industry is one of the most progressive and innovative industries in today’s dynamic and competitive world that caters to the need of every individual and every aspect of life from a micro level to the macro level and fulfils the demand of almost all industrial sectors and therefore is a key element responsible for driving the economy of a nation. Pakistan Steel Mills Corporation (PSMC)—once a highly profitable organization and considered one of the largest and sole steel producers in Pakistan—is on the verge of collapse and passing through critical stages of its survival. Despite its monopoly and vast potential to expand and grow, PSMC has not only lagged far behind in comparison to its neighbouring nation, but has also been unable to meet the demand of its own nation. This study attempts to explore and analyze the pros and cons of its current deteriorating condition by considering the various factors and challenges faced by PSMC for the last few years and in particular the consequences of the unsuccessful post-privatization attempt made by the government. Numerous apparent and inherent factors are attributed to this failure, namely, the high bureaucratic influence, financial irregularities, managerial incapabilities, inefficient management techniques, etc. In addition, the role and impact of other steel sources such as ship-breaking, steel melting, imports, etc., are also taken into account, that, if carefully managed and controlled, can help PSMC come out of its dilemma.
Keywords
Introduction
Steel is considered to be one of the key drivers of an economy and touches almost every aspect of life. It is an essential component of various industries such as construction, automotive, transport, power, machine guards, etc. According to the World Steel Association, the construction industry alone consumes around 51 per cent of the global steel produced. 1 From the steel rails of trains to the body of aircrafts and cars, steel hulls of ships, steel frames of cranes, and from harbour and ports to factories, from factories to warehouses and from warehouses to ultimate destinations, all intermediary paths make use of steel products in some way. Steel is not only used in industry but it is one of the vital elements needed for infrastructure growth and development of societies. Steel is a fundamental and inevitable need of the industrial sector. Steel serves as one of the major components in the production of numerous products like tyres, furniture, railways, consumer goods and the energy sector, thus making it an essential commodity for an efficient economy.
Pakistan, soon after its independence in 1947, realized the extreme need of a steel-making plant for its survival, economic development and self-reliance because total dependency on import would result in a serious setback to the country which already inherited a weak industrial base. Initially a steel plant was set up in Karachi in 1968, which later was upgraded with the assistance of the United Socialist Soviet Republic (USSR), and the foundation stone of the country’s largest industrial complex was laid down in 1973 as the only integrated crude steel producer with an operating capacity of 1.1 million mt/annum. Pakistan Steel Mills Corporation (PSMC) is now a state-owned entity, and is operational, having its facilities spread over an area of 19,088 acres. It holds the rank of being the sole processor of iron ore and long rolled steel and heavy iron products in Pakistan. Almost 20 per cent of Pakistan’s finished steel capacity is constituted by PSMC (State Bank of Pakistan, 2012). The enormous dimensions of the project can be judged from its construction inputs which involved the use of 1.29 million cubic metres of concrete, 5.70 million cubic metres of earth-work (second to the Tarbela Dam), 330,000 tonnes of machinery, steel structures and electrical equipment. Its unloading and conveyor system at Port Qasim is the third largest in the world and its industrial water reservoir with a capacity of 110 million gallons per day is the largest in Asia; the 2.5-km long sea water channel connects the sea water circulation system to the plant site with a consumption of 216 million gallons of sea water per day (Pakistan Steel, 2012). Figure 1 reveals the product chain process in the Pakistan steel industry.
Unfortunately, PSMC demonstrated a constant stagnancy in its production over a last couple of years, despite the potential for expansion and growth. As a result, PSMC has exited out of the world market list. The facility at present is small and cannot gain efficient economies of scale (State Bank of Pakistan, 2012). There are a number of causes attributed to this anomaly the analysis of which is the main subject of this case which are covered subsequently.
Other Sources of Steel in Pakistan
PSMC is the major platform and occupies a pivotal position in fulfilling these demands. Apart from PSMC, steel is also obtained from alternative sources such as from ship-breaking, from scrap material and imports.
Steel from Ship-breaking
Old dying ships and boats are another source of getting steel, as they are broken down to get steel parts. The Pakistani ship-breaking industry performs this function and is located in Gadani, Baluchistan, at a distance of about 50 kilometres away from Karachi. The ship-breaking industry suffered great challenges and at the time of privatization of PSMC, it was about to be finished. A number of environmental hazards are associated with the ship-breaking that requires the attention of the concerned authorities. However, the reduced production of steel by PSMC has once again provided an opportunity to the ship-breaking industry. At present, it is serving as a major source for bridging the steel demand and supply gap in Pakistan.
Steel from Scrap Material
There are various companies in Pakistan that are privately owned and produce steel through scrap parts of vehicles, building supplies, and surplus materials by melting them in furnaces. However, despite being a steel provider, local scrap sales remain undocumented; that allows them to evade taxes. This situation has brought about large tax evasion in the steel production sector and is creating a challenging situation for those firms who pay their taxes on time (State Bank of Pakistan, 2012).
Imports
The challenging issues of a monetary and non-monetary nature faced by the main provider of finished steel in Pakistan, that is Pakistan Steel Mills, have led the country to meet its steel requirements with the help of finished steel imports. According to the State Bank of Pakistan, in FY11, 3.2 million mt of iron and steel have been imported to Pakistan, that in monetary terms amounts close to US$2 billion. If Pakistan Steel Mills operates at its full capacity, the import of finished steel can decline to only 0.1 million mt a year. This consequently brings about a net saving that could exceed US$1.0 billion per year (State Bank of Pakistan, 2012). However, despite heavy import duties, the domestic steel prices are high when compared with the import figures. The factors contributing to this situation include small-scale production and lack of integration resulting in lower economies of scale for Pakistan Steel Mills.
Issue of Privatization
The process of privatization in Pakistan started with the privatization of the financial institutions in the early 1990s. ‘Privatization’ means the sale of state-owned enterprises (SOEs) to private owners or at least shifting their operations to private sector management. Interest in this option is attributed to various causes and varies from country to country depending upon its micro- and macro-economic environment, namely, the mounting foreign-debt servicing burden, deteriorating balance of payments, rising fiscal deficits, less than expected performance, political disposition and pressure from international agencies such as the International Monetary Fund (IMF) and World Bank. The justification cited for privatization of PSMC was to reduce the financial burden of the government and encourage foreign investments.
The privatization theme regained momentum in the year 2002 in Pakistan, when 33 organizations were privatized with a budget of PKR 2 302 billion (Ahmad, 2007). Till now, Pakistan has sold a total of 166 SOEs for PKR 476.5 billion since 1990 (Daily Dawn, 2012). Since steel plays an important role in the industrial and economic development of a country, the basis for the establishment of PSMC was to enable the nation meet its local demand. When PSMC failed to live up to the performance expectation, the issue of privatizing PSMC came into being. In the year 2006, PSMC was sold at an open auction held in Islamabad for $362 million for a 75 per cent stake in PSMC. An amount of PKR 21.6 billion or $362 billion was paid by Al Tuwairqi, Russian Magnitogorsk and local brokerage firm, Arif Habib Securities, to take control of Pakistan Steel Mills. This amounted to PKR 16.8 per share (Hashmey, 2012).
The government failed to comprehensively analyze the post-privatization consequence of such a massive initiative concerning the only steel industry of Pakistan, an important strategic asset of the nation. Later, it resulted in its withdrawal, proving it to be an unsuccessful attempt made by the government. There are a number of arguments and criticisms against the privatization issue of PSMC. One view holds that that privatization was a hasty decision, and it was sold at far less price than its actual estimated value. Another view holds that the sale price was justified in comparison to the liabilities of PSMC.
The fact that non-government organizations proved helpful in meeting the demand and thus complementing the steel industry also provides a basis for the justification of privatization. The opposing activists stress that PSMC is a strategic asset of the nation and steel is needed for sensitive purposes such as meeting the defence, military and other nuclear needs, and thus, PSMC must not be disposed off for reasons of national security, sovereignty and social necessity, and it should be under governmental control. The proponents of privatization hold the opinion that steel mills are crucial for the production and supply of steel and political influences on such a production facility can have multiple negative effects in maintaining the consistency of operations and efficiency.
It is also a common knowledge that most of the SOEs globally have a high turnover of top management personnel, who are often chosen for their political connections rather than their professional competency. When the parties in power change, executive posts become stools in a political game of musical chairs. The managers exit, taking with them their experience and institutional knowledge. This situation indeed has intense implications and has severely impaired the management capabilities, strategic coherence and competitive abilities. It is also observed that the management executives joining the vacant slots usually walk in divergence from directions followed by their predecessors, thus leading the organization towards an erratic behaviour.
Tuwairqi Steel Mill (TSM)—A Complementary Body or a Competitor to PSMC?
The continuous downfall and low productive capacity of PSMC created a huge gap in the demand and supply of crude steel in Pakistan. Simultaneously, it created opportunities for foreign companies, strengthened by the initiatives of privatization as followed by the government. Tuwairqi, which bought 75 per cent shares of the PSMC in 2006, became such an entrant. However, later the privatization was revoked by the Supreme Court of Pakistan (Constitution Petition No. 9 of 2006) and Tuwairqi established its own plant at Port Qasim in Karachi. The Al Tuwairqi Group (ATG) of the Kingdom of Saudi Arabia was founded in the year 1977. They started their operation with contracting and trading activities. In addition to this, ATG has acquired a number of steel manufacturing companies making Al Tuwairqi Holding one of the largest Middle East private steel organization, showing an expanding trend to engulf parts of South Asia and Europe. In the way of capturing the South Asia’ steel industry, the ATG made a large investment in Pakistan in the form of introducing Tuwairqi Steel Mills (TSM) that will be considered as the only true large investment in Pakistan’s Steel industry.
It is worth mentioning that TSM will utilize natural gas as its feed supply against electricity consumption which is already facing a severe shortage crisis. TSM will complement PSMC by reducing its dependency on the import of raw materials by supplying the raw material to the rolling industry. Second, TSM will make effective utilization of the iron ore present in the country. Initially, TSM was expected to begin its operation in the year 2010, but the shortage of utility supplies (fuel) led to the delay of its proper commissioning. The government halted this project since 2010, as the availability of natural gas was also questionable. However, the company has assured the government that it is more efficient in utilizing the natural gas as compared to other industries and it is most likely expected that the government will arrange the supply of gas to TSM from other industries (State Bank of Pakistan, 2012). It is expected that the project will start by the end of year 2012.
TSM Limited has estimated that the annual demand for steel in Pakistan stands at 8.4 million tonnes per annum, and their plant will operate at a capacity of 1.5 million mt/annum (Table 1). It reveals that the full capacity in Pakistan stands at 7 million mt/annum, and if the operating capacity of TSM is added to this figure, the total operating capacity will be just enough to meet up the demand of steel in the country. This view provides support to the notion that the introduction and the operation of TSM will serve as a complement and help PSMC in bridging up the supply and demand gap in Pakistan.
Full and Actual Capacity of Finished Steel Produced by Various Sectors
bEstimated.
cImports of products for which sufficient domestic capacity is not present will continue.
In Pakistan, TSM will serve as the largest private sector steel integrated manufacturing unit. The plant covers an area of 220 acres at Port Qasim, Karachi, incorporating the most complex DRI technology of the MIDREX process. The production process at TSM is shown in Figure 2. POSCO, a South-Korean based and the world’s third largest steel maker in terms of market value, has made an investment of US$15 million in the project of TSM (Khan, 2012).
Pakistan Steel Mills Amid Crisis
Pakistan Steel Mills enjoyed a golden era of prosperity and success since its inception. But unfortunately the crisis started when the Government of Pakistan decided to sell PSMC to private investors in the second quarter of 2006. This was one of the largest embezzlements in history because it was being sold below its potential value. As a result, privatization was annulled because of the wide protests which largely came from the steel mill’s employees and the labour unions.
Pakistan Steel Mills remained a profitable organization from year 2001 to 2008 after which an adversarial and challenging period started for PSMC. A period came when there was no chairperson and the organization was said to be a headless organization as there was no one to navigate and steer PSMC in the right direction and bring it out of the crisis which was increasing day by day. Presently, Pakistan Steel Mills is on the verge of collapse and appears to be a victim of its own inability and incompetency and fails to adjust to the changing competitive environment. It is mainly suffering from the financial crunch and mismanagement.
Financial Crisis
Pakistan Steel Mill is considered to be a ‘sternly sick organization’ because it is facing a severe financial crisis due to mismanagement and a sharp decline in sales. Highlights of the financial losses of PSMC are shown in Table 2.
Financial Losses of PSMC from the Year 2008 to 2011
Financial crunch has resulted in the shortage of raw material which is one of the primary and fundamental problems for PSMC. Shortage of raw material has led to a massive decline in production, now by 23.8 per cent (State Bank of Pakistan, 2012). Currently, raw material including fine ore and coal is almost extinct (coal in Pakistan is of lower quality and cannot be used for this purpose). The corporation also had a negative equity of PKR 11,298 million, which provides an indication of the existence of material uncertainty (Maken, 2012). When PSMC used to produce at full capacity, it generated its own electricity but now it is not able to operate at its full capacity which has resulted in purchasing electricity from KESC, thereby further increasing the financial burden of PSMC. Added to these problems, the corporation has been working without a permanent and full-fledged chief executive officer for the last several months, while the losses are also simultaneously increasing day by day further deteriorating the already collapsing organization. PSMC has requested the Ministry of Industries and Production and the Ministry of Finance to arrange a bailout package of PKR 25 billion to help the mill run efficiently and overcome its financial problems (Hashmey, 2012)
The non-payment of timely salaries to employees is further creating frustration and resulting in demotivation among the employees. PSMC is facing a loss of billions of rupees, in the form of huge bank loans and government taxes.
According to the Associated Press of Pakistan (APP)—a government-operated national news agency of Pakistan—the counsel for Pakistan Steel Mills has said that according to final reports from 27 July 2011, a total of PKR 26.5 billion in losses was detected during 2008–2009. Out of the total, PKR 4.68 billion is shown as a business loss, PKR 9.99 billion due to corrupt practices and PKR 11.48 billion due to mismanagement (APP, 2012).
There was an increase of 200 per cent administrative costs in the year 2008–2009 while production was very low (Razzaq, 2012). PSMC has to spend PKR 1 billion every month under different heads, whether it is making any profit or running into losses. Crude steel production has dropped from 80 per cent of installed capacity in FY2008 to 23.8 per cent in July–November FY2012 (State Bank of Pakistan, 2012). Apart from the low production, PSMC also faces liabilities of damaged claims of PKR 10 billion filed in different courts by contractors, dealers and suppliers (Cheema, 2011).
PSMC Downfall and Its Impact on the Economy
Pakistan Steel Mills is the sole supplier of crude steel in Pakistan (State Bank of Pakistan, 2012). Reduction in production has resulted in increased dependency on other sources of Steel, majorly on imports and ship-breaking. Imports have no production function and are therefore not accounted for GDP; thus PSMC downfall has resulted in lowering of GDP. Moreover, most of the time the quality of import material is inconsistent and does not meet the standard as desired by steel mills. The steel is mostly imported from Bangladesh, which is of low quality. Lower GDP is followed by reduced employment of labour and technical staff in the mill, thereby increasing the unemployment rate.
The steel smelters have gained interesting opportunities from the downfall of PSMC. These companies acquire steel from scrap, and melt it for use. However, this scrap is undocumented, the transactions are conducted claiming false amounts, resulting in tax evasion. In this context, a regulatory rule was enforced that a fixed rate per unit of electricity consumed will be applied in electricity bills. Many of these companies have acquired natural gas connections and are involved in captive power generation (self-production of electricity). This again has resulted in tax evasion resulting in lower market prices as compared to PSMC and other players whose transactions are documented legally. These practices have further created problems in the downfall of PSMC (State Bank of Pakistan, 2012).
The sharp production decline of PSMC has also resulted in the upsurge of the ship-breaking industry in Pakistan. The government is presently supporting this industry, as it is a potential source of steel. However, this source is considered to be dangerous and responsible for environmental degradation. The old ships have large quantities of chemicals and residual oil as fuel in them and this waste is usually dumped in the sea without any treatment or proper procedure. This results in polluting marine life and sea water. In addition to environmental degradation, a job in the ship-breaking industry is itself a dangerous job and it is highly vulnerable when the labour is appointed on a daily basis to work on these sites without offering them any sort of job-training. In the fiscal year 2009–2010, there were 17 on-the-job reported casualties (Shakil, 2011).
According to the Occupational Safety and Health Administration (OSHA), the associated dangers with ship-breaking can be categorized into three types, (a) Hazardous Work Activities; (b) Hazardous Work Conditions; and (c) Hazardous Exposures (OSHA, 2001). According to the estimates of European Commission, approximately 1.3 million tonnes of toxic materials are disposed-off from these derelict ships, which are exported from Europe alone, to South Asia (European Commission, 2008).
Undocumented Concerns and Tax Evasion
In the year 2006, the government offered its support and as a subsidy allowed two private companies to import duty-free raw materials for the purposes of manufacturing steel products. This concession was later extended to several other companies also. However, later in an investigation by the Federal Investigation Agency (FIA) it was found that the companies had furnished false information about their manufacturing facilities and were victims of selling raw materials to local companies at substantial profit, which they had acquired at duty-free rates. This resulted in an estimated five million tonnes of raw material imported on duty-free category. Billions of rupees in revenues were lost in customs duty exemption and trillions of rupees worth of foreign exchange flew out of the country (Khan, 2011).
Lost Economies of Scale
The downfall of Pakistan Steel Mills has resulted in loss of economies of scale (State Bank of Pakistan, 2012). PSMC used to generate electricity for its own facility with the utilization of heat energy produced from coal. However, when the production capacity was not utilized in full, this power generation source became ineffective, and as a result PSMC had to buy electricity from KESC, putting more burdens on the already troubled organization (State Bank of Pakistan, 2012).
Concerns and Challenges
PSMC is the sole steel producer of Pakistan and managed under a strong influence of bureaucracy. A state-owned entity has to face inevitable governmental interference; this results in poor performance both from qualitative and quantitative perspectives. States resort to privatization for a better financial performance. It is presumed that privatization will bring in efficiency. However, when resources are adjudged to be scarce and sensitive for the economy of the state or need state controls for strategic reasons, state control becomes necessary. There also exists a room for improvement and perfection for even state-owned units. There is a need to consider the issues objectively. PSMC needs a professional approach allowing its executives to craft strategies for success. The role of the state changes to support the initiatives of national interests as against interference to show off authority. The privatization decision of PSMC was undertaken without comprehensively analyzing the pros and cons associated with it. Privatization neither proved to be a panacea nor an ultimate solution. The search and positioning of a capable and diligent leader is the need of the hour in uplifting an organization showing a declining trend. There are a number of examples around the globe witnessing the action of its executives who turned a sinking organization into a highly profitable one. PSMC is in a state of flux and confronting critical challenges amidst competition. The undertaking needs strategies and initiatives for revival. A number of concerns require redressal. Several issues are to resolved. Some of these include the following:
Should privatization of PSMC be reiterated and will it be successful? Can the national interests, as highlighted, be served without PSMC under state control? A private ownership firm is often referred to be highly efficient, more focused to reach performance, possess result-orientation that lead to a high profitability. Can a public sector unit also rise to these heights? How? If not, why not? When do you think that a state-owned unit is more desired than a private-owned firm? Does PSMC fall in that category? Will restructuring lead to revival of PSMC? What steps are needed for revival?