Updated: Nov 15, 2019
The World Steel in Figures 2019 report indicates a decrease in Pakistan’s Steel Production and Consumption.
Pakistan is no steel juggernaut. Our contribution to global production is barely 0.25%. We are situated next to the World’s two largest steel producers, China and India. Why would anybody in the Steel business put their money in Pakistan?
The truth is that despite the absence of any apparent comparative advantage for global steel production in Pakistan, we are home to a large fraternity of the steel processing value chain. However, most of these businesses are tragically uncompetitive, and would not survive outside of the domestic market, without the protection of the government of Pakistan.
Traditionally, the government of Pakistan has been criminally interventionist with the steel industry. The perpetual failures of the Pakistan Steel Mills have always exposed the private sector steel producers to political experimentation.
Pakistan Steel Mills is Pakistan’s largest mega-corporation and white elephant. After a series of taxpayer bailouts nearing over a billion dollars, Pakistan Steel Mills is virtually defunct since 2015, yet owes over three billion dollars in debt.
Private Sector and Imports
The national steel needs were instead met by private sector manufacturers and imports. We produce around half the steel we consume and import the rest. In fact, strong demand in the construction sector coupled with CPEC demand made longer-term investments feasible for private producers. And forward-thinking entrepreneurs made capital investments to enhance their production processes.
Since the election of the new government, capital investment feasibility scenarios have changed drastically. Public sector demand for steel has come to a standstill, and CPEC projects are also experiencing a slowdown. Steel producers are undergoing a period of great financial stress and face multiple sustainability challenges. While the rest of the economy has slowed down, steel sector production has literally contracted by 300,000 tons in one year. And net imports have also decreased, which means we are consuming less domestically as well.
The government thought that industries such as steel would be able to maintain their current production levels, and could compensate for the reduction in domestic demand by exporting. This is where political convenience trumps rational thinking.
Steel producers, especially of long products mainly rebars, were hit badly by the Rupee devaluation. Raw materials typically constitute around 30 percent of the cost of steel processing. The government additionally imposes an import duty of 10% on "meltable" scrap, making sure that exportable steel product costs are high as possible. Recent changes in the indirect sales tax regime have added an additional burden of 3% to 5% on many steel manufacturers. Declining demand ensured that almost none of the increase in production cost could be passed on to the consumer without losing revenues.
Domestic energy prices also rose, including the prices of gas and electricity. Energy constitutes about 20 to 40 percent of the production cost. In fact, Pakistan’s energy outages are in part to blame for around 40% unused capacity across the steel manufacturing sector. Government policy also systematically encourages the production of substandard steel products through politically motivated exemptions in the import regime. One such exemption is the allowance of duty-free "reroll-able" scrap material, a low-grade alternative to meltable scrap and iron billets. The domestic market is flooded by substandard locally manufactured steel rebars, utterly impossible to export.
Pakistan’s per capita consumption of steel is amongst the lowest in the world, around five times less than the global average. And this is a problem. Steel consumption correlates well with capital expenditure. Steel is used in civic and entrepreneurial infrastructure. Increased Steel consumption would indicate improved overall economic capacity and possibly hint at improved efficiency as well.
This national iron deficiency is a hindrance to economic development and security. The national economy needs steel. We need it to build the urban landscape where the majority of Pakistanis will be living by 2030.
When Pakistan signed a free trade agreement with China, that steel finally became available, at least for a little while. Chinese steel is globally competitive, and Pakistan is a proximity market. The Chinese products available in the local market offered a variety of qualities at a variety of costs.
However, the government used anti-dumping laws to restrict Chinese products after receiving complaints from local steel manufacturers. The anti-dumping theory is in itself questionable, more equipped to deal with political considerations than economic ones. The key here is to understand that the government refused to help local steel manufacturers reduce their cost of production. But it was happy to block Chinese products.
The anti-dumping duties will eventually be removed, they are diplomatically unsustainable. Note how the essence of government policy has created a situation where the interests of Pakistani steel consumers and producers are at cross purposes. This would never happen in a fair and free market. Consumers need high-quality products at globally competitive prices. Domestic producers who produce export quality steel products are artificially suppressed through non-economic costs resulting from the incoherent policy.
We expect to see another attempt at the revival of the Pakistan Steel Mills in the coming years, and we should have no reason to expect anything but a failure. The degree of politicization inflicting all State-Owned Enterprise is fatal to good business management and reform. We should rest assured that despite the mythical capabilities of the Pakistan Steel Mills if we want to build this nation, we should focus on the private sector and on imports.
Competitiveness is corrupted
Our primary problem lies in our global competitiveness. Pakistan ranks 110 on the global competitiveness index and an equally dismal 108 on the Doing Business Index. Whatever we produce, the chances of its failure are higher than those of success. This is the direct consequence of political inadequacy and bureaucratic corruption.
We must understand that industry sector competitiveness is an aggregation of domestic entrepreneurial performance. The more competitive businesses are, the more competitive the national economy will become. Protectionism is an ineffective tool to improve overall competitiveness because it allows for the survival of businesses with unhealthy practices.
Pakistan’s steel industry consists of more than 600 different players contributing to different aspects of the supply chain. But only a handful of these players are competitive enough to stand firmly in front of Chinese and Indian steel businesses under a competitive setting. In fact, 42 percent of Pakistan Steel Production comes from four private-sector producers.
Pakistan Steel Mills produces only 11 percent, which means that the remaining 47 percent of demand is met by the rest of the producers. To have a sustainable competitive steel industry in Pakistan, we must allow competitive players to succeed against less competitive players under a free-market setting. Note here that India produces about 106.5 Million tons of Steel or around 5.5% of global output, and 96.5% of this output comes from ArcelorMittal, the largest steel producer in the world. The entire goal of the global steel business is maximizing the benefits from economies of scale.
At the present moment, many businesses in the Steel Industry are facing sustained losses. The great misfortune is that businesses who had invested in business process competitiveness are most vulnerable at this time. To ensure that domestic steel producers have a fair chance to compete in the domestic and international markets, the government needs to take certain short, medium and long term measures.
The government must immediately ensure that any cost disadvantages inflicting domestic manufacturers be dealt with. The import duty on "meltable" scrap must be immediately removed, and this would meaningfully reduce the price of exports, and help raise revenues for Steel manufacturers in the short run. The removal of import duties on "meltable" scrap and billets would improve the overall quality of rebar products originating from within Pakistan.
For domestic steel industry players to develop global level competitiveness, electricity plays a key role. Energy interruptions are just as devastating as the high electricity prices. National electricity infrastructure is still years from meeting the national demand. With getting electricity ranking of 123rd on the Doing business index, entrepreneurial access to the national grid is a complicated endeavor.
The government can allow Steel manufacturers to import their own power generation equipment and fuel, duty-free. Such a policy would encourage the integration of energy solutions into the steel manufacturing process, and provide a unique set of core competencies for Pakistan’s steel manufacturers. The focus of the industry would shift towards energy efficiency, and this would differentiate us from China and India in a significant sense. A framework to enable this can be established within the tenure of the present government.
In the longer run, there must be a focus on improving the domestic consumption levels of capital goods such as steel. The global average is 228.5 kg per capita, and this should be our steel consumption per capita goal beyond 2025. At the moment, per capita consumption of steel according to the World Steel Association in 2017 was 47kg. Over time as policy bottlenecks in construction, mortgage financing, and property rights are overcome, urban development itself will drive much of the domestic demand.
The development of CPEC allows Pakistan to become closer to the Chinese end of the global value chain. We should under be no illusion that our least competitive businesses might die in the face of Chinese competition, and they should be allowed to do so. Foremost is the Pakistan Steel Mills. Pakistan’s Steel industry might not survive another economic experiment in the name of PSM’s revival. The global steel industry is significantly competitive, and this means our private sector entrepreneurs have little space to make mistakes.
Our best steel businesses will find a way to compete in a fair market, but this is only possible when the government stops becoming a barrier to market access and competitiveness. A possible future scenario would be the shifting of export-oriented steel plants towards special economic zones planned near Karachi and Gwadar Ports. This should help minimize the tax burden, costs of raw material and its transportation.
Technology will play a key role in the future of the Steel Industry. Worldwide, plant designs are constantly improving, and if Pakistan has any chance of competing with India and China, our entrepreneurs must have access to the technologies they want, without being penalized with duties, and excessive processing time at customs.
Government intervention has been the great bane of the steel industry, because our inherited policy model rewards incompetence, and discourages success under unfair market rules. A free market and open trade are fundamental to cultivating a competitive culture in domestic business, and this is where the future of industrial policy lies. Intervention and protectionism only offer a future of economic obscurity for our entrepreneurs. It may very well be time to get ready to play with the big boys!