Power to the people proves a costly wager

Senior officials from Enron arrived in Islamabad earlier this year expecting to see the avenues covered with red carpets. The US energy company clicked its corporate finger at everyone, including prime minister Benazir Bhutto, to ensure that all necessary doors would be opened ­ and fast. "The kind of support they were demanding was ludicrous," says a Pakistani power company executive. "They expected the prime minister to run around with them shouting 'do this, do that'."

Enron, though, had not reckoned on the equally swollen egos of some Pakistani politicians. In the end the company's plan to build a 750MW thermal power plant collapsed amid disagreement with the government about the cost of the imported naphtha fuel.

More galling for Enron was the fact that Pakistan was not prepared to bend over backwards to revive negotiations. The country's private power initiative has been so successful at attracting investment that there are already more than enough plants under construction ­ the government does not need to bow and scrape to arrogant multinationals.

Pakistan's power policy is no longer about wooing investors. It has progressed way beyond that. Put in place in March 1994, it includes a package of incentives, including a generous bulk power tariff of 6.5 cents per KW and foreign currency guarantees, reckoned to be among the most attractive in the world. When the policy began, Pakistan faced a shortage of 2,000MW during peak load hours and extremely low annual per capita consumption of electricity of around 300KW.

A conservative projection for the annual increase in demand at that time was 8% for the next 25 years, which called for 44,000MW of additional capacity by 2018.

Such an ambitious programme could not, it was decided, be financed in the public sector because of IMF ceilings, hence the emphasis on making conditions for private investors as attractive as possible.

The initial target of 7,000MW has now been revised down to 4,000MW. This is because the response from private finance, well beyond the forecast of the policy's chief architect, Shahid Hassan Khan, has narrowed the focus to the investment that can go forward now. Projects worth close to $4 billion ­ more than the total amount of foreign investment in Pakistan since partition ­ have secured financing. All this is against a backdrop of the breakdown of law and order in Karachi, and generally lukewarm interest in emerging markets.

So successful has Pakistan's power policy been that other developing countries such as Bangladesh and Sri Lanka have copied its terms almost to the letter. Only China has been too proud to duplicate it, while India bloodied its nose because of clumsy dealings with Enron last year.

Buying power from foreign sources

Power, say some analysts, is the one sector in Pakistan showing much life. The new power plants, they argue, will be the country's saviour, by promoting economic growth and increased prosperity.

"If you look at historical data, per capita GNP is very closely linked to per capita consumption of electricity," says Syed Akbar Kazim, the finance director of Southern Electric Power Company (Sepcol), whose 117MW thermal plant is due to begin operating next year. "If you accept the correlation, the 40% increase in electricity capacity ought to lead to a 40% increase in GNP, which is enormous by any standards."

But in the meantime the government will need to find large amounts of foreign exchange to import fuel and ­ given that most of the financial backing is foreign debt and equity ­ convert private operators' electricity payments into dollars. By reserving incentives for projects with more than 100MW capacity the government has effectively ruled out large-scale local involvement and may have sown the seeds for a balance of payments crisis on a scale beyond Pakistan's capabilities.

"The government should have given permission to, say, 20 Pakistani companies to build 20MW to 30MW plants which are manageable within national resources," says one Islamabad-based entrepreneur. "That way they could have got between 400MW and 500MW within 14 to 16 months. Instead, the government's insistence on 100MW-plus projects eliminated 90% of Pakistani entrepreneurs. Larger plants should have been built by Wapda [the Water and Power Development Authority] or the world's leading power companies, after competitive solicited proposals. Unfortunately, the private power policy was just a money-making exercise for the government. On a micro level it's a beautiful policy ­ in terms of attracting investors. But when you implement it at a macro level, the loopholes become only too apparent."

The biggest dangers ­ so far as investors are concerned ­ appear to be posed by the poor financial state of the distribution companies, Wapda and Karachi Electricity Supply Company (KESC), and slender foreign exchange reserves.

Price rise dangers

As things stand, the chances of the distribution companies defaulting on their obligations to independent power projects (IPPs) appear to be quite high. "Wapda's finances are in a terrible state," admits Sepcol's Kazim. "They have huge arrears from government departments, which may cause a cash crunch." The poor financial state of both Wapda and KESC is also a result of transmission and distribution (T&D) losses, which have increased sharply in recent years. For KESC, for example, such losses amounted to 31% of electricity supplied in 1995, compared with 27% in 1994.

The 1995 annual report states: "The existing T&D system is overloaded and inadequate to cater to the maximum demand of consumers, which requires major augmentation and rehabilitation."

KESC, for which NatWest Markets is seeking a strategic investor for partial privatization later this year, hopes that expansion and rehabilitation of the transmission system ­ with the help of loans from the Asian Development Bank ­ will reduce such losses. Wapda and KESC will also benefit from bringing in new consumers. Some 60% of households in Pakistan are without electricity. "Even if these just use a single light and fan, it would mean a tremendous boost to revenue," says Sepcol's Kazim.

Hamid Butt, head of investment banking at Citibank in Karachi, adds: "The only reason Wapda might be unable to pay for the power is if they can't sell it. The only question is whether people will buy the power, and I think the answer is yes. There is a shortfall of 2,000MW now which will soon rise to 3,000MW."

But both distribution companies will still have to cope with the problem of customers not paying their bills, meters not being read because of urban disturbances, and the theft of electricity using kundas ­ metal hooks used to tap into electricity supply lines.

The IPPs are fully aware of threats to their income streams. A team from Hubco, whose first plant came on line earlier this year, is training staff at Wapda in better collection methods. An official at the Karachi headquarters of Hubco points out that it received its first large payment for electricity ­ $22 million ­ from Wapda on August 1. "They paid very promptly," he says. "They realize it's serious business." The Hubco official commends the government for changes in this year's budget, which mean that electricity allowances for provincial governments are now paid directly to Wapda, easing its cashflow difficulties. But Hubco is only the first power supplier that will need to be dealt with. The real problems will begin when the rest of the IPPs come on line over the next year or two.

Wapda and KESC will meanwhile have to find ways of striking a balance between investor returns and politically sensitive consumer needs. Industry analysts are already predicting electricity price rises of about 15% in Karachi by the end of this year and much more in the years to come. The price of electricity in Pakistan is currently around PRs3.5 (10 cents) per KW and households already spend on average PRs500 of their PRs3,000 monthly income on electricity. It is hard to see where they will get the money to pay for electricity if its price rises by 50%, as some analysts are forecasting. Price rises sufficient to enable the distribution companies to fulfil their obligations under the power purchase agreements with IPPs will be hugely unpopular and damaging to Pakistan's competitiveness.

IPPs derive comfort from the fact that the distribution companies' obligations are guaranteed by the government under a specific agreement. Perhaps more important, it is a government that has never defaulted or requested a moratorium on its external debt.

The availability of foreign exchange is problematic. According to Javed Noel, joint secretary at the finance ministry, "initial estimates are that between 4,000MW and 5,000MW would not imply balance of payments constraints". Yet such assertions are at least partly based on an act of faith that extra power will enable the production of sufficient extra exports to offset the foreign exchange costs of buying fuel and paying the IPPs under their power purchase agreements.

Power plants under construction are already sucking in capital-equipment imports. As they start generating power over the next year or so, a sharp increase in fuel imports will add to the strain. In March the government capped the number of projects that rely on imported fuel ­ hence its reluctance to entertain the Enron project ­ and stipulated that in future proposals would only be considered if they tapped indigenous resources.

Khalid Nazir, director at AKD Securities in Karachi, calculates that as more power stations come on line, fuel import costs will rise from $104 million in 1996-97 to $414 million by 1998-99. He further estimates that the annual cost of servicing the debt associated with the projects, which the government has guaranteed in dollars, will rise from $68 million to $439 million over the same period, based on interest rates of 10%.

Meanwhile the foreign exchange cost of paying dividends, based on guarantees of around 20% returns on equity, will rise from $34 million to $239 million. Nazir estimates that combining these with existing external debt-servicing costs and dividends to shareholders in privatized companies, Pakistan's dollar requirements by 2000 will be $3.6 billion. He says this will place "extreme pressure on the government reserves and the currency situation".

Others are more sanguine. Citibank's Butt says: "Obviously there is concern that the balance of payments will come under strain, but our estimate is that an additional $700 million to $800 million would not be unmanageable. There should be a big spurt in GDP and the additional growth should take care of the extra the government has to pay."

Balance of payments crisis

Even without the extra burden imposed by the IPPs, there is already concern about the government's increasing reliance on short-term foreign currency debt in excess of its exchange reserves, which leaves it vulnerable to external shocks such as rising interest rates. Another worry is that foreign currency deposits in Pakistani banks amount to some $7.4 billion, whereas foreign exchange reserves stood at just $1.7 billion at the end of July, indicating that most of the money held on account has already been spent. A large and sudden outflow from these accounts, which could result from a loss of confidence in government policies, would trigger a balance of payments crisis. Some observers have even suggested that the country could be heading for a Mexico-type crisis.

Syed Shahid Husain, former senior executive vice-president of the World Bank, wrote recently: "The slightest crisis in confidence and the run on these funds could wreck the national currency, and cause high inflation and depression." A Karachi-based economist adds: "If there is a $1 billion outflow, Pakistan's economy will at least slide. If it exceeds $2 billion, the economy will crash. The US government had to arrange $10 billion in hard cash and $18 billion in guarantees to bail out Mexico. Where will Pakistan find that sort of money?" A run on foreign deposits almost occurred last November when it was rumoured that the government would freeze convertible accounts. The panic subsided only after the government reassured depositors.

Allegations that between $5 billion and $6 billion has been siphoned from the economy during the past two-and-a-half years through official corruption do little to ease worries about the balance of payments. Stories abound of expensive overseas properties being bought by influential members of the government. A recent survey of international businessmen carried out by the Berlin-based publication Transparency International suggested that only Nigeria is more corrupt than Pakistan. And according to some newspaper reports, even IMF board members are demanding that the organization goes public on the level of corruption in Pakistan.

"Corruption stands in the way of some of the good foreign investment and much of the domestic investment," says Karachi-based journalist Sultan Ahmed. "It retards industrial growth and hurts the industries already functioning. It slashes the revenues of the state, inflates public expenditure, reduces the efficacy of public spending and cripples the social sector, because corruption is large in the educational and health sectors as well." Husain adds: "Pakistan is inexorably moving towards its worst economic crisis." He describes Bhutto's government as one "with its political authority on the wane and moral authority lost".

Tough budget to satisy the IMF

Pakistan's balance of payments situation has recently been adversely affected by large budget deficits ­ last year around $4 billion ­ which have tended to be financed by increases in the current account deficit through increased imports. Pakistan's current account deficit last year amounted to some $3 billion, despite $8.6 billion of exports ­ the highest it has ever achieved. The country remains overly reliant on cotton and textile products which make up two-thirds of exports. According to the finance ministry's Noel, the higher-than-normal level of imports not only sprang from increased purchases of machinery for power plants but also increased fertilizer orders. "We're hoping to reap the benefit by way of higher agricultural growth and fewer imports of food and edible oils," he says. "The imports of machinery for the power sector are not a permanent feature. They should gradually fade out."

During the first half of last year, Pakistan's exports were priced out of the market because of currency devaluation among competitors and high domestic inflation (around 11%) because of a rising budget deficit. The government took various measures to correct this situation in October 1995, including devaluing the rupee by 7% and levying a 10% duty on non-essential imports. As a result, exports, which had fallen by 5.3% in the first half, rose by 14.9% in the second half (to June 1996). Meanwhile, imports, which had risen 23.2% in the first half, grew by just 4% in the second half.

Conscious of the need to raise revenues and reduce the budget deficit, the government passed a tough federal budget on June 13, imposing $1.1 billion of new taxes for 1996-97, including an across-the-board sales tax on imports and manufactured goods. The budget was an about-turn from that of a year ago and a return to an IMF-guided programme of structural reforms. The primary aim was to reduce the overall budget deficit to 4% of GDP from an estimated 5% in 1995-96. This was in compliance with IMF wishes, which held back on the third tranche of its $600 million standby arrangement until after the budget, so that it could gauge the fulfilment of its targets as well as the government's specific budgetary measures.

As Euromoney went to press the IMF mission had still not visited Pakistan. It therefore remained unclear whether the Pakistan government would succeed in securing the next standby arrangement tranche and be able to renegotiate a medium-term extended structural adjustment facility.

The government has had little room to squeeze expenditure. Defence spending will always be a high priority while the dispute with India over Kashmir remains unresolved. According to figures produced by the finance ministry, defence expenditure as a proportion of total government expenditure fell from 26% in 1988 to 23% last year.

However, defence expenditure and debt servicing still make up almost half government expenditure. As a proportion of current expenditure (excluding capital projects), they amount to over 70% and together they swallow up more than 100% of total tax revenues. Meanwhile, spending on the social sector, including education and health, remains low at 14.9% of total expenditure. Several "low priority" development projects have been slashed recently.

Tax reform needed

The constraints on cutting expenditure intensify the need to make the most of taxation. Pakistan's tax system suffers from a weak collection system and a very narrow base. Just a million people out of a population of 130 million pay direct tax. Fewer than 20% of these declare annual incomes in excess of PRs100,000 ($3,000).

The general sales tax has broadened the base, but it has also been widely criticized by the business community as likely to lead to inflation and recession. The Karachi Stock Exchange KSE-100 index fell 5.2% in the two days after the announcement of the budget. "This budget has killed business confidence," says AKD's Nazir. "My own tax rate went from 16% to 33% in one day. I had several people phone me to ask where to send their CVs for jobs abroad."

"The imposition of a general sales tax is a sensible long-term measure," he adds. "But the hike in rates is highly inflationary and probably counterproductive. By increasing the rates from 15% to 18% and from 20% to 23% in a tax-unfriendly country, the government is virtually encouraging tax fraud. A more realistic policy would have been to reduce the rate and concentrate on efficient collection ­ rather than simply squeezing the existing taxpayers and thereby increasing tax-evasion incentives."

The budget review of Karachi stockbroking firm BMA Capital Management broadly agrees: "The absence of any major concrete measures to stimulate investment, make taxation more equitable and cut non-developmental expenditure, along with a poor track record in achieving budgetary targets, will limit the macroeconomic impact of the budget. The GDP growth target of 6.3% appears to be rather ambitious given the harsh fiscal and monetary measures that are associated with the current budget, which is inherently recessionary in nature."

Urban resentment at the budget has been increased by the absence of any measures to tax income from agriculture in an effective way. The benefit of such a tax to revenues has perhaps been exaggerated: although over half of the population are farmers, agriculture accounts for only 24% of GDP. "Most farmers would not meet the tax threshold," says Citbank's Butt. "Even rich agriculturalists aren't as wealthy as your average multinational executive."

Nevertheless, not only is such a tax a priority for the IMF, its absence almost certainly hinders collection of other taxes. "Those who are paying their taxes know full well that no-one in agriculture or in government is paying," says AKD's Nazir. "So long as people recognize that it is one rule for one and another rule for another, then the system won't work. You shouldn't underestimate the earning power of small businessmen here in Pakistan. Many of them earn perhaps $5 million per year and yet for tax purposes they don't exist. What is called for is radical tax reform. The IMF recipe is disastrous. You can't go around prescribing the same medicine to everybody. Instead of telling the government to raise the level of taxation, they should tell them to widen the net."

Taxation can go only part of the way to solving balance of payments problems. As the IPPs come on line the government is pinning its hopes on a spurt in GDP sufficient to produce exports to offset additional forex requirements.

The growth in GDP for 1995-96 was a satisfactory 6%, but it was very much the product of a good cotton crop of 10.5 million bales. The performance of manufacturing remains disappointing. The growth of large-scale manufacturing ­ which accounts for 70% of manufacturing output ­ slowed dramatically from an average of 7% between 1982 and 1993 to only 0.5% in 1994-95 and 1.5% in 1995-96. Too many spinning plants lie idle because they cannot produce yarn at competitive prices ­ the result of historical protection and lack of investment. Carpet exports have also tapered off, perhaps because importers are becoming careful about not purchasing carpets that may have been made by child labour.

The government is relying on the increase in the country's power supply to reinvigorate such industries and avert a balance of payments crisis. Whether the goal can be reached is very much an open question.

Floating-rate funding

The government of Pakistan has become increasingly reliant on commercial banks to meet its foreign currency borrowing requirements. Such loans amount to around 15% of Pakistan's total external debt of $24 billion. But given the country's credit rating and perceived risk, banks are unwilling to lend much beyond 12 months. So the country's first floating-rate note (FRN) issue at the end of June, led by Citibank and worth $150 million, is an important step towards diversifying the government's funding sources.

The after-market performance of Pakistan's debut sovereign $200 million Eurobond, issued in late 1994, has been rather disappointing, although it is now trading at a slight premium. The FRN was favoured as a means of achieving longer-term funding at a lower cost. "With fixed-term securities, investment funds tend to prefer investment-grade credits," says Javed Noel, joint secretary at the finance ministry. "The floating-rate note seemed a sensible way of controlling the cost of our funding as well as extending the tenor." The FRN was sold at a weighted average of 210 basis points over Libor compared with 350bp over Libor for the Eurobond. With put options at 18 months and 36 months, the tenor of the security can be extended to a total of four-and-a-half years.

The FRN not only provided a means of going beyond the one-year tenors available in the syndicated loan market, it also enabled the government to make use of investors that had already been granting the country short-term commercial bank loans. According to Sumant Sinha, vice-president of capital markets at Citibank in London, the attraction to investors who already hold short-term non-tradeable Pakistani paper is that much of the risk is now on price rather than on default. "Investors feel they can get out at whatever time, depending on their comfort levels."

Because the FRN is traded through Euroclear, which is fairly opaque, the government cannot look and see what investors are doing, and therefore cannot exert any pressure. The put options are anonymous, but it is not expected that they will be exercised unless there is a major calamity.

So far as the government was concerned, the other plus was expanding its investor base, in particular into the Asian market. Asian investors tend to be very FRN-oriented and Pakistan has never borrowed in Asia before ­ even by way of syndicated loans.

Buoyed by the success of its debut FRN issue, the government is keen to access the market more regularly, possibly starting with another FRN issue of a similar size this autumn. According to Noel at the finance ministry, the government plans to have outstanding international issues totalling between $500 million and $600 million. But the government will almost certainly have to wait until the conclusion of talks with the IMF, whose mission was due to visit the country this month, and the subsequent reaction of the rating agencies. ­ PE

As demand for electricity increases, so will consumer prices and the cost of foreign investment capital.

Poor pricing could damage your liberty

Pakistan's Privatization Commission has earned a reputation for professionalism and efficiency. But despite the government's desire to speed up the sale of state companies, the process has become bogged down. Especially problematic is the sale of telecoms company PTCL, which has been hampered by regulatory problems and unrealistic pricing

Across the road from the government secretariat in Islamabad stands the gleaming white Bhutto House. The building was conceived in the 1980s as a museum to celebrate Pakistan's state-owned industries. But by the time it was completed the original purpose was deemed outmoded. It is now a shrine to private enterprise, home to a shopping arcade and a collection of private companies. Its next-door neighbour is the Privatization Commission.

Established in 1991 while Nawaz Shariff was prime minister, the Privatization Commission's staff have come and gone with each successive change of government. But its divestment strategy has remained more or less constant, along with its objectives ­ to improve production, reduce government debt, develop capital markets and introduce a shareholder democracy. Over the years, it has also gained a reputation with foreign bankers and investors for its professionalism and efficiency, in stark contrast to some of the more chaotic corridors of bureaucracy over the road.

The commission oversaw the privatization of three banks and 90 industrial units between 1991 and 1994. The sale of the cement industry in particular proved a tremendous success, with production now up 40% in most units.

The task of involving domestic investors more in the process is being tackled by the $100 million Privatization Fund, launched earlier this year by James Capel's office in Islamabad. The fund will initially consist of shares in 12 unlisted and 12 listed companies which the government has partly privatized; it will be listed on the London Stock Exchange as well as the three local stock exchanges. This year probably the most successful privatization in the programme has been carried out ­ the sale of a 26% strategic stake in the 1,600MW Kot Addu power plant to UK company National Power for $215 million.

"All four bidders [National Power, British Gas, AD Consortium and Southern Electricity] agreed afterwards that the process had been very transparent," says Mudassar Malik, a director of Karachi firm BMA Capital Management, which advised on the sale. "The proof is that the losers have come back to bid for [another state-owned power plant] Jamshoro. The government can now proceed and divest the remainder of the equity."

The government will be hoping that the successful conclusion of the Kot Addu sale, albeit a year or so later than planned, will speed up programme as a whole. The shortlist of bidders for Jamshoro is now expected to be drawn up in September. Other privatizations in the pipeline include the Karachi Electricity Supply Company, for which NatWest Capital Markets is currently seeking strategic bidders, and the Faisalabad Electricity Board.

The total size of the privatization programme is well over $20 billion, but at the recent historical rate of progress it will take around 20 years to complete. Progress has become rather bogged down with the attempts to sell strategically important entities such as Pakistan Telecommunication Corporation Limited (PTCL), the Water and Power Development Authority (Wapda) and United Bank Limited (UBL). The IMF is among those calling for an acceleration that will enable the government to reduce its debt service charges and meet the future dollar liabilities of its private power programme.

In some cases, speed can introduce flaws, as has happened with the UBL strategic sale for which the government was accused of allowing insufficient time for due diligence earlier this year. The Privatization Commission refused to allow a second potential buyer ­ Faysal Islamic Bank of Bahrain ­ more time to check UBL's financial health, leaving Saudi Arabia's Bisharahil group as the only prequalified bidder.

Abdullah Yussuf, secretary of the Privatization Commission, explains it as a case of simply accepting an unconditional bid over one that was conditional. "Besides," he adds, "if you look at just one of Faysal's conditions, that the government deposit PRs20 billion [$601 million] in UBL without interest for five years, you can see that theirs was effectively a negative bid." Nevertheless, with the Bank of England rumoured to be among those voicing their concerns about Bisharahil, it remains unclear whether management control will be transferred to the successful bidder.

But despite concern over the way the UBL sale has been handled, most analysts seem to agree with the IMF that the programme as a whole needs to be speeded up. In this context, most eyes are on PTCL (known as PTC until its incorporation on January 1). It is valued now at around $5 billion and completion of its sale will be of immense symbolic importance, besides providing much-needed opportunities for the retirement of the government's most costly liabilities. It will also have a huge impact on the Karachi Stock Exchange, where it already accounts for half of turnover and around one-third of total market capitalization.

The PTCL privatization has been fraught with difficulties ever since 1992 when the government appointed Bear Stearns to advise on the sale of a 26% strategic stake. Four years later, with a new financial adviser (Morgan Grenfell) in place, there is still no shortlist of bidders. Deadlines have come and gone, but still the government appears to be scarcely nearer to offloading its most valuable asset. "It has taken a lot longer to generate enthusiasm than we had thought," admits Ian Logan, assistant director in the emerging markets division of Morgan Grenfell in London. "And we're not there yet."

Some of the reasons for the difficulties encountered by Morgan Grenfell are obvious enough. For example, it must appear rather odd to many investors that the new, supposedly independent regulator ­ the head of the Pakistan Telecommunications Authority ­ is none other than the chairman of PTCL, Mian Javed. By law, Javed was supposed to have resigned from PTCL when becoming regulator but he has failed to do so. One can read all sorts of reasons into why he has stayed put.

Another concern is that the telecoms law setting the framework for the sale has still not been put before the National Assembly. An ordinance ­ similar to a presidential decree ­ was promulgated last November and was supposed to be put before the National Assembly in the first quarter of 1996. Unfortunately this hasn't happened. Ordinances can be changed every four months in their renewal phase. Potential investors are therefore unsure of the legal environment they are dealing with.

But progress has also been hampered by the government's failure to seize the moment and sell its strategic stake back in 1994, since when the world markets have become rather swamped with telecoms issues.

According to the government's initial pledge, the strategic sale was originally supposed to go ahead immediately after the sale of an initial 2% tranche to domestic investors in July 1994. Flushed with the success of the domestic voucher sale, however, the government decided to sell a further 11% to foreign investors through a global depositary receipt (GDR) issue in September. Having sold the first tranche of vouchers for PRs30 each, the government achieved a price of PRs55 for the GDRs, raising an additional $900 million.

By any reckoning this was a good price, not least because the offering came just before the Mexican crisis and the subsequent downturn in emerging markets. However, when investors discovered that the sale documents prepared by Jardine Fleming had overstated by 30% the number of telephone lines in operation, the price of the GDRs slumped. Jardine Fleming, which had replaced Union Bank of Switzerland just 10 days before the sale, mistook the number of lines installed for the number in operation.

Avoiding old mistakes

In its haste to raise the money to meet specific debt repayments, the government had insisted the sale of the second tranche go ahead without due diligence. The original prospectus was therefore used again with a disclaimer as to the accuracy of its information. The end result was a rather sour taste in the mouths of many international investors.

The extent to which all this has contributed to subsequent delays in the sale of the strategic stake is debatable. But many feel the inflated price may have raised the government's expectations to unrealistic levels. "The whole programme here suffers from the problem that the government thinks its companies are worth more than they are," says a foreign banker in Islamabad. "Compare that with what happened in the UK where the government said we want to privatize utility x and we'll see what the market will give us. Because they were realistic, the programme was very quick."

Two years on, for whatever reason, the PTCL strategic sale has still not happened. The government eventually lost faith with Bear Stearns, which it felt had undervalued PTCL, and appointed Morgan Grenfell in August 1995. But the new financial adviser has found it equally hard to find investors willing to stump up the required sums.

All the original vouchers were converted into shares on August 6 following the listing of PTCL's shares on Pakistan's three stock exchanges. Of these 74% are class A shares (12% are traded on the stock exchange while 62% are still held by the government). The remaining 26% are class B shares with enhanced voting rights which Morgan Grenfell is attempting to sell. The revised target of June has come and gone and still the formal prequalification phase has yet to begin.

The conditions of the sale have now been radically altered to boost interest. The original intention was to sell all 26% to a single operator or a group controlled by the operator. But given that operators appeared unwilling to go it alone while at the same time it was evident that there was interest from financial investors, particularly project-finance funds in the Middle East and South East Asia, the requirements were relaxed in April. "The intention was to marry the two by allowing financial investors to form a bidding group with an operator locked in under the terms of a management contract," explains Morgan Grenfell's Logan. "There is no obligation on the operator to take any stake at all, but many will want at least a small share."

The contract will tie the operator in for seven years ­ the same length of time as PTCL's monopoly period. The operator will be obliged to provide day-to-day management control for which he will be remunerated on a performance-related basis. Logan says a number of groups are now looking at this structure and making plans to visit Islamabad to meet the Privatization Commission and, in effect, begin due diligence.

Logan expects the mistake in the 1994 GDR prospectus to have little bearing on the strategic sale, which is targeted at a completely different set of investors. Besides, he explains, while Morgan Grenfell will be setting up a data room for use by potential investors, the onus for due diligence this time lies very much with the buyer.

The list of interested bidders is thought to include various consortia led respectively by General Electric, Mitsubishi, Deutsche Telekom, Indonesia Telkom, British Telecom and Singapore Telecom. AT&T has publicly stated that it will not bid.

Price remains a sensitive issue. Following the GDR issue, the voucher price fell rapidly, reaching a low in November 1995 of around PRs27. It then proceeded to rise to the mid-40s but has since come off again. As Euromoney went to press, Morgan Grenfell had not completed its valuation report, and the price expectations of the government remained something of an unknown quantity. "There have been some ludicrous figures bandied around in the last year as to the value of the whole company," says Logan. "Figures of $10 billion for it are quite absurd. I think the government is now becoming more realistic."

Over two years have elapsed since the initial domestic public offering, but there would still be immense difficulties in presentation were the government forced to let the class B shares go for less than PRs30 ­ the price Pakistani investors paid for their vouchers. Indeed, there are grounds for arguing that the price should be considerably higher, because the company has increased lines in operation and profits.

The senior officials of the Privatization Commission cannot afford to slip up and be deemed to be selling off the family silver cheaply. Incoming governments in Pakistan have a habit of treating their predecessors harshly. The former Privatization Commission chairman during the Nawaz Shariff government, General Saeed Qadir, has been under house arrest since Benazir Bhutto came to power. The current chairman, Naveed Qamar, may well think he has to tread carefully to avoid suffering the same fate when the political tables are next turned. *

Efficiency upgrade

The success of Pakistan's privatization programme relies heavily on the efficient working of the local stock market. So the speed with which the Karachi Stock Exchange (KSE) has developed its central depositary will come as a relief to the government and investors. The law allowing for the electronic book entry of shares is expected to be passed within the next couple of months.

The Central Depositary Company (CDC) was first incorporated in January 1993 and it awarded the contract for the design and implementation of the central depositary to an IBM-led consortium in November 1994. Since then it has taken under two years to complete the project ­ a far shorter time than in many other countries ­ at a cost of around $5 million. The CDC is owned 30% by the KSE, 20% by Citibank, 10% by the IFC, 10% by Muslim Commercial Bank and 5% each by six other Pakistani financial institutions, including the Lahore and Islamabad stock exchanges.

Based on an initial design by consultants Price Waterhouse, the central depositary is a hybrid system tailored to the Pakistani market which allows for both scripless and physical transfer. It should help to improve settlement procedures substantially. The need for such a system has become increasingly urgent, with 775 companies listed and average daily turnover now worth around PRs1 billion ($30 million), compared with PRs136 million when the country's economic reforms got under way in 1991. As the government proceeds from the strategic to the public offer stages of its sell-offs, these figures should rise considerably.

The current settlement system is expensive, laborious and often protracted. "Registration is one of the biggest problems for foreign investors in the Pakistani equity market," says Javed Hassan, equity sales manager at ING Barings in London. "I've know situations where it has taken up to a year. If you don't get the certificate back you can't sell the shares. This is one of the major disincentives of this market for foreign investors. With the central depositary I expect the potential investor base to increase by 50% to 60%."

The old system can also be risky: the physical handling of shares providing ample opportunity for fraud. From now the transfer will be instantaneous by way of an electronic book entry system.

"The central depositary provides a platform for further development and increases investor confidence," says CDC chief executive Najam Ali. "Foreign brokerages, many put off by the present system, are enthusiastic. Foreign investors tend to be long-term, so their presence should lend the market stability. They also act as a catalyst for local investors. On the domestic level the impact will be felt over the next two to three years."

The central depositary will become operational in phases. To begin with there will be a gradual depositing of all eligible securities with the CDC, starting with 80 to 100 of the most actively traded stocks in the first year. The most liquid stocks, such as Hubco, ICI, MCB, Sui Southern and Enro will be brought into the system as soon as it has been proven. Eventually it will become mandatory for all new issues to be with the CDC.

The central depositary is also expected to have a major impact on secondary-market trading of domestic debt instruments, for which there is virtually no market at present. "It will facilitate their settlement, registration and trading," says Ali.