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How real estate sector manages to refuel itself

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KARACHI:

Real-estate is a major avenue for investment in Pakistan and, in terms of returns, has beaten almost all asset classes. According to the House Price Index of Zameen.com, houses have exhibited a compound return of almost 13% in the last 10 years. This compounded return has reached almost 18% in the last two years.

But the drivers of demand for real-estate in Pakistan are slightly different from global drivers.

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It is naïve to believe that the rising price of houses results from a rise in consumption. While consumption may be one of the drivers here, it is not the most important. Why do I say this, you ask? Well, consumption in Pakistan has started to dwindle in response to contractionary monetary and fiscal policies. Although car sales and gasoline consumption has taken a noticeable dip, real-estate prices have refused to budge.

Five years ago, I wrote an article in this newspaper in which I compared Karachi, Pakistan’s real estate hub, with other metropolitan cities. In view of the traditional demand-side indicators i.e., rent-to-price ratio and salary-to-rent ratio, Pakistan’s real-estate sector seemed to have peaked; the bust of which seemed imminent. To my amazement, however, this did not happen. In hindsight my situation can be best explained by a verse from Ghalib;

“Thee khabar garm ke Ghalib ke urenge purze,

Dekhne hum bhi gae thay, par tamasha na hua”

(It was big news that pieces of Ghalib’s body were going to be taken apart,

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I was amongst those waiting to watch, but the predicted circus-act never took place)

In the case of the topic at hand, Pakistan’s real-estate bubble never burst as predicted. So, why then did the “tamasha” not place or the real-estate bubble not burst? Let’s discuss the reasons

As mentioned above, in Pakistan, consumption is not the main driver of real-estate demand. Instead, real-estate demand is driven by surplus funds parked in this sector by the more affluent classes of society. Now, with the Financial Action Task Force (FATF) conditions in place, it has become very difficult to take money out of the country. Additionally, those popular destinations, ordinarily used by Pakistanis to stash away their financial surplus, are themselves grappling with the FATF and money-laundering issues. Therefore, the funds that are unable to find a way out of Pakistan have instead found a place in its real-estate market.

Let’s discuss a hypothetical transaction: Mr A wants to park funds in real-state so he purchases a plot of land from Mr B, but what will Mr B do now? Will he buy shares from this money, invest it in T-bills or pour it into his own company as a form of investment? No, he doesn’t do anything of that sort. Instead, he buys another plot of land in view of making more profit. This chain seems to continue indefinitely. This is how Pakistan’s real-estate refuels itself, becoming more and more profitable for those who can afford it.

In a movie, Kevin Spacey says ‘land is a limited resource’ and in Pakistan, a finite amount of land is chase by an apparently infinite number of buyers. So, while these buyers and sellers manage to multiply their investment every few years, the money being offered for plots is also growing exponentially. Supply, however, is naturally limited. This limited supply causes the prices to rise again, and so on and so forth.

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If economic policies remain the same, there is no end in sight for this boom.

Secondly, property market investments are also an avenue for people to turn black money into white cash. This is also an important driver for real-estate as, at least, 40% of Pakistan’s economy is undocumented, hence, huge sums of money are channelled in through this avenue.

So, then what’s the problem with this?

The problem with getting on this self-refuelling real-estate bandwagon is that it is diminishing the productive potential in the country. Why would anyone want to export goods, a measure critical to our economic survival, when you can easily double the money in a few years playing golf all day.

Furthermore, the tax laws governing this area are such that these real-estate barons end-up paying infinitely lower taxes than those applicable in the corporate sector. This acts as an incentive in favour of the real-estate band wagon and also results in the government consistently being unable to collect the required amounts of tax.

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Man is motivated by incentives. You cannot coerce people to export goods, especially if the incentives lie in the passive real-estate sector.

But the real-estate people need to understand that this boom, although self-refuelling, cannot go on indefinitely. Pakistan’s Balance-of-Payment (BoP) crisis is a result of the lack of incentives offered in other productive, lucrative businesses.

The nudge theory in economics can be employed to turn this situation into something that is favourable for all parties involved. Incentives must be established so that surplus capital can flows through productive businesses, especially on the export-side. IT-exports, for example, seem to be an easy, albeit important, avenue that could help lead Pakistan out of its economic mess.

If Pakistan doesn’t quickly realise the importance of stopping this self-refuelling real-estate bandwagon, our economic woes will continue to pile up.

The writer is a banker and teaches economics

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Published in The Express Tribune, November 14th, 2022.

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Privatisation fails to meet objectives

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ISLAMABAD:

The success of Pakistan’s privatisation programme has remained limited to only generating $11 billion in sale proceeds, as the country could not achieve the post-privatisation objectives of improving efficiency and competition, says a new independent study.

The findings come amid the International Monetary Fund’s (IMF) push for approval of the State-Owned Enterprises (SOEs) Bill to improve efficiency and management of public sector firms. The finance ministry has requested the holding of a joint session of parliament to approve the law, after the bill was rejected by the Senate.

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In a study titled “Public Sector Enterprises (PSEs) in Post-Privatisation: Evidence from Pakistan”, authors Naseem Faraz and Dr Ghulam Samad concluded that the key objectives of the privatisation programme had remained unfulfilled. The study has been published in the Journal of Applied Economics.

“Our main finding is that the performance of firms has improved in the post-privatisation period but (it is) statistically insignificant,” said the authors. Privatisation has been carried out with the motive of reducing the fiscal burden and increasing the efficiency of the inefficient PSEs. Since 1991, the sale of PSEs has raised revenues of Rs649 billion, or $11 billion.

The $11 billion has been worked out by applying the exchange rate of the year when a privatisation transaction took place.

Pakistan is one of the developing countries where privatisation of a large number of PSEs has taken place, but the post-privatisation effect is yet to be analysed. Second, rather than focusing on one or a few sectors, the study considers all the privatised PSEs.

The study showed that the performance of a few firms improved in the post-privatisation period but it largely remained negative.

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“In particular, the privatised PSEs in energy, cement and chemical sectors do not show positive gains in the post-privatisation period. However, the telecom and textile sectors have experienced a positive change in the performance of the privatised PSEs.” “Similarly, the results also showed that the efficiency of firms did not increase significantly.”

The authors said that according to their assessment through the Key Informant Interviews, the malfunctioning of regulatory environment led to the market failure that eventually resulted in market exploitation.

Regulations and regulators are captured by the market, bureaucrats, judiciary and politicians. An effective regulatory environment does not exist to force the privatised entities to have higher efficiency and develop a competitive environment.

Government intervention in the regulatory sphere is dominant. Every regulatory authority has a board member from the government. This practice is clearly not aligned with the privatisation regulations.

The government intervention (secretary sitting as a board member) creates conflict of interest by having ownership and management together.

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The privatised banking and energy companies have failed to bring in the benefits of sell-off, according to the study. The process of privatisation and rewards distribution favoured mainly the buyers, while the government faced risk and cost.

According to the authors, the privatised companies earned a higher average rate of return on assets compared to their fully government-owned counterparts, as measured by the total net profits-to-sales ratio.

The higher returns on assets suggest a favourable effect of privatisation. On the contrary, the profitability or productivity measure (net profits-to-sales ratio) was relatively higher for the privatised firms but it was statistically insignificant compared to the period when the firms were fully government owned.

“The privatised firms experience a mild increase in productivity compared to their pre-privatisation period. This difference in performance is not statistically significant.”

Privatisation also did not enhance the efficiency of the privatised firms in terms of increase in sales. It suggested that the efficiency improvement was merely coming through the reduction in cost of production.

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The study identified weak regulators as a reason for the failure to achieve the privatisation objectives.

“Unfortunately, the regulator Pakistan Telecommunication Authority (PTA) did not influence PTCL and other related entities to work in a regulated market environment.”

The role of the PTA is limited to overseeing the determination of market prices. PTCL’s privatisation was not a fair deal. It lost $800 million and also did not improve the market in terms of competition.

“The government sold 26% shares to Etisalat and also transferred the management, which is against the rule, which requires 51% shares,” emphasised the authors.

The government had agreed that Etisalat would pay $2.6 billion by making upfront payment of $1.4 billion and the remaining $1.2 billion in nine installments of $33 million each. For the deal, the government received only $1.8 billion and the remaining $800 million was never paid.

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“The monopoly of the telecom sector persisted despite the privatisation and drove away billions of dollars.”

The privatisation of KESC, now KE, also did not achieve the objectives. Though the main reason of the privatisation was to get rid of the loss-making enterprise, unfortunately the government is paying more after privatisation, according to the study.

Published in The Express Tribune, November 24th, 2022.

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Tractor maker faces legal action over fraud

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KARACHI:

The Federal Tax Ombudsman (FTO) has ordered legal action against a tractor manufacturing company as the Federal Board of Revenue (FBR) reported a fraud of more than Rs10 billion.

According to FBR sources, the tractor company has allegedly committed a fraud of over Rs10 billion under the previous government’s initiative to provide tractors at a lower cost to the farmers.

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As part of the subsidy scheme, the government gave billions of rupees to the deserving and underprivileged farmers for the purchase of tractors.

Sources said that the tractor manufacturer had claimed sales tax refunds on fake documents and flying invoices. The FBR then referred the case to the FTO.

They added that the FBR recommended the application of the Benami Transactions Act while taking legal action against the tractor manufacturer.

“The respondent company misused pay orders of the complainant by issuing bogus and fake sales tax invoices to other persons for obtaining fraudulent adjustment and refund,” a notification of the FTO office read.

The FBR has initiated legal proceedings against the owners and dealers of the tractor manufacturing company for the recovery of money obtained through fraudulent means.

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The Directorate General of Intelligence and Investigation, Inland Revenue has been tasked with investigating the fraud and tax evasion case.

Published in The Express Tribune, November 24th, 2022.

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G7 looking at Russian oil price cap of $65-70

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BRUSSELS:

The Group of Seven nations (G7) are looking at a price cap on Russian sea-borne oil in the range of $65-70 per barrel, a European Union (EU) diplomat said on Wednesday.

Views in the EU are split, with some pushing for a much lower price cap and other arguing for a higher one. The G7, including the United States, as well as the whole of the EU and Australia, are slated to implement the price cap on sea-borne exports of Russian oil on December 5.

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“The G7 apparently is looking at a $65-70 per barrel bandwidth,” the EU diplomat said.

“Poland, Lithuania and Estonia consider this too high because they want the price set at the cost of production, while Cyprus, Greece and Malta find it too low, because of the risk of more deflagging of their vessels, which might mean the G7 has found a good middle-ground,” the diplomat said.

Some 70%-85% of Russia’s crude exports are carried by tankers rather than pipelines.

The idea of the price cap is to prohibit shipping, insurance and re-insurance companies from handling cargos of Russian crude around the globe, unless it is sold for no more than the maximum price set by the G7 and its allies.

Because the world’s key shipping and insurance firms are based in G7 countries, the price cap would make it very difficult for Moscow to sell its oil – its biggest export item accounting for some 10% of world supply – for a higher price.

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At the same time, because production costs are estimated at around $20 per barrel, the cap would still make it profitable for Russia to sell its oil and in this way prevent a supply shortage on the global market.

Brent crude front-month future oil prices initially fell to $86.54 from $87.30 on the news.

Published in The Express Tribune, November 24th, 2022.

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