This Selected Issues and Statistical Appendix paper presents cross-country regression results that identify investment in physical capital and improvements in institutional quality as having the largest pay-off in terms of increased growth. The paper employs three approaches to forecast inflation in Pakistan. A leading indicator model outperforms a univariate autoregressive moving average model as well as a vector autoregressive model in terms of forecast quality. The paper presents three case studies of Pakistani public sector enterprises that have recently witnessed strong improvements in their financial performance.

Abstract

This Selected Issues and Statistical Appendix paper presents cross-country regression results that identify investment in physical capital and improvements in institutional quality as having the largest pay-off in terms of increased growth. The paper employs three approaches to forecast inflation in Pakistan. A leading indicator model outperforms a univariate autoregressive moving average model as well as a vector autoregressive model in terms of forecast quality. The paper presents three case studies of Pakistani public sector enterprises that have recently witnessed strong improvements in their financial performance.

V. The Contribution of Managerial Improvement in the Financial Rehabilitation of Selected Public Enterprises in Pakistan29

A. Introduction

103. This section examines the improvement in the financial performance of three major nonfinancial public enterprises in Pakistan since 2000. During the 1990s, Pakistan Steel Mills (PSM), Pakistan International Airlines (PIA), and Pakistan Railways (PR) incurred substantial losses that were covered by the federal budget and thereby contributed to macroeconomic instability. Poor governance was singled out frequently as a key cause of the public enterprises financial weaknesses and low quality of service. As part of its economic reform strategy, the government that took office in 1999 had the objective of redirecting budgetary expenditures from subsidies towards high priority human and physical capital development, as well as enhancing the contribution of all three enterprises to economic growth by providing better services at a lower cost.30

104. The improvement in the financial performance of the three public enterprises is analyzed by comparing the period 2000/01 to 2003/04 with the period 1994/95 to 1999-2000 (prior to reforms). 31 Some improvements were made possible because the federal government, as owner of the enterprises, took over the burden of their debt service or recapitalized their balance sheets, leaving the consolidated public sector accounts unchanged. However, management efforts were key to improved financial performance.

B. Measuring Public Enterprise Performance: An Accounting Framework

105. Financial performance is measured as the retained income of the enterprise corrected for the net contribution made by the government (adjusted earnings). By definition, any improvement in adjusted earnings reduces an enterprises burden on the budget in the absence of other financing sources. The accounting framework is presented in Table V.1.32 Accrual-based accounting is used as it measures the loss or profit more accurately than cash-based accounting. After adjusting for the contribution of the government, the financial improvement is then split into two components: (a) improvements that are exogenous to the enterprise and can be attributed to a more favorable environment; and (b) improvements that reflect better management and corporate governance and are therefore directly attributable to economic reform efforts at the level of the individual enterprises.

Table V.1.

Operations of a Nonfinancial Public Enterprise: An Accounting Framework

(accrual basis)

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C. Financial Performance of Public Enterprises

106. The financial operations of PSM, PIA, and PR over the period 1994/95 to 2003/04 are presented in Table V.2,V.3, and V.4. The entire period under analysis is divided into two subperiods: 1994/95 to 1999/2000 (before reforms) and 2000/01 to 2003/04 (during reforms). The financial results of the selected enterprises over both periods are compared.

Table V.2.

Operations of Pakistan Steels

(Accrual basis; in millions of Pakistani rupees)

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Source: Pakistan Steel Mills, Karachi.

Pakistan Steel Mills has no pension scheme for its employees. However, some amount of pension is being paid to ex-employees of Chitagong Port transferred to Pakistan Steel Mills treating government of Pakistan employees.

Table V.3.

Operations of Pakistan International Airlines

(Accrual basis; in millions of Pakistani rupees)

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Source: Pakistan International Airlines, Karachi.

PIAs annual contribution to recognised Pension Fund.

The 18-month period data (July 1997-December 1998) was converted into 12 month period (multiplying the number by 0.667) to make the table consistent.

Effective January 1999, the accounting year was changed from fiscal year (July-June) to calendar year (January-December).

No dividends were distributed as the PIA recorded losses during the period under analysis.

In 2002, government’s equity increased to 76 percent against non-payment of interest by the PIA.

Corrected retained income is adjusted for GoP’s equity contribution of PRs. 2,936 million to the PIA in 2002.

Since the accounts are on accrual basis, the net increase/decrease in cash and bank balances are not taken here.

Table V.4.

Operations of Pakistan Railways

(Accrual basis; in millions of Pakistani rupees)

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Source: Pakistan Railways

Due to extraordinary retirement in 1995/96.

Number of pensioners revised as per issuance of departmental identity cards.

Operations of Pakistan Steel Mills

107. PSM was incorporated in 1968 with the objective of enhancing the domestic availability of basic raw material (iron and steel products) for the engineering and construction industries. PSM’s creation facilitated the establishment of 22 downstream public steel companies that produce engineering goods with higher value added. The production capacity of PSM is 1.1 million tons of raw steel per annum which is planned to be expanded to 3 million tons over the next 10 years. The establishment of PSM lessened Pakistan’s dependence on steel imports.

108. A comprehensive restructuring plan addressed ingrained problems. PSM had been plagued by operational inefficiency, overstaffing, poor maintenance, low capacity utilization, unsatisfactory work discipline, and mismanagement. In order to make PSM economically viable and to facilitate repayment of outstanding loans, the new management, appointed in 2000, undertook a restructuring strategy to stem the losses. Manpower was significantly reduced as a large part of noncore activities were outsourced. Management also focused on enhancing capacity utilization. Financial restructuring, repairs and maintenance, and improving governance were part of the reform agenda. A number of incentives including cash rewards, and merit certificates were introduced for good workers, and employees were given access to the chairman of the PSM to redress their grievances. A Welfare Trust was established to look after medical, education, and transport needs of the workers. The new management was given a full mandate to lay off surplus employees. To improve governance, PSM signed a memorandum of understanding with Transparency International (Pakistan) to strengthen procurement procedures.

109. The restructuring contributed to a turn-around in financial performance. PSM made losses after taxes during the late 1990s. However, during the past four years, the financial position of PSM improved significantly, despite the fact that the workforce reduction by about 40 percent during the last 10 years (mostly since 2000/01) did not result in a decline in salary outlays because of severance payments offered as incentives for voluntary retirement.33 PSM did not receive any direct subsidies or capital transfers from the government throughout the period under analysis. In fact, PSM made a positive contribution to the net worth of the public sector: adjusted retained income rose from PRs 1.4 billion in 2000/01 to PRs 7.4 billion in 2003/04.

110. The external environment became mostly favorable only after 2002/03. Following the events of September 11, industrial production and construction activities slowed, causing a fall in demand for steel products and depressing prices for PSM output. This was aggravated by increased import competition following a reduction in import tariffs in July 2001. Only in 2002/03 and 2003/04 did the economic environment become more favorable to PSM. The levy of 30 percent import duty on steel products by the United States raised the prices of steel products in the international market, as did a growing demand from China. In addition, expansion of domestic construction activity gave a boost to the steel industry in Pakistan. Accordingly, PSMs net sales rose sharply, reflecting both price and volume effects. Capacity utilization rose from about 80 percent in the 1990s to 93 percent in 2003/04. However, the cost of fuel and electricity rose significantly over time, as did payments for raw materials.

111. Summing up, over the past four years PSM improved its adjusted retained earnings and retired its domestic debt. Its workforce declined significantly and capacity utilization and sales volume increased. The improvement in financial and operational performance was primarily due to better management. Only in the last two years did a favorable external environment contribute to the improvement.

Operations of Pakistani International Airlines

112. PIA is a well established international carrier. PIAs network reaches 33 international and 21 domestic destinations. Unlike PR and PSM, PIA is listed on the stock exchange.34 The governments share in PIA was 57.7 percent till 2001 but rose to 75.9 percent in 2002 and 87 percent in 2003.35 PIA recently lost its monopoly in the domestic market as five private airlines were granted licenses.

113. PIA incurred sustained operating losses, accompanied by liquidity problems, in the 1990s. Frequent pilot strikes, problems with suppliers/vendors, overstaffing, political interference, mismanagement, staff indiscipline, and low employee morale were the main factors behind PIA’s weak performance. The events after September 11 further undermined the financial position of the national carrier because of the closure of the Afghan airspace, higher fuel costs, large war risk premiums, and restrictions on flying over India as well as visa restrictions by many countries that reduced travel to and from Pakistan. But PIA also benefited as other international carriers stopped flying to Pakistan.

114. The present management prepared and implemented a business plan aimed at reestablishing the profitability of PIA. PIA suffered heavy losses until 2001 as income after taxes remained negative during most years, hitting bottom in 2000. The new management, which took over in April 2001, took various cost cutting and revenue enhancing measures, including eliminating nonprofitable flights, increasing flight/duty time, downsizing of personnel (in particular at foreign stations), moving from manual to automatic ticketing, outsourcing noncore functions, increasing domestic and international fares, and replacing old aircraft with new ones. Cash awards for employees were introduced to reward performance. As a result, PIA became profitable and its income after taxes was positive, PIA did not receive any subsidies or capital transfers from the government, but instead made a positive net transfer to the government.36

115. Containing costs contributed significantly to improved financial performance. A workforce reduction by 10 percent over 10 years resulted in lower overall cost of salaries and pensions, particularly during the past three years. Cost per employee fell by 24 percent between 2000 and 2003.37 Engineering and maintenance costs also declined during the last two years. In some years, fuel costs fell in line with international oil prices and a strengthening rupee. However, recently, rising oil prices pushed fuel costs higher. Depreciation adversely impacted total costs.

116. PIA revenue from both passenger and cargo traffic increased markedly between 2000 and 2003. Incentives for travel agents resulted in higher sales and increased seat occupancy. Reducing the number of free tickets to employees left more seats available for paying passengers. As a result, receipts per passenger grew substantially during 2001-2003 compared to 1995-2000.

116. PIA’s financial improvement is primarily due to better management. PIA improved its adjusted retained earnings by containing costs and strengthening revenues. In particular, salaries and pension payments declined sharply, though cost factors outside PIAs control eroded some of these gains. Revenues were strengthened by raising capacity utilization and revenue per passenger.

Operations of Pakistani Railways

117. PR operates in most parts of Pakistan and caters for the bulk of freight movement as well as passengers who cannot afford other more expensive means of transportation. The existing network of tracks is in disrepair, and trains and coaches need modernization. As a result, demand for rail traffic has declined.

118. PR’s poor performance was the result of years of mismanagement. The merger of PRs financial operations with the budget of the federal government in 1970 marked the beginning of PRs financial difficulties. In particular, no funding was made for contingent liabilities such as pensions, the provident fund and depreciation. The shift in preferences toward road transport as well as a lack of investment, management, inefficiencies, and corruption also undermined PRs financial performance. As a result, PRs financial performance steadily deteriorated during the 1990s, as its losses (i.e. income after taxes) rose from PRs 0.6 billion in 1994/95 to PR’s 5.3 billion in 1998/99. In order to cover PR’s losses, the government transferred substantial amounts to PR.38

119. In order to reverse the decline, a new PR management began structural and managerial reforms in 1999/2000, including through recruitment of finance, marketing, and information technology professionals. Measures included rationalization of staff, removal of ghost pensioners and employees, minimizing ticketless travel, disciplinary action against corrupt employees, scaling back free railway passes to employees, and leasing un-utilized PR land on a competitive basis. The new management also established a Vigilance Directorate to monitor the performance of employees at all levels.

120. Workforce rationalization and removal of ghost employees did not result in lower costs. The number of employees fell from 113,000 in 1994/95 to 88,000 in 2003/04, but there was a corresponding increase in retirees.39 Despite the reduction in staff, salaries and pensions kept rising. The average annual cost per employee increased by 7.4 percent and per pensioner by 12.2 percent during the 2001-03 period, which was higher than during the 1995-2000 period. However, salaries and consequently annual cost per employee decreased in 2003/04.

121. Annual revenue from passenger trains increased much faster than revenue from freight trains. Annual revenue from passenger trains increased sharply in 2003/04, because of a significant increase in fares. A shift from less profitable short-haul routes to long-haul routes also contributed to higher receipts per passenger.40 By contrast, revenue from freight trains increased only marginally from 1994/ 95 to 2003/04. The average annual increase in the fare of freight transportation fell from 10.9 percent during 1995-2000 to 1.6 percent during 2001-03. More recently, the average fare of freight declined further by 10.3 percent in 2003/04.

122. The reforms failed to bring about a fundamental improvement of PR’sfinancial performance. Labor costs were not contained. In addition, fuel costs increased significantly on account of international oil prices.41 There was some improvement in revenue from passenger trains reflecting better managerial efforts as PR improved its facilities to attract more passengers and raised tariffs significantly. By contrast, for transportation of freight, ground lost to transportation by truck could not be recovered. Taken together, there was some improvement in PR’s income after taxes, reflecting sharply higher net transfers from the passenger trains reflecting better managerial efforts as PR improved its facilities to attract more passengers and raised tariffs significantly. During the past four years, PR’s corrected retained income averaged negative PR’s 4.5 billion compared with PR’s 4.2 billion during the preceding six years, implying little financial improvement so far.

123. Summing up, over the past four years, PR failed to improve its adjusted retained earnings, but stepped up its acquisition of fixed assets and retired domestic debt. Sharply higher government transfers to PR allowed repayment of debt and accumulation and replacement of capital equipment. The improvement in operations of PR, in particular the reduction in the workforce, reflected better management. Overall, the financial performance of PR remained roughly the same during the past four years.

D. Conclusion

124. PSM and PIA succeeded in improving their financial performance while PR is still lagging behind (Figure V.1). PSM, PR, and PIA all suffered heavy losses and were in financial difficulties during the 1990s. However, during the last four years, the management of all three companies have undertaken measures to improve their financial position and operational performance. The financial position of PSM and PIA improved markedly as the enterprises turned from loss makers in the 1990s to profitable entities. In contrast, the financial performance of PR deteriorated during the same period. With regard to managerial efforts, all three enterprises reduced significantly their workforces and repaid relatively expensive debts. Unfavorable external factors like oil price hikes, however, harmed the financial performance during the reform period.

Figure V.1.
Figure V.1.

Corrected Retained Income

(of Railways, Steel Mills, and PIA)

Citation: IMF Staff Country Reports 2004, 415; 10.5089/9781451830644.002.A005

125. Four more general lessons emerge from these case studies. First, the induction of a competent and effective management is crucial to good financial performance. Second, PSEs need to be financially independent and have a clear accountability yardstick. Continued government involvement typically leads to weak budget constraints and can imply conflicting objectives besides profitability. Third, cleaning up balance sheets can provide a clean slate and allow a distressed PSE to return to profitability. However, this needs to be combined with management reforms and increased (financial) accountability to ensure that the second chance is not wasted. Fourth, improving financial performance is more difficult in business areas that have characteristics of natural monopolies such as railways. Here, lesssons from the industrial organization literature as well as the experience with deregulating and regulating state monopolies such as power utilities may be useful for formulating a comprehensive reform strategy.

29

Prepared by Zafar Iqbal, Senior Economist, IMF Resident Mission, Islamabad, Pakistan.

30

The Ministry of Finance and the responsible line departments prepared and monitored quarterly financial improvement plans (FIPs) of PSM, PIA, and PR in August 2002. Quarterly reports on the performance of each enterprise have subsequently been posted on the Ministry of Finance website (www.finance.gov.pk).

31

The fiscal year in Pakistan starts on July 1.

32

For a detailed description and further disaggregating of the financial accounts of a public enterprise, see A Manual on Government Finance Statistics, 1986, International Monetary Fund.

33

PSM has no pension scheme for its employees, except for small amounts paid to ex-employees of its former Chitagong Port entity.

34

PIA was listed on the Karachi Stock Exchange in 1957.

35

The increase to 75.9 percent in 2002 and 87 percent in 2003 occurred when PIA settled interest payment obligations to the government by issuing equity shares.

36

However, under the financial package, an amount of PRs 1.2 billion on account of interest payable to the government during August 2001 to December 2002 was converted into equity. Further, the government of Pakistan also provided PRs 1.8 billion ($30 million) to PIA during 2002 toward equity contribution under the aircraft replacement plan. Consequently, the governments equity in the PIA increased from 57.7 percent in 2001 to 75.9 percent in 2002. The governments equity further increased to 87 percent in 2003 on account of interest payable to the government (PRs 1.4 billion) and an amount of PRs 3.5 billion ($60 million) under aircraft fleet replacement plan, used for purchasing eight Boeing 777 aircrafts.

37

In recognition of the contribution of its employees in the turnaround, PIA management increased salaries of its employees by 20 percent in January 2003, which reflected a higher salary bill in 2003. In addition, PIA also hired some more employees (1,881 in number) mainly on contract basis in 2003.

38

A special retirement program caused a sharp one-time loss in 1995/96.

39

In 2000/01, Pakistan Railways management issued departmental identity cards to its pensioners and identified over 21,000 ghost pensioners, thereby reducing the number of pensioners from 127,000 in 1999/00 to 106,000 in 2000/01.

40

The average annual increase of fares was 9.1 percent during the 2001-04 period, compared with 8.2 percent during 1995-2000.

41

The average annual fuel cost increased significantly from PR’s 1.5 billion during 1995-2000 to about PR’s 3 billion during 2001-04.