Coming out of the shadows

13 February 2004 10:31  [Source: ACN]

In the first of a two-part series of emerging market features, Malini Hariharan examines the economic and political challenges facing Pakistan, Bangladesh, Sri Lanka and Nepal and looks mainly at the implications of these challenges for polymer markets. In the second part of the series, which will appear at a later date, we will examine the implications for the other chemicals

OVERSHADOWED by India in more ways than one, Pakistan, Bangladesh, Sri Lanka and Nepal have not really caught the attention of the global petrochemical industry. Business in these countries has been constrained by political and economic risks, poor infrastructure, small markets and inadequate feedstock availability.

All four are currently in the midst of an economic and political overhaul, the results of which are likely to be clear only a few years from now.

Pakistan has regularly been in the news since the 9/11 tragedy with the US and its allies cracking down on global terrorism and proliferation of nuclear arms. But what has often not been reported is the substantial economic progress that the country has made after embarking on much-needed reforms in late 1999.

GDP (gross domestic product) expanded by 5.1% in fiscal 2002-03, up from 4.4% in the previous year. And the expectation is that 2003-04 should yield a growth of at least 5.3%. The reform programme is far from over, though, and political stability is still in question. However, optimists are confident that the country will be able to sustain the current level of economic growth.

Sri Lanka was the first country in South Asia to open its doors to reform and the global market in the late 1970s. However, nearly 20 years of civil war slowed down progress to such an extent that the country all but disappeared from the radar screen of international investors before 2001.

The start of the peace talks in 2001 revived the country's prospects, although last November's shocking dismissal of three elected ministers and the declaration of an emergency by the president has once again raised doubts about Sri Lanka's ability to maintain stability.

Bangladesh, the poorest country in South Asia, has tried hard to woo investors. But its chequered past has not endeared it to investors.

As for Nepal, the country's troubles seem as imposing as the Himalayan peaks that dot its landscape. Communism, which has all but died in almost all parts of the world, has taken root in rural Nepal with Maoist rebels currently engaged in a bitter battle with the government. Nepal is in serious danger of collapsing unless the insurgency can be controlled and the economy brought on track.

Putting their respective houses in order will be a challenging task for these governments. There is much that needs to be done to attract foreign investors in a big way.

For the petrochemical industry, even if peace and stability are achieved, these countries are unlikely to reach the stature of China or India in terms of market size. However, this does not mean they should be ignored.

While there is no immediate need for mega-sized plants, the requirements for a whole range of petrochemicals are growing slowly but steadily despite the uncertainties. And given the current low levels of per capita consumption of products such as polymers there is a considerable potential for future growth.

These markets have already captured the attention of a number of Middle Eastern, Indian, Southeast Asian and even South Korean exporters. Some have been active for a few years now while others are testing waters in the hope that these secondary markets will absorb some of their surpluses at prices that are as good as, if not better, than the more competitive Chinese market.

Pakistan

With a population of around 175m, which is growing annually at 2.2%, Pakistan offers the second largest domestic market in South Asia after India. Figures from the Asian Development Bank show that per capita income had risen fairly steadily in the previous two decades to reach Pakistani Rupee26 231 (US$475) in 2002.

However, economists point out that Pakistan lags behind countries with comparable per capita income on most social indicators. For instance, the literacy level in Pakistan is only 44% compared with an average 64% for comparable countries. Poverty is a major issue as around 33% of the population is estimated to be poor. Importantly, the differences in per capita income across various regions in Pakistan have persisted or widened over the years, says the World Bank.

But the reforms initiated by President Pervez Musharraf after he came to power through a military coup in October 1999 have earned kudos for the country.

According to Moody's Investors Service, a positive turnaround has taken place in the Pakistani economy over the past five years. The agency assigned a B2 rating to Pakistan's 5-year Eurobond issue in early February. This issue marks the country's return to the capital market since it restructured all previous eurobonds and floating rate notes at the insistence of creditors in December 1999.

Moody's also pointed out that the economy had responded positively to macroeconomic reform and stabilisation. The country had seen an improvement in its liquidity position thanks to ample external assistance, faster export growth and a pickup in overseas workers' remittances during the past two years.

But Pakistan is also besieged by a number of structural problems. Moody's says that public debt is still quite high and living standards are relatively low when compared with other countries in the same rating category as Pakistan. Even after the debt relief obtained in recent years, interest payments and defence spending consume over half of government revenue, restricting its ability to redress persistent poverty and underdevelopment.

These concerns have been echoed by many other international agencies. Last year, the International Monetary Fund stressed that further reforms were needed to improve governance and reduce corruption, including the enactment of effective anti-money laundering and bankruptcy legislation.

Other worries include the political future of the country following repeated assassination attempts on the president, two of which took place in December 2003.

A stable political environment is an essential prerequisite not only for the economy but also to sustain peaceful relations between Pakistan and archenemy India. There are plenty of areas, including chemicals, where the two countries can work together.

Normal relations between Pakistan and India would go a long way towards boosting bilateral trade currently estimated at around US$200m, although informal trade is estimated at US$1.5-2.0bn. Much of the trade is said to take place indirectly through third countries such as Dubai. Informal exports from India include tyres, chemicals, machinery, cement and tea while synthetic fibre, chemicals and food items figure on the Pakistani export list.

Some economists have also cautioned that claims of a full recovery of the Pakistani economy could be a little premature. Their main concern is whether Pakistan will be able to cope with a poor agricultural season and/or a drop in textile exports post-2005 when textile quotas are phased out. Agriculture accounted for nearly 25% of GDP in 2002 while cotton yarn, thread and cloth accounted for around 22% of total exports.

Turning to petrochemicals, despite the promise of a growing domestic market the industry has yet to take off in a big way. Requirements for most of the products are currently met through imports. Polyvinyl chloride (PVC), purified terephthalic acid (PTA), polystyrene (PS) and polyethylene terephthalate (PET) are among the major petrochemicals that are produced locally.

Sohail Amin of SaSa & SaSa estimates that annual demand for polyethylene (PE), polypropylene (PP) and PVC is 230 000 tonne, 160 000 tonne and 65 000-70 000 tonne respectively. A second industry source believes that the market for all of these products totals 500 000-600 000 tonne/year.

PVC demand is met by local producer Engro Asahi, a joint venture between Engro Chemical, Asahi Glass and Mitsubishi Chemical of Japan. The company operates a 100 000 tonne/year plant near Karachi.

In PE and PP, major market participants include Sabic, Equate, PCC Iran, ExxonMobil and Reliance Industries. Reliance is active mainly in PP as direct imports of only this polymer are allowed from India. Imports of other polymers have to be routed through a third country. There is talk that Pakistan will soon allow direct imports of PE, although it is not clear when this will take place.

Amin points out that the polymer trade is dominated by traders who account for nearly 70% of the imports. Only major end-users in the raffia sector prefer to import directly. And traders are said to be essential to reach local processors. Many foreign companies have reportedly failed in their endeavors to establish a direct link.

The polymer processing and import business is concentrated in and around Lahore and Karachi. There is a small requirement from Baluchistan and Peshawar. Small processors located in this area also ship finished products further north to as far as Tashkent in Uzbekistan.

Polymer imports currently attract a basic import duty of 20%. Traders importing material also pay a sales tax of 15% and an advance income tax of 6%. Clearing and handling charges amount to around 8%.

Amin says that Pakistan is bound to further reduce the basic duty. The country currently has three slabs for customs duties - 20%, 10% and 5%. But the government has applied to the WTO (World Trade Organization) to change the slabs to 15%, 10% and 5%.

Polymer demand has been stagnant for the past few years mainly because Pakistan lost the Afghani market, points out Amin. Previously, a small volume of polymers was imported into Pakistan for further shipment to Afghanistan and even Iraq. But now Iranian material is said to reach Afghanistan over the land border.

But Amin expects growth to pick up this year given the country's robust economic performance, a decline in interest rates, a booming stock market and a pick-up in construction activity. Growth in PP is likely to be faster than PE as the government has started advocating the use of PP woven sacks for packaging of rice and wheat. The government has now made it mandatory for 40% of rice and wheat packaging to be in PP woven sacks, up from the earlier requirement of 20%. Cement is currently packed in paper bags but this industry is likely to move to woven sacks in the future.

Pakistan's dependence on imports has raised interest in some quarters for a cracker project. National Refinery Ltd (NRL) and Pak Arab Refinery (Parco) had commissioned a study for a cracker complex last year that would be mainly based on naphtha obtained from local refineries (ACN 20 October 2003). Besides PE, PP and monoethylene glycol, the project could include PVC, PS and chloralkali. No time frame has been set for the for the project, the viability of which is in question given the small domestic market and the ambitious plans of Iran, Saudi Arabia and also India.

'A cracker doesn't make sense given the cracker and polymer expansion plans in the Middle East. After all, it takes only around two and a half days to ship product from Iran to Pakistan,' points out Amin.

But projects that are likely to go ahead in Pakistan include Pakistan PTA's plan to debottleneck its 400 000 tonne/year PTA plant by 25 000 tonne/year by 2005. A PTA project makes sense given the expansions that polyester companies have planned. One of them is Dewan Salman Fibre, which has identified a 70 000 tonne/year polyester project at Hattar in northwestern Pakistan for commissioning in 2005.

Bangladesh

Moving to Bangladesh, the current annual demand for all commodity polymers is estimated at a little over 200 000 tonne. One exporter to Bangladesh estimates that the annual high-density PE (hdPE) market is around 35 000 tonne, while the low-density PE (ldPE)/ linear ldPE (lldPE) market is about 15 000 tonne/year. However, a second exporter estimates that annual PE demand is around 70 000 tonne. Estimates of the PP market range from 55 000-90 000 tonne/year with film said to be the largest segment.

A PS exporter to the country says consumption of this polymer is currently around 30 000-35 000 tonne/year. Major end-products are packaging material and hangers for the readymade-garments export sector.

Once again traders are said to dominate the market with many of them indulging in opportunistic buying. 'You are likely to see traders buying as much as 5000 tonne in a month and then disappear for the next couple of months,' says the first exporter.

He also says that there is considerable smuggling across the Indian border, although the other two exporters do not back this claim.

Despite the speculative nature of the market, Bangladesh can be rewarding, especially when material is scarce. At such times, it is possible to obtain a premium as there are few participants, points out the first exporter.

But he cautions that Bangladesh offers a bumpy ride given its many economic problems.

Poverty is rampant in the country with nearly half of its population living below the poverty line despite strong economic performance in the last decade which saw annual GDP growth averaging 5%.

The country is heavily dependent on annual foreign aid of between US$1.2bn and $1.7bn to finance development and imports.

The government is pressing ahead with a wide range of painful economic reforms despite strong protests within the country. The financial market has been liberalised and the peak customs duty brought down to 32.5% from 37.5%. And the government has said that it plans to sell 49 state-owned companies in the financial year ending June 2004 in order to raise Taka5bn (US$88m).

But Bangladesh's biggest problem is that its many favourable foreign investment policies have failed to bring in investors. Foreign direct investment (FDI) is allowed in all except five sectors of strategic interest such as defence. The government is very keen to promote investment in textiles and chemicals such as pesticides, dyes and pigments, pharmaceutical chemicals, soda ash and plastics. Incentives offered by the government include no ceiling on investments, tax holidays and capital, profit and dividend repatriation facilities. Besides this, the country also offers competitive labour costs, low land and energy costs and good access to neighbouring markets such as Myanmar.

Despite the many advantages, Bangladesh is said to have attracted only 0.2-0.5% of its GDP as FDI in the second half of the 1990s. There has been improvement since then with FDI totalling US$287.67m in the first six months of 2003, up from US$168.16 in H1 2002. The country's Board of Investment is confident that the country is on track to achieve its US$1bn FDI goal by 2005.

However, doubts persist especially as weak infrastructure, bureaucratic procedures, widespread corruption, poor law and order and political unrest continue to disillusion foreign investors.

According to one local media report, it takes exporters an average of 12 days to get imported raw materials released from ports or airports. Customs clearance for exports is said to take an average nine days with companies having to spend a considerable amount of time dealing with various government agencies.

Bangladesh's natural-gas reserves, estimated at 20 000-40 000bn cubic feet, have attracted interest from foreign investors. Recently, China's Shenzhen Huaxin Co said it is exploring opportunities to build Bangladesh's first methanol facility. Huaxin is considering forming a joint venture with local firms for the project, which could be brought onstream in five phases, with an eventual capacity of 1m tonne/year. Bangladesh is being considered because gas prices here are lower than in China.

However, many other multinational investors are said to be keener on selling the gas in foreign markets while the government is interested in utilising the gas resources within the country.

Another sector that has emerged as a major money-spinner in the past two decades is readymade garments which is now responsible for nearly 75% of the country's export earnings. But with textile quotas due to be removed from 2005, will Bangladesh be able to keep its market share?

China is widely expected to become the biggest player in a quota-free textile world. But there is hope that Bangladesh, along with other countries in South Asia such as Sri Lanka, Pakistan and India, will enjoy a good share of the market.

However, some industry analysts believe that Bangladesh will have to put in significant efforts to maintain market share. The country's focus should be on improving quality, lowering costs and creating a better image, they say.

Sri Lanka

Turning to Sri Lanka, the country has seen a considerable improvement in its image since the start of peace talks in 2001 with the Liberation Tigers of Tamil Eelam (LTTE). This came after a long civil war that killed around 64 000 people, displaced at least a million and arrested Sri Lanka's economic development. It is estimated that the war lowered annual economic growth by 2-3 percentage points per year.

But significant progress has been made since 2001. In response to various government initiatives, GDP grew by 4% in 2002 after contracting by 1.5% in 2001. Inflationary pressures started to recede and inflation dropped to single-digit levels from 14% in 2001. Sri Lanka also saw the rupee appreciate against the dollar, pound and yen for the first time in 25 years. And tourism, a major contributor to the economy, picked up

However, the current power struggle between president Chandrika Kumaratunga's and prime minister Ranil Wickramasinghe, which came to the forefront in November 2003, threatens to reverse some of the gains achieved in the past few years.

Peace talks with the LTTE have been held up. The country's foreign-exchange reserves have dropped in the past few months while its currency has depreciated against the US dollar. Worries about political instability have forced the International Monetary Fund to withhold an US$80m loan towards a poverty-reduction programme. And the finance minister has admitted that many foreign investors are adopting a wait-and-see policy, which is a matter of concern to the government.

The president recently announced that national elections would take place in April which should, hopefully, result in a resolution to the power crisis. But local businessmen fear that the election is likely to be violent which would impact day-to-day life, tourist arrivals and the stock market.

The sooner the crisis is resolved the faster Sri Lanka can get back to the task of undertaking more structural reforms that would sustain growth in the future.

Hopefully, these reforms will further improve the business environment. International businessmen currently face few barriers to doing business in Sri Lanka as foreign-exchange controls have been removed and tariffs and other taxes have been lowered. However, bureaucratic delays are not uncommon - a complaint often heard in other South Asian countries.

Since the 1980s, Sri Lanka has seen a decline in the share that agriculture contributes to GDP while the service sector has expanded. But it is export-led manufacturing that has been the major driver of economic growth. The key sectors are textiles, clothing, food and beverages which together accounted for over two-thirds of total production in 2002.

Moving to polymers, the current market is estimated at slightly over 100 000 tonne/year. PE demand is estimated at 50 000 tonne/year, PP at 40 000 tonne/year, PVC at 10 000 tonne/year and PS at 10 000 tonne/year.

Trading activity is said to be quite low with most of the imports carried out by end-users.

While the market has seen steady growth of around 5%/year since the peace initiative with the LTTE, it is expected to grow at 8-10%/year in the future.

Nepal

Polymer consumption in Nepal, the last country on the list, is at almost the same level as that of Sri Lanka. The biggest market is for PP (30 000-35 000 tonne/year), followed by hdPE (25 000-30 000 tonne/year).

Annual demand for ldPE is estimated at 4000-6000 tonne, 8000-10 000 tonne for PVC, 6000 tonne for PET and 2000-2500 tonne for PS. The estimates for the size of the lldPE market vary widely, ranging from 10 000 tonne/year to 24 000 tonne/year.

There are said to be about 400-500 processors in the organised sector. The majority are small, although there are a few big players in the PP yarn sector.

Nearly 60-70% of polymers consumed in Nepal comes to India as finished products, says one Indian industry source.

Polymer imports into Nepal attract a basic duty of 15%, a local development tax of 1.5%, a special duty of 1.5% and a value-added tax of 10%. However, basic duty is refunded when the final product is exported although after a long wait. And a 3% duty that is levied on all exports is also refunded if the product moves to India. To take advantage of this duty setup, some Indian processors are running plants in Nepal.

Servicing land-locked Nepal is not an easy task. Exporters (except for those from India) have to ship material to the Indian port of Calcutta which is then transported by road to Nepal.

Given the geography it would be simple to assume that Indian polymer exporters have a major share of the Nepalese market. However, this is not the case because until quite recently, the Nepalese government only permitted polymer trade with India to take place on the not-so-attractive Indian rupee terms.

Indian producers were also not too keen on servicing Nepal as there were concerns over polymers smuggled back to India.

But Indian participation is expected to increase as the Nepalese government decided in early February to permit PE and PP imports from India on dollar terms. Haldia Petrochemicals, Reliance and Indian Petrochemicals Corp Ltd are now expected to be more active in capturing business enquiries from Nepal.

The recent decision by the Nepalese government has come after nearly five years of lobbying by the local industry, points out Shyam Tibrawala of Tibrawala and Sons, a Nepal-based polymer importer. 'I expect importers will now give priority to Indian exporters because of the geographical proximity.'

Tibrawala also believes that the Indian industry should not worry too much about product flowing back into India. 'A market as small as that of Nepal should not disturb India. Also with Indian import duties falling almost every year, the scope for such activities is much less than in the past,' he says.

Tibrawala believes that the Nepalese market has the potential to show a double-digit growth annually especially as investments in the packaging, cement and fertiliser industries are in the pipeline. However, the country's political troubles have raised doubts over whether the potential will be realised.

The government has been engaged in a bitter battle to suppress Maoist rebels since 1996 which has resulted in 8700 deaths.

An hdPE exporter to Nepal points out that consumption in the pipes sector is at a standstill as aid from international agencies has fallen, making it difficult for the government to implement water-distribution projects. The pipes sector, which used to absorb 5000-6000 tonne annually, now consumes only about 1000 tonne/year of hdPE.

Recently, the US government concluded that the ongoing civil war threatened to make Nepal a 'failed state' and a haven for international terrorism. Not surprisingly, the US has therefore stepped up assistance to the Nepalese government in an attempt to crush the Maoist rebels. But critics of US policy point out that the problem is because the people are dissatisfied with the way the country is being run.

Widespread poverty (42% of the country's population are estimated to live below the poverty line) is also at the root of the problem. And the war has only succeeded in damaging the lucrative tourism business and wrecking the country's fragile economy.

King Gyanendra has also been criticised for taking a hard-line approach towards the rebels. Many of the local people are said to be fed up with his arbitrary rule. The king has appointed two prime ministers since assuming executive powers in 2002. But both prime ministers have not succeeded in holding elections which means that the king still has absolute power.

Can they work together?

What lies ahead for all the four countries is not easy to predict. The population figures, the efforts towards economic reforms and the opening of markets suggest that manufacturing and consumption will rise slowly if peace can be achieved. There is also the promise of a South Asian free trade area.

At the 12th Saarc (South Asian Association for Regional Cooperation) summit held at Islamabad, Pakistan, earlier this year, leaders of India, Pakistan, Bangladesh, Sri Lanka, Nepal, the Maldives and Bhutan agreed on the creation of a common market modelled along the lines of the European Union. The Indian prime minister even talked of a South Asian union by 2015 including a common currency.

The leaders also signed a framework agreement for a South Asian Free Trade Area (Safta) which is expected to materialise in early 2006. Safta is expected to result in greater inter-regional trade. Current inter-regional trade among the Saarc countries is estimated at only 4.46% of the total trade of member countries. In comparison, the figure for the EU is 55% and 25% for Asean (Association of Southeast Asian Nations).

With South Asia home to nearly 20% of the world's population there are no doubts that a common market would greatly boost the economic fortunes of these countries. The chemical industry, especially the big players in India, can look forward to easier market access.

However, the FTA proposal appears to be a belated attempt to create a market that will counter the power of the Asean and other trade blocs.

And full regional integration looks impossible as long as the countries remain deeply divided on cultural, religious, political and economic issues. Pakistan and India have moved closer in the last few months, but doubts linger on whether the two can bury an extremely acrimonious past. The smaller countries lag behind considerably on industrialisation and development which means that there is unlikely to be a union of equals.

But to end on a positive note, stranger things have happened. Let us wish them luck.

Pakistan - key indicators (2002)

Population (million)	143.71
GDP at current market prices (million Rs)	3726.6
Agriculture (% of GDP at current prices)	24.2
Industry (% of GDP at current prices)	22.4
Services (% of GDP at current prices)	53.4
Per capita GDP (Rs)	26 231
Production ('000 tonne for fiscal year ending 15 July)
Sugarcane	48 042
Wheat	18 227
Rice	3882
Cotton	1805
Maize	1664
Limestone	9805
Salt	1359
Gypsum	328
Major exports (million Rs; fiscal year ending 30 June)
Food and live animals	58 191
Crude materials excl. fuels	9344
Mineral fuels, etc.	11 771
Chemicals	9359
Major imports (million Rs; fiscal year ending 30 June)
Food and live animals	32 262
Crude materials excluding fuels	52 080
Mineral fuels	17 6233
Chemicals	11 4930
Machines, transport equipment	13 5254
1 US$ = 59.375 Pakistani Rupee
Source: Asian Development Bank

Bangladesh - key indicators (2002)

Population (million)	131.2
GDP at current market prices (Taka bn)	2732.0
Agriculture (% of GDP at current prices)	21.9
Industry (% of GDP at current prices)	25.5
Services (% of GDP at current prices)	52.6
Per capita GDP (Rs)	20 823
Major exports (Million Taka; fiscal year ending 30 June)
Textile and textile articles	218 746
Footwear, headgear	4087
Vegetable products	1686
Plastics and rubber	795
Prepared foodstuffs	745
Mineral products	650
Chemical products	329
Major imports (Million Taka; fiscal year ending 30 June)
Textile and textile articles	97 449
Vegetable products	24 696
Animal or vegetable fats	14 538
Mineral products	40 889
Chemical products	32 640
Plastics and rubber	14 351
1 US$ = 60.078 Bangladeshi Taka
Source: Asian Development Bank

Sri Lanka - key indicators (2002)

Population (million)	19.007
GDP at current market prices (million Rs)	1 584 845
Agriculture (% of GDP at current prices)	20.1
Industry (% of GDP at current prices)	26.3
Services (% of GDP at current prices)	53.6
Per capita GDP (Rs)	83 382
Major exports (million Rs)
Beverage and tobacco	75 400
Food and live animals	16 979
Chemicals	3012
Mineral fuels	1366
Major imports (million Rs)
Machines, transport equipment	105 944
Mineral fuels, etc.	80 037
Food and live animals	62 286
Chemicals	28 518
Beverage and tobacco	9367
Crude materials excl. fuels	8034
1 US$ = 96.415 Sri Lankan Rupee
Source: Asian Development Bank

Nepal - key indicators (2002)

Population (million)	23.67
GDP at current market prices (Rs million)	420 263
Agriculture (% of GDP at current prices)	40.6
Industry (% of GDP at current prices)	21.8
Services (% of GDP at current prices)	40.8
Per capita GDP (Rs)	17 755
Major exports (million Rs; fiscal year ending 15 July)
Carpets	6210
Garments	7825
Pulses	1215
Jute goods	1630
Major imports (million Rs; fiscal year ending 15 July)
Food and live animals	7054
Crude materials excl.fuels	6891
Mineral fuels etc.	15 231
Animal, vegetable oil and fats	7888
Chemicals	12 505
1 US$ = 79.865 Nepali Rupee
Source: Asian Development Bank

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