CONSTRUCTION INDUSTRY

A key sector suffering from funding constraints and irregularities

By M. K.AREOLA
Oct 27- Nov 02, 1997

Construction sector, the world over, is considered to be a basic industry on which the development of the country depends to a great extent, the growth of a country and its development status, is generally determined by the quality of its construction companies and their capability.

It is treated as an important sector, not only in the developing countries but the developed ones which have separate ministries that look after the housing problems of the people. Turkey, South Korea and Malaysia are but some of the countries where the support of the government has helped the sector grow and in return the sector has build a strong country.

Many governments created separate departments within the housing ministries which generate soft loans for the people. By doing so, not only is the government generating business but also providing shelter for the shelterless.

It has been, and still is a practice of some governments in the developed world to provide loans for other countries on the condition that the project is given to its construction industry, thereby providing business for their local construction sectors.

But unfortunately, in Pakistan there is no ministry or department that caters to the construction industry and the Housing Ministry is only there in name as it has failed to provide shelter for the populace.

During the days when the Steel Mill was being built, most of the Gulf states were being developed at the same time. This brought the birth of many construction companies in the country. The sector provided good revenue for the economy in those days in terms of foreign exchange.

But as soon as the Mid-East boom ended and the Steel Mill project was completed, the state of affairs in the industry became chaos, forcing some of the smaller players to close down business in search of greener pastures.

According to analysts, today, the industry is in total chaos, and to construct projects as roads, bridges, canals, power houses or drains, foreign construction companies were usually invited which resulted in higher cost and further deterioration in the standards of the local companies.

According to sources close to the industry, though the sector was declared as an industry since 1992, however the source claimed that no SRO is issued in this regard to date and the sector continued to suffer due to the indifference of the government agencies and one sided conditions of contract and lack of support from the financial institutions in terms of guarantees and bonds.

CRISIS

Devaluation is one of the major problems facing the industry. Depreciation of the local currency and the cost escalation eroded away the capital itself and therefore the industry could not cope with the funding of projects.

A typical capital of Rs 44 million which was worth $5.5 million about 10 years ago, is worth only one million dollars today. And a project that once cost Rs 35 million will not cost less that Rs 200 million in today's rupee value.

According to sources in the industry, except for the housing sector, contractors don't generally make provision for massive devaluation such as the ones the country has witnessed for the past 21 months or so.

During the last fiscal year alone, the currency was devalued more than twice which totaled about 12% while during this year alone there have been more than five devaluations which totaled 11%. This, in many cases, creates a tussle between the constructors and the owners of the projects because while the constructors demand more money the latter usually wriggle out of it on one pretext or the other.

Fiscal policies impose further burden, on the weak sector in the form of registration fees, professional tax, withholding tax and other taxes.

Some of the contractors are now complaining of the preference given to foreign contractors in cases of huge projects, on the pretext of their possessing more and latest construction machinery "when the actual case is that we could not bring these machineries into the country in view of the present condition", one of the contractors said. For example huge projects such as Mangla Dam and Tarbela Dam were constructed by foreign firms.

While talking to Engineering Review some time ago, Engineer Ikramul Haq Siddiq, chairman of Muslim Constructors, mentioned problems such as tax laws, labour laws, registration laws, bonding, estimating and tendering, funding, dispute settlement and lack of benefits as partly responsible for forcing the industry to its knees.

The income tax calculations are based on the assumption that all constructors always make profit of upto 20% or more, without considering whether such project is executed on no profit basis. And this is contrary to the government-contractor agreement in the 70s, which allowed a certain amount to be treated as ex-gratia payments, in case a project is a non- profit venture, in which case these ex-gratia payments are being treated as taxable by the Income Tax Department.

Bonds, such as bid bonds, performance bonds, mobilisation advance bonds and maintenance bonds, have been introduced in the industry, which results in the fact that smaller or medium-sized contractors cannot come forward to compete for a project, giving foreign companies more and more chances.

Bid bonds are usually required as a guarantee that the bidder shall honour the tender in case it is awarded and the amount is usually two percent of the tendered price.

Performance bond on the other hand, ranges between five percent to 10% of the contract value while the prevailing conditions require 100% cash margin or partial cash margin with 200% coverage of the balance with property as collaterals.

According to sources in the industry, the usual practice in other countries is that the organisations providing such bonds, which are banks in most cases, consider the past performance of the company through a system of annual review.

A good company can get the bond on the basis of no margin while others on token margins of between five per cent to 10%. Therefore, the absence of such facilities for Pakistani companies puts them at a disadvantage even within the country while bidding for large projects.

Same is the case with mobilisation bond, which also requires a 100% cash margin or a combination of cash plus 200% of balance amount by way of property as collateral. And the maintenance bond is again governed by the same requirements for margin collateral as other bonds.

According to some analysts in the construction industry, contractors are usually referred to by the banks as "bad clients". Therefore, they are barred from utilising the facility of short-term funding which is required to take care of temporary negative cash flow on a project.

Another important set-back of the industry is the lack of a standardised method of estimating costs. Different bases of rate analysis are being adopted in different departments. For example, the Military Engineering Services, the Public Works Department and Wapda follow different systems of calculating rates and the basis of rate analysis. Construction companies, too, adopt different methods, which results in large variations and creating more risks.

Despite repeated advise of the Pakistan Engineering Council to the development agencies and government bodies to rationalise the conditions of contract which were said to be 'client oriented' the government, it is said did not pay any attention to these requests advices.

And according to sources in the industry, this indifference results in lack of progress on the industry which has even forced some of the construction houses to close down and "those that are surviving cannot compete with the foreign companies", another source said.

Another problem facing the industry is the lack of management skills, according to M. Aslam Mirza of Project Engineering company, the industry is often run in most haphazard manner while the peculiar nature of the industry and the problems confronted, demand the application of the advanced management techniques in fulfillment of the commitments.

The poor performance of the industry have kept it low in the eyes of the government and business houses. There are only four construction companies listed on the Karachi stock market and right now three of them are trading on the defaulters counter. The four companies are Haydari Construction Company, Gammon Pakistan, MLC and Pak German Prefabs. Of these only Gammon Pakistan is still trading on the ready board while the others for one transgression or another are trading on the defaulters counter.

The companies have a very poor record of dividend payouts also. None of these four companies have paid any dividend for the past few years which alone is enough to get them all on the defaulter counter. If nothing at all this suggests the attitude of these companies towards their shareholders so one can imagine what their attitudes towards their customers would be like. The three listed on the defaulters counter have not paid any dividend for the past few years.

The share prices of all these companies has also on average fallen to about 50% or less of their face value while MLC is trading at just 80 paisas for a Rs 10 share. The profitability situation of these companies shows a mixed trend with Gammon Pakistan being the only company to have recorded a profit in 1997.

SOLUTION

The Income Tax Department should allow the industry to offset annual profits against the losses incurred prior to imposing income tax on them.

The cash deposit of earnest money should be dispensed with and bid bonds should be provided without margin and with prior arrangement of providing performance bonds.

While performance bonds on the other hand should be provided in view of the track record of the company and only on the basis of normal margin and the advance bonds should be made available on the basis of assets of the establishment in the shape of plant, equipment and other items .

Dispute settlement is one of the principal causes of the downfall of the construction industry in the country due to the unending arbitration, and in some cases the companies close down before the final decision is arrived at. For this purpose, better facilities should be made available for expeditious settlements.

Modalities should be provided to have data on prices and quantifying the rate of escalation on periodical basis for tendering and settling of price escalation claims.

Traditional companies with good track record should be allowed to participate in bidding and the project awarded to them if they qualify. In order to do this, there is every need to change the rules which presently practically disqualify the domestic companies from participating in the bidding.

As far as the management of the industry is concerned, there is every need to involve professionals to handle the construction commitments, the experienced professionals would in this case bring the results with efficient control on cost, time and quality of a project.

Mostly the misconception for higher cost of the professional services restrain the investors in the industry to involve the professionals, but the sort of professional services is always self financed by the savings in efficient controls on construction cost, quality and wastages.

Realising the importance of the industry, a committee was constituted by the federal government in the beginning of this year with the objectives of finding solutions to the problems being faced by the industry under the chairmanship of the representatives of Association of Builders and Developers (ABAD) and the results of their findings was said to have been submitted before the middle of this year.

According to sources from ABAD's office, the committee's recommendations include the immediate issuance of the pending SRO declaring the sector as an industry as was notified by the Ministry of Industries in July 1992.

It is further recommended that import of heavy construction equipment, not manufactured in the country and needed for the introduction of new construction technologies in the country should be completely exempted from import duties, sales tax and other charges.

For the periodical replacement of old and obsolete plants with cost efficient machinery, the committee recommended that incentive relief in duty and tax credit which is available to other industries in the form of Balancing, Modernisation and Replacement (BMR) should be made available to the industry as well.

Some analysts, while talking to PAGE, differ on this, they said since construction industry is a service one and not a manufacturing industry it is not applicable in the same sense.

It is recommended that the construction companies should not be made responsible for collecting the Withholding Tax from the vendors engaged in the supply of goods, labour, services and materials.

According to the committee, the main difficulty in financing is the collateral because the machinery owned by the construction companies is mobile and therefore not considered good security, it is therefore recommended that loans and guarantees should be extended to the larger companies on the basis of plant and machinery provided it is insured.

This recommendation was earlier made by Secretary General (Finance) Saeed Ahmed in his report on the construction industry prepared in 1992 under the instructions of the then prime minister to help improve the performance of the construction industry.

According to the recommendations, a number of projects handled in the last three years by the foreign constructors could have been easily undertaken by the Pakistani companies, this could have helped develop expertise beside saving substantial foreign exchange.

It is recommended that the levies and contributions such as education, Cess, EOBI, Social Security, Professional Tax, Labour Tax which presently come under various departments should be simplified and lumped into one as under the present system the state is not getting much revenue as compared to the potential because the collecting authorities indulge in corruption which therefore defeat the very purpose of such levies.

HOUSING

Since the construction is inter-related with housing, it will be incomplete to conclude the problems going on in the construction industry without making mention of the housing as well.

The lack of adequate housing is one of the most pressing problems facing humanity at present. The United Nations Centre for Human Settlements estimated in 1995 that over a billion people worldwide live in inadequate housing and that the world's homeless population totals over 100 million.

Over the years, various governments and international commissions have recognised the problems and the World Health Organisation has stressed that housing is the single most important environmental factor associated with disease conditions and life expectancy.

Global government expenditures for housing are remarkably low as compared to other areas. The United Nations Development Programme estimates in 1990 that government expenditure for housing was only 3.32 percent of overall public funds available.

The need for adequate housing is however, described in various international human rights instruments, including the Universal Declaration of Human Rights (article 25), the International Covenant on Economic, Social and Cultural Rights (article11), the International Convention on the Elimination of All Forms of Discrimination against Women (article 14) and the Convention on the Rights of the Child (article 27) .

THE RIGHT

The Universal Declaration of Human Rights, adopted in 1948 clearly states in its article 25.1 "Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care......"

And the International Covenant on Economic, Social and Cultural Rights in its article 11.1 says "The states parties to the present Covenant recognise the right of everyone to an adequate standard of living for himself and his family, including adequate food, clothing and housing and to the continuous improvement of living conditions...."

Though there are various other international documents that indicate rights to housing, legal experts however said that these rights, at the most basic level do not imply that the State is required to build housing for the entire population or that housing is to be provided free of charge to all.

And The Centre for Housing Rights and Evictions (COHRE) emphasises that housing rights have more to do with political will than logistics of actually providing housing to people.

It is noted that while the physical structure of a house, including the infrastructure and surrounding facilities, and security of tenure are important issues, they are largely dependent on whether land is affordable, available and accessible, whether cheap building materials are available and whether people have a right to choose where they want to live - all of which, in turn depend on whether governments make these conditions possible.

PROBLEM

In 1972, one of the major political parties running for candidacy to the national assembly came up with a slogan 'Roti, Kapra ,Makan' , (meaning bread, cloth, shelter) not only did the party won tremendously, but command an absolute majority in the national assembly as well.

In Pakistan, the problem is generated mainly by the very rapid population increase which grew from 84 million in 1981 to over 125 million in 1996.

Though the slogan 'Roti, Kapra, Makan' created the awareness of housing problem in the country as far back as 1972, however, no any government agency attended to this problem until 1987 when the National Housing Authority (NHA) was created.

According to the 8th Five Year Plan, there is a shortage of 6.25 million housing units in the country and this shortage is increasing at the rate of 150,000 housing units every year which will increase to over 10 million units during the next 20 years.

According to the Plan, in order to overcome this problem at least 500,000 housing units would have to be built every year.

While on the other hand, the National Housing Policy though put the housing deficit at 6.25 millions, clearly put the current annual requirement as 580,000 housing units, based on the incremental population increase at the rate of six persons per housing unit.

It is said that the unchecked growth of slums, katchi abadis and encroachments are the direct outcome of these pressure. And according to one estimate, 50% of the urban population will be living in squatter settlements and slums by the year 2000.

URBAN PROBLEM

Karachi, considered to be one of the world's megacities shot up from 0.25 million population when the country got independence from the British and broke away from India in 1947 to over 12.25 million population it is today, with annual rate of increase of 6%.

This rapid growth, considered to be one of the highest in the world, with lack of proper law has made housing and construction the most thriving business for the players in the country.

One of the problems facing the cities is said to stem from the fact that the development authorities of these cities are constantly facing an acute financial problems therefore unable to tend to the problems.

When a development authority draws up a plan for the development of a housing scheme, it prepares a project which on the cost side includes expenditure on the acquisition of land, development of roads, water supply, sewerage, bulk power supply and street lighting as well as the expenditure on the establishment.

These costs are then distributed over the various kinds and sizes of plots developed in the scheme and a system of disposal of these schemes are then outlined.

The feasibility is worked out on the basis that most of the developed plots would be auctioned in the open market while only a limited percentage is set aside for allotment at fixed prices by drawing lots.

Not only is such system designed to ensure that the cost of the development of the scheme would be recovered but also surpluses are expected to be generated to meet non-developmental expenditure of the authority.

But what actually happen in case of authorities like Karachi Development Authority (KDA) is that most of these plots are usually given out in 'throw away' prices under pressures from successive political powers. Throw away prices technically refers to the prices as stipulated in various laws which were formulated in the 40s and still in force, for example under the Sindh Land Tribune Act, some of the areas which falls under KDA jurisdiction in the city today could not be sold higher than 24 Annas per square yard (one Anna is equal to Rs 1.5) while on the other hand the present market value of these areas is above Rs 750 per square yard.

So what most of the allottees do is to sell these plots at the open market rates and share the booty with those who matter, an amount which should have gone to the development authority for further developing the city.

And in some cases, some of these plots are allotted as political payoffs by obliging politicians or people who have either rendered service or have the potential of doing so.

This phenomenon does not end with the Karachi Development Authority alone, same trend is witnessed at all the major city developing agencies throughout the country such as the Capital Development Authority in Islamabad, Lahore Development Authority, Multan Development Authority, Faisalabad Development Authority, Peshawar Development Authority, Rawalpindi Development Authority, Quetta Development Authority as well as Hyderabad Development Authority

The existing building regulations of Karachi Building Control Authority, for example, were framed in 1963 and re-drafted in 1979 with minor changes, values of plots on the other hand have gone up more than 300 times since then and the cost of building materials and labour charges have witnessed a tremendous change, the only logical reason why the old laws are still retained is simply because of the land prices stipulated in the laws which has become a source of income between the policy makers and the land grabbers.

FINANCE

While it is said that industrial growth took place in the country with the help of financial support, the housing industry like its sister industry - the construction , developed entirely on its own resources.

While banks and other financial institutions were not allowed by the government to go into house finance, House Building Finance Corporation, a DFI, is the only one and institution in the country that is devoted wholly into providing financial assistance to housing activities on an individual cases though in most cases through the builders who initiated a housing project and invites an individual to buy.

The project was smooth sailing until the corporation run out of funds due to massive default from the clients, but in order to recover the bad loans the government has no choice but to keep it functioning, though all sort of funding has been suspended for the last two years.

As home, ownership is the most important objective for social and economic stability the flow of housing finance makes up a significant share of the entire financial system in the developed countries which on the other hand is on the lower side.

In the United Kingdom, the household sector's holding in financial assets in Building Societies was said to be around 32.1% of the total saving in 1989 as compared to 20.5% of that of the commercial banks. And in the United States the outstanding debt for residential accommodation was $2.2 trillion.

The level of mortgage debt as a percentage of GDP in the United Kingdom was 58.3% as compared to 45.2% in the United States and 25.1% in Japan. In other words, in developed economies institutions dealing with housing finance hold a high proportion of household savings.

Another major problem stemming out of finance problem in the housing sector is the fact that almost everyone is his own architect, designer and builder in the country with the result that only the wealthy segment which is less than 0.1 percent of the population are able to build their own houses or build them for rent which results in an unplanned urban development.

Alternate investment opportunities is said to be another important factor that hinders the development of housing finance in the country. Existing financial institutions have alternate options for advancing credit that reduce the attraction for housing loans.

In a market starved for funds the banks are not under any pressure to venture into activities other than those they have done traditionally.

During the month of November 1995, one of the representatives of the Government of Pakistan to the UN Conference for Human Settlements (Habitat-II) stated that Pakistan firmly stood committed to attain the objective of the Global Strategy for Shelter aimed at providing adequate shelter for all by the year 2000.

According to the paper, the Government has taken a number of steps to enable different sectors to play a role to achieve that objective. It will be important to note that while one of the steps taken include 'to assist low-income segments of the society to obtain housing for which a revolving fund is set up to initiate inexpensive housing projects', HBFC the only DFI in the housing sector was made redundant few months earlier and has not been able to fund any housing project to date.

Another step taken according to the paper was "Formulation of national as well as provincial urbanisation policies to provide a coherent, long-term framework for the development of new towns. Contrary to this statement, the Islamabad New City, a low-cost housing scheme that was launched near the federal capital two years ago as a joint venture with a foreign company is said to have run into an administrative snag .

Dubbed as a low-cost scheme, sources close to the deal claimed that the land were purchased from the original owners at 'throw away' prices and then sold to the developers three years after the scheme was floated, whatever the truth of the case, the fact remained that the National Housing Authority and the Capital Development Authority, the two authorities that were behind the project did not, in any of their successive advertisements mentioned or do anything that could have encourage any lower income groups to come forward for the scheme.

SOLUTION

Though formulating and announcing National Policy on housing is viewed as a good sign as far as policy matter is concerned but much is still desired to be seen as implementation is concern.

According to a report on the housing industry prepared and submitted to the government recently by Engineer Abdul Karim Tai ex-Chairman of Association of Builders and Developers (ABAD), the fiscal measures taken in the recent past by the Government have not reflect the fact the industry has been declared as highest priority.

According to the report, funds are not allocated for infrastructure as required while construction materials, though locally available are heavily taxed.

Conversion charges are collected from the plot owners for commercialisation, which are solely meant to reinforce existing infrastructure are normally spent on non-development expenses.

Property tax, betterment tax, motor vehicle tax, conversion charges and additional floor charges are directly or indirectly collected by the provincial government, whereas the maintenance of infrastructure facilities and distribution of services such as roads, water supply, sewerage and solid waste disposal system is responsibility of the local government.

In order to solve the ever growing housing problems of Karachi development of new satellite towns and industrial areas along with required infrastructure in the city's vicinity would be an idea.

And as major component of housing is cost of land and its development, low cost housing will not be possible without really having a low cost land with initial bare minimum infrastructure facilities. These low cost lands, however should be given out through maximum transparency without the influence of the land mafias.

Home ownership in major urban areas is around 25% and purchase of home in such location is becoming practically un-affordable due to increase in prices of land and building materials.

The mortgage financing can therefore play a pivotal role in helping home ownership while at the same time in order to encourage this, the long-awaited foreclosure law should be enacted which will enable the house finance companies to repossess the property finances by them in the event of default without going through the present cumbersome, time consuming and complicated procedure which makes most of the other financial institutions shied away from house financing.

According to some analysts who have carried out some studies of the sector, the small and medium-sized construction companies will soon go out of business unless certain corrective measures are taken.

Even birds want to have a nest, a home is a place where the man's heart lies, and as the major portion of real estate is home, majority of the populace, especially in the cities will become homeless, after having sold out whatever they have in the rural areas and moved to city in search of better home which according to Saghiruddin, a migrant from interior Punjab in the 60s and is still living in a rented house in Gulshan-e-Iqbal, "has become a nightmare, because there is neither future to hope for nor is the past possible to go back to".