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Will The Construction Industry Revive Pakistan's Economy?

The stakeholders give their view.
Updated 12 Oct, 2020 02:03pm

When Aurora covered the FMCG sector in the July-August 2019 edition, Pakistan was experiencing an economic downturn and the outlook for the forthcoming fiscal year was not promising. At the time, industry experts attributed the downturn to several factors, including an increase in international commodity and oil prices, import duties and the rupee’s devaluation against the dollar.

Fast forward to over a year later, and according to the Pakistan Economic Survey 2019-20, (released in June 2020), the GDP growth rate in FY 2019-20 stood at 1.91%, decreasing by 3.6% compared to the 5.5% growth rate for FY 2018-19 (considered low at the time). Furthermore, core inflation in urban and rural areas amounted to 7.8% and 8.7% respectively from July 2019 to April 2020, registering an increase of 0.6 and 1.9% (they stood at 7.2% and 6.8% during the same period in the previous year) and overall inflation increased by 2.1% – from 4.7% to 6.8%. The unemployment rate, meanwhile, increased by 2.8% – from 5.8% to 8.6%.

Part of the reason for this decrease is the fact that Pakistan’s economy (as was the case for most countries), experienced a major hit from March to June 2020 due to Covid-19, which led to lockdowns across Pakistan (and the world). The result is that the global economy is heading for a recession and global GDP is expected to contract by 3.8% – a substantially larger amount compared to the 0.4% contraction witnessed after the 2009 global financial crisis. More specifically in Pakistan, Dr Abdul Hafeez Shaikh, the Prime Minister’s advisor on Finance, estimates that the pandemic has resulted in an economic loss of approximately three trillion rupees.

The estimated growth rate for Pakistan’s GDP in FY 2020-2021 is -0.38% (the first time in nearly 70 years to hit negative numbers). This has been calculated keeping in mind that although the agriculture sector registered a growth rate of 2.67% in FY 2019-20, the industrial and services sectors (two other major contributors to the overall economy) registered growths of -2.64% and -0.59%. (Agriculture, industry, and services sectors were expected to register growth of 3.5%, 2.3% and 4.8% respectively and did not meet these expectations.)

The Government Launches a Package for the Construction Industry

To counter the dwindling economy, the government announced a Rs 100 billion relief package for the construction industry in April 2020. In many countries, the construction sector is considered the backbone of their economies and this is also true for Pakistan.

According to Hadi Akberali, COO Strategy, Amreli Steels (see his interview), “the construction industry is a major employer and comes with a lot of allied industries. It is a tried and tested way the world over for construction to kick-start an economy.” He cites Brazil, China and India as countries that improved their economies by means of increased construction activity.

Although formally, on average, the construction sector has contributed between 2.3% and 2.85% in the last five fiscal years to Pakistan’s GDP (it was valued at Rs 316 billion in the Pakistan Economic Survey 2019-20), most economists estimate its value to stand between 10 and 12% of the total GDP. This is because it provides stimulus to over 42 ancillary sectors including aluminium, brick, cables, cement, fixtures, glass, kitchen and bathroom fittings, marble, paint, steel, tiles, transportation, warehousing and wood. Therefore, it has a far-reaching impact on the overall economy as it employs eight percent of the total labour force.

What’s in a Package?

The package’s objectives are two-fold. The first is to bridge the affordable housing gap through the Naya Pakistan Housing Program (NPHP) which was initiated in April 2019 with the goal of building five million houses in five years (see Incentivising Affordability) and second to jumpstart the economy by creating employment. To ensure these goals are met, the government set up the National Committee on Housing Construction and Development (NCHCD) in July. The Committee’s objectives include monitoring the construction sector and ensuring that any hurdles that arise are overcome to ensure that construction activities continue to increase rapidly.

Broadly speaking, the construction package includes tax incentives, waivers and subsidies for builders, developers and property owners (see Major Incentives in the Package below). To take advantage of the incentives, builders and developers have to register their projects on the Federal Board of Revenue’s (FBR) dedicated portal, Iris, by December 31, 2020 and complete ‘grey structures’ (basic structures without interior finishings) by September 30, 2022. In addition, a Construction Industry Development Board (CIDB) will be set up to “promote, encourage, facilitate the private construction industry and encourage investment.” (A Real Estate Regularity Authority [RERA] will be formed to regulate the sector with regard to property transactions among other functions.)

Incentivising Growth

According to the industry stakeholders Aurora spoke to, one of the most effective incentives is the one that does not require people to declare their sources of income before investing in construction related projects. “This is a key factor that will attract investment; if a buyer is interested in buying a property, all he has to do is put his money in a bank and make the payment,” explains Shafi Jakvani, CEO, Citi Associates.

This is a view that Mohsin Sheikhani, Chairman, Association of Builders and Developers Pakistan (ABAD) and Hamza Bhatti, General Manager, Pakland Builders, agree on as does Mohammed Adil Sami, Head of Marketing, Meezan Bank.

“The ‘no questions asked’ policy will encourage builders to invest their undocumented wealth in property and construction. This initiative, apart from providing legal cover for such individuals, will encourage people to invest in property. It will also encourage the expat community, who will be spared the cumbersome paperwork required to buy or build a home,” says Sami. He adds that the tax exemptions will lift investments in property and impact the construction sector and its allied industries in a positive manner.

In Jakvani’s opinion, the fact that there will be a 90% tax reduction for builders who invest in NPHP will also give a boost to the economy. “Even in the first stage, if 500,000 units are built, they will require labour, building materials so all related sectors will benefit. That is one area where I see a positive outcome to emerge.”

Sheikhani adds that the fact that taxes will be computed based on the property’s covered area (instead of the value) will be a major incentive for mid- and low-tier builders and developers as it will result in substantial savings. He is of the opinion that the fact that builders and developers will not be required to withhold tax on building materials, other than steel and cement, will prove to be beneficial as well. Bhatti adds that if taxes are waived on cement and steel, the construction sector would benefit even further. Muhammad Irfan Anwar Sheikh, Director Finance & CFO, Bestway Cement, agrees. “An important step that could lead to increased cement sales is to reduce the Federal Excise Duty (FED). Pakistan’s development is dependent on products such as cement and it should not be subject to FED.”

Sheikhani is confident that the incentives will bear fruit shortly, especially as all transactions will be digitised through Iris and approvals from various government entities (such as building authorities and utility companies among others) will now be, as per the government’s directives, ‘one window operations’ and be completed online within 45 days. Furthermore, building bylaws will be updated in a uniform manner across the country through this system. This, he says, will reduce the number of illegal buildings as all projects have to be registered with Iris. He adds that prior to this, builders and developers used to show reduced profits in order to pay lower taxes and “this will bring much needed transparency to a sector that has been unregulated thus far.”

A Bumpy Road Ahead?

Not everyone shares Sheikhani’s optimism. A former ABAD chairman and developer, who spoke on the condition of anonymity feels otherwise. “Obtaining certifications and approvals from local authorities will prove to be a herculean task. Furthermore, the deadlines for registering projects (December 31, 2020) and for completing grey structures (September 30, 2022) are impractical, given the fact that approvals from various authorities take a long time to come through.” He adds that procuring the services of reliable contractors and workers, not to mention securing financing, will make it extremely difficult to meet the mandated deadlines.

Naeemuddin A. Siddiqui, Former Chairman, Constructors Association of Pakistan (CAP) and CEO, Ziauddin Ahmed & Company, has his own reservations. Although he believes they are a step in the right direction, he points out that formalising the industry was tried by the Nawaz Sharif government in the nineties but never materialised. “Even today, despite the talk about formalising the industry, we have yet to receive any notifications regarding this and what it will mean for the industry.” In his opinion, the major issue is that the majority of construction activities are not carried out by certified or professional companies and that regulating the industry to ensure that only licensed professionals should be allowed to work on registered projects should be a priority for the government.

Another issue is securing financing. Although there is talk about lower interest rates, no concrete steps have been taken in this direction. “Because the sector is not regulated, we are unable to receive financing and guarantees from banks. As a result, we are unable to meet our project deadlines, which further cuts into our margins. Furthermore, no specific incentives have been announced for contractors, and they should have been brought on board prior to announcing the package and related incentives,” says Siddiqui. “We requested that the government establish a dedicated financial institution (like in other countries) that mandates the provision of financing to the industry through lending techniques that are different from those that regular commercial banks offer.”

He adds that when builders and contractors go to a bank to secure a loan, they are asked to provide collateral or liquid assets that they do not have as the requirements are too high. “If we had that kind of money, we would not need a loan the first place. The right model would be to issue a guarantee based on the project’s receivables. That is why we have requested that the government establish a Construction Infrastructure Development Bank, a common practice in many other countries.” He says that in other countries, such banks also serve as an intermediary body between developers and the people who buy property. The bank safeguards the interests of both parties and ensures that developers complete their projects in the stipulated time, secure the services of licensed builders and contractors and do not increase property prices randomly. Similarly, to safeguard the developer, such banks ensure that the buyers pay their instalments on time.

Promoting Low-Cost Housing

As far as financing is concerned, the main incentive at the banking end of the spectrum is aimed at people who own five and 10-marla plots (see Building Dreams on Solid Foundations), who can now take advantage of reduced and/or competitive interest rates to build houses on these plots.

According to Muhammad Afaq Khan, Head of Islamic Banking, HBL, “a steering committee has been set up under the chairmanship of the Governor of the State Bank of Pakistan (SBP) and the Chairman of the Naya Pakistan Housing & Development Authority (NAPHDA). The presidents of six banks, including HBL, are members of this committee.” As a result, several banks including Bank of Punjab, HBL, Meezan Bank and UBL, are promoting home financing options such as the ‘Mera Pakistan Mera Ghar’ initiative. Although it is too early to comment on the response to the initiative, Khan says “HBL will offer mortgages, including for low cost housing, through our Islamic Banking. We are gearing up to scale up the business and are committed to ‘Mera Pakistan Mera Ghar’.

Cautious Optimism

Given that the construction package was only announced five months ago, the full response remains to be seen. As of August 14, according to DAWN, 40 projects have been registered and 4,812 are drafted for registration. The Minister for Information and Broadcasting, Senator Shibli Faraz, expects that projects worth Rs 400 billion will be registered by the end of 2020. Furthermore, ABAD has pledged to invest Rs 1,370 billion in various construction projects, including residential ones specifically for the NPHP, in addition to 30 to 40 high-rise buildings in Karachi and at least 1,000 more projects across the country.

According to Fahd K. Chinoy, CEO, Pakistan Cables, the incentives have induced a “somewhat positive sentiment in the market.” He says indicators such as rising cement and steel sales have given rise to “cautious optimism that the construction package will bring about a boost in downstream demand for building materials, including wires and cables.” He points out that “housing societies such as DHA are showing signs of activity as they roll out development plans for new phases in Bahawalpur, Lahore, Multan and Peshawar. However, several projects are at very early stages and it will be some months before they reach the level of maturity where orders for cables are placed.”

A representative of a private cement company confirms that demand for cement has started growing, especially in northern and southern Pakistan and the All Pakistan Cement Manufacturers Association recently announced that the consumption of cement has increased by five percent and amounted to 3.5 million tons in August.

Sami too is cautiously optimistic. “SBP has played an immense role in aggressively cutting interest rates and stimulating the economy and signalling intent to make low-income housing finance easier. Furthermore, the government has encouraged banks to allocate five percent of their portfolio to the construction segment.”

In Jakvani’s view “these incentives will be of most benefit for mid-tier and small developers and builders. That said, the incentives will also affect the real estate sector in a positive way and given that property prices have started to rise, I foresee almost 100% growth in property transactions within six months.”

Given all the above, it is too soon to judge whether or not the construction sector will be able to revive Pakistan’s economy. Nevertheless, if the December 31, 2020 deadline for registering projects is extended and if the formation of RERA, CIDB and ‘one window’ operations for approvals are expedited, the chances are fairly good that the impact on the economy will be positive.

Major Incentives in the Package

  • Investors, developers and builders will not be questioned about their sources of income.

  • Taxes will be computed according to the size of the property (per square foot or per square yard) instead of the price of the property (the case previously) and as a result will be substantially lower.

  • Builders and developers will not be required to withhold tax when purchasing building materials (except steel and cement) and on certain services (such as plumbing).

  • If builders and developers take on a project related to low-cost housing under the Naya Pakistan Housing Program, taxes will be reduced by 90%.

  • Sales tax and excise duties levied on construction materials will be reduced.

  • Owners of five- and 10-marla residential plots will receive subsidised house building loans.

  • People constructing, buying or selling their first houses are exempted from several taxes and fees, including Advance Tax, Capital Gains Tax, Stamp Duty Tax and Registration Fees.

Additional reporting by Uzma Khateeb-Nawaz.