KARACHI: The sharp rise in agricultural commodity prices over the last decade offers has begun to attract new players to the Pakistani agro-industry sector, increasing competition and boosting efficiency.
The entry of companies like Engro Foods, Nestle and Haleeb has already had a transformative effect on the dairy industry, inducing a rapid transformation from a dispersed, low-margin sector to one that now has higher margins and integrated supply chains running through the length and breadth of the country. Now it appears that both the government and the private sector are looking to team up and target other agricultural sub-sectors for a similar transformation. This increased competition is likely to have a significant impact on the contours of the economy over the next decade.
Agriculture is Pakistan’s largest employer, accounting for almost 45% of the workforce, according to the ministry of finance’s Economic Survey of Pakistan. But, despite considerable government attention and energy expended on trying to extract more economic utility out of the sector, agriculture has remained one of the most inefficient segments of the economy over the past several decades. However, a substantial increase in efficiency and productivity in this sector it is also likely to have the most far-reaching impact on income and poverty levels in the country.
Several economists have identified the development of agriculture as the sector that is most likely to contribute to a more inclusive growth model in Pakistan, with a very large segment of the population benefiting from higher revenues, more investment and greater competition and efficiencies. There are, however, several challenges, most notably the lack of a reliable supply of electricity, poor road conditions outside major cities (and sometimes even within them) and a relative dearth of agricultural finance.
Nevertheless, the provincial governments of both Sindh and Punjab have focused their attentions towards promoting agriculture as a means of fostering economic growth. Both the Sindh and Punjab investment boards have devoted significant resources towards completing feasibility studies and identifying opportunities in agriculture, all of which are available on their respective websites. Investment conferences held by both provincial governments have attracted several interested investors, both locally and from abroad.
The logistical challenge: cold chains and storage
One of the central challenges identified by both governments is the fact that Pakistan does not yet have either the storage capacity or the kind of large supply chains necessary to maximise the revenues from bringing the farm product to the market.
The dairy sector is a primary example of this where, according to estimates by the Sindh Board of Investment, only about 30% of the total milk produced in Pakistan is marketed and only 3.5% is packaged. Up to 40% of the country’s milk production – which at 35 million tonnes is the fourth largest in the world – is wasted simply because there are very few chillers available that can store the milk properly.
Engro Foods CEO, Sarfaraz A Rahman, estimates that the country will face a shortage of approximately 4 million tonnes of milk by the year 2012 unless there is a rapid build-up in cold chain capacity.
The shortage of storage capacity extends to many other commodities, including wheat. According to the Food & Agriculture Organisation of the United Nations, Pakistan has the sixth largest crop of wheat in the world. Yet every year the country is unable to store the surplus production and is forced to export it at the time when prices are low, only to be faced with a shortage later in the year and having to import when global prices are higher.
This year’s crop of tomatoes faced a similar dilemma, when prices collapsed just around harvest time, making it unfeasible to sell. Without adequate cold storage facilities, many farmers simply left their crop to rot in the field because they could not store it until prices rose again. There are also very few manufacturers of tomato-based processed foods who would be willing to buy up the growers’ excess capacity.
There is also the distributional challenge. As the sixth largest population in the world, Pakistan has a large enough local market without sellers having to think about exporting. But most Pakistanis buy their groceries from small, local shops rather than national supermarket chains which are a much more recent phenomenon. This makes distributing finished products a far more cumbersome process than in the primary export markets of the GCC.
The Engro effect
One company that has decided to take on the challenges of investing in agriculture is the Engro Corporation, already a well-established powerhouse in the fertiliser business. The manufacturer of the country’s most popular brand of urea, Engro has had a distribution network throughout rural Pakistan for decades and is beginning to use the synergies from that network in its newer lines of business.
The firm created a food products subsidiary, Engro Foods, that has already taken away substantial market share from established players such as the Nestle, the Swiss-based global conglomerate, and Haleeb Foods, one of the first players in the packaged foods industry.
Engro Foods currently gets most of its milk from independent suppliers that have been supplied with chillers by the company for storage. It has its own herd of about 2,200 heads of cattle which it plans to increase to 150,000 over the next several years so that it can control its own supply chain. The focus on logistics has led the company to create another subsidiary, the Engro Foods Supply Chain Company, which will manage the company’s integrated supply chain throughout the country.
The entry of Engro Foods has had a significant impact on the dynamics of the market, with packaged milk becoming more readily available in many parts of Sindh and Punjab. In addition, the company has taken away market share from the more established players such as Nestle and Haleeb.
“They have certainly had an impact on our distribution in the southern part of the country,” said Arif Kitchlew, CFO, Haleeb Foods.
Key to Engro’s success has been the integration between their logistics and finance divisions. Engro is known to pay their suppliers far more promptly, often within three business days compared to two weeks for Nestle and Haleeb. Before Engro, Haleeb had the biggest supply chain and distribution network in the country, which had led Nestle to make an unsuccessful Rs6 billion bid to take them over in the earlier part of the last decade.
Beyond its current offering of dairy products and ice-cream, the company is now looking to enter into the meat packaging business in addition to several other lines of business.
Why agri-credit has yet to take off
According to data made available by the State Bank of Pakistan, agriculture accounts for 7.2% of the total credit disbursed in the economy during 2009, despite forming nearly 25% of the GDP. The gap between the figures represents the underinvestment in the agriculture sector. Yet there does not seem to be a consensus as to why this gap exists in the first place.
“The banks do not like lending to us,” says one agricultural landlord from Sindh. When pressed for the reason, he said that he did not know why.
For their part, bankers agree that lending to the agriculture sector is not something they prefer doing.
“We view the sector as too high a risk to justify expanding lending,” says one banker at a large Middle East-owned bank in Karachi without elaborating the specific risks.
The answer, according to Fahim Rauf, a chartered accountant based out of Karachi, lies in the accounting.
“Land prices on official titles are frequently far below the market prices,” says Mr Rauf.
The reason most people do this is to have a lower tax liability for land taxes. Yet it also has the effect of reducing the legal value of the collateral that can be used on a loan application.
In addition, following the land reforms in the 1960s and the 1970s, the largest landowners in Pakistan transferred the legal title to the land to much smaller parcels that are, at least on paper, owned by the tenants. The landholding families, however, retain effective control.
Nevertheless, banks must rely on official records and since the official record is more likely to show 200 different farmers with 150 acres each to their names rather than one landlord with 30,000 acres they are unwilling to fund large investments in agricultural technology over the entire area. It would simply be too difficult to manage.
A solution commonly proposed by agricultural economists is corporate farming, where many smaller farmers combine to create a single corporation and then seek to raise capital, but this idea has yet to gain much traction. In the meantime, even the biggest landowners in the country continue to face a difficult time raising capital for investment in agriculture.