The Pakistan International Airlines (PIA) is poised to commit $2 billion on its ambitious fleet replacement plan over the next 10 years. The Chairman, PIA, on 26th August ,disclosing details of the plan at a press conference said that new technology long-range wide-body aircraft like B-777 family, A-340-300, 500, and 600 will be inducted, with seven Turboprops. Two A-310-300 freighters and up to seven B-737 family or Airbus A-320/321/330 family of aircraft will also be purchased.

He said, six Cathay Pacific B-747-300 aircraft have already been purchased, though five of them were already on lease with the PIA. The PIA Board has taken the decision, with transparency as hallmark of the shopping of the aircraft on competitive rates, he said adding that on the recommendations of the Aircraft Acquisition Committee (AAC), aircraft have been identified for purchase of long-haul (Europe, the USA, and Far East), regional/short and medium range (Middle East, South Asia, and Far East, domestic), feeder/socio-economic routes, and freighter operations for the cargo market. He also said that the PIA Board would deliberate over the mode of purchase of these aircraft.

Large capital outlays need to be handled very carefully. Procurement in Pakistan of ships, tanks, submarines or other high-value items is often not without problems. Buying of PIA planes is a major capital investment, mostly in foreign currency. Price, delivery time, buy, hire or lease options, loan and equity funding, new or used aircraft, sovereign guarantee and other securities, etc. are matters that need careful scrutiny at various levels before the orders are placed. PIA should strive to get full worth of the money spent. In case there are problems in procurement, now or afterwards, eventually Pakistan will suffer. To assist the government and the PIA in better execution of the replacement plan, attention is invited to the following critical areas:

Financial restructuring: It is good that PIA has turned around and posted profit of Rs552 million for Jan-June this year. The national flag carrier is expecting to close the year 2002 with profit of Rs2.4 billion, as against a loss of Rs2.2 billion during 2001 and bigger loss of Rs5.3 billion during 2000. In the face of daunting challenges after 9/11, PIA management evolved turnaround strategy based on cost-cutting measures and restructuring of its overall operations to save it from total collapse. This is all very well, but will it be possible for the PIA to finance, from its own resources, the rupee cost associated with the plan. It cannot be said with certainty that PIA’s cash generation would support fully the debt servicing pertaining to the loans used for replacement of ten aircraft during 2003. Continued stringent cost control and revenue enhancement measures are imperative throughout the plan period, supplemented by major capitalization restructuring of PIA. The plan may face problems without such restructuring.

Audited Accounts: The PIA’s financial strength and profitability will largely determine the cost of borrowing and loan security.The GOP and PIA credit ratings will be considered, as most probably the GOP will be providing the guarantee. The bankers always wish to see the prospective borrowers’ profits and strong financial position depicted in a properly audited annual account, without any qualification, specific or implied. Otherwise, mostly they do not deal or quote unreasonably high fees and strict terms as to security and repayments. The PIA management is urged to work with the existing creditors and the government with the aim to resolve / streamline major financial issues and properly reflect the same in the audited annual accounts for year ending Dec. 31, 2002. The PIA may take up the matter with its external auditors for early finalization of the audit, possibly before the start of formal negotiations with the creditors.

Mode of Purchase: The PIA’s immediate attention might be on progressing the aircraft acquisition arrangements for the three Boeings and seven turboprops scheduled for 2003, as announced by the chairman PIA. This is the major area of concern and must be handled with caution. In this context, PIA might consider the following:

1. Due to worldwide slump in the air travel market and consequently over-capacity, aircraft prices are low and there is an opportunity for PIA Board to get favourable terms on financing and aircraft prices, including deep discounts.The PIA might stand a better chance if the airline had strong balance sheet and rest of the funds were already lined up.

2. There are four probable mode of acquisition for the new aircraft scheduled for 2003. These modes are: (i) lease-purchase, (ii) hire purchase, (iii) outright purchase through buyers credit and (iv) cash basis. Selection of a particular mode might be made after comparison of net present value of costs and benefits under each mode. PIA and the government might also keep in view the chance to utilize part of the substantial foreign exchange reserves for the profitable placement of which the State Bank of Pakistan is presently contemplating. The proposed interest / profit rate in the lease or hire rental or the interest rate applicable to the buyers’ credit must not be too divergent from the expected profit on placement of foreign exchange reserve by the SBP. Export credit insurance fee, delivery schedule and extensiveness of security/legal documentation might be the other factors that need to be examined for each mode.

3. The negotiation team shall have to do considerable work even after the mode for acquisition has been agreed. For the selected mode, detailed terms and conditions particularly conditions precedent need to be agreed and documentation prepared accordingly.

4. The Ministry of finance has reportedly advised PIA to avoid payment of any commission or fee/brokerage to any middleman, broker or institution involved. In this context, it may be mentioned that procurement of new capital equipment directly from the genuine manufacturers is the first precaution. Therefore, it would be advisable if the acquisition of the aircraft were directly from Boeing or Airbus, without involving any middleman. An undertaking from Boeing or Airbus has more value. Undertakings to this effect from any leasing or trading companies do not mean much.

5. Major upcoming events such as general elections may also be taken into account while proceeding with such major capital investment.

6. Security asked by the lenders is also important. Certain lenders may be asking for government guarantee as well as charge on the aeroplane so financed. The other lenders may not be so strict. So there is possibility of negotiating a better security option for PIA and the government. Sovereign guarantee for PIA borrowings may complicate GOP matters with the IMF.

7. For financing facilities at comparative rates, the PIA might as well keep provision for the loan funds from Middle Eastern banks, based on interest or on Islamic mode of finance.

Manufacturers’ campaign: Now that there is decision on make of the aircraft, chances are the selling campaign by Boeing and Airbus will still continue. Each manufacture may offer certain improved features in the aircraft over the ones in the earlier proposal. They may also offer to add certain frills to help in PIA’s advertising or marketing campaigns. Due to such additions, and if agreed to by PIA, they may ask substantial increase in price. This might entail more work for the AAC and another round of approvals.

Kickbacks/commissions: The Chairman, AAC in the press conference reportedly said that the committee provided the “professional advice” while the decision was left with the PIA Board. The committee weighed the pros and cons of the proposals and recommended purchase of new aircraft since their reliability is good and these do not entail extra expenditures on spares for the initial eight years, and the provision would also reflect on the quality of service, he added. The PIA Board met several times but there was no decision on the choice of aircraft. It was reported in the press that as PIA directors could not agree, the finance minister would be deciding in the matter.

However, the finance minister, in a meeting with the PIA Board on 12th August, reportedly made it clear that his ministry had nothing to do with the fleet selection but the government would not tolerate any under-hand deal to benefit any individual or group. He also added that PIA might borrow or get planes on lease but everything should be transparent.

A meeting presided over by minister for finance and attended by chairman PIA, managing-director and its board members, at Islamabad on 12th August reportedly cleared PIA’s $1 billion financing plan to buy new and old planes to upgrade the airline’s fleet. The government has agreed to contribute $ 150 million over three years as equity to help the airline purchase first three planes.

It has been said that the financial package includes short-term debt restructuring, issuance of TFCs of Rs15.4 billion to repay overdue liabilities and repayment of bridge loans and about Rs12 billion mark-up on restructured debts / TFCs which would reportedly be picked up by the government of Pakistan over a period of five years. This would be treated as equity contribution from the government in PIA books.

Capacity building: It is advisable to up-date the plan periodically in the light of actual developments locally or abroad. The PIA might set up a multi-discipline team to work in close coordination with the internal departments and the external agencies, with easy access for advice to the chief operating officer and the managing director. This team might be supporting the AAC and the PIA Board. The team may be able to develop preparatory reports regarding different aircraft matters such as technical specification, safety, regulatory approvals, cost of spares, engine over-haul, no frills price, fuel consumption, credit availability and cost of credit, loan security, down payment, government guarantee, delivery schedule, certification about price and kick-backs, etc. Based on PIA’s actual experience, the criteria may be further refined. The team may be provided full access to required information and also encouraged to develop proper databank to be able to perform its functions well in future.

Attracting clientage: It is said that the PIA would cater largely to Pakistani expatriates working in Europe, North America and Middle Eastern countries. This may be so but PIA must not forget the aim to become the airline of choice by nationals of these countries and regions. Once PIA is able to attract these travellers on all routes, only then PIA can claim itself a competitive airline of the world. For that, PIA shall have to improve its performance in many areas including service, quality of food, security, courtesy and punctuality. More efforts are needed on consistent basis for improving passenger comfort.

For better service and facilities to the travellers the PIA shall have to work closely with the CAA and the Airport Security Agency. The three institutions together can ensure excellent service and passenger comfort.