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Perwaja losses - AWSJ
By web aNtu

14/6/2000 11:32 pm Wed

Subject: AWSJ: Perwaja Steel Update June 12

From Asian Wall Street Journal 12th June 2000

By LESLIE LOPEZ Staff Reporter

Malaysia's Perwaja Sees Losses Mount

KEMAMAN, Malaysia - Along the coast of northeastern Terengganu state, a steel plant hulks silently over the waters of the South China Sea. On a recent hot afternoon, the sprawling complex is deserted. Its rusting chimneys are smokeless.

"It's been like this for more than a year," sighs a former employee of Perwaja Terengganu Sdn. Bhd. "There is just one shift and the plant comes alive only at night to keep costs down."

Perwaja was to be the centerpiece of a state-led industrialization drive Prime Minister Mahathir Mohamad began in the early 1980s. Today, it is Malaysia's most costly industrial failure and the biggest financial fiasco to befall Dr. Mahathir's 19-year old administration.

It's been four years since Kuala Lumpur acknowledged that Perwaja was insolvent - undermined by mismanagement, production woes and a mountain of debt. At the time, the government said it would swallow Perwaja's 9.9 billion ringgit ($2.61 billion) in accumulated losses and other liabilities and start over. In a controversial move, Dr. Mahathir brought in a small local steel company - Maju Holdings Sdn. Bhd. - to acquire and rescue Perwaja. The new managers promised profit would soon follow.

Instead, Perwaja continues to bleed red ink and remains mired in problems. According to government officials, the steel-maker has ama#sed another 800 million ringgit in accumulated losses since 1996. Moreover, the officials and members of parliament say that reports prepared by Malaysia's Accountant General show that Perwaja's net liabilities climbed to more than 9.1 billion ringgit at the end of 1998, including 5.1 billion ringgit in state-guaranteed borrowings from local and foreign banks.

The fresh financial burden comes amid still-incomplete investigations into what went wrong with Perwaja. An Anticorruption Agency probe into allegations of irregularities and mismanagement, begun in April 1996, has come to nothing. No Perwaja employee - past or present - has been charged with any wrongdoing.

What's more, Dr. Mahathir's plan to revive Perwaja by selling its steel a#sets to Maju has stalled because of Maju's lack of financial clout and slack steel demand. The result: Perwaja - 15 years after it produced its first steel - has yet to earn a single ringgit in profit.

Perwaja's troubles are reverberating through Malaysia's struggling steel sector. The Malaysian currency's 34% depreciation since mid-1997 has saddled steelmakers with rising costs for imported materials such as iron ore and scrap iron. Senior industry officials say the steel sector, which has five main companies producing a gamut of products for a relatively small domestic market, is operating at just 50% capacity.

"We are looking at a complete rationalization of the (steel) sector and its players," says C. Rajandram, chief of Malaysia's Corporate Debt Restructuring Committee, which has appointed British consultancy W.J. Atkin to oversee consolidation of the steel sector.

The government's attempt to nurture a steel sector behind high tariffs - averaging about 25% on steel product imports - isn't an isolated case of heavy industry hubris. Consider Perusahaan Otomobil Nasional Bhd., or Proton, the long-sheltered state-controlled auto company.

Protected by an average 200% tariff on imports of foreign-built cars, as well as substantial duties on parts for rival auto makers' locally a#sembled vehicles, Proton controls about 60% of the domestic market. But that dominance is threatened by regional and international trade agreements that will force Malaysia to eliminate import tariffs by as early as 2003, allowing foreign competitors much freer access.

The challenges facing the steel and automotive sectors pose a dilemma for Malaysia. The government could concede that its plunge into heavy industries was a flawed policy, cut losses and try to make its ventures competitive through tie-ups with international investors. Or Kuala Lumpur could plod on, pump more money into the steel and car industries and jeopardize Malaysia's participation in the global market by retaining tariffs on imports. That would expose Malaysia's rebound from its worst-ever recession in 1998 to big risks. Some economists contend that pouring funds into Old Economy industries that can't compete internationally could discourage foreign investment and delay Malaysia's effort to move up the technology ladder.

For the moment, it appears that Dr. Mahathir is bent on protecting his industrial projects. Earlier this month, the 74-year-old premier said he was having "second thoughts" about complying with the Free Trade Area strategy of the a#sociation of Southeast Asian Nations. Dr. Mahathir said that auto makers such as Proton would be at a disadvantage under the plan, known as AFTA, because they must import technology and components. "If we open up our market then naturally we will not be very competitive," he said. Although Dr. Mahathir didn't refer to Perwaja, it, too, would be affected by the AFTA plan, under which six of the 10 Asean members have agreed to cut tariffs on an array of manufactured and agricultural products to no more than 5% by 2002.

While Proton's protected grip on the domestic car market has a#sured it of profits, Perwaja has never come close to making money.

The company was formed in 1982 as a $465 million joint-venture between then-state-owned Heavy Industries Corp. of Malaysia Bhd., or Hicom, and Nippon Steel Corp. Under a turnkey contract, Nippon Steel built a billet-making plant and a direct-reduction facility to smelt ore into hot briquetted iron. But the project floundered, racking up large losses in the mid-1980s. In 1987, the direct-reduction plant, which never functioned properly, was closed.

Frustrated with the lack of progress, Dr. Mahathir stripped Hicom of its 51% interest in Perwaja and appointed Eric Chia, a close a#sociate and trusted troubleshooter, to overhaul the venture in 1988. Nippon Steel eventually gave up its 30% stake in the company and dropped out of the project, leaving ownership in the hands of the Malaysian government, which took 81% of Perwaja's equity, and the Terengganu state government, which held the remaining shares.

Under Tan Sri Chia's stewardship, Perwaja borrowed heavily and expanded rapidly. Before long, the tough-talking, burly businessman announced that the steel operation was making a profit and promised that the government would soon recoup its investment by listing Perwaja on the local stock exchange.

But by mid-1990s, it became increasingly apparent that Perwaja's putative turnaround was an illusion that masked deepening financial woes, production snags and widespread management irregularities.

There were no profits. An internal audit report that was completed in December 1995 and became public two months later declared that Perwaja was insolvent and was unable to pay the interest and principal on its 5.7 billion ringgit in domestic and foreign borrowings. The report also detailed an array of alleged irregularities during Tan Sri Chia's tenure. Among them: inaccurate accounting records and hundreds of millions of ringgit in apparently unauthorized and one-sided contracts between Perwaja and Malaysian and foreign companies.

Tan Sri Chia resigned from Perwaja shortly before the audit report was completed. In 1996, Malaysia's anticorruption agency revealed it was investigating the Perwaja affair and Tan Sri Chia's involvement in it.

Since then, the agency has periodically acknowledged that the investigation is continuing. The last time it did so was late last year. But results haven't been publicly disclosed. Since his resignation, Tan Sri Chia, who hasn't been accused of wrongdoing, hasn't responded to requests to discuss his role at the company. A person answering the phone at his Kuala Lumpur home last week said that Tan Sri Chia is currently in the U.S.

Kuala Lumpur had to honor Perwaja's huge debt obligations in 1996 because a default on one loan could have triggered cross-default clauses in loan agreements with other creditors, exposing Malaysia to a potential banking crisis.

But the scandal didn't deter Dr. Mahathir from pursuing his steel dreams. In a bid to salvage the Perwaja, Kuala Lumpur decided to privatize the company by transferring its steel a#sets - free of its debt burden, which was to be shifted to the government - to Equal Concept Sdn. Bhd. That company is 51% owned by a Maju Holdings and 49% by the government. But the privatization plan has been stalled by a soft economy and Maju's inability to raise the necessary funding, according to government officials familiar with the situation.

Equal Concept, led by Maju Chairman Abu Sahid Mohamed, manages Perwaja's steel operations. It is struggling with slowing demand and rising costs for imported iron ore because of the ringgit's depreciation. Equal Concept officials declined to be interviewed for this article, but people familiar with the company say that Perwaja's steel business posted a loss of 340 million ringgit in 1998 and that the company continues to run in the red.

To keep costs down, Perwaja's plant in Terengganu is operating just one shift between 10 p.m. and 8 a.m. and produces about 40,000 metric tons of steel products a month, almost entirely for the local market. That represents about 37% of the plant's total production capacity of 1.3 million tons annually. Despite cost cuts, the plant loses about 35 million ringgit a month through operations, according to people familiar with its operations.

Meanwhile, Malaysian taxpayers are paying a big bill for the country's steel ambitions. Perwaja is the single-largest borrower among all state-controlled enterprises with outstanding government-provided advances of four billion ringgit at the end of 1998. It carries another 5.1 billion ringgit in government-guaranteed loans taken by Perwaja from local and foreign creditors.

According to officials familiar with the situation, government guarantees on domestic loans taken by Perwaja stood at 2.75 billion ringgit at the end of 1998. The loans, which carry interest charges ranging between 7% and 9.5% annually and varying maturity dates between 2000 and 2007, were taken to repay earlier loans owed by the steelmaker. Government guarantees on overseas loans totaled 2.38 billion ringgit during the same period. That foreign debt load, which carries varying interest charges of 0.2% to 0.45% over the London interbank offered rate, was mainly raised from Japanese banks and will mature in 2003.

The government's exposure to Perwaja's liabilities is also becoming a political headache for Dr. Mahathir. The Terengganu state government, which owns a 19% stake in Perwaja, is controlled by Parti Islam Se-Malaysia, a Muslim-based opposition party. The state is conducting its own investigation into what went wrong at Perwaja, and some political analysts say the opposition party could try to embarra#s Dr. Mahathir's government by making public its findings.

"The state government has put in one billion ringgit into the steel project, and we don't plan to spend another cent more," vows Mustafa Ali, a senior party leader in Terengganu, who oversees the state government's investments.