Industrial reforms — a pressing priority

With the glaring example of Sri Lanka defaulting on its debt, the risk of Pakistan facing a similar fate should be an impetus to spur ambitious reforms in almost every area of country’s economy. A default situation results in damaged relationship with investors resulting in far reaching detrimental consequences. Therefore, it is imperative for us to take an evaluative look at our policies, institutions and markets to identify roadblocks and inefficiencies if we want to bring about economic stability and sustainable growth. Pakistan needs to nurture an export culture, focus on investment, productivity, and exports, while removing sludge and bottlenecks related to finances, energy, and tariffs.

It is troubling to note the pace with which long-term growth is declining. This decline is taking place on multiple fronts. Pakistan does not have an export culture, despite the fact that export-oriented units have a 30% higher productivity rate than companies serving domestic market. The export trend remains quite flat, and growth is volatile.

Pakistan’s textile sector accounts for a major share of country’s exports, which are vital for the cash-strapped economy. In recent times, the textile industry has made notable progress and yielded spectacular results, particularly following a sharp rise in investment from industrialists. At this pace, sustained yearly growth of over 25% is possible. However, the scenario is changing and coming year presents a unique set of challenges as Pakistan’s textile exports in October 2022 have slashed by 15.2 percent to $1.357 billion over the corresponding month a year ago. Over the previous month too, its exports declined by 11.1 percent, with major decline in components including cotton cloth, knitwear, bedwear, towels, and readymade garments. In terms of US dollars, the exports in October, 2022 were $ 2,384 million (provisional) as compared to $ 2,446 million in September, 2022 showing a decrease of 2.53% and by 3.25% as compared to $ 2,464 million in October, 2021. Pakistan is still a very small player with only about 1.7% market share in 2020, which signifies ample room for expansion and diversification.

Textile exports are expected to remain under pressure due to lack of new orders amid global economic slowdown and recession. It has created a cascading effect on the buying power of consumers. Along with a number of global factors Pakistani textile industry is facing domestic issues where energy issues are a constant. Pakistani textiles industry consumes less than 9 percent of the overall national gas supply yet is the first to take the hit on any nationwide gas cuts. This adversely impacts the export sector of Pakistan, being heavily reliant on the textiles industry, as 75 (seventy-five) percent of the textile industry relies on gas-based electricity generation due to its inadequate supply from the national grid. The downstream textiles value chain—processing and composites—rely almost entirely (67 (sixty-seven) to 75 (seventy-five) percent) on gas for their electricity requirements—thus targeting gas cut towards the textiles industry is a direct curb on exports and foreign exchange gains.

Pakistan’s electricity and gas tariffs for textile industry remain the highest in the region, rendering firms uncompetitive despite the RCET tariffs being in play. The general industrial tariff remains at 0.15USD/KWh, twice that in Vietnam and 1.5 times higher than Bangladesh and India. Likewise, Pakistan’s Textiles industry faces highest gas/LNG tariff in the region. Pakistan’s textile industry is paying 9USD/MMBtu, which is 3.5 times more than Uzbekistan, and 1.5 times the Bangladesh’s industrial tariff.

In spite of the challenges discussed, we have still tried to bridge up the gap, which shows our huge potential that needs to be tapped by government friendly policies.

Pakistan’s export market is heavily reliant on its textiles while the stability of textile exports is majorly reliant upon free access to the global market such as that of EU. Thus, Pakistan needs to enhance its eligibility under the EU’s GSP+ preferential status and utilize it effectively to make its export-led growth steady as well as to stay in line with other regional competitors including Bangladesh. The status has also supported Pakistan to enhance its capability to grow in a sustainable manner, diversify its economy and create employment opportunities. It has also accelerated Pakistan’s efforts in improving compliance to major human and labour rights and environment and good governance related international conventions. EU awarded Pakistan the GSP+ status in 2014 and Pakistan, fortunately, became the largest beneficiary of GSP+ among all other awardee countries (European Commission 2022b). This status will end in December 2023 and its continuation is highly reliant upon a strong implementation of the 27 mandatory international conventions related to environmental and social compliance along with the treaties to be newly added. Bangladesh aptly prioritized export growth, with a particular focus on streamlining its textile sector, and thus ensured that it remained adaptive to global trends. Technology upgradation remained frequent. The same approach could have produced better results in Pakistan, but the unfortunate fact that human development has not been given priority has cost Pakistan immensely.

According to a recent World Bank report, “Pakistan’s poor trade performance in recent years is an outcome of diminishing export competitiveness”. The reason for the loss of competitiveness is the increased cost of doing business.

According to the ease of doing business report, Pakistan stands at 147 out of 190 countries significantly lower than regional peers and competitors like India, Vietnam, Indonesia and Turkey. A country with a regionally uncompetitive business environment cannot be expected to compete with regional players. Value addition, competitive inputs and trade competitiveness can effectively result in sustainable economic growth; as unlike aid, these measures are free of any liability. Earnings through enhanced exports serve as a valuable inflow to the economy, and can pull Pakistan out of its current account deficit and economic stagnation. Job creation is another crucial metric for an economy in the growth stage, as yearly increases in unemployment must be catered to. The private sector provides us with a viable means to achieve this, as export-oriented sectors are highly labor intensive. The textile sector creates jobs in every tier of the economy, as different skills are required at each stage, be it cotton picking, ginning, stitching, designing, innovating or strategic planning. The expansion and development of exporting industries thereby reduces unemployment in addition to being essential for a healthy Balance of Payments.

Historically, we are more focused on taxation, not on growth. We have to shift this focus to growth by prioritizing investment, productivity, and exports. In attempting to do so, we face a number of bottlenecks. Sales tax is consumption based, which inflates inventory and capital costs, serving as an impediment to new projects as capital cost increases by 20 percent and refund can only happen after commercial operations. In this huge cycle of sales tax collection, exporters suffer in the form of delayed pending and deferred refunds.

The cost of collecting and refunding sales tax outweighs the revenue collected by a significant margin. The administrative cost of collecting and refunding sales tax is estimated at Rs.10 billion. The imposition of sales tax has resulted in billions (over Rs. 250bn) of rupees in liquidity transferring from the industry to the FBR. Despite the commitment to pay refunds within 72 hours under the FASTER system. Rs. 25 billion outstanding since 2013 under Provincial Taxes on Services (PRA & SRB) due to non-availability of real time data of provincial authorities on FBR central portal. Taxation reforms are also greatly needed. Income tax claims of Rs. 50 million are still pending. Rs.30 billion pending under FASTER system with the RPOs issued but payments not cleared and Income tax claims of Rs. 50 million are still pending shifting working capitals from the industry to FBR’s Office.

Similarly, With the withdrawal of Zero-Rating (SRO 1125) and the implementation of a 17 percent General Sales Tax (GST) on export-oriented sectors, the cost of doing business has increased to unsustainable levels, as a consequence of the liquidity crunch from the non-payment and delay in refund of GST collected. A lower uniform rate for GST will foster compliance and lower the incentive to cheat. The distinction between filers and non-filers should be abolished as it just creates a nuisance and does not contribute to improving the tax net.

Another paramount domestic issue is cotton. Once Pakistan’s favorite cash crop, cotton had its area under cultivation decline by over 1 million acres over the course of ten years. Decline in cotton crop caused by a number of variables involved specially the recent floods.

To offset this decline and reduce the crop to its former glory, we must encourage the textile industry to grow its own cotton, reform variety approval system to speed up the process as well as to support private sector R&D organizations. Identification and development of new areas for cotton can also provide great returns.

In Pakistan, a fundamental structural issue is insufficient forex earnings to sustain the economy. To this effect, the country has huge export potential that is not being adequately leveraged. To tap this potential, policy must be formulated to simplify Taxation Regime (online portal or one window operation), provide credit on simple terms (minimal documentation) linked to export receipts and a policy should be formulated where any tax levied must be on net profits, not revenue / no turnover taxes.

The ideal way forward is through developing an export culture wherein all investments and operations are focused to maximize exports. To this end, the textile sector is the key player, since it contributes 62 percent of all exports.

The pace of competitiveness and modernisation in global textile market is increasing exponentially. In order to effectively compete, we must lower our cost of doing business and make it comparable to our regional competitors such as India, Bangladesh, and Vietnam.

To achieve the targeted exports, business-friendly policies should be ensured for the industry to grow and further achieve increased targets on a yearly basis. There is immense potential in our textile industry to engineer an economic turnaround and achieve targets not only in exports but in economic growth, through consistent policy support.