Garment sector faces pressure from rising energy costs, IMF programme: PACRA

KARACHI: The garment sector, a key contributor to the country's exports and GDP, is facing pressure from rising gas prices and the removal of energy subsidies under the International Monetary Fund (IMF) programme, a rating agency said.

Pakistan Credit Rating Agency (PACRA) said in its latest study on the garment sector that the recent gas tariff hike of November 2023, which increased the cost of gas to $10.3 per million British thermal units (MMBTU), the highest among regional competitors, would adversely affect the sector's margins and competitiveness.

“The removal of subsidies under the IMF directives is likely to render exports non-competitive in the international market.. garments sector’s margins are expected to rangebound, owing to domestic factors like higher expected cotton production during FY24, stable interest rates and consistent demand, both locally as well as globally, with global economic activity to rebound," PACRA said, adding that the impact of the gas tariff hike was yet to unfold.

Pakistan entered a $3 billion IMF standby programme in July 2023 to avert a balance of payments crisis and agreed to implement structural reforms, including raising energy tariffs, broadening the tax base and reducing fiscal deficits. The garment sector, which includes textiles, clothing and leather products, contributed 3.0% to the country's GDP in fiscal year 2023, reaching a market size of Rs2.6 trillion, up 8.0 percent year-on-year.

However, textile exports, which accounted for 59 percentof the country's total exports, declined by 14.6 percent in fiscal year 2023, due to supply chain disruptions caused by import restrictions imposed by the central bank and flash floods in August 2022. Textile imports also fell by 21.8% in fiscal year 2023, as the central bank restricted the import of raw materials and machinery to conserve foreign exchange reserves.

The garment sector is dominated by 59 organized composite units, with 32 listed on the Pakistan Stock Exchange (PSX), PACRA said.

The rating agency said the sector's margins were expected to remain rangebound, owing to domestic factors such as higher expected cotton production in fiscal year 2024, stable interest rates and consistent demand, both locally and globally, with global economic activity expected to rebound.

The local textile sector is classified as a Large Scale Manufacturing (LSM) industrial component within the industrial sector. In FY23, the textile industry’s weight in the QIM was recorded at 18.2 percent. In FY23, despite a 10.7 percent year-on-year increase in cultivation area, cotton yield declined by 45.9 percent due to floods in August 2022, resulting in 41 percent year-on-year decrease in cotton production to 4.9 million bales.

"FY24 target for cotton production is set at 12.7 million bales, while the government announced an incentive in the form of minimum Support Price (MSP) of Rs8,500/40kg bag for the FY24 cotton crop," PACRA said. “The FY23 dip in gross profit margin resulted from increase in cost of sales by 20 percent year-on-year, offsetting the increase in sales... similarly, operating margins remained at 13 percent in FY23 owing to the increase in operating costs (especially the energy costs) which nullified the increase in gross profit." The report said net margins dipped to 7 percent from 9 percent in FY22, owing to higher finance costs which grew by 127 percent year-on-year due to the increase in policy rates during the year.

"As per IMF’s directives, the government withdrew the Regionally Competitive Energy Tariff (RCET) for export-oriented sectors. Moreover, gas prices were revised upwards as of Nov 2023 lowering the competitiveness of Pakistan’s export prices."