Money Matters

Stitching a future: billions in textile exports

By Asif Inam
Mon, 06, 24

Pakistan’s textile sector has experienced nothing short of a rollercoaster ride over the past few years. From a phase of remarkable growth and optimism in 2021-22 to entrenched deindustrialization, the industry’s current state highlights the critical need for conducive policies to stimulate its revival.

Stitching a future: billions in textile exports

Pakistan’s textile sector has experienced nothing short of a rollercoaster ride over the past few years. From a phase of remarkable growth and optimism in 2021-22 to entrenched deindustrialization, the industry’s current state highlights the critical need for conducive policies to stimulate its revival.

In the lead-up to 2022, buoyed by supportive policies such as the regionally competitive energy tariffs (RCET) regime, zero-rating for export-oriented sectors, and the Temporary Economic Refinancing Facility (TERF), the textile sector was flourishing. Textile exports increased by 54 per cent, from $12.5 billion in FY20 to $19.3 billion in FY22, in just two years. Approximately $5 billion of fresh investment at a 60:40 debt-to-equity ratio was made in upgrading and expanding production capacity, taking the sector’s installed export capacity to $25 billion per year. There was a notable shift in the textile export basket towards high-value-added products. For every unit of cotton/fibre, value-added exports increased from 2.5 units to 3.9 units over the last three to four years.

However, this period of prosperity was short-lived. Amid the economic crisis of 2022-23, characterized by the withdrawal of the RCET regime, zero-rating for export-oriented sectors and historically high borrowing costs, textile exports plummeted to only $16.5 billion in FY23 and are expected to remain at the same level for FY24. The economy has become stuck in a time-freeze, the industry is in a downward spiral and, as the world leaps into a new age of artificial intelligence, Pakistan is regressing towards an agrarian society.

Industrial output has been contracting since FY23, and projections for GDP growth in the upcoming year are reliant on agriculture. Deindustrialization is becoming increasingly entrenched as over 60 per cent of the basic industry in the textile sector has shut down, with more on the verge of closure. This is evidenced by the rapid increase in imports of cotton yarn -- from around two million kilograms in July 2023 to 14 million kilograms in May 2024 -- and other intermediate inputs, as local manufacturers are unable to compete with their international counterparts due to a prohibitive business environment.

Domestic value addition in exports is declining as local inputs are substituted by cheaper foreign inputs; around $10 billion of annual export production capacity is left unutilized while the government pleads before the IMF and other countries for bailout packages and expensive foreign loans.

The situation is the result of three major challenges that, despite repeated pleas from the industrial sectors, the government has failed to address and continues to remain oblivious to. These are uncompetitive energy tariffs, prohibitive borrowing costs, and a dysfunctional taxation regime.

Energy costs in Pakistan are the single biggest challenge faced by the industrial sectors. Power tariffs for industrial consumers are over twice the regional average at 16.3 cents/kWh and were as high as 17.5 cents/kWh in January 2024, compared to 6.0 cents/kWh in India, 8.6 cents/kWh in Bangladesh, and 7.2 cents/kWh in Vietnam.

Similarly, gas prices have increased by 223 per cent since January 2023 and are well above regional levels. There are now increasing indications that the government plans to completely deprive industrial captive consumers of gas to force them towards a prohibitively expensive grid, where they are forced to pay over Rs240 billion in cross-subsidies (expected to increase by 60 per cent following the tariff rebasing for FY25) and Rs150 billion in stranded capacity costs to bear the government’s welfare obligations and inefficiencies.

Parking revenue shortfalls and inefficiencies on industrial consumers may be an easy fix for the government in the short term, but it has grave long-term consequences as industrial sectors cannot compete with such high input cost differentials, especially for something as critical as energy. Prohibitive energy costs are resulting in a collapse of industrial sectors and millions of lost jobs.

Power tariffs must be reduced to a regionally competitive 9 cents/kWh to prevent further deterioration and stimulate industrial activity and job creation. This will generate over 3,000 MW of additional grid demand, and boost power sector revenue by over Rs500 billion, which will both reduce the burden of unutilized capacity costs and more than cover the revenue impact of removing the cross subsidy. The resulting increase in exports will also bring numerous indirect benefits, including additional government revenues, an improved trade balance, lower external financing requirements, and external sector stability, apart from the social and political benefits.

The current interest rate of 22 per cent is another major factor stifling economic growth. Inflation and exchange rate depreciation since early 2022 have significantly increased operating expenses for the same dollar-denominated order. However, borrowing is financially unviable at rates of over 25 per cent in a high-volume-low-margin business like textiles. There is also a severe shortage of working capital as non-bank supply chain finance, prevalent across all sectors of the economy, has dried up, with the usual investors finding it more attractive to simply park their money in banks.

While high interest rates were understandable when inflation was in the high 20s, it has been on a downward trajectory for several months, clocking in at 11.8 per cent in May 2024. The real interest rate of positive 10 per cent provides sufficient space for monetary easing that should be utilized to provide relief to both the private sector and the government. With an interest rate of 12 per cent, the real rate would still be positive while alleviating the private sector’s constraints on financing and saving the government around Rs3 trillion in interest payments, significantly improving its fiscal position. These savings could be reinvested in development projects and infrastructure improvements, further stimulating economic growth. Moreover, affordable credit would enable businesses to expand operations and enhance productivity, contributing to overall economic stability.

The third major challenge is the current taxation system, which is beyond dysfunctional and highly burdensome for businesses. Persistent delays in the issuance of sales tax and other refunds are major contributors to an industry-wide liquidity crisis. As per the law, FASTER refunds are to be issued within 72 hours. However, the Federal Board of Revenue (FBR) only issues partial refunds with delays of several months, while the bulk of the claims are deferred for manual processing and are neither processed nor paid despite the RPOs being issued; refunds remain pending for years as a result. At any given time, the government is holding on to Rs300 billion worth of industrial sales tax refunds in addition to around Rs65 billion in other dues such as duty drawbacks, DDT, TUF, mark-up support, and unpaid differentials of RCET.

Delays in refund issuance, compounded by high borrowing costs, severely hamper the financial health of businesses. A critical step towards resolving this issue is the restoration of zero-rating (SRO 1125). This policy change would allow for the collection of an additional Rs250 billion worth of sales tax at the retail stage, providing additional revenue for the government and much-needed liquidity to businesses.

Additionally, the turnover tax regime, which imposes a minimum 1.25 per cent tax on gross revenues regardless of profitability, is particularly detrimental to small and medium enterprises (SMEs). SMEs contribute significantly to the economy, employ 78 per cent of the non-agricultural labour force, and are shutting down the fastest. They face a compounded tax burden across multiple stages of production, unlike vertically integrated firms. Removing the turnover tax, especially for SMEs, would create a level playing field, allowing these businesses to compete effectively, innovate, and grow. This would foster a more dynamic and resilient industrial sector.

The current policies have placed Pakistan’s industrial sector in a precarious position, akin to being stuck in a time freeze while the rest of the world moves forward. The high power tariffs, exorbitant interest rates, delayed tax refunds, and punitive taxes have driven the industry into a downward spiral. Without immediate and bold policy reforms, the economy will continue to deindustrialize, leading to increased unemployment, further economic instability, and social chaos.

The time for action is now. The industrial sector is ready to deliver growth and textile exports can rapidly increase from $16.5 billion to $25 billion, with $7.5 billion as the net addition to exports since $2.5 billion of inputs such as cotton and PSF need to be imported. There is also a strong focus on enhancing domestic cotton production and productivity through initiatives like the APTMA Cotton Foundation. Over the next four years, the textile sector plans to increase its export production to $50 billion per year by investing in 1,000 new garment plants across four state-of-the-art industrial zones with plug-and-play facilities. This significant investment will not only boost exports but also create over one million direct and indirect jobs. However, achieving it requires a supportive policy environment.

The government must recognize the urgency of this situation and act decisively. The future of Pakistan's economy hinges on the revival of its industrial base. By implementing these necessary reforms, policymakers can secure a prosperous future for all Pakistanis, ensuring that the country remains competitive in the global market and capable of meeting its economic challenges head-on.