The snake has truly bitten
There have recently been a spate of ill-informed articles on the stagnation of textile exports, subsidies to the textiles sector, under-taxed domestic sales, rationale for removing zero rating and APTMA's lack of professionalism. It is time that the record was set straight.
First of all, increasing exports through devaluation is highly contentious as the bulk of inputs into the textile chain are directly or indirectly linked to the dollar and international markets. This point is very well illustrated by the direct linkage of cotton prices to the New York cotton exchange and the dollar based energy pricing covering 80 percent of the cost base of the sector.
The other fallacy that is being expounded is that exports can be increased or decreased within a short time period just through manipulation of incentives and short term reduction in cost of doing business. For exports to increase meaningfully it requires an exportable surplus which requires modernization, upgradation and expansion of industry. For these to be achieved you need long term stable policy and an internationally competitive cost of doing business.
Alas policy stability was not to be, as each successive governments has disowned policies of the previous governments, even to the extent of disowning the Technology Up-gradation Scheme of 2009-14 for which none of the payments due have been made so far. Payment of Sales Tax Refunds or Duty Drawbacks despite sovereign guarantees, has been an even sorrier story and as a consequence trust in government pronouncements is currently at the lowest ebb ever. Under these circumstances, the government's claim of honoring any refund commitments can hardly be relied upon. Given the current scenario, substantial immediate increase in exports, large scale investments for the upgradation, expansion or modernization are highly unlikely to be fulfilled.
Furthermore, it is incorrect to state that the textile sector in Pakistan is getting subsidies especially on the energy rates. It is a matter of fact that the cost of inefficiencies and corruption cannot be exported in inflated tariffs and that the true cost of energy has to be charged for exports to remain competitive.
Recognising this, the PTI government provided a level playing field to the sector on a regional basis. Energy is the largest component of the conversion cost in textiles and necessarily has to be competitive if Pakistani exports are to compete in a highly price sensitive market.
The following graph depicts the regional disparities that existed prior to the government's intervention. The fall in yarn exports is not because of any fall in production levels but a very positive signal that more of the yarn was consumed for value addition leading to the higher export of finished goods. Point to note is that yarn production has increased over the same time period. This has always been a long standing goal of policy makers and yet when it has been achieved, there is unjustified criticism.
Regarding the quantum of domestic sales it is highlighted that the total quantity of fibre availability to the sector is known last right down to the last gram. An analysis of the fibre availability reveals that the total value of the output of domestic industries is $ 18 Billion out of which $ 13.5 Billion is exported. The $ 4.5 billion domestic sale of industry underpays sales tax, at only Rs 9 billion which at 6% (the old GST rate) which should have been Rs 41 billion.
The fundamental reason for the under collection of sales tax on domestic production is the prevalence of the unregistered dealers and the cottage industry in the textile sector. The known brands selling in the domestic market are all members of APTMA such as Nishat, Gul Ahmed, Bareeze, Sapphire, Khaadi and Chenone, etc., are all fully sales tax-compliant. The manner in which these can be brought into the tax net is through enforcement of sales tax at the retail stage and by denying industrial power and gas connections to unregistered industries. It is strange that the entire focus remains on the few industries that are fully compliant rather than tackling the unregistered industries while the compliant industries are now being forced out of business due to the belligerent attitude of FBR.
A cursory glance at the table below will reveal that the domestic sale from local industry is only 40% of the retail sale in quantum terms. The balance 60% in quantity and 80% in value is either under-invoiced imports or smuggled or new clothing in the guise of used clothing.
The value at the retail stage of all textile and clothing can be conservatively estimated to be US $ 40 Billion and if brought into the tax net at a GST rate of 17% can generate revenues of $ 6.8 billion or Rs 1 trillion. This is the real value of domestic sales tax if taxed at the retail stage. A word of caution however as the 17% GST rate is extremely high for a developing economy like ours, this would lead to very strong incentive to smuggling and staying out of the tax net.
It is very strange that in order to collect the anticipated Rs 100 billion sales tax from sale of domestic production the entire industry is being subjected to a Rs 600 billion plus collection of Sales tax, when the better and much higher yielding mechanism would have been to tax all sales at the retail stage and could have been worked out in collaboration with the industry.
It is all very well to state that refunds will be made on time however reality is that the production cycle will take nearly nine months prior to exports so the sales taxes would have been collected and in FBR coffers, for at least that time period, even in the best case scenario. The sales tax collection would therefore entail an interest cost of nearly Rs. 100 Billion, assuming that the industry could come up with that sort of liquidity in the first place. In the current scenario, this liquidity is unlikely and as a consequence we anticipate closure of a large proportion of the sector leading to a precipitous fall in exports and large scale unemployment.
In an industry where the end product price is dictated by international competition the profit margins are extremely low (3-4%) generating the additional funds for GST would be impossible. So it would have been prudent to start with a smaller rate and gradually increase the rate. Furthermore, the world over baby clothing are exempt from GST and in India clothing for the poor attracts a much lower sales tax rate.
This begs the question as to why FBR is focusing on taxing registered and compliant industry rather than the retailers, where as they say the real "Moolah" is.
Blaming APTMA for a non-professional approach is highly irresponsible as APTMA was the only trade organisation which agreed to work with the government to formulate a system to collect tax on domestic sales in line with national priorities, while balancing the liquidity requirements of the sector. Furthermore, APTMA has repeatedly informed the government of the menace of smuggling, used clothing and the propriety of taxation at the retail level. Just to set the record APTMA has published more than 40 technical papers in leading journals and newspapers on all aspects of the business in just the last one year. APTMA has more than 8 highly qualified research staff and is engaged with the government at all levels co-operating and supplementing the government's effects to modernize and expand the sector.
In a recent article "Ladder and the snake" carried by this newspaper in May 2019, we had written that whenever the sector is on the verge of take-off something or the other strikes and pushes the sector back by quite a few years. "The snake has truly bitten this time".
======================================================================================= DOMESTIC COMMERCE ======================================================================================= Fiber Consumption in Pakistan M. KGs Per Capita (kg) ======================================================================================= @207 Million Population Pakistan Total Fiber Used (including imported cotton & MMF 3,550 - Less-Total Fibers used in Textile products for Exports 2,441 - Fibers Available for Domestic Consumption 1,109 5.4 Official Imports of Textile & clothing 340 1.6 Worn Clothing Imports 443 2.1 Informal Textile & Clothing trade i.e. smuggling and ATT 326 1.6 Sub Total 5.3 Global Average Per Capita Fiber Consumption 12.5 kg Imports/smuggled/informal trade of textile & clothing is equal to the size of domestic industry but far less in value. =======================================================================================