Beyond the Billionaires Bash: Pakistan’s Real Crisis
By Asif Inam

In a recent op-ed published in Dawn, Mr. Khurram Hussain has made several claims to misrepresent fundamental issues at the heart of Pakistan’s energy sector and overall economic crisis.

One of these is that “the core problem here is not capacity charges. The core problem is devaluation, because the dollar value of your electricity bills has not risen by much more than 30 percent in the past decade. Check and find out.” Well, we checked:

Notes: Effective power tariffs including base variable and fixed charges, financing cost surcharge, fuel price adjustment, quarterly tariff adjustment, and electricity duty, excluding additional taxes billed; Source: NEPRA

Over just the last five years, never mind the entire decade, power tariffs for B-3 industrial consumers—in dollar terms—have increased by 60-70%, and this is the non-RCET power tariff. For other consumers they have similarly increased by much more than 30%, in dollar terms:

These very high power tariffs are a direct result of increasing capacity charges and unutilized capacity, and a shrinking pool of consumption over which these are spread. However, it’s not even the absolute number or the increase that is plaguing the industry. It is that Pakistan’s industrial power tariff is over twice that of competing economies like Bangladesh, India, and Vietnam, and this disparity in energy costs is a critical factor undermining the economy’s industrial competitiveness.

It is widely understood that Pakistan’s most fundamental economic problem is a shortage of productive capacity, that is neither sufficient to meet domestic demand nor to generate exportable surpluses to meet import requirements. This shortfall creates a chronic shortage of foreign exchange and repeatedly lands the economy into balance of payments crises. The only sustainable solution is rapid industrialization, and a most basic input that any industrial setup requires is energy. But when that energy is twice as expensive as what competitors in other countries are getting, its cost—comprising 10-35% of input costs across the textile and apparel value chain—gets passed into the product and makes its significantly more expensive than those of your competitors, rendering it uncompetitive in the international market.

Expensive energy is one of the main reasons Pakistan’s industry struggles on the international stage and a major factor deterring efficiency-seeking foreign direct investment into the country. Imagine an investor looking to establish a garment factory in South Asia. A comparison of the business environment in India, Bangladesh, and Pakistan would reveal that while labour costs may be comparable, everything else, including energy, taxes, and borrowing costs, is two to three times as much in Pakistan. Naturally, Pakistan would be the first to be dropped from consideration.

The economy faces an annual foreign exchange shortfall of over $25 billion for the next five years. Without further debt—an entirely untenable option—the only way to bridge this gap is through a drastic increase in the industrial base and exports. However, this increase is impossible if something as basic as energy costs over twice as much in Pakistan as in the rest of the world.

Pakistan’s textile sector is a crucial component of the country’s economic fabric, contributing 8-9% of GDP, employing 40% of the industrial labour force, and bringing in over half of the country’s export earnings. In fact, the textile sector is one of the very few industries in Pakistan that does not receive protection, and that is why it has innovated and increased the share of value-added goods in textile exports from around 50% in 2013 to 80% in 2023. It has produced companies like Interloop, one of the largest of its kind in the world, and Gul Ahmed, IKEA’s single largest supplier, that is now also venturing into foreign markets with its branded goods. But the problem is that we have not been able to build enough companies like these because of the continuously prohibitive business environment faced by the private sector.

Where removing the cross-subsidy was sufficient to achieve a competitive energy tariff a year ago, failure to do so exacerbated the predicament. Inflated power tariffs, including the cross-subsidy, drove manufacturers out of business, causing a sizable reduction in demand for grid electricity and increasing the burden of growing capacity costs on the remaining consumers, further reinforcing the cycle. Today, despite a reduction in the cross-subsidy, power tariffs remain over twice the regional levels due to unutilized capacity costs, driving more firms out of business and affecting the livelihood of countless workers and their families.

The capacity payments issue is not about reverting to a subsidized energy regime. It is about addressing the fundamental imbalance in the power sector’s cost structure. In Pakistan, capacity constitutes around 70% of the total cost, with fuel making up the remaining 30%. Globally, this ratio is reversed, with 30% capacity cost and 70% fuel cost. This structural anomaly means that a significant portion of the power sector’s revenue goes to fixed payments to power producers, regardless of the actual electricity produced or consumed. This results in exorbitant costs for all consumers, including industrial, commercial and residential.

The campaign for fair energy tariffs is about the entire country, not just the textile sector. Both Fitch and Moody’s have predicted dangerous levels of sociopolitical instability due to rising inflation, taxes, and most importantly the unbearable cost of energy.

The textile industry is not merely seeking relief for itself but advocating for a restructuring of the power regime to benefit the entire nation, including the common man so he no longer must pay 22 cents for a kWh whose cost should be in single digits. We are calling for IPP contracts to be renegotiated in the same line as those calling for the country’s domestic and foreign debt to be restructured. Not out of self-interest, but to ensure that the power sector and the economy can be made sustainable. The opacity and inefficiency currently plaguing the power sector are detrimental to all Pakistanis, not just the textile sector.

There is a consistent theme across all such baseless criticism. And that is there’s always a lot of “billionaire bashing”, but never any realistic solutions to the problems faced by this country. It’s easy to sit back and criticize without understanding the complexities of the issues or offering viable solutions. Constructive dialogue requires an acknowledgment of the facts and a willingness to engage with the realities of the situation.

A comprehensive review and restructuring of capacity payments and the broader energy tariff regime is not just necessary but existential. The goal should be to align our energy costs with those of economies at a similar stage of development. This is critical to attracting investment, boosting industrial output, and increasing exports to address this dangerously unsustainable economic situation. Sustainable growth requires a stable, predictable, and competitive energy supply. This, in turn, fosters an environment conducive to investment, innovation, and growth.

Our stance is grounded in a vision for a prosperous, competitive, and economically stable Pakistan. We call for an open, fact-based dialogue involving all stakeholders to address these critical issues. The textile industry stands ready to work collaboratively towards a more efficient and equitable energy sector that serves the best interests of the entire nation.

Export Ambitions vs Economic Realities

By Shahid Sattar and Absar Ali

While the Government is seeking a 100% increase in exports over the next three years, maintaining even the current level would be miraculous given current economic policies that fail to promote industrialization or exports.

Last week a high-level committee began consultations on rationalizing import tariffs with a view to increase exports to $60bn. Simultaneously, the FBR undermined industrial competitiveness and exports by withdrawing the sales tax exemption on locally manufactured inputs for export manufacturing, disproportionately impacting SMEs, especially in upstream segments.

This sales tax does not impact a small number of large vertically integrated firms, providing them with an edge over many unintegrated firms staggered across the value chain. It also makes duty-free and sales tax-free imports of the same inputs through the Export Facilitation Scheme more attractive than local procurement as unintegrated firms in downstream segments must now pay sales tax on the latter and wait several months for it to be refunded, if at all. That the EFS does not extend across multiple stages of the value chain, combined with existing and fresh import duties including 2% additional customs duty on all 0% base tariff goods, reinforces this as enterprises in upstream segments, like yarn and cloth manufacturers, cannot import duty-free inputs since their products go through multiple stages of production before reaching the final exporter.

This follows SRO 350(I)/2024 that requires linking up the entire supply chain to file sales tax returns, conditioning them on compliance by upstream suppliers. Firms are blocked from filing their returns on time due to upstream suppliers’ non-compliance, resulting in sales tax already paid by them to be disregarded and incurring substantial penalties. Government-owned entities in the energy sector top this list, frequently delaying filing and preventing their consumers from doing the same. The rule has cascading effects; when a buyer cannot file their return, their customers also cannot claim input sales tax, leading to further delays. Despite persistent requests and the Prime Minister’s assurances, the FBR is yet to address these issues.

Then comes the energy sector; one of the most significant factors contributing to the low competitiveness of Pakistan’s textile industry, and overall manufacturing, is the prohibitive cost of energy. While the government took an appreciable step to reduce cross subsidies embedded in industrial power tariffs by around Rs. 150bn, they have not been eliminated entirely. Simultaneously, unutilized capacity costs in the power tariff have ballooned so much that for the upcoming year industrial power tariffs will range between 15-17 cents/kWh compared to 6-9 cents/kWh in competing economies.

The same disparity exists in gas/RLNG prices, with gas supplied to industry in Bangladesh, for example, costing as low as $7.4/MMBtu, while rates for Pakistani industry are as much as $14/MMBtu. While on one hand the government is reducing cross subsidies in power tariffs, on the other, RLNG consumers are being subject to a Rs. 50bn cross subsidy to the fertilizer sector, increasing the cost of gas supplied to industries. There are also ill-advised and impractical plans to cut off gas supply to captive power plants by January 2025, despite the fact that the grid is in no position to supply the quantity or quality of power required by manufacturing units. This move will force them onto a financially unviable grid, leading to more closures and severe negative impacts on employment and the economy.

The textile sector—responsible for over half of the economy’s exports and employing up to 40% of the industrial workforce—has been struggling to compete internationally for the past two years as the sector’s exports have declined from $19.3bn in FY22 to $16.7bn in FY24. The government should be actively cutting down red tape and slashing expenditures to reduce the fiscal burden on the private sector and bringing manufacturing costs at par with international levels. Instead, it is continuously ignoring on-the-ground realities and going against economic fundamentals.

Comparisons with major competitors such as India, Bangladesh, and Vietnam highlight significant disparities in key input costs like energy and an overall high cost of doing business that erode Pakistan’s competitiveness in the international market. The minimum wage—an indicator of labour costs—is around $0.64/hour in Pakistan compared to $0.55 in Bangladesh, $0.68 in India, and $1.59 in Vietnam. While Pakistan enjoys relatively competitive labour costs, this does not offset the high energy costs and other inefficiencies. Moreover, the lack of investment in skill development and technological advancements means that Pakistani labour is less productive compared to its counterparts in these countries.

Similarly, while Pakistan has an advantage with domestic cotton production over countries like Bangladesh, its yield and productivity are low and there are serious quality issues that make it unfit for export without mixing with higher quality imported cotton. These productivity and quality gaps further exacerbate the uncompetitiveness of Pakistan’s textile industry.

To add to these challenges, the budget has increased the tax on export proceeds from a 1% fixed tax regime to 2% advance tax on export proceeds, adjustable against a 29% tax on profits plus a 10% super tax. Not only is this significantly higher than regional benchmarks, the advance tax increases cost of compliance and dries up liquidity in low-margin high-volume businesses like textiles, leaving no space for working capital or reinvestment.

In contrast, regional economies offer a highly favourable environment for exporters. In Bangladesh, export-oriented industries are eligible for exemptions from income tax for up to 50% of their earnings and preferential income tax rates of 10-12%. India provides substantial incentives as well, including rebates of state and central taxes and levies for exporters, rebate of up to 3% of the turnover of new export-oriented units and R&D finance for up to 80% of project costs. Vietnam’s policy environment is similarly favourable, with lower corporate tax rates and extensive support for export enterprises.

The financial support available to exporters in Pakistan is inadequate and prohibitively expensive compared to its competitors as caps on financing schemes like EFS and LTFF have not been increased despite repeated demands from the industry. Bangladesh offers 15% cash credit for pre-shipment expenses and post-shipment finance at 50-80% of the Letter of Credit (L/C) value. India provides pre- and post-shipment working capital financing through foreign exchange accounts and term loans for capital expenditures.

Vietnam and India also facilitate long-term financing for the acquisition of plant machinery and ancillary equipment. In contrast, Pakistani manufacturers face high benchmark interest rates at 20.5%, significantly higher than the 8.5% in Bangladesh, 6.8% in India, and 5.3% in Vietnam. While TERF was successful in supporting the upgradation and expansion of production capacity across the industry, much of this investment was never operationalized due to unviable energy and other operational costs.

India and Bangladesh also have more favourable policies regarding the import of raw material and intermediate inputs, offering lower import duties and other support to their textile and apparel sectors. Vietnam has signed multiple free trade agreements (FTAs) that allow for duty-free import of raw materials, significantly reducing production costs. In contrast, Pakistan imposes a 5% and 7% import duty in addition to up to 12% anti-dumping duty on imports of purified terephthalic acid and polyester staple fibre, basic raw material for man-made fibre-based products, to protect select inefficient manufacturing facilities that keep domestic PSF prices around 20% above the international market.

The result of these disparities is that Pakistan has seen its exports, as well as the domestic value addition in exports, plummet. According to the PBS, yarn production is down by ~30% compared to FY22 and cloth production by ~20%. Importing intermediate goods has become cheaper than procuring the same domestically due to increasing costs and tax and compliance burden, as evidenced by a dramatic surge in imports of cotton yarn, up seven times from 2 million KG in July 2023 to 14 million KG in May 2024, because the basic textile industry cannot compete—even in the local market—and is thus being wiped out.

These trends have serious economic implications. The economy has an annual foreign exchange shortfall of over $25bn. Any reduction in exports or domestic value addition in exports exacerbates this shortfall. The country desperately needs higher exports with significant domestic value addition to meet its foreign exchange requirements. Furthermore, Pakistan has a large, young, and unskilled population that needs employment opportunities to escape poverty. Manufacturing export-led growth represents the only viable solution for addressing these issues and avoiding a major social and political catastrophe.

Yet, the FY25 budget fails to prioritize the growth of this important sector and has significantly increased the challenges facing it, further diminishing its ability to compete internationally. To expect the manufacturing base and exports to increase and the economy to grow under these circumstances is purely unrealistic; even maintaining the current level of exports would be miraculous.

To turn the tide around, a major reorientation in policies, reduction in energy costs, and a holistic export-focused strategy are essential.

By Shahid Sattar and Absar Ali

Ten days into the new fiscal year, the FY25 budget is already in disarray.

Amid calls for a nationwide strike, the turnover tax on petroleum dealers was reversed. This was followed by a strike from the All Pakistan Flour Mills Association against newly imposed taxes, while the newly formed Salaried Class Alliance is on the streets Monday through Friday.

After two years of severe economic hardship, the public expected relief and a fairer redistribution of the tax burden. What it received is the exact opposite.

The “tax to GDP ratio” has become a strange obsession, demonstrating a lack of direction, and the government’s unwillingness to reduce its own wasteful expenditures and address structural flaws that have plagued the economy for decades. This is reinforced by the fact that while the tax to GDP ratio is frequently referred to, we never hear about the government expenditure to GDP ratio.

It needs reminding that the tax to GDP ratio is little more than a symptom, not a cause, of deep underlying problems that remain unaddressed to safeguard the ruling elite’s interests. In the same breath where a crushing burden of taxes was announced for the public, and private sector enterprises, there was no reduction in government expenses. Instead, only an increase in allowances and exemptions for the state’s own employees.

Perhaps the state of the country is best explained by the fact that a 30-year-old Assistant Commissioner must use a Rs. 20 million vehicle, accompanied by three guards and two clerks—one to carry his water bottle, another to hold an umbrella over his head—to investigate whether vegetable vendors on the poverty line are overcharging Rs. 20 on a kilo of tomatoes.

Economic growth and public trust are crucial for improving the tax to GDP ratio, and the FY25 Budget misses the mark on both. The World Bank estimates that around 40% of Pakistan’s population lives below the poverty line, with 96% at subsistence level. This indicates a limited capacity for the majority to contribute to the government’s wasteful expenditures and need for boosting incomes to increase revenue collection.

Around 20% of Pakistan’s GDP comes from agriculture, 20% from industry, and 60% from services, of which 20% is wholesale and retail trade. Yet, agricultural income and retailers remain excused from contributing their fair share. This means the government wants to extract taxes worth 15% of GDP from only 60% of GDP, effectively subjecting 40% of GDP to no taxes while the remaining 60% are subject to 25%. While reality is more complex, this simple illustration demonstrates the incentives created for capital and human resources to exit more productive tax-ridden sectors for less productive under-taxed sectors. The result is that the share of GDP that is relatively tax-free will increase, while that being taxed will decrease, leading to an overall reduction in the tax to GDP ratio.

Effective tax policy must be guided by long-term development priorities and a vision for growth. It has been repeatedly emphasized that the lack of productive capacity is the country’s most pressing issue. Because domestic production is neither sufficient to meet domestic demand nor enough to generate exportable surpluses to meet import requirements, there is a persistent shortage of foreign exchange and surplus demand that leads to repeated episodes of devaluation and inflation.

Of the $30.65 billion exported in FY24, about one-third is by only 100 top firms, most of which are in the textile and apparel sector. Moreover, the 10.5% increase in exports compared to the abysmal performance last year is largely due to an increase in exports of unprocessed foods driven by external circumstances. Compared with FY22 exports declined by 6%, with textile exports down 15% from $19.3 billion in FY22 to $16.7 billion in FY24. There is also a reduction in the share of domestic value added as basic industry producing yarn, cloth and other inputs has been wiped out due to prohibitive energy, borrowing and other operational costs, with yarn imports having surged seven times from 2 million KG in July 2023 to 14 million KG in May 2024.

Given these realities and that the country’s gross external financing requirements stand at over $25 billion annually for the next five years, the ratio we should worry about is the export to GDP ratio.

At around 10%, Pakistan has the lowest exports-to-GDP in the region, with Bangladesh at 13%, Sri Lanka at 20%, India at 22%, and Viet Nam at a whopping 94%. In view of these horrid numbers, the government should have prioritized and incentivized productive export-oriented activities with a focus on increasing domestic value addition in exports. Instead, the 1% fixed tax on export proceeds has been changed to a 2% advance tax on turnover adjustable against a 29% tax on profits, not only raising the rate but also adding to the cost of compliance.

To make matters worse, the sales tax exemption on local supplies for export manufacturing has been withdrawn because—according to the Chairman FBR—audits revealed that five companies, out of around 1800 beneficiaries, had misused it. Because the FBR’s incompetence does not permit increased checks and balances, it decided to resort to collective punishment and do away with the entire program instead.

The sales tax exemption on local supplies for export manufacturing was valuable trade facilitation that ensured a level playing field for domestic manufacturers of raw material and intermediate inputs, primarily benefiting SMEs. Its withdrawal removes all incentives for exporters to use domestically manufactured inputs and will cause a further reduction in domestic value addition in exports. These policies are akin to providing protection to imported inputs by making domestically manufactured inputs significantly more expensive.

And it doesn’t stop there; 0% base tariff goods, including critical inputs for textile and apparel manufacturing that are either not produced domestically or in insufficient quantities to meet industry demand, have been slapped with an additional customs duty of 2%. Like the withdrawal of the sales tax exemption, this too will have a disproportionate impact on basic industries, especially SMEs.

Very few firms possess full vertical integration, and the benefits of duty-free import for export EFS do not extend across the entire value chain. For instance, a spinner cannot import under EFS because the yarn they manufacture goes through several stages of value addition—such as weaving, processing, and dyeing—before reaching the final exporter. Despite persistent efforts for a multi-stage EFS with a robust traceability system, it has been actively sabotaged by the FBR.

One of the textile and apparel sector’s main challenges is that around two-thirds of its exports are cotton-based compared to only one-third of international textile and apparel trade. Diversification of exports towards man-made fibre-based products is essential for the industry’s growth and the imposition of the ACD on synthetic/artificial fibres not produced domestically, and the failure to rationalize duties on purified terephthalic acid and polyester staple fibre will prove severely detrimental towards this goal.

When, consequently, investment is diverted from productive export-oriented activities towards less productive and less taxed agriculture and real estate, the same voices will complain that savings aren’t being utilized towards productive activities and that tax collection is not increasing, while conveniently ignoring the fact that it is their tax policies that incentivized such behaviour in the first place.

There is an endless list of regressive measures that the Finance Act 2024 has imposed in hopes of increasing the tax to GDP ratio. However, the two most essential ingredients for this recipe are fostering economic growth and building public trust; the budget fails to achieve either. Instead, it only perpetuates a cycle of fiscal mismanagement and public disillusionment.

Without addressing the underlying structural issues, incentivizing productive activities, and ensuring equitable tax policies, the government is merely setting the stage for further economic decline. The current budget is not a roadmap to recovery but a prescription for continued doom and gloom.