By Shahid Sattar | Sarah Javaid
The EU’s Carbon Border Adjustment Mechanism (CBAM) is now a pressing challenge for exporters worldwide. By pricing the carbon content of imports, CBAM ensures companies outside the EU face the same climate costs as European manufacturers under the EU Emissions Trading System (ETS). It is a key part of the EU’s goal to be carbon neutral by 2050, preventing “carbon leakage” ensuring that all carbon emissions – regardless of origin – are equally penalized.

In its first phase (2023–2025), the CBAM targets high-carbon sectors such as iron, steel, cement, aluminum, and fertilizers. However, from 2030 onwards, textiles are expected to be included, posing serious implications for textile manufacturing countries.

While textiles are not as energy-intensive as the sectors currently covered under CBAM, the policy could still undermine Pakistan’s export competitiveness given the dependency on textile export revenue.

With the EU as Pakistan’s largest export market and textiles as its major export, future market access will increasingly depend on the carbon footprint of Pakistani goods. Given the price-sensitivity and highly elastic nature of textiles, even marginal cost increases from carbon tariffs could lead to a noticeable drop in demand.

For Pakistan, the risk of losing competitiveness is especially urgent due to three interrelated structural challenges in its industrial sector.

First, industrial emissions in Pakistan have steadily risen over the past five decades, driven by a growing reliance on coal. This shift could make the country’s manufacturing base increasingly carbon-intensive and less competitive in a climate-conscious global market.

Second, Pakistan is a net importer of carbon emissions – an often overlooked aspect of its climate profile. The carbon embedded in imported raw materials and intermediate goods adds to the emissions footprint of its export value chains, inflating the overall carbon intensity of its final products.

Third, recent energy reforms – such as the gas levy and the proposed CPP levy legislation under IMF conditionalities – appear designed to push industries away from cleaner, gas-based self-generation toward the more carbon-heavy national grid, risking an increase in emissions per unit of output.

Together, these trends not only raise Pakistan’s exposure to CBAM-related costs but also risk non-compliance with international climate obligations under the UNFCCC, the Paris Agreement, and Sustainable Development Goals (particularly SDG 7 on clean energy and SDG 13 on climate action).

In an era where climate standards are becoming a precondition for access to global markets, Pakistan’s energy trajectory – marked by rising emissions, imported carbon, and coal reliance – could undermine its export competitiveness and expose it to carbon and trade penalties if left unaddressed.

Coal reliance and accelerating carbon emissions in Pakistan:

Pakistan’s emissions profile underscores the urgent challenge ahead. Coal power, which accounts for 40% of the country’s energy mix, is a significant contributor to rising emissions. Despite its environmental costs, Pakistan remains heavily reliant on coal imports due to its low cost and CPEC-linked investments that have deepened this dependence.

However, this reliance clashes with the global shift toward carbon accountability. Over the past five decades, carbon emissions from industrial processes in Pakistan have increased at an average annual rate of 5.3%, signaling not only sustained but accelerating carbon intensity in domestic production (see figure 1).

Pakistan as a net importer of carbon:

Importantly, Pakistan’s carbon challenge extends beyond domestic emissions. As a net carbon importer, much of the emissions embedded in its exports come from imported raw materials and machinery, particularly from high-emission economies like China (figure 2). This outsourced carbon, combined with rising local emissions, could make Pakistan’s supply chains carbon intensive – a situation that should be avoided at all costs.

Since CBAM taxes emissions across the production process, Pakistan’s status as a net carbon importer heightens the vulnerability of its exports. In contrast, regional competitors like Vietnam, China, and India are net carbon exporters (figure 3), shifting their emissions abroad. For instance, Zhang and Chen (2022) find that over 6% of China’s exports contain carbon transferred to other Belt & Road Initiative countries, most of which are net carbon importers. Pakistan’s growing reliance on Chinese inputs raises the embedded emissions in its textile exports – thereby potentially eroding Pakistan’s price competitiveness in major markets.

Policy paralysis:

Recent IMF-backed energy reforms further compound this challenge. At the center is the CPP levy, which taxes gas supplied to industrial captive power plants (CPPs) and is set to rise incrementally to 20% by August 2026, over and above grid parity.

Intended to shift industrial demand to the national grid, this policy has unintended climate consequences. By making gas costlier, it pushes manufacturers toward cheaper but dirtier fuels – primarily coal – undermining Pakistan’s climate targets and increasing emissions per unit of output just as global buyers tighten carbon-related standards.

While this levy may force some additional units to shift to the grid, its overall impact remains marginal, as gas/RLNG consumption has already declined by 75% due to prohibitively high OGRA-notified prices.

The long-term costs are steeper: elevated emissions, rising industrial energy costs, and greater exposure to carbon border taxes. With more trading partners adopting carbon accountability frameworks, Pakistan stands to lose billions in export revenues unless it aligns its industrial energy policy with global climate goals. While the IMF has recently proposed a domestic carbon levy for Pakistan, the detailed framework is yet to be developed.

Potential violation of international conventions:

The implications extend beyond trade and competitiveness. Increased coal use driven by distorted energy pricing risks violating Pakistan’s international commitments.

As a signatory to the United Nations Framework Convention on Climate Change (UNFCCC), and the Paris Agreement, Pakistan is obligated to reduce emissions by 20% by 2030 and transparently report its progress. Increased reliance on coal will spike carbon emissions, drawing international scrutiny and weakening Pakistan’s credibility in climate negotiations. It also risks non-compliance with the EU’s GSP+ scheme, where upcoming monitoring missions – such as the one expected in June – assess adherence to environmental commitments.

More broadly, continued coal dependency clashes with the global shift toward Environmental, Social, and Governance (ESG) standards under WTO frameworks, increasing the risk of non-tariff barriers and reduced market access. It also undermines Pakistan’s progress toward Sustainable Development Goals—particularly SDG 7 (Affordable and Clean Energy) and SDG 13 (Climate Action) – and threatens the country’s broader 2030 development agenda.

CHPs for industrial decarbonization:

To avoid the rising costs of carbon non-compliance and trade penalties, Pakistan must urgently reorient its industrial energy strategy. The path forward lies in smartly integrating renewable energy with gas-based Combined Heat and Power (CHP) systems. CHP offers a low-carbon, flexible solution capable of stabilizing the intermittency of renewables like solar, while leveraging existing gas infrastructure.

Additionally, CHP engines can be integrated with solar PV and battery energy storage systems (BESS), creating a practical and scalable route to decarbonize industrial energy use while reducing dependence on imported coal.

These systems also extract maximum economic value from gas molecules by simultaneously generating electricity and useful heat.

In this context, gas and RLNG emerge as essential bridge fuels – classified as cleaner technologies – that can complement renewables and enable the transition to a low-carbon industrial base. Aligning with this strategy not only supports compliance with CBAM but also helps uphold Pakistan’s international climate commitments by lowering industrial emissions.

When reforms backfire:

However, while the need for decarbonization is clear, current policy measures are pulling in the opposite direction. The growing disconnect between Pakistan’s energy reforms and its climate obligations must be urgently addressed to preserve the country’s industrial future.

The objective of the IMF-backed policy – aimed at maximizing grid usage to lower tariffs by increasing consumption and spreading fixed costs over a broader base – has failed to materialize. Instead, frequent outages and rising costs have pushed consumers toward solar and industries toward alternative fuels like RFO, coal, and biomass.

What persists is an unreliable and unsustainable national grid, burdened with massive stranded costs. If these issues are not urgently resolved, they could lead to a permanent loss of industrial competitiveness and severe environmental consequences.

Meanwhile, the combined circular debt of the gas and power sectors has already exceeded Rs 5 trillion (as of March 2025) – a figure that will only increase if reliance on the fragile grid continues, expensive RLNG is diverted to the household sector, and domestic oil and gas fields are shut down.

Too often, policies are crafted in isolation, overlooking their long-term consequences on industrial vitality and export growth. Yet, in a landscape where fiscal reforms are essential, sacrificing sustainable revenue streams like exports is a risk Pakistan can no longer afford.

Therefore, an open cost-benefit analysis is urgently needed for all policies that currently overlook social, environmental, and economic costs to end this policy disconnect before the consequences become irreversible.

By Shahid Sattar | Sarah Javaid
Pakistan’s export sector is undergoing a seismic shift, one that will affect its competitive edge for years to come. The U.S. has imposed ‘reciprocal tariffs’ globally, including a 29% duty on Pakistan, as part of its protectionist policy.

The misaligned trade diplomacy – relying on the U.S. as its largest market for value-added exports while maintaining an intertwined supply chain with China – underscores how the 29% tariff is merely the first step toward a deeper economic pit that Pakistan risks falling into.

Structural inefficiencies – worsened by regressive taxation and ill-conceived energy policies – have already eroded Pakistan’s export competitiveness. This year marked a turning point when over 50% of Pakistan’s textile import bill was dominated by cotton and cotton yarn – a trend never seen before. Once a leading producer, Pakistan is now increasingly reliant on imports, with cotton yarn imports expected to surge nearly 200% and the cotton import bill projected to rise by over 50% this financial year. Together, these are projected to cost the economy a staggering $2.8 billion, with the combined total for cotton imports and textile intermediates reaching $4.4 billion.

While Pakistan sources the bulk of its raw cotton from the U.S. and Brazil, over 60% of its cotton yarn imports – cheaper than domestic yarn – now come from China, raising concerns over potential dumping and associated compliance risks.

As we officially enter the global trade war, beyond tariffs, another non-tariff threat looms: the potential for a U.S. ban on Pakistani exports.

In 2019, the U.S. banned Chinese cotton from Xinjiang over forced labor concerns, extending restrictions to any product containing Xinjiang cotton, regardless of origin.

However, through strategies such as China Plus One, transshipment, and third-country exports, China has sustained its presence and deepened its hold on the global textile supply chain. In 2024, China exported $3 billion worth of cotton intermediates to eight South Asian countries, including Pakistan, accounting for 30% of its $10.8 billion global exports in this segment.

While Pakistan didn’t directly benefit from China Plus One, it has become a key market for cheap Chinese textile intermediates, including knitted and woven fabrics, filament yarn, and cotton yarn.

Despite U.S. policies and growing supply chain scrutiny, Pakistan remains one of the largest importers of Chinese cotton yarn. And this is where the fire begins.

Pakistan’s Trade Dilemma – Cheaper Imports from China and Compliance Risks:

With a sharp decline in local cotton production, Pakistan has increasingly turned to cotton imports from the U.S. and Brazil, which now account for over 60% of total imports. In fact, Pakistan is the second-largest importer of U.S. cotton.

Simultaneously, the country has become the top importer of cotton yarn from China. This shift has strained the local spinning industry and at the same time introduced compliance risks, particularly due to the potential inclusion of Xinjiang cotton in Pakistan’s textile supply chain, especially in the absence of a traceability mechanism.

Since Xinjiang produces 87% of China’s cotton, China has redirected its (non-tradable) cotton toward textile manufacturing in response to U.S. bans. Additionally, it has implemented a tariff-rate quota system on cotton imports, ensuring that textile manufacturers primarily rely on Xinjiang cotton.

As the U.S. strengthens oversight of textile supply chains, any trace of Chinese cotton in Pakistani textile exports could result in bans in the US market for apparel.

The key question remains: What is driving Pakistan’s growing reliance on imported cotton yarn?

Price Disparities and the Absence of a Competitive Edge for Local Yarn:

The Chinese textile and apparel industry benefits from extensive subsidies. Under the Make in China initiative, the government has introduced over 900 subsidies to support local manufacturing.

In contrast, Pakistan’s textile sector faces mounting challenges, particularly following the reversal of regionally competitive tariffs and the withdrawal of zero-rating on local supplies under the EFS scheme. Power tariffs have hit record highs of 12–14 cents per kWh (the highest in the region), and the price of gas for captive power plants has surged to Rs. 3,500/MMBtu, with an additional levy of Rs. 791/MMBtu. Beyond energy costs, the rising prices of other textile inputs have further undermined the competitiveness of yarn production in Pakistan, making it increasingly difficult to compete with cheaper, duty-free Chinese imports.

China’s pricing advantage in textile intermediates is evident in its export rates. For most traded cotton yarn tariff lines, the prices offered to Pakistan are not only lower than those offered to Vietnam and Bangladesh (Table 2a), but also well below Pakistan’s domestic yarn prices (Table 2b). This cost edge enables China to maintain its competitiveness in the Pakistani market, while leaving Pakistani yarn manufacturers struggling to compete in a market distorted by cost disadvantages.

China’s Strategic Emphasis on Maintaining Low Production Costs:

The cost and pricing edge is no accident. China controls over 50% of global spinning capacity and 45% of fabric manufacturing, and in response to increasing global trade restrictions, it is doubling down on its domestic textile sector. Plans are underway to expand spinning capacity in Xinjiang and raise the cotton-to-textile conversion rate from 40% in 2024 to 45% by 2028. Generous subsidies for transporting cotton from Xinjiang to central and eastern provinces further reduce production costs and incentivize yarn manufacturers.

With this level of government support and massive economies of scale, China is able to export yarn and other intermediates at competitive prices – often lower than the prevailing prices in importing countries.

Here the challenge for Pakistan is threefold: protecting its local industry from potential dumping, managing compliance risks tied to increased dependence on Chinese imports, and securing preferential access to key export markets, particularly the U.S. and EU, where Pakistan’s value-added textiles are primarily destined.

The Current State of Cotton Yarn Imports in Pakistan:

China’s competitive edge in yarn is also visible in Pakistan’s import patterns. The most traded cotton yarn import tariff lines in Pakistan account for 100% of imports from China, which were initially subject to an 11% MFN duty (Table 3a). However, under the 5th Schedule of Pakistan Customs, these duties were reduced to 5%, and the China-Pakistan Free Trade Agreement further lowered them to 4.2%.

Moreover, exporters can access duty-free yarn imports under the EFS scheme. The combination of low export prices and 0% duty has made Chinese yarn highly competitive in the domestic market – crowding out local production.

In contrast, peer economies such as India and Bangladesh have adopted a more defensive policy posture, protecting their local industries through higher duties on Chinese yarn as reflected in their respective customs schedules (Table 3b).

A Global Snapshot:

Under WTO rules, countries can impose anti-subsidy or countervailing duties to protect domestic industries from unfair price advantages created by subsidies from trading partners.

Recently, several countries have initiated anti-dumping investigations and imposed duties in response to unfair trade practices by China.

For example, the European Commission recently imposed anti-dumping duties (26.3% to 56.1%) on Chinese glass fiber yarn imports to protect 1,200 EU jobs and restore market competition. The investigation found that Chinese imports were harming local industry.

In December 2024, India launched investigations into the alleged dumping of nylon filament yarn and trimethyl dihydroquinoline (TDQ) from China, with potential recommendations for duties.

In September 2024, Turkey initiated an anti-circumvention investigation into synthetic staple fiber woven fabrics from Malaysia, suspecting that these imports were bypassing existing anti-dumping measures on China, as the share of Malaysian imports rose sharply in 2023 and 2024.

In June 2025, Malaysia announced provisional anti-dumping duties (6.33% to 37.44%) on polyethylene terephthalate (PET) imports from China and Indonesia.

Egypt also extended anti-dumping duties on Chinese synthetic fiber blankets, maintaining tariffs of 55% to 74% until August 2025 to prevent a surge of dumped products in its market.

Urgent Call for Government Intervention to Ensure Fair Trade:

Given the global trend of rising anti-dumping measures, Pakistan faces a similar threat to its domestic industry. With heightened trade restrictions on China from the U.S., such as increased tariffs and escalating non-tariff barriers, there is a growing risk of more dumping of cheaper textile intermediates, and local manufacturers risk being priced out of their own market.

The National Tariff Commission (NTC) has previously acted decisively – even imposing anti-dumping duties on relatively low-impact products like lead pencils from China. Today, the stakes are much higher, involving Pakistan’s largest export sector, millions of livelihoods, and billions in export revenue. With the margin for error narrowing, Pakistan must take urgent and well-calibrated action to safeguard its textile industry from unfair competition.

By Shahid Sattar | Sarah Javaid
After a challenging year in 2023, Pakistan’s value-added textile sector has demonstrated remarkable resilience in 2024. Export data reveals a return to pre-crisis performance levels, echoing the record-breaking achievements of 2022. At the outset of the current fiscal year, projections for textile and apparel exports estimated a range of USD 15-16 billion for FY 2025. However, the latest export figures suggest a potential recovery to the export levels seen in 2022.

As the current calendar year ends, a sneak peek at value-added textile exports during CY 2024 indicates a strong finish, reinforcing optimism that CY 2025 might at least match the record levels of 2022, if not outperform.

In order to ensure a better year for exports in 2025, key actions are needed, including continuing gas supplies to captive power plants, reversing the withdrawal of zero-rating on local supplies, reducing industrial power tariffs, and boosting domestic cotton production to safeguard net exports.

Textile Industry Performance: A Sneak Peek into the 2024 Calendar Year:

Pakistan’s total value-added exports (knitwear, woven garments, and home textiles), which saw a 15% decline in the 12-month CY 2023 compared to CY 2022, are expected to rebound with a year-on-year growth of 13% in CY 2024 as the year closes on a positive note for the downstream industry. A closer look at the numbers reveals that value-added textile exports have reached, or in some cases exceeded, the monthly levels seen in 2022. Knitted garments outperformed 2022’s record in October 2024 (Figure 1a), while woven garments and home textiles came close to matching their 2022 peaks (Figure 1b and 1c). Despite remaining below the USD 500 million mark per month, knitted garment exports show potential to surpass this threshold if the current growth trend persists.

The bullish trend in Pakistan’s value-added textile exports can be attributed to a mix of demand-side and supply-side factors, including rising demand from the West for compliant suppliers, increased orders driven by the weak performance of regional peers, and a global demand surge fueled by easing inflation in the US and Eurozone. If this momentum continues, Pakistan’s export growth could stay strong through 2025, further fueling the textile sector’s recovery and growth.

Global Trade is Projected to See an Uptick in 2025:

Meanwhile, WTO economists forecast a 2.7% increase in world merchandise trade volume in 2024, recovering from the -1.2% contraction in 2023. This rebound is primarily driven by declining inflation in Pakistan’s key export markets, the US and Eurozone. Lower inflation has enabled monetary easing, setting the stage for increased economic activity and demand for imports, which boosts the outlook for Pakistan’s textile exports in these regions.

Building on 2024’s momentum, the global trade outlook for 2025 is even more optimistic, with world merchandise trade projected to grow by 3.0%, despite challenges like regional conflicts and policy uncertainty. Asia is expected to lead global trade, with export growth of 4.7% and import growth of 5.1%.

These global trends present a significant opportunity for Pakistan’s export sectors, particularly value-added textiles, to sustain their growth in 2025. With knitted garments already surpassing 2022 export levels and woven garments and home textiles approaching their peaks, Pakistan’s exporters are well-positioned to capitalize on the global recovery, provided that supportive policies are enacted to maintain competitiveness and ensure long-term growth.

Did Pakistan’s Export Gain Ground Amid Bangladesh’s Setbacks?

While future demand for Pakistan’s exports from Western markets shows potential for growth, Bangladesh has also played a short-term role in driving Pakistan’s exports. Political unrest and labor disputes in Bangladesh caused some export orders, between December 2024 and March 2025, to be redirected to textile producers in Asia, including Pakistan. Although this redirection has provided short-term gains, other developments in Bangladesh could have long-term implications for Pakistan’s exports throughout 2025.

The Bangladesh Knitting Owners Association (BSCIC) has reported significant strain on the industry, with over 2,300 registered and unregistered factories struggling, many of which have closed in the past 18 months. An estimated 85% of BSCIC knit traders are operating at a loss. Bangladesh has already experienced a decline in knitted garment exports, dropping from USD 6.43 billion in the four-month period from July to October 2023 to USD 5.34 billion in the same period in 2024.

In contrast, Pakistan has demonstrated remarkable growth in value-added exports, with an overall increase of 21% during the same period (Figure 2a). This includes 19% growth in knitted garments, along with 25% and 20% growth in woven and home textiles, respectively, outpacing Bangladesh (Figure 2b).

Given that both Pakistan and Bangladesh share the same key markets for textile exports, this growth in Pakistan’s exports is particularly noteworthy and underscores its ability to perform well in 2025, contingent on protecting the full value chain and sustaining export momentum across all segments.

The grass isn’t always greener on the other side:

Although 2024 proved to be a strong year for downstream textile exports, it has been a setback for the upstream sector. Data indicates that Pakistan’s exports of cotton, cotton yarn, cotton cloth, and other intermediate goods are at their lowest in the past three years, even falling below 2023 levels. In 2022, exports of this group were valued at USD 3.5 billion, while in 2023, they decreased to USD 3.02 billion. However, in 2024, exports are expected to hover around USD 2.7 billion (Figure 3).

While value-added exports have driven overall growth, the decline in upstream textile exports may prevent total exports from reaching 2022 levels. Given this declining trend in exports of intermediate goods, total exports for CY 2024 are projected to reach USD 17 billion, with USD 13.4 billion from value-added textiles, USD 2.4 billion from intermediates, and USD 1.2 billion from other textile exports.

A Word of Warning—if the declining trend in intermediate goods’ production and exports continues due to withdrawal of zero-rating and rising energy costs, CY 2025 may not match even 2024 levels and could fall significantly below those of 2022.

As a result of these policy lapses, Pakistan is on the brink of facing an annual export loss of intermediates valued at USD 3 to 3.2 billion.

Based on our projections, value-added textile exports in CY 2025 are expected to remain consistent with CY 2024 levels, hovering around USD 13.3 billion (Figure 4a). However, the total export outlook hinges on the recovery of intermediate exports. If this downward trend continues, Pakistan’s total textile exports are projected to remain around USD 16.9 billion in CY 2025 (Figure 4b).

What Lies Ahead for Exports?

Amid declining inflation, the SBP has reduced the policy rate by 750 basis points since July 2024, bringing it to 13%, offering some relief to the strained business community. This follows a challenging period when Pakistan faced a record-high policy rate of 22% for 12 consecutive months (June 2023–July 2024), which significantly pressured businesses. This strain was further exacerbated by the 2024 budget, which shifted businesses from a fixed tax regime to the normal tax regime, resulting in a cumulative tax burden of 39%, including the super tax.

However, with total exports rising by 8.7% (July-Oct 2024), driven by growth in value-added textile exports, recent data indicates signs of recovery in economic activity. Nevertheless, given the policy volatility in Pakistan’s economic landscape, the future still remains uncertain.

Market Based Solution is the only Sustainable Solution:

To sustain the export momentum which is the only sustainable solution to Pakistan’s twin deficit problem, the government must foster an environment that promotes industrial activity rather than stifles it. Cutting gas supplies to Captive Power Plants is a counterproductive policy that not only jeopardizes textile manufacturing but also drives up gas prices for lifeline consumers, who have long benefited from cross subsidies provided by the industry.

Aligning Pakistan’s Policies with International Regulations through Traceability and Compliance:

Apart from addressing the power sector’s structural challenges, the government must prioritize enhancing Pakistan’s export competitiveness in international markets through compliance and traceability.

As textile value chains evolve, super-vendors – vertically integrated companies managing all processes across the value chain – are emerging as the future of global supply networks. Buyers are now seeking fewer, but more reliable partners, driven by rising trade tensions and ethical sourcing concerns.

Pakistan’s textile businesses are well-positioned to meet these demands, but their success depends on compliance with international regulations. To strengthen Pakistan’s position in global value chains, the government must operationalize the National Compliance Center and align with Western policies without any further delay. Traceability and adherence to environmental and labor standards must be ensured from cotton fields to finished garments, guaranteeing compliance at every stage and preventing the negative impact of ‘blaming and shaming’ on Pakistan’s textile exports.

Through establishing a comprehensive traceability plan, Pakistan will unlock a first-mover advantage in the region.

In conclusion, to sustain the export growth momentum of 2024 and beyond, securing competitive access to inputs—whether energy or raw materials—is crucial. Protecting all segments of the value chain is vital to avoid disruptions that could jeopardize overall export performance. Prioritizing compliance with international standards is equally important. The government must focus on export-led growth and sustainable solutions to fiscal mismanagement, rather than relying on short-term fixes.

As the current year comes to an end, the industry hopes for a policy-shock-free year and, most importantly, a Happy New Year for Pakistan’s export sector and overall economy.

Pakistan’s textile industry, a key component of the economy and a full-spectrum value chain, is unravelling under the weight of poorly conceived policies. The government frequently champions private sector-led growth in rhetoric, yet its actions are stifling competition and undermining the very firms they claim to support.

Instead of fostering market-driven progress, policies remain entrenched in short-termism and mismanagement, suffocating the private sector and driving Pakistan closer to economic collapse. The textile sector – a vital contributor to exports and employment—now finds itself in a crisis, its decline symptomatic of broader structural failures.

At the centre of this are two policy measures: the elimination of gas supply to captive power plants (CPPs) by January 2025 and the withdrawal of zero-rating for local supplies under the Export Facilitation Scheme (EFS). These decisions, taken under the guise of economic adjustments to meet IMF conditions, reflect a myopic focus on immediate fiscal concerns rather than the long-term health of Pakistan’s industrial base.

From cotton farming to spinning, weaving, and garment production, Pakistan is one of only three countries with a full textile value chain that supports an entire ecosystem of employment, sustaining millions of livelihoods and billions in revenue.

However, this value chain is fragmenting thanks to short-sighted policies that actively exacerbate the challenges faced by this sector.

The removal of zero-rating for local supplies under the Export Facilitation Scheme has hit upstream segments of the textile industry – such as spinning and weaving – particularly hard. These segments, critical for creating intermediate goods used in finished textile products, now face an 18% sales tax, while imported inputs remain duty-free and exempt from sales tax.

This imbalance creates an uneven playing field, making imported inputs cheaper and more attractive than domestically produced goods.

The consequences have been immediate and dire: domestic yarn production fell by 40% year-on-year in 2024, while yarn imports surged to an unprecedented 27 million kilograms in November 2024, up 391% YoY.

The resulting erosion of local manufacturing capacity has destabilized the entire value chain, jeopardizing jobs, exports, and the trade balance.

Compounding this problem is the inefficiency of the sales tax refund system, which has failed to provide exporters with timely and adequate reimbursements.

Refunds, legally required to be processed within 72 hours, are often delayed by six months or more. Exporters typically recover only 60% of their claims, according to the World Bank’s 2022 Country Memorandum.

These delays and partial refunds add an additional interest cost of 10-15% to working capital required for procurement of intermediate inputs made in Pakistan, eroding competitiveness and forcing exporters to substitute domestic inputs with imports to avoid cash flow constraints.

While recent months have seen a modest increase in textile exports of approximately $200 million, this is concentrated in a handful of large companies and attributable to a low base effect from when Pakistan’s economic crisis was at its peak last year.

It does little to offset the broader challenges and financial unsustainability facing the industry and economy. In fact, the limited progress underscores the fragility of the sector, as critical segments of the value chain continue to face deindustrialization, threatening its long-term viability.

If the government genuinely aspires to foster private sector-led growth, it must offer the private sector breathing space it so desperately needs.

One way forward would be to adopt a progressive sales tax structure akin to India’s model. This system applies a graduated tax rate of 5-12% on raw materials and inputs as they progress up the value chain, with final consumer goods taxed at the higher rates of 12-18%.

Such a structure not only ensures robust revenue collection under the value-added GST regime—where input taxes are fully refundable—but also provides a fairer, more efficient tax framework that bolsters local industries.

By aligning taxation policy with industrial development goals, this approach would safeguard domestic producers while maintaining fiscal discipline.

Energy policy missteps are another major source of the crisis. The decision to eliminate gas supply to captive power plants reflects a fundamental misunderstanding of Pakistan’s energy and industrial dynamics.

Captive power plants, which many industries rely on, provide a stable and cost-effective alternative to the national grid, which is both expensive and unreliable.

Grid electricity costs in Pakistan range from 14–16 cents/kWh, significantly higher than the 5–9 cents/kWhin regional competitors like China, Bangladesh, India, and Vietnam.

Moreover, the grid is plagued by frequent interruptions, voltage fluctuations, and frequency instability, rendering it unsuitable for precision industries such as textiles.

The government argues that diverting gas from CPPs to the grid will optimize resource allocation and improve efficiency. Yet this rationale fails to account for the efficiency of CPPs, particularly those using combined heat and power systems, which operate at 80–90% efficiency.

In contrast, government-run RLNG plants achieve net efficiencies of just 40–52%, as the grid suffers from substantial transmission and distribution losses. Forcing industries to rely on the grid would not only increase their costs but also destabilize their operations, pushing many firms toward closure.

The cumulative effects of these policies threaten a cascading collapse of the textile value chain.

As spinning mills shut down due to exorbitant energy costs, weaving units are next in line to fail. This domino effect will ripple through the entire sector, crippling the cotton sector, destroying livelihoods, and plunging the economy into deeper instability.

The textile sector, which accounts for $3–6 billion in annual exports, is vital to Pakistan’s foreign exchange earnings. Its collapse would exacerbate an already precarious balance of payments crisis, further depleting foreign reserves and undermining economic stability.

The broader energy landscape of Pakistan is a result of decades of mismanagement and inefficiency. Circular debt in the gas and power sectors now exceeds Rs. 5 trillion, a testament to years of poor governance, unrealistic pricing models, and unplanned capacity additions.

The decision to eliminate CPPs is emblematic of this broader failure, conflating systemic issues with short-term fixes that only exacerbate inefficiencies. Instead of addressing the root causes of circular debt and grid inefficiency, policymakers are imposing measures that threaten to dismantle the very industries that underpin the economy.

To provide industrial sectors with competitively priced energy and allow them to compete in international markets, Pakistan must adopt a comprehensive, market-driven approach that prioritizes efficiency and transparency.

The continuation of RLNG supply to industrial self-generation facilities is essential, with measures to ensure ring-fenced RLNG pricing for stability, rationalized unaccounted-for-gas (UFG) rates in line with actual UFG of RLNG consumers, and the elimination of cross-subsidies that force industries to subsidize gas consumption in other sectors like fertilizer.

Additionally, industries must be granted the right to import their own RLNG, with transmission and distribution facilitated through wheeling on the Sui companies’ network. This would enable greater flexibility and reduce dependence on an inefficient centralized system.

Further reforms should grant industries the right to establish bilateral contracts with local gas fields, consistent with government policies that allow third-party access to 35% of domestic gas resources from new discoveries.

In the power sector, the operationalization of the Competitive Trading Bilateral Contracts Market (CTBCM) is imperative, enabling industries to engage in B2B contracts for power procurement.

This must be supported by rational Use of System and wheeling charges that exclude cross-subsidies and stranded costs. Such a framework would ensure access to competitively priced electricity while adhering to international environmental regulations and supporting net-zero targets.

Particularly, the distinction between gas used for power generation and other industrial applications must end, as in-house power generation, often through cogeneration systems, is an integral part of the industrial process.

Many industries utilize cogeneration not only for power but also for heat, steam, and hot water, making energy an essential input to manufacturing. It is not the government’s role to dictate how this input is used within industrial premises. A uniform gas tariff for industry is not only fair but essential for sustaining industrial competitiveness.

Importantly, all these recommendations are grounded in market principles without any reliance on subsidies. They represent a clear pathway toward creating an energy system that supports industrial growth while maintaining fiscal discipline.

By fostering a competitive, transparent, and market-oriented energy framework, Pakistan can provide its industries with the tools they need to drive economic recovery and sustainable development.

It is also important to address the flawed structure of the winter incentive package for incremental consumption that could otherwise be an excellent means to stimulate demand on the grid.

The package has been designed to fail as it is exceedingly complex and difficult for industrial consumers to comprehend and implement.

The estimated savings for the industry under the package amount to only 5-6%, which is inadequate for meaningful rejuvenation, particularly when savings are capped at 25% of incremental consumption over base units.

Power consumption among APTMA members was down by approximately 40% YoY in October 2024, and 60% compared to the year before, with similar trends in other LSM industries.

To benefit from the incremental package in its current form, industries must first recover their reduced consumption to previous years’ levels, which is calculated based on the 50-30-20 weighted average of the past three years for the same month. After this, they are required to increase power usage by an additional 25% to fully maximize benefits.

This mechanism is highly unrealistic, as increasing power consumption is tied to manufacturing demand, which depends on confirmed orders. Scaling up production also involves significant costs, including labour and other overheads, which far outweigh the limited relief offered by the 25% incremental savings.

The 25% cap on incremental consumption is also unnecessarily restrictive. Current demand remains highly suppressed due to skyrocketing tariffs over the past two years, meaning the tipping point for higher generation costs is still far off. Removing the cap would allow industries greater flexibility to benefit from the package.

Furthermore, the proposed Rs. 26.07/kWh tariff is misaligned with actual marginal generation costs, which, based on expected winter demand levels of 8,000-13,000 MW, is closer to Rs. 17/kWh.

The higher tariff figure provided by CPPA-G appears inflated and fails to create a meaningful incentive for industries to increase energy demand on the grid. A revised tariff closer to Rs. 17/kWh would encourage significantly higher consumption and support the government’s energy demand and transition-to-grid objectives.

Bring Back Zero-Rating

By Shahid Sattar and Absar Ali

Should the government ensure implementation of sales tax at the point-of-sale, ~Rs. 293 billion in tax revenue could be collected from ~Rs. 1,620 trillion domestically retailed apparel in 2024.

Yet, it insists on maintaining a dysfunctional sales tax regime that creates supply-side distortions, erects barriers to competitiveness and causes the exchequer to lose out on a significant chunk of tax revenue.

Pakistan operates under a value-added General Sales Tax (GST) regime, where at each stage of production manufacturers pay 18% sales tax on the difference between the value of inputs and output, with refunds allowed for exported goods. This system entails a high cost of compliance, around 10%, for businesses in addition to the opportunity cost of tying up funds that could earn a return of ~20% if simply parked in the bank. The costs are even higher for SMEs which often lack the financial resources and technical expertise to manage these complex requirements.

It also imposes a high administrative burden on the FBR. Even if the cost of administration is roughly 10% of the collected amount, the fact that over 70% of sales tax collected from the textile and apparel sector has been refunded in recent years (Table 1) means that the net collection is minimal. This raises a critical question: why subject businesses to these prohibitive costs and excessive red tape and the FBR to such administrative expenses when the bulk of the amount collected is simply returned?

Table 1. Textile and Apparel Sector Sales Tax Collection (million PKR)

The point is further underscored by the fact that while the Sales Tax Rules 2006 mandate all FASTER refunds to be processed within 72 hours, the FBR only processes partial refunds once a month with a significant portion of claims being deferred for manual processing that can take several months and even years. And even then, according to a report by the World Bank, sales tax refunds are never made in full causing industry liquidity to become perpetually stuck with the government.

This creates a severe liquidity crunch in a sector already struggling with prohibitive borrowing costs and an overall shortage of financing, shifting billions of rupees from the industry to the FBR every month. At present, approximately Rs. 250 billion of the textile and apparel sector’s liquidity is stuck in deferred sales tax refunds and Rs. 35 billion in provincial tax refunds. Another Rs. 200 billion is stuck in FASTER refunds at any given time, taking the textile and apparel sector’s total liquidity stuck in the refund regime to around half a trillion Rupees. This trapped capital could meet working capital and reinvestment needs that would ultimately result in higher exports. Instead, firms have been forced to scale back operations, delay expansion, and pause research initiatives, resulting in sizable unrealized export earnings—a lifeline for an economy struggling with unsustainable foreign debt and debt servicing.

The sales tax regime also has a detrimental impact on the medium- to long-term growth and development of the industry. SMEs, prevalent across the textile and apparel value chain, are faced with an inherent disadvantage compared to their foreign counterparts as well as larger and vertically integrated domestic firms.

When sourcing domestically produced raw material and intermediate inputs, for instance, exporters must first pay sales tax and then wait several months for it to be refunded, if at all. Conversely, the same exporters can import duty-free and sales tax-free inputs under the Export Facilitation Scheme, making domestic procurement of the same much more expensive due to the costs associated with payment and (delayed) refunds of sales tax, as well as higher energy and other operational costs.

Effectively, the GST regime provides protection to foreign producers of raw material and intermediate inputs over domestic ones. The result is that domestic inputs in export manufacturing are substituted with imported ones, as evidenced by the dramatic surge in yarn imports from 2 million KG in July 2023 to 14 million KG in May 2024. Consequently, there is a significant reduction in the domestic value addition in exports and deterioration of the trade and current account balances.

Another significant issue is the disparity between a large number of unintegrated SMEs and a small number of large, vertically integrated firms. Pakistan holds a ~2% share in global textile and apparel trade, with exports totalling around $16.7 billion in FY24—nearly two-thirds of which come from only the top 100 firms. Facilitating the entry of new players and the growth of existing SMEs is crucial for expanding Pakistan’s market share, but the sales tax regime is a major hinderance to this.

A T-shirt manufactured by a large, vertically integrated unit, for instance, is much more cost-competitive because all stages of production—spinning, weaving, dyeing and processing, and garmenting—occur within the same facility, avoiding the payment of sales tax at each stage. Conversely, if the same T-shirt were to be manufactured by four SMEs performing the same tasks, they would have to pay sales tax at each stage, making the final product more expensive than that of the vertically integrated firm. This results in SMEs being outpriced in the market, creating barriers to market entry and firm growth, and giving larger existing players an inherent advantage over newer and smaller ones.

The excessive rate of the sales tax at 18% also incentives unscrupulous elements to engage in smuggling and double bookkeeping. While this is not prevalent in the export sector due to strict compliance and reporting requirements, the same is not true for domestically oriented sectors. In the domestic arena, unscrupulous elements might resort to under-invoicing, misdeclaration of goods, and other fraudulent activities to avoid the hefty tax. This not only undermines the tax revenue collection but also puts compliant businesses at a competitive disadvantage.

The significant tax differential creates an unlevel playing field, encouraging illicit trade and making it difficult for legitimate businesses to compete. Additionally, the administrative burden and costs associated with ensuring compliance can be prohibitive for smaller enterprises, further driving them towards such practices. The overall effect is a distortion of market dynamics, where unethical practices become more profitable than legal operations, ultimately leading to a loss of government revenue, market inefficiencies and reduced economic growth.

The cotton sector is a prime example of this. Ginners, responsible for separating cotton fibers from seeds (banola), are required to pay sales tax on sales of banola to farmers. This additional tax burden creates a financial disincentive for accurately reporting cotton production volumes. As a result, many ginners resort to underreporting their output to minimize tax liabilities (gol maal). This underreporting not only skews official production statistics but also reduces the overall tax revenue. Moreover, the distortion in data hampers effective policymaking and planning for the cotton industry. The informal market thrives as ginners and other stakeholders in the cotton value chain seek to avoid the sales tax, leading to decreased transparency and increased illicit trade.

The broader economic consequences of the current sales tax regime are far-reaching and severe. Compliant small and medium-sized enterprises (SMEs), which are the backbone of the textile industry, are being driven out of business, resulting in millions of job losses. This decline reduces government revenue and diminishes value addition in exports, exacerbating Pakistan’s external sector vulnerabilities. The reduced domestic production also increases reliance on imports, further straining foreign exchange reserves and worsening debt sustainability issues. Consequently, overall economic stability and growth prospects of the country are severely jeopardized.

To mitigate the detrimental effects of the current GST regime and support industrial sectors, especially SMEs, it is imperative to restore zero-rating on sales tax and reinstate SRO 1125. This will alleviate the liquidity crunch by eliminating the need for cumbersome and delayed refund processes, allowing businesses to maintain healthy cash flow and meet their financial obligations. Restoring zero-rating will also level the playing field for domestic manufacturers vis-à-vis their foreign counterparts, encouraging local production and reducing the incentive for smuggling and tax evasion.

Additionally, shifting to a sales tax on final goods at the point of sale will significantly reduce the FBR’s administrative costs. By moving to a simpler POS-based sales tax, the FBR can streamline its workforce, reduce redundancies and operational costs, and improve efficiency. This transition would not only ease the compliance burden on businesses but also enhance government revenue collection through a more straightforward and effective system. In 2023, for example, domestic apparel retail was valued at $6 billion or Rs. 1,668 trillion, according to STATISTA, while net sales tax revenue from the textile and apparel sector was only around Rs. 71 billion (Table 1, above). Had a final sales tax been collected at the point of sale rather than the current value added tax at each stage of production, it would have yielded Rs. 300 billion in tax revenues.

The urgency for reforming the sales tax regime cannot be overstated. Restoring zero-rating and implementing a point-of-sale sales tax system will not only alleviate the liquidity crisis strangling the textile industry, but is essential to boost domestic production, enhance export competitiveness and push the economy towards resilience and sustainability. The choice is clear: embrace reform and pave the way for growth or persist with a flawed system that stifles industrial sectors and undermines the country’s economic future.  

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:

Select Consumer Power Tariffs, cents/kWh
	Jul-19	Jul-24	Change
Residential (Unprotected) 0-100 Units	4.85	8.89	83%
Residential (Unprotected) 201-300 Units	7.63	15.27	100%
Residential ToU	11.25	18.49	64%
Commercial ToU	11.98	17.77	48%
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

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.