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.

 

 

By Shahid Sattar | Absar Ali

The turnover tax regime in Pakistan poses significant challenges for small and medium enterprises (SMEs), placing them at a disadvantage compared to vertically integrated firms.

Despite contributing around 40% of GDP, 25% of export earnings, and employing 78% of the non-agriculture labour force, according to the SBP, small and medium enterprises (SMEs) face numerous challenges that hinder their growth and development.

These include limited access to finance, as SMEs often struggle to secure financing due to stringent collateral requirements and high interest rates which limit their ability to invest in growth and innovation. Poor infrastructure, such as unreliable electricity supply and poor transportation networks, increase operational costs and reduce efficiency, especially in rural areas.

Many SMEs also suffer from inadequate management skills, leading to poor decision-making and inefficient operations. Complex and cumbersome regulatory requirements, often difficult to navigate for SMEs, further inhibit their growth. (Khan, Hussain & Afraz, 2013; Khan, 2022; Zeshan, 2023)

SMEs being large firms of the future, this is also one of the reasons Pakistan has very few large firms, and even these are relatively small by global standards. For instance, according to the Pakistan Export Directory, the largest exporter in 2021 exported goods worth Rs. 52 billion, the 10th largest Rs. 29 billion, and the 100th largest only Rs. 5 billion.

“Among these barriers, the turnover tax stands out as a significant impediment that disadvantages SMEs as compared to vertically integrated firms. The turnover tax in Pakistan mandates that all businesses, regardless of profitability, pay a minimum tax of 1.25% on their turnover.”

While this policy aims to create a uniform tax environment, it inadvertently imposes a heavier burden on SMEs due to the cumulative nature of the tax across multiple production stages.

When a single, vertically integrated firm manages the entire production process, the turnover tax is applied once on the final product. However, SMEs, which typically rely on multiple independent businesses for various production stages, face a different reality.

Each stage—from raw material processing to manufacturing, distribution, and retail—involves separate entities, each subject to the turnover tax on its revenue. This results in the tax being applied multiple times across the production chain, significantly increasing the overall tax burden on SMEs.

For example, in the textile industry, an SME might source yarn from one company, fabric from another, and finally sell the finished product. Each transaction between these businesses incurs the turnover tax, creating a compounding effect that does not affect a vertically integrated firm in the same way. This cumulative tax burden increases costs for SMEs, making their products more expensive and less competitive compared to those produced by integrated firms.

This compounded tax significantly hampers the competitiveness of SMEs. Vertically integrated firms, by consolidating all production stages, incur the turnover tax only once, resulting in a lower overall tax liability. SMEs, unable to vertically integrate due to financial and operational constraints, end up paying much higher cumulative taxes. This creates a market environment where SMEs struggle to compete on price and profitability, stifling their growth and innovation.

The financial strain imposed by the turnover tax also limits the ability of SMEs to reinvest in their businesses. With higher taxes eating into their margins, SMEs find it challenging to fund expansions, adopt new technologies, or enhance their workforce, further hindering their competitive edge.

To support the growth of SMEs and create a more equitable tax environment, several policy reforms can be considered. Implementing lower turnover tax rates specifically for SMEs can alleviate the compounded tax burden they face, helping them to price their products more competitively. Providing tax rebates or credits for SMEs that engage in multiple stages of production could further offset the cumulative effect of the turnover tax and encourage SMEs to expand their operations without facing prohibitive tax penalties.

Facilitating access to finance and resources for SMEs to achieve greater vertical integration can reduce the number of taxable events in the production process, while also fostering firm growth. Government programmes that support mergers and collaborations among SMEs are essential to achieve this goal. Introducing a graduated tax structure that imposes lower rates on the initial stages of production or for lower turnovers can also help reduce the overall tax burden on SMEs, making the tax system more progressive and fairer.

In conclusion, reforming the turnover tax policy is crucial to ensure that SMEs have a fair chance to compete with vertically integrated firms. Addressing the inherent disadvantages posed by the current tax system will not only support the growth of SMEs but also drive economic diversification, innovation, and employment. By creating a more equitable tax environment, Pakistan can unlock the full potential of its SME sector, fostering a more dynamic and robust economy.

By Kamran Arshad

As Pakistan prepares for a significant increase in electricity prices next year, driven by further rupee devaluation and capacity payments of over Rs 2.1 trillion, addressing these issues that have bogged down the entire economy has become a question of survival. One of the biggest contributors to prohibitive power tariffs is the heavy burden of capacity payments of over Rs 2.1 trillion per annum, which necessitates an urgent action.

Pakistan’s energy sector has long been entangled in flawed contractual arrangements with Independent Power Producers (IPPs). These contracts, dating back to the Power Policy of 1994, were intended to resolve the energy crisis by attracting private investment. However, the terms of these agreements have led to a spiralling circular debt, reaching Rs2.64 trillion as of February 2024.

The incentive structures offered to IPPs, including guarantees indexed to the US dollar, mean any depreciation of the Pakistani rupee increases returns for IPPs and places a heavier financial burden on the government. Initially, the return on equity for IPPs was set at 18%, later reduced to 12% in the Power Policy of 2002, but it remains high compared to global norms.

Additionally, cost comparisons with similar projects in other countries suggest that many IPPs were funded through over-invoicing on capital goods, resulting in no “real” underlying equity. Consequently, Pakistan is burdened with perpetual returns on ghost equity. An analysis of various published accounts and balance sheets further reveals that actual dollar-based returns to many IPPs exceed 70%.

Additionally, the government’s decision to incorporate residual fuel oil (RFO) plants, known as Peaker plants, to boost base capacity has proven problematic. These plants are inefficient, costly to operate, and environmentally unfriendly.

While the inclusion of Peaker plants is not inherently problematic, their disproportionate share in Pakistan’s energy mix, currently at 14%, is concerning. Globally, these plants typically operate during peak demand periods and constitute a maximum of 4-6% of total consumer bills.

Pakistan has an installed capacity of approximately 44,943 MW, with a huge disparity between a base-load of around 12,500 MW and summer peak load of around 30,000 MW due to shifting of winter heating loads to gas.

However, due to contractual obligations, the government must pay for the entire installed capacity year-round, regardless of utilization. In contrast, global grid planners operate some plants solely during peak demand periods, paying only when the capacity is actively utilized, while Pakistan’s generation mix is heavily skewed towards take-or-pay base-load plants.

There are two main types of energy contracts: take-or-pay and take-and-pay. Pakistan operates under a take-or-pay contract system with IPPs, where a fixed percentage of their capacity must be purchased regardless of actual demand.

This setup can be unfavorable for buyers, as they must pay for electricity up to the contracted capacity, leading to increased unit costs. In contrast, take-and-pay contracts involve buyers paying solely for their electricity consumption, though this can lead to higher prices due to negotiation or competitive buying.

The tariff structure in IPP contracts also raises issues. Consumer tariffs include various components like Energy Purchase Price (EPP), Capacity Purchase Price (CPP), T&D losses, Distribution and Supplier Margin, and prior year adjustments.

Besides IPP charges, consumer tariffs also include add-ons from Distribution Companies (Discos), such as technical losses (typically 5-10%) and factors like theft and uncollected receivables, which inflate these add-ons to over 20%.

In FY 2022, EPP comprised roughly 60% of the tariff, with CPP at 40%. By FY23, both EPP and CPP were around 50%, marking a shift from historical trends. Projections for FY24 suggest a further deviation, with CPP expected to rise to 67% and EPP decreasing to 33%. This increasing emphasis on fixed charges significantly inflates tariffs, posing challenges for consumers.

Moreover, there is significant alleged misreporting and overbilling done by IPPs as the tariffs enshrined under the take-or-pay contracts are guaranteed under international law. For instance, the actual oil consumption of several oil-based plants is allegedly less than what is billed by the IPPs; there have been alleged attempts to audit these occurrences, but any such efforts are thwarted by IPPs through, among other means, stay orders, etc.

Similarly, the O&M margins are also overstated, where the expense is Rs 500 million it is being billed at Rs 1.5 billion per annum. All other heads are similarly overstated but because the sanctity of these contracts is protected under international law and the government of Pakistan has surrendered its sovereign rights there is little that can be done to reevaluate these contracts.

Currently, electricity tariffs in Pakistan are prohibitively high. Over the past 24 years, tariffs have surged from Rs 1.37/unit in 1990 to Rs 34.31/unit in 2024, a 25-fold increase. This rise is not solely due to variables like PKR-USD parity but also due to factors like the introduction of private generation and the government’s tendency to pass on its own socio-economic obligations to certain power consumers like industrial and high-end domestic through cross-subsidies.

This scenario has contributed to premature deindustrialization, causing a decline in electricity consumption and elevated electricity costs. Immediate action is required to lower power tariffs for industries to 9 cents/kWh, stimulating demand for electricity and effectively utilizing idle capacity. Furthermore, the addition of new capacity to the system should be halted for the next 3-4 years.

Removing cross-subsidies, which act as indirect taxation on exports, is essential. Increasing tax collection to directly subsidize energy for economically disadvantaged segments and transitioning to other direct support mechanisms like unconditional cash transfers, as advised by IMF and World Bank consultants, is more economically efficient compared to cross subsidies in power tariffs.

Moreover, to reduce the undue burden of capacity payments within current contractual agreements across all consumers, there must be a significant increase in power consumption. Typically, industries drive electricity demand globally.

However, in Pakistan, inefficient allocation leads to unproductive sectors consuming a significant portion of electricity (around 47%) while industries consume only 28%. This results in industries bearing the burden of inefficiencies through cross-subsidies and additional transaction costs.

Competition plays a pivotal role in the effectiveness of take-or-pay contracts. Competitive bidding often results in favourable arrangements, especially in cases involving multiple investors and suppliers in large countries. However, problems may arise in government-to-government contracts without competitive bids, highlighting the importance of clear contract pricing through market mechanisms.

“In advanced countries with competitive electricity markets, take-or-pay contracts are prevalent. Here, electricity prices are influenced by supply and demand in spot markets, offering a mix of options for both buyers and sellers to mitigate risks effectively. Even in Pakistan, the ADB-funded Jamshoro coal power plant has demonstrated cost-effectiveness through competitive bidding.”

 

 

However, while these points must be kept in mind while negotiating future contracts, ultimately, the resolution to Pakistan’s existing capacity payment woes lies in stimulating industrial growth, which will significantly increase power consumption and reduce the per-unit burden across consumers.

By Shahid Sattar | Amna Urooj

The recent upsurge in circular debt (CD) accumulation coincided with the signing of “take-or-pay” contracts for imported coal and RLNG-based plants. These contracts, intended to address energy shortages, came with volatility and a hefty price tag.

This escalation in electricity generation costs has severely impacted Pakistan’s transition to renewable energy by diverting financial resources away from potential investments in renewables and locking the country into long-term dependencies on fossil fuels.

The persistent rise in circular debt (CD) within the power sector, currently amounting to PKR 2.6 trillion, is fueled by a multitude of factors, including high transmission and distribution (T&D) losses, inefficiencies within power distribution companies (Discos), and unbudgeted energy subsidies.

Frequent hikes in electricity tariffs aggravate Pakistan’s CD by increasing non-payment rates and T&D losses, as these losses are calculated as a percentage of the tariff. Instead of temporary fixes, policies must address the root causes of this debt.

For instance, transmission and distribution losses stood at 16.45% in FY 2022-23, while the inefficiencies and low collection rates of DISCOs have led to significant commercial losses, with outstanding debt from defaulters exceeding PKR 900 billion.

According to World Bank, Pakistan’s high energy subsidies to the domestic sector, currently estimated at PKR 976 billion (0.9 percent of GDP) for FY 2024, further strain the financial system. This explains the increasing financial burden on the power sector, highlighting the urgent need for a shift towards lower cost energy sources.

By reducing dependence on imported fossil fuels, where long-term forex-based prices are currently rising and unpredictable, Pakistan can alleviate some of these financial pressures, stabilize power prices, and pave the way for a more sustainable and economically viable energy future through indigenization and the induction of a local supply chain and renewables.

However, the current fossil fuel-based power plants should be retired, potentially through public debt financing, to address overcapacity issues and reduce the CD crisis. Advancing the planned retirement of outdated and inefficient power plants while ensuring that new additions focus exclusively on renewable energy is need of the hour.

Investing in renewable energy not only offers a sustainable solution to the circular debt crisis but also brings numerous economic and environmental benefits. Renewable technologies, such as solar and wind, have near-zero marginal costs of production, which can significantly lower overall electricity generation costs. This makes renewables highly competitive in the long term.

For example, the International Energy Agency (IEA) reports that new solar projects are now the cheapest source of power on a levelized cost of energy (LCOE) basis, with solar energy costing around $60 per MWh, while gas is $20 more expensive at $80 per MWh. Redirecting funds from LNG and coal infrastructure to renewable energy projects aligns with global trends favoring climate-friendly investments and will ensure a resilient energy future for Pakistan.

But where do we stand in terms of renewable energy in the country? Pakistan’s energy production and consumption landscape is predominantly fueled by fossil fuels. As of recent data, thermal sources—comprising natural gas, oil, and coal—contribute to nearly 60% of the country’s total installed capacity. Specifically, natural gas accounts for approximately 33%, oil for 15%, and coal for about 12% of the energy mix.

In contrast, renewable energy sources such as hydropower, wind, solar, and biomass make up a smaller fraction of Pakistan’s energy portfolio. Hydropower constitutes around 30% of the installed capacity, while wind and solar energy contribute approximately 4% and 2%, respectively.

Despite the declining costs of renewable technologies and the substantial potential for clean energy, the pace of renewable energy development has been insufficient to offset the use of fossil fuels to any significant extent. As of 2023, the total installed capacity of renewable energy sources, including hydropower, wind, solar, and bagasse/biomass, exceeds 13,000 MW out of 45,885 MW.

The truth is Pakistan’s current energy mix has significant environmental impacts. The extensive use of natural gas, oil, and coal contributes to high levels of carbon emissions and air pollution has adverse effects on public health and the environment.

While Pakistan emits less than 1% of the world’s planet-warming gases, its emissions are insignificant on a global scale, yet Pakistan suffers disproportionately from the outcomes. For instance, power plants burning fossil fuels are major sources of sulfur dioxide (SO?), nitrogen oxides (NO?), and particulate matter, leading to respiratory illnesses and other health problems among the population.

Lahore is already bearing the brunt of it, ranked 5th in the 2023 IQAir World Air Quality Report. The city frequently experiences severe air pollution, directly linked to emissions from these power plants, resulting in increased cases of asthma, bronchitis, and other respiratory conditions. Fossil fuel extraction and combustion contribute to soil and water pollution, further degrading the country’s natural resources.

Economically, the high costs associated with fossil fuel imports place a substantial burden on Pakistan’s financial resources. The country spends a significant portion of its foreign exchange reserves on importing oil and gas (roughly one-quarter of Pakistan’s imports are oil and gas), which makes its economy vulnerable to global price fluctuations.

In fiscal year 2022-23, energy imports accounted for a large share of the total import bill, intensifying the country’s trade deficit. Socially, the energy crisis in Pakistan leads to widespread energy access issues, with many rural and remote areas lacking reliable electricity supply. This energy insecurity affects education, healthcare, and overall quality of life, hindering social and economic development.

Switching to renewable energy in Pakistan offers numerous benefits across environmental, economic, and social dimensions. Environmentally, renewable energy significantly reduces greenhouse gas emissions and mitigates climate change impacts. For instance, projections indicate a potential 50% reduction in projected emissions by 2030, with a 35% reduction contingent on international grant finance and a 15% reduction from the country’s own resources.

Economically, the transition creates jobs within the renewable energy sector and provides long-term cost savings compared to fossil fuels, enhancing energy independence and security. Socially, renewable energy improves public health by reducing pollution, enhances energy access in remote areas, and empowers local communities through decentralized energy systems. These combined benefits underscore the urgent need for Pakistan to accelerate its shift towards sustainable energy solutions.

Moreover, the implementation of distributed energy solutions and localized energy grids with renewables can further strengthen these benefits. By enabling DISCOs to purchase power from the grid while supplementing it through solar rooftops, particularly in areas with limited energy access, and allowing direct purchases from dedicated plants, Pakistan can ensure a more sustainable and resilient energy use that rooftop solutions alone cannot achieve.

Wind energy also presents substantial opportunities, especially in the wind corridors of Sindh and Balochistan. The Gharo-Jhimpir wind corridor alone has an estimated potential of 50,000 MW, with several successful projects already operational.

For instance, the Jhimpir Wind Power Plant, with an installed capacity of 50 MW, has been effectively harnessing wind energy and contributing to the national grid. These projects not only support energy diversification but also promote energy security and reduce carbon emissions. To further enhance resource utilisation and cost efficiency, the government should mandate that wind installations also incorporate solar power. This hybrid approach would ensure optimal use of available land and infrastructure, resulting in greater energy output and more sustainable energy solutions.

A key development in Pakistan’s renewable energy sector is the expansion of net metering. As of June 30, 2023, net metering consumers reached approximately 56,000, a nearly 50% increase from the previous year. In FY22-23, net metering generated 482 gigawatt-hours, a remarkable 220% year-on-year growth.

Despite this impressive growth, 482 gigawatt-hours represent less than 0.4% of the total energy sold/generated, highlighting its relatively small impact on the overall energy market. Rather than penalizing net metering through gross metering, which would discourage consumer participation, it is crucial to continue and support net metering policies.

The proposal for gross metering raises serious concerns. Gross metering, which requires consumers to sell all the electricity generated by their solar panels to the grid at a fixed Feed-in-Tariff (FiT) and then buy back the electricity they consume at retail rates, is a travesty of justice.

The significant rate disparity—selling electricity at 11 rupees per unit while buying it back at up to 62 rupees per unit—makes solar investments financially unsustainable. This policy shift would compel consumers to seek mechanisms to go completely off-grid, undermining the growth of renewable energy. Instead, the government should focus on revising unsound tariff structures to support renewable energy growth, consumer benefits, and grid stability.

In addition to net metering, hydropower remains a critical component of Pakistan’s renewable energy strategy, leveraging the country’s abundant water resources. The total hydropower capacity, including WAPDA and IPPs, stands at 10,635 MW as of June 30, 2023. Major projects like the Tarbela and Mangla dams continue to play pivotal roles.

Wapda plans to add up to 10 GW of hydropower capacity by 2030 through the phased completion of its under-construction projects. Future projects, including the Diamer-Bhasha Dam, are expected to add significant capacity. However, managing seasonal variability is crucial for optimizing hydropower generation. Effective water management and storage solutions are essential to balance supply during dry periods and maximize generation during peak flow seasons.

Technological innovations play a pivotal role in overcoming challenges and advancing the renewable energy sector in Pakistan. Recent advancements in solar and wind technology have significantly lowered costs, making renewable energy more competitive with traditional fossil fuels.

The average cost of solar power generation has dropped to PKR 3.67 per kWh, making it cheaper than many conventional energy sources. In addition, the development of battery storage systems and smart grid technologies is crucial for stabilizing the power supply and managing the intermittency of renewable energy sources.

Supporting the integration of renewable energy and enhancing grid flexibility is essential. The National Transmission and Dispatch Company (NTDC) is modernizing the grid infrastructure to better accommodate the distributed and variable nature of renewable energy. This includes implementing advanced forecasting tools, real-time monitoring systems, and automated control mechanisms to quickly respond to changes in power generation and demand.

Strategies such as demand response programmes, which adjust consumer power usage during peak times, and the development of microgrids, capable of operating independently or alongside the main grid, are also being adopted. These measures not only improve the resilience and reliability of the power system but also facilitate the seamless integration of renewable energy, supporting Pakistan’s ambitious goal of achieving 30% renewable energy by 2030.

Building on Denmark’s remarkable achievements in renewable energy, Pakistan can draw valuable lessons. In 2022, Denmark announced an ambitious target to achieve net-zero emissions by 2045, aiming for 110% emissions reductions by 2050.

The Danish government has strategically focused on offshore wind, biomethane, district heating, carbon capture and storage (CCUS), and hydrogen. This comprehensive approach is guided by robust energy and climate governance under the Danish Ministry of Climate, Energy and Utilities, ensuring annual policy actions and funding through the ‘year wheel’ of the Climate Act of 2020.

This strategic focus on renewable energy sources, coupled with Denmark’s technology leadership, showcases how a well-coordinated policy framework and technological innovation can drive a successful energy transition. By adopting similar best practices, Pakistan can enhance its renewable energy adoption, ensuring a sustainable and economically viable energy future.

“The future of Pakistan lies in harnessing the power of the sun, wind, and water to create a sustainable and prosperous nation. By embracing renewable energy, Pakistan can address its energy challenges, improve public health, and build a resilient economy. As the famous quote goes, “The best time to plant a tree was 20 years ago. The second-best time is now.” It is time for Pakistan to plant the seeds of a renewable energy revolution.”

By Shahid Sattar

The government’s recent contemplation of cutting off gas supply to industrial captive power plants (CPPs) while maintaining subsidized gas supply to so-called “industrial connections” is a move that defies all economic rationality.

It’s a policy decision that will not only undermine the principles of efficient resource utilisation but also threatens the competitiveness and survival of large industrial units, particularly in the textile industry.

A more prudent approach based on free-market principles and sound economic arguments is required.

At the heart of this is a fundamental misunderstanding of energy efficiency in industry.

In addition to captive power generation, natural gas is used extensively in industrial processes across various sectors in Pakistan, including for textiles, chemicals, glass, cardboard, and plastic manufacturing. These typically involve the use of gas for generating steam via boilers, heating thermal oil for dryers, directly hearting dryers, powering chillers, etc., (Table 1).

==================================================================================
Table 1: Gas Consumption in Industrial Processes
==================================================================================
Textile and Apparel Sector    Other Industries
==================================================================================
Hot water/steam boilers       Hot water/steam boilers (*50-60% of total gas usage)
Printing                      Injection molding machines (plastic)
Stenters                      Pharmaceutical manufacturing
                              Industrial/molding furnaces (glass)
                              Packaging machines for corrugated materials
                              Oil Heaters, Power Chillers, Printing etc.
==================================================================================

The gas tariff code separates industrial gas usage by process and captive, with the price of gas for the latter at Rs 2,750/MMBtu compared to only Rs. 2,150/MMBtu for the former.

Now, the government is exploring options to completely cut off gas supply to CPPs based on the argument that captive gas usage is inefficient, lowers demand for grid electricity, and that redirecting gas supplies to other uses could optimize resource allocation.

Conversely, various reports and consultations with industry experts highlight the extremely low efficiency of boilers at 45-50% as over 90% of operational boilers are low pressure and single burner based.

Furthermore, problems such as poor insulation, unaddressed leaks, outdated equipment, and improper operational settings are also prevalent.

However, no comprehensive surveys or audits have been conducted to benchmark the efficiency of gas usage in industrial processes. This lack of data and analysis hinders efforts to implement targeted improvements and achieve higher efficiency and sustainability in gas-based industrial processes.

The wastages not only drive-up operational costs but also undermine broader efforts to achieve energy efficiency and sustainability.

The government’s perspective overlooks the critical role of cogeneration units in CPPs, which are far more efficient than the available alternatives. Cogeneration units, or Combined Heat and Power (CHP) systems, operate at efficiencies exceeding 70%. These units not only generate electricity but also utilize the same gas to produce steam and hot water, essential byproducts for industrial manufacturing processes.

The dual output from a single energy source maximizes the utility derived from each unit of gas, making it the best possible use of our scarce energy resources.

Contrastingly, the alternatives are less efficient and more costly. Grid electricity tariffs are prohibitively high, currently around 15.4 cents/kWh and as high as 17.5 cents/kWh a few weeks ago and are expected to increase by another 2 cents/kWh following the tariff rebasing in July.

Moreover, the frequent outages, voltage fluctuations and overall poor reliability associated with grid electricity cause significant operational disruptions, leading to costly wastages and downtime.

Similarly, standalone industrial boilers used for steam and hot water generation typically operate at efficiencies of around 45-50%, substantially lower than cogeneration systems.

Thus, shifting away from high-efficiency CPPs to these less efficient methods would result in a greater overall energy consumption to achieve the same industrial output, undermining the very goal of resource optimization and energy efficiency.

Moreover, the distinction between gas used for industrial processes and that used for captive power generation is highly problematic. It is not only artificial but also opens the door to widespread corruption and system leakages. Many industries already use their process gas connections for both process use and power generation.

If the government decides to completely cut off gas supply for CPPs, more industries will inevitably find ways to circumvent these restrictions, leading to unauthorized use of process gas for power generation.

Overcoming this would necessitate stringent administrative measures and policing, incurring significant administrative costs and fostering corruption as industrialists seek to bribe inspectors to overlook violations. The implications of such a policy are far-reaching.

“Cutting off gas to CPPs would force industries to rely more heavily on grid electricity in the short-term while seeking cheaper sources of energy, increasing their operational costs and making them less competitive in international markets. This is particularly detrimental at a time when Pakistan’s industries are already struggling with high production costs and shrinking margins. Many of the most efficient and largest vertically integrated manufacturing units, which rely heavily on captive power for stable and cost-effective energy, would be hit the hardest. With energy prices constituting a significant portion of total production costs, any increase in energy expenses could lead to a decline in exports, loss of jobs, and further economic downturn.”

Just a few years ago, the government introduced policy measures to incentivize CPPs to transition from less efficient single cycle units to highly efficient combined cycle units. In response, several CPPs made substantial investments in CHP units and even had their efficiencies audited by NEECA.

According to SNGPL data, of the 383 CPPs on its network, 306—or 80 percent—are now CHP co-generation units. A blanket ban on captive generation would show a complete disregard for policy continuity and the commitments made by the government to private sector investors.

This move would sink the substantial investment that has been made in CHPs, further erode trust in Pakistan’s policies, increase investment uncertainty, and deter future investors from considering Pakistan as a viable investment option.

Moreover, the proposed policy overlooks the broader economic implications of inefficient energy allocation. Historically, the power sector has been the primary offtaker of imported RLNG, with its cost passed through to consumers.

However, as the power sector is transitioning to cheaper alternatives, this results in a surplus of RLNG in the system that then needs to be diverted to consumers who would otherwise be supplied with indigenous gas, at highly subsidized rates.

Cutting off gas supply to CPPs will further exacerbate the issue of surplus RLNG and diversion costs. The increased RLNG diversion to domestic and fertilizer sectors at highly subsidized rates is likely raise SNGPL’s Revenue Requirement (RR) to Rs 100 billion for 115 MMCFD. For instance, OGRA, in its Estimated RR decision dated May 20, 2024, has allowed Rs 184 billion for RLNG diversion in FY 25 at the rate of Rs 3400 ($12.19) per MMBtu, significantly lower than the Rs 298 billion requested by SNGPL for 209 MMCFD RLNG diversion, resulting in a Rs 114 billion annual shortfall for SNGPL.

In addition, the sale of indigenous gas of 59 MMCFD to public sector power plants at Rs 1,050/MMBtu instead of Rs 2,750/MMBtu for captive power plants will generate an additional Revenue Requirement of Rs 38.5 billion for SNGPL.

The cumulative increase will be a staggering Rs 138.5 billion, which will necessitate a price increase of Rs 310/MMBtu for all SNGPL consumers due to the shifting of Captive Power Plants in the SNGPL network to the Power Grid.

Reduced domestic demand during the summer could result in the diversion of cargoes at distressed prices, and SNGPL may also incur significant losses due to take-or-pay clauses and demurrages. If the take-or-pay clause is triggered after 96 hours of LNG cargo arrival, the penalty incurred will be passed through, leading to demand destruction among RLNG consumers.

This will expose SNGPL to take-or-pay contractual risks with RLNG suppliers or sovereign default, potentially causing the cascading collapse of several State-Owned Entities of the Petroleum Division, i.e., PSO, SNGPL, PLL, OGDCL, and PPL.

A more prudent approach in this regard would be to recognize the high efficiency of certified cogeneration units and classify them as industrial consumers, entitled to the same gas tariff rates as other industrial processes.

This would ensure a level playing field and encourage industries to maintain or improve their efficiency levels.

Additionally, introducing mechanisms for regular monitoring and public reporting of compliance would foster transparency and build public trust, ensuring that CPPs operate within stipulated efficiency parameters.

The government’s role should be to create an enabling environment that promotes efficiency, competitiveness, and sustainable growth.

By cutting off gas supplies to CPPs, it is doing the opposite—discouraging efficient energy use, increasing operational costs, and undermining the competitiveness of industrial sectors. It is crucial to adopt policies that align with free-market principles, where resource allocation is driven by efficiency, productivity, and economic rationality.

In conclusion, the proposal to cut off gas supply to industrial captive power plants is a regressive step that threatens to undo the progress made in industrial efficiency and competitiveness. It is a policy that fails to recognize the superior efficiency of cogeneration systems and the critical role they play in the industrial ecosystem.

Rather than penalizing these high-efficiency units, the government should support and incentivize their use, ensuring that industries can compete on a level playing field and continue to drive economic growth.

Only by embracing rational, efficiency-driven policies can we hope to secure a prosperous and sustainable future for Pakistan’s industrial sector.

====================================================================================================
Table 2: Benefits of Combined Heat and Power (CHP) Systems over Industrial Gas
====================================================================================================
Benefit Category for           Description
Combined Heat & Power
====================================================================================================
Primary Efficiency             CHP systems can achieve efficiencies over 70%, with some systems
                               even approaching 90%
Fuel Efficiency                CHP systems require less fuel to produce a given amount of energy
                               output, leading decreased fuel dependency
Avoid Transmission             Producing electricity on-site eliminates losses associated with
and Distribution Losses        transmitting electricity over long distances
Reduced Greenhouse Gas         CHP systems emit less CO2 SOx NOx and PM, reducing Scope 1
Emissions                      emissions aligning with the European Union's Carbon Border
                                Adjustment Mechanism (CBAM) standards
Improved Energy                CHP systems provide a stable supply of electricity and heat, ensuring
Resilience and Reliability     energy supply during power outages, interruptions, breakdowns,
                                voltage fluctuations, brownouts and blackouts.
Cost Savings and               High efficiency and reduced fuel consumption lead to lower energy
Enhanced Competitiveness       costs, lowers operational costs and improves energy efficiency with
                                additional savings from avoided steam generation, water heating and
                                T&D losses
Flexibility and Scalability    CHP systems can be tailored to various applications and utilize
Support for Renewable           different fuels, adapting to different operational contexts. It can
Energy Integration              complement renewable energy sources, providing tailor made
                                solutions to meet climate targets for exports to the West.
====================================================================================================