By Shahid Sattar | Amna Urooj

In the expansive arena of economic governance, Ludwig von Mises’ profound assertion resonates: “If one rejects laissez-faire on account of man’s fallibility and moral weakness, one must, for the same reason, also reject every kind of government action.” Amidst this philosophical backdrop, Pakistan grapples with a complex array of economic challenges, demanding a sophisticated and nuanced approach to trade policies.

A disconcerting array of economic indicators paints a grim picture. Over the past five years, the budget deficit has ballooned from 5.8% to a concerning 7.7% of the GDP. The tax-to-GDP ratio has witnessed a precipitous drop from 11.4% to 9.2%, accompanied by a sharp decline in development spending from 4.1% to 2.3%. Public debt, a looming specter, now constitutes a formidable 74.3% of the GDP.

Stark income inequality persists, with the top 10% commandeering 44% of the national income, while the bottom 50% languishes with a mere 16%, resulting in a glaring per capita income ratio of 14:1. In official records, the unemployment rate has risen significantly, climbing from 6.9% in 2018-19 to a concerning 9.5% in 2022-23, affecting more than 7 million workers. Unofficial figures, however, paint a grimmer picture, indicating that the actual unemployment rate may surpass 20%.

Poverty, estimated at 34% in 2018-19, is projected to reach a staggering 46% by 2022-23, affecting over 20 million idle youth. This crisis is further exacerbated by a real wages slump of over 20% in the last two years. The tax burden, distributed unevenly across sectors, contributes to an overall tax incidence of under 10% of the GDP, with a UNDP report suggesting elite capture causing a loss of over 2.5% of the GDP.

 

The industrial contribution to the economy is currently very low, and it has experienced a decline in recent years, with strong indications pointing towards widespread deindustrialization across the economy.

The contraction of industrial production during the 2022-23 economic crisis, intensified by economic volatility, escalating energy costs, inflation, and exchange rate depreciation, has precipitated the permanent closure of numerous firms. This impact is particularly pronounced in the textile and apparel sector, evident in a significant year-on-year decline in power consumption for firms on both LESCO and MEPCO networks. These challenges accentuate the pressing need for Pakistan to embrace an export-centric culture, a pivotal shift considering the country’s gross external financing requirements, which are poised to exceed $25 billion annually for the next five years.

Protectionism, as a set of policies aimed at shielding domestic industries from foreign competition through tools like tariffs, quotas, subsidies and non-tariff barriers, is a focal point of discussion. However, the pervasive call for import substitution as a solution to the ongoing economic crisis reveals a fundamental misunderstanding. The crux lies in the basic premise of international trade, founded on the principle of comparative advantage. In a simplified two-goods-two-economy scenario, each economy optimally produces and exports what it excels at, extending this principle to the diverse goods and economies in the real world.

Economies, as a rule, should export what they excel in producing and import what they lack comparative advantage in. The current discourse in Pakistan, advocating for benefits to “import substitution” industries to reduce imports and enhance the Balance of Payments (BoP), is flawed. Import substitution is inherently unproductive and internationally uncompetitive. Granting benefits and protection to these industries perpetuates inefficient production, leading to elevated prices for domestic consumers and wasteful resource utilization.

The genuine solution lies in fostering export-led growth, where all industries oriented towards exports, bolstering foreign earnings to offset the impact of imports and maximizing economic advantages.

In this strategy, the focus should narrow down to a few key sectors where the economy boasts a comparative advantage. Simultaneously, efforts should concentrate on creating localized backward and forward linkages within these sectors. This approach stands in stark contrast to the impractical notion of attempting to localize the production of an exhaustive range of goods under the umbrella of “import substitution.”

In 2022, Pakistan’s trade policies exhibited a subtle yet complex stance on tariffs, with an exceptionally high applied tariff rate of 98.6% (see table below). According to the WTO’s World Tariff Profile 2023, this rate underscores the challenges and potential adverse consequences of protectionist measures. Such a high applied tariff rate can act as a significant trade barrier, leading to increased costs for imported goods. This, in turn, may have detrimental effects on consumers, businesses, and the overall efficiency of the economy. The focus on applied rates in this analysis aims to shed light on the immediate and tangible impacts of protectionist trade policies. Particularly, the agricultural sector faces comparatively higher tariffs with a simple average applied rate of 10.3%, while non-agricultural products face a rate of 13.1%. Trade-weighted averages for agricultural (8.7%) and non-agricultural (6.4%) goods further highlight variations within different product categories.

Examining specific product groups, the tariff analysis unveils limited duty-free imports and a prevalence of applied tariffs falling within the 15% to 25% range, particularly for non-agricultural products. Distinct variations emerge among product categories, with higher average duty rates for non-electrical and electrical machinery, in contrast to lower rates for petroleum and chemicals. Major trading partners for both agricultural and non-agricultural products include the European Union, China, the United Kingdom, and the United States.

The analysis of Most Favored Nation (MFN) applied duties in Pakistan, India, and Bangladesh sheds light on the implications of protectionist measures on the Pakistani economy. While Pakistan generally maintains lower average duties, indicative of a relatively open trade policy, the impact of protectionism extends beyond duty rates to encompass non-tariff barriers and subsidies. Striking a balance is crucial; lower duties in sectors where Pakistan has a comparative advantage, such as cotton, suggest the potential benefits of an open trade approach. However, protectionist measures, if not carefully calibrated, could lead to inefficiencies, reduced competitiveness, and missed opportunities in global markets. The key lies in fostering an environment conducive to export-led growth, protecting domestic industries judiciously, and ensuring overall economic efficiency for sustained growth.

 

Debates are useless without factual concepts, and to begin with, Pakistan’s economy has not been performing well. Foreign exchange reserves started at $4.5 billion at the beginning of the current financial year, and the national currency, the rupee, depreciated by over 81% in the last two years. External debt stands at nearly $128 billion, constituting almost 43% of the GDP. Cumulative external financing requirements, net of likely rollovers, are projected to exceed $55 billion from 2023-24 to 2025-26.

The World Bank, in its 2023 feature story titled “Protectionism Is Failing to Achieve Its Goals and Threatens the Future of Critical Industries”, expresses heightened concerns regarding the repercussions of protectionism on global trade. Despite escalating trade tensions and geopolitical challenges, global trade showcases remarkable resilience, an observation that gains significance as protectionist measures become more prevalent, prompting discussions about deglobalization. This evolving landscape unveils three distinct paradoxes in global trade, each with implications that resonate with Pakistan’s economic context:

I. China’s increased centrality amid the US-China trade war

II. The growing significance of global value chains:

Contrary to expectations, disruptions such as the US-China trade war and the COVID-19 pandemic have failed to weaken global value chains. Instead, these chains have increased in significance, challenging predictions and underlining their enduring importance in global trade. For Pakistan, actively participating in global value chains, especially in sectors like textiles, becomes even more crucial as the paradox emphasizes the continued integration and relevance of these chains in the face of protectionist headwinds.

III. Firms persist in global connections despite challenges

These paradoxes underscore the dynamic nature of global trade in the context of protectionism and highlight potential strategies for Pakistan to navigate these challenges. Increased international openness and cooperation would better achieve the goals currently pursued through protectionist measures.

The World Bank also emphasizes the need for a new consensus on global rules to address international tensions and benefit all countries. The problem is not excessive globalization but excessively narrow regulation, advocating for a global set of rules covering various aspects beyond trade.

 

Recognizing the failure of protectionism and import substitution approaches, the emphasis on export-led growth becomes imperative. The need to increase foreign exchange earnings is highlighted as an alternative to falling deeper into the debt trap. Fostering an open and competitive international trade environment is essential for stabilising industries, encouraging growth, and creating opportunities for market diversification. Free trade, by fostering global economic cooperation, can mitigate the impact of economic downturns on individual countries by providing opportunities for market diversification, access to resources, and the possibility of stabilizing industries through increased exports and market competitiveness.

Trade liberalization in developing countries, like Pakistan, sparks debate. Advocates argue it boosts efficiency, expands markets, and fosters competition, contributing to economic growth. Theoretical models support this, but critics highlight uneven benefits and the role of domestic policies. Empirical evidence from scholars like Kruger, Taylor, Robinson, Barro and Martin, Romer, Chamberlin, Dollar and Karray, Vallumea, and Ahmad suggests trade openness enhances efficiency, productivity, and technological progress, emphasizing the importance of human capital and supportive policies. Overall, the literature underscores the need for extensive trade liberalization for effective economic growth in developing nations.

Case Study 1: Tariffs on polyester staple fiber in the textile industry

Pakistan’s textile industry, historically a significant contributor to the economy, has faced challenges, witnessing a decline in contribution and employment trends. The economic crisis in 2022-23, marked by high volatility, rising energy costs, and exchange rate depreciation, led to the closure of several textile firms, with a substantial decrease in power consumption across the sector.

Export-led growth is crucial for Pakistan, evident from the failure of protectionism and import substitution strategies.

The imposition of tariffs and protectionist measures on polyester staple fiber (PSF) in Pakistan has adversely affected the textile industry, impeding its global competitiveness. Despite the increasing global demand for synthetic fibers, particularly polyester, Pakistan’s textile industry has been slow to shift from conventional cotton, limiting its share in the expanding market for synthetic textiles. Garment exports still favor cotton at an 80:20 ratio, with only a quarter of spinning machines utilizing man-made fibers.

Moreover, the concentration of global polyester staple fiber production in countries like China, India, and Southeast Asia, which dominate synthetic textile exports, highlights Pakistan’s limited participation in the MMF (man-made fiber) apparel market. Protectionist policies and the absence of a fully integrated chemical industry for synthetic polymers hinder Pakistan’s progress in this sector. Adequate raw material availability could have boosted the country’s share in the global synthetic textiles market, but domestic policies influenced by protectionist measures have impeded tapping into this potential.

To boost Pakistan’s textile industry, the 12% customs duty on Polyester Filament Yarn (PFY) should also be eliminated, ensuring no import duty on this crucial raw material. Aligning withholding tax (WHT) and abolishing the 3% value addition tax (VAT) at the import stage for PFY is vital. The current policy, with total import duties reaching 20%, including antidumping duty, hampers PFY industry growth and raises costs for end-users. Additional Regulatory Duty exacerbates challenges, underscoring concerns about protectionist measures impacting the textile sector. Creating a competitive and open market is essential for the industry’s success.

On the other hand, to enhance its global competitiveness, Pakistani manufacturers must build industry capacity for producing textile articles based on man-made fibers, recognizing the growing demand in the global market for synthetic or man-made fibers (MMF) over traditional cotton articles. While the input is duty-free for qualifying firms under certain schemes, a significant 80% fail to meet the criteria. However, these non-qualifying firms, despite lacking duty exemptions, play a crucial role as technology capacity incubators, especially in the absence of Polyester Staple Fibre (PSF), fostering cultural development. Unfortunately, Pakistan has struggled to fully leverage benefits from initiatives like GSP+ due to an economy heavily reliant on textiles and a lack of awareness and interest among traders, impeding the country’s ability to exploit the full advantages of such programs. It is also to be noted that Pakistan misses out on around 70-80% of the export lines to Europe where the MMF is heavily concentrated, indicating a lack of full utilization of GSP+ benefits.

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Case Study 2: Protectionism in agriculture

Protectionist policies in Pakistan’s agriculture sector, intended to bolster local farmers and ensure food security, have faced limitations in achieving their goals. Contrary to expectations, the academic text indicates that the gains from agricultural trade liberalization surpass those from protectionism. Many studies, such as the one conducted by Ahmad, Khan, and Mustafa (2022), suggest that protectionist measures have not significantly benefited Pakistani farmers, with richer rural households reaping more substantial rewards under trade liberalization. Concerns about income distribution among vulnerable populations, particularly poor rural households, have arisen, challenging the assumption that protectionism leads to improved food security.

Moreover, the implications of protectionism extend to international trade relationships. While protectionist measures aim to shield domestic agriculture, many studies such as the one conducted by Ahmad, Khan, and Mustafa (2022), point out that exposing the sector to foreign competition through liberalization may result in concerns about market access and potential losses for less-developed countries. The broader economic impact is underscored by the conflict among empirical studies regarding gains from agricultural trade. Despite marginal economic growth, protectionist policies in Pakistan have not effectively addressed income inequalityas they often benefit select industries and contribute to higher prices, disproportionately impacting lower-income individuals and hindering overall economic growth and job creation, emphasizing the need for a distinct approach that considers welfare, income distribution, and global trade dynamics when evaluating the efficacy of trade policies in the agriculture sector.

Insights from both case studies affirm the documented inefficiencies stemming from protectionism, particularly in sectors such as agriculture, automobiles, polyester staple fiber, and glass.

The textile industry, the cornerstone of Pakistan’s economy, faces decline amid economic challenges, highlighting the imperative shift towards an export-centric approach. While Case Study 1 extols the benefits of free trade for sectors like textiles, Case Study 2 underscores the limitations of protectionist policies in agriculture, revealing that trade liberalization offers more significant gains than protectionism, especially for poorer rural households.

“The broader implications on income distribution and international trade relationships emphasize the need for subtle yet effective approaches that consider welfare, income equality, and global trade dynamics in evaluating the efficacy of trade policies in these critical sectors.”

By Khalid Mustafa

ISLAMABAD: The country’s power sector has lost billions of rupees in revenue as high electricity tariffs have cut the consumption of export-oriented industries by up to 49 percent in some areas, an industry group said on Tuesday.

The All Pakistan Textile Mills Association (APTMA) said in a letter to the energy minister that the power consumption of textile and apparel firms had declined by 49 percent on the Lahore Electric Supply Company (LESCO) network and 36 percent on the Multan Electric Power Company (MEPCO) network in October 2023, compared to the same month last year.

The consumption has fallen after the government increased the power tariff to 14 cents per unit for export industries – the highest in the region – and made them uncompetitive in the global market, APTMA said.

The power sector revenue from these industrial units was over Rs1.1 billion less on the LESCO network alone in October 2023, the letter said, adding that the actual losses were likely to be much higher.

“This has nullified the argument that any substantial increase in power tariffs will increase the power sector’s revenue collection and reduce capacity payments for all consumers. If the status quo is maintained, industrial production and electricity consumption will continue to decrease, which will further worsen the economic situation.”

The letter suggested to Energy Minister Mohammad Ali that the only way to avert this crisis is to provide the export sector with power tariffs that exclude cross-subsidies, stranded costs, and other economic inefficiencies.

APTMA argued that following the withdrawal of regionally competitive energy tariffs and power tariff rebasing earlier this year, power tariffs for export-oriented industrial consumers increased from 9 cents per unit to 14 cents per unit, which is almost twice the average prevalent for export sectors in regional economies.

The letter mentioned that high tariffs have caused export firms to be priced out of international markets and lose export orders to competitors with significantly lower power tariffs in regional economies.

APTMA’s analysis suggests that above a threshold of 12.5 cents per unit, export-oriented firms are increasingly forced towards closure and the export sector is crowded out in due course. At the same time, domestic industries also face weak demand as rampant inflation has eroded consumers’ purchasing power and this has in turn lowered manufacturing activities and therefore industrial power consumption across the board.

“Declining consumption of electricity, increasing capacity charges, and decreasing revenue are causing power tariffs to increase continuously, as also evidenced by the Quarterly Tariff Adjustment for the first quarter of ongoing FY24, which will cause consumption to decline even further.”

APTMA also argued that in addition to direct implications on power sector revenue, there are also significant implications for the entire economy. “Exports went down 15 percent in November 2023 compared to the same period last year. If the energy prices remain regionally uncompetitive, any recovery to pre-crisis levels of exports can be ruled out.”

“The country’s economy will continue to face balance of payments and exchange rate pressures, which will further add to debt servicing costs and other fiscal challenges, fuel inflation, and rule out a decrease in interest rates for the foreseeable future and continue to weigh down on industrial and economic growth.”

The letter also pinpointed that as the slowdown in industrial activity worsens, direct and indirect employment in upstream and downstream sectors will be reduced even further, affecting millions of livelihoods.

By Mushtaq Ghumman

ISLAMABAD: Electricity consumption of the textile sector in the jurisdictions of Lahore Electric Supply Company (Lesco) and Multan Electric Power Company (Mepco) has declined massively due to higher tariffs and the withdrawal of concessional tariffs.

In a letter to Minister for Power, Muhammad Ali, All Pakistan Textile Mills Association (Aptma), has stated that following the withdrawal of regionally competitive energy tariffs and power tariff rebasing earlier this year, power tariff for export-oriented industrial consumers increased from cents 9/kWh to almost twice the average prevalent for export sectors in regional economies.

According to the textile sector, it has repeatedly indicated throughout the year that high tariffs have caused firms to be priced out of international markets and lose export orders to competing firms in regional economies with significantly lower power tariffs.

APTMA assails ‘unprecedented’ gas tariff hike

“Our analysis suggests that above a threshold of 12.5 cents/kWh, export-oriented firms are increasingly forced towards closure and the export sector is crowded out in due course,” said, Shahid Sattar, Executive Director Aptma in his letter.

He said that at the same time domestic industries also face weak demand as rampant inflation has eroded consumers’ purchasing power and this has, in turn, lowered manufacturing activities and therefore industrial power consumption across the board.

In October 2023, for instance, power consumption of APTMA member firms declined by 49 percent on the Lesco network and 36 percent on the Mepco network, year-on-year.

The negative impact of higher power tariffs on volumetric consumption has more than offset any revenue gains from the price effect such that the absolute impact of higher power tariffs on power sector revenues has been negative.

Just on the Lesco network, power sector revenue from Aptma member firms was over Rs 1.1 billion less in October 2023, compared to the same month last year. Actual losses are likely to be much higher because had the power tariff remained at cents 9 per unit, power consumption would have increased as overall economic conditions showed an improvement starting FY24.

Moreover, this is not a one-off phenomenon as power consumption of textiles and apparel firms has been on a downward trajectory since the withdrawal of RCET earlier this year and is expected to decline even further in the coming weeks and months.

As it stands, declining consumption, increasing capacity charges, and declining revenue are causing power tariffs to increase continuously, as also evidenced by the Quarterly Tariff Adjustment for FY24Q1, which will cause consumption to decline even further.

These short-sighted policies have given rise to a vicious and never-ending cycle of decreasing consumption and increasing power tariffs that the country is forever stuck in. The increase in power tariffs is having the opposite impact from what was intended and a fast-track policy review on this issue is urgently required.

In addition to direct implications on power sector revenue, there are also significant implications for the entire economy. Exports for November 2023 were down 15% compared to the same period last year. If energy prices remain regionally uncompetitive, any recovery to pre-crisis levels of exports can be ruled out.

As such the economy will continue to face balance of payments and exchange rate pressures, which will further add to debt servicing costs and other fiscal challenges, fuel inflation and rule out a decrease in interest rates for the foreseeable future, and continue to weigh down on industrial and economic growth.

As the slowdown in industrial activity worsens, direct and indirect employment in upstream and downstream sectors will reduce even further, affecting the livelihoods of millions of households.

In turn, these effects will again increase various power sector costs such as capacity charges and fuel prices, further decrease power consumption, and necessarily increase power tariffs for all consumers based on how the current process is designed.

“The only way to avert this crisis is by providing the export sector with power tariffs that exclude cross-subsidies, stranded costs, and other economic inefficiencies.

This will allow the industry to become competitive again, resume manufacturing activities, significantly increase industrial power consumption, and provide gainful employment opportunities for millions across the country,“ said Shahid Sattar.

The increase in volumetric consumption will greatly offset any price effect from removing the cross-subsidy, resulting in a net increase in power sector revenue.

By Shahid Sattar | Absar Ali

On Tuesday 28th November, power regulator Nepra will hold a public hearing on the Discos’ petitions to determine a ‘Use of System Charge’ for power wheeling under B2B contracts. A seemingly routine matter, this determination will, however, define Pakistan’s economic trajectory for years to come.

For context, the National Electricity Policy allows for a Competitive Trading Bilateral Contract Market (CTBCM) where bulk power consumers can directly purchase electricity from competitive power producers and use the government’s transmission and distribution system to transport it from the point of generation to the point of usage. The Use of System Charge (UoSC) is the “price” such consumers must pay to use the transmission and distribution system.

The export sector has long advocated for this to overcome prohibitive power tariffs that render manufactured exports internationally uncompetitive and are a barrier to not just export growth but also foreign and domestic investment in export-oriented activities.

Pakistan’s power sector is characterized by a single-buyer model where the government purchases electricity from different power producers and distributes it to final consumers at self-determined prices.

The grave issue with these prices is that in addition to the actual cost of generation and service, they include various economic inefficiencies like inter- and intra-DISCO cross-subsidies that make power tariffs for industrial consumers in Pakistan almost twice the average tariff for competing firms in the region (Figure 1).

To achieve regionally competitive energy costs ideally requires a separate power tariff category for exporters based on the actual cost of service, excluding all forms of taxation and other distortions. B2B power contracts with a UoSCat 1-1.5 cents/kWh to cover the transmission and distribution costs incurred by Discos can also achieve the same objective without any subsidies from the government.

If allowed, this would rid the export sector of prohibitive distortions in power tariffs and significantly boost export competitiveness.

Estimates suggest that annual exports could increase by up to $9 billion annually by facilitating closed production units to reopen and operationalizing additional capacity already installed under export financing schemes but sitting idle due to high energy costs. It will also create a favorable business environment to stimulate fresh investment in further expansion and upgradation of production capacity to add another $20 billion to annual exports.

In this regard, Nepra has solicited petitions from the DISCOs for the determination of the UoSC. What the DISCOs have proposed, however, can be described as preposterous at best(Table 1).

Table 1. DISCOs’ proposed UoSC for hybrid consumption.

============================================================================================
                            LESCO     FESCO     GEPCO     HESCO     IESCO     MEPCO    PESCO
============================================================================================
                                    Industrial B3 Consumers
============================================================================================
Energy Cost                 0.00                                    0.28      0.71      1.20
Capacity Cost               8.73      8.75      10.12     13.65     5.87      6.21     11.70
Transmission Charges        0.70      0.71      0.81      1.10      0.47      0.50      0.90
Distribution Charges        1.13      1.37      2.93      4.22      1.37      1.26      2.20
Total Applicable Costs      10.56     10.83     13.87     18.97     7.99      8.67     16.00
Impact of Losses            1.27      0.92                2.68      0.32      0.83      2.70
Total Cost of Service       11.83     11.75     13.87     21.65     8.31      9.50     18.70
Cross Subsidy               5.58      6.74      6.93      10.37     7.06      15.56     5.20
Proposed UoSCRs./kWh        17.41     18.49     20.80     32.02     15.37     25.07    23.90
Proposed UoSC cent/kWh      6.11      6.49      7.30      11.24     5.39      8.79      8.39
============================================================================================
                                    Industrial B4 Consumers
============================================================================================
Energy Cost                 0.00                                    0.07      0.09      1.23
Capacity Cost               8.58      8.53      10.12     16.93     6.14      7.00     12.62
Transmission Charges        0.69      0.69      0.81      1.36      0.56      0.56      1.02
Distribution Charges        0.88      0.66      2.93      2.70      2.03      0.79      1.93
Total Applicable Costs      10.15     9.88      13.87     20.99     8.80      8.44     16.81
Impact of Losses            0.26      0.16                0.62      0.08      0.11      0.40
Total Cost of Service       10.41     10.04     13.87     21.61     8.88      8.55     17.21
Cross Subsidy               7.40      9.50      7.35      10.34     7.25      16.58     6.81
Proposed UoSCRs./kWh        17.81     19.54     21.21     31.95     16.13     25.13    24.01
Proposed UoSC cent/kWh      6.25      6.86      7.44      11.21     5.66      8.82      8.43
============================================================================================
Rs. 285 = $1 assumed for conversion to US cents. 
Source: DISCOs’ petitions for determination of UoSC as published on NEPRA website
============================================================================================

Taking B3 industrial consumers as an example, the DISCOs propose a UoSC ranging from 5 cents/kWh to 11 cents/kWh. Not only is this around as much and in some cases higher than the average cost of generation and service at 9 cents/kWh in Pakistan, but also much higher than what firms in competing economies are paying for power generation, transmission, and distribution (see Figure 1).

What is even more appalling is that no basis or justification behind the application of cross-subsidies—mathematical or otherwise—has been provided, except by LESCO, which specifies that:

“Undoubtedly, the consumer price should reflect the real cost of the generation, transmission, distribution, and supply of electric power to allow the fullest recovery of the legitimate cost for the provision of the electricity. However, where the same is not possible for any reason whatsoever then the cost for the provision of electricity is recovered in a manner that the consumers who can pay the high cost pays for the high prices which supports the other consumers.

The eligible BPCs are the consumers of 1 MW or more of the power. Generally, such BPCs are the industries who actually pass on the costs.” (LESCO petition for UoSC determination, as available on the NEPRA website) Several points require emphasis:

First, this statement concedes that cross-subsidies paid for by industrial consumers are undefined and untargeted. It acknowledges that consumer prices should reflect the real cost of generation, transmission, and distribution, but when this is not possible “for any reason whatsoever” the cost is recovered through cross-subsidies.

This implies that the cross-subsidy is not necessarily directed towards lifeline or protected consumers as it has been made to believe. Rather, it is effectively a subsidy to the DISCO when and where it fails to conduct its most basic task of recovering the amount for which it has sold electricity for “any reason whatsoever”.

Second, the cross-subsidy is paid on the principle of “who can pay the high cost pays for the high prices which support the other consumers”. Apart from the obvious issue that DISCOs have no expertise or jurisdiction in deciding who can or cannot pay for the high costs, the indiscriminate application of cross-subsidies across all industrial consumers is in contradiction to this objective.

Third, the assumption that generally consumers who can pay the high costs are “industries who actually pass on the costs” is problematic in every conceivable manner.

Broadly, industries can be categorized into non-traded and traded sectors.

Non-traded sectors are those that cater to the domestic market. Firms in these sectors pass on the impact of power sector inefficiencies and the government’s own welfare obligations to domestic consumers at the cost of consumer welfare. Because the cross-subsidy is applied indiscriminately to all industries across the country, it is paid for by all consumers of any goods manufactured in Pakistan.

Effectively, this is an extremely inefficient and unequal form of taxation, much like sales tax, that is paid for in the same manner by rich consumers and poor consumers, those buying essential commodities or non-essential commodities, no matter what.

In the case of traded sectors, it is even more problematic. Unlike non-traded firms that receive heavy protection through import duties and other restrictions and, therefore, have the ability to pass on the impact of higher energy costs to consumers, export-oriented firms must compete in international markets where competition is fierce and on price.

These firms cannot pass on the impact of higher energy prices because consumers can simply substitute their products with those of competing firms in regional economies with lower energy costs and lower prices. For traded sectors like textiles and apparel, on which the entire economy depends to generate foreign exchange earnings — the shortage of which is the fundamental issue behind every economic crisis Pakistan has faced — cross-subsidies in power tariffs take the form of a tax that cannot be exported.

But this logic seems to be completely lost on our policymakers. It was reported in a newspaper on November 21st that the power division has shown a reluctance to propose to operationalize the CTBCM model because it would mean an end to the cross-subsidies that the power sector is extracting from exporters. Furthermore, the NTDC is seeking wheeling charges at Rs 27/kWh, which is actively “meant to fail the CTBCM model.”

So, to answer those who ask why exports have not increased despite substantial investment in the textile and apparel industry, it is because they are being held hostage by a power sector unable to sustain itself and bent on passing on its own inefficiencies to the rest of the economy. But at what cost?

As power tariffs have increased following the withdrawal of the Regionally Competitive Energy Tariffs regime, textile and apparel production has been reduced by over 50 percent and exports have plummeted. Repeated warnings that deindustrialization is imminent went unheeded to the point that in October 2023, monthly power consumption of textiles and apparel firms on the LESCO network stood at only 114GWh compared to 224GWh in October 2022—a decline of 49%. If the status quo is maintained only to balance the books in the short term, this trend will continue to the point where there will be no export sector left to extract cross-subsidies from.

It must be reiterated that the trajectory of our economy over the coming years hinges on this UoSC determination. Over the next 5 years, Pakistan’s gross external financing requirements—i.e., the difference between all expected inflows and outflows of foreign exchange—are projected at an average of $27 billion annually.

This is the number by which we must increase our annual exports if we are to service our debt and finance our imports without completely drowning in a debt trap in which we are already knee-deep.

“Allowing B2B contracts at a rate of 1-1.5 cents/kWh will provide the export sector with the necessary business environment to work towards this number. It will also facilitate exports in the long run by allowing industry to directly procure electricity from clean sources and achieve net zero emissions that are required to continue exporting to key Western markets beyond 2030.”

Exports cannot be held hostage by policy inaction. Disallowing B2B contracts with wheeling at 1-1.5 cents/kWh will be tantamount to committing economic suicide.

By Shahid Sattar | Syed Absar Ali

The fundamental problem of our economy is that balance of payments crises and a perpetual risk of default have become the status quo.

This is because we import too much and export too little for the economy to be stable. Since FY04, our imports and exports have diverged so much that in FY22—during the run-up to the economic crisis—we imported 2.25 times what we exported, compared to 1.6 times in FY13 and 1.2 times in FY04 (Figure 1).

 

Instead of focusing on increasing exports and balancing our trade, we have relied on foreign remittances and external financing to fill the gap. Both increase the vulnerability of the economy to external shocks, and external financing comes with its own additional costs in the form of debt servicing and an implicit tradeoff on sovereignty when an economy inches closer to delinquency as Pakistan has.

Our policies continue to suppress exports while protecting unproductive domestically oriented industries to substitute imports—a strategy that has terribly failed in Pakistan and many other countries around the world.

Furthermore, uninformed rhetoric from various quarters of protected non-traded sectors and even some media outlets has not helped. For instance, a recent article in Business Recorder incorrectly claimed that “one of the members of the current interim setup who represents a specific sector tried to outsmart the system by using general non-export industries to cross-subsidize the export sector.” Even in other newspapers, claims regarding the export sector being provided with subsidies are frequent and have dangerously misguided the discourse on economic recovery and reforms. First, the authors of such misinformed propositions need to check their definitions of what a subsidy is. Second, they must present at least some evidence of where these subsidies are because our analysis indicates that there are none.

Power tariffs for exporters include a cross subsidy of around 5 cents/kWh to nonproductive sectors, making them almost twice the regional average. Similarly, gas prices following the recent reform have been increased to well above what prevails in the region, especially amongst competing economies (Figure 2).

 

Under the new pricing structure, the cost of captive power generation for export sectors has increased to as much as 15 cents/kWh for SNGPL and around 12 cents/kWh for SSGC consumers, which is around the same as getting electricity from the grid so that there is no real benefit in captive power generation. A statement from the IMF (International Monetary Fund) confirms that this was indeed the government’s purpose behind setting gas prices at these levels.

Ironically, captive power generation is—in the first place—incentivized by prohibitively high power tariffs that force productive sectors to pay for the government’s own social obligations and inefficiencies through cross subsidies, transmission and distribution losses, and stranded costs, etc.

The obvious balancing act was to remove the cross subsidy from power tariffs and equalize end-use prices for captive and grid electricity to shift industry away from captive generation. Instead, the government has included these unwarranted costs in gas prices to further undermine export competitiveness.

In the case of electricity—as acknowledged by the Power Division and power regulator NEPRA—a component of the cost of generation for power used by residential and agricultural consumers is extracted from industrial and commercial consumers, and this cross subsidy is clearly seen if one compares the power tariffs across different categories to the cost of generation and service (Figure 3).

 

But in the case of gas, it is a fuel delivered to consumers to convert and use as they prefer—i.e., as electricity in the case of industrial captive, and heat in the case of industrial process or household cooking and heating. Of the country’s total consumption, around 75 percent is indigenous gas, the cost of which, as per Ogra, is Rs 1,350/MMBtu, and 25 percent is imported LNG at approximately $13.50/MMBtu based on October 2023 rates. Accordingly, the weighted average cost of gas is around Rs 1,990/MMBtu.

Revised gas prices for export captive are Rs 3,145/MMBtu from March to November and Rs 3,830/MMBtu from December to March for SNGPL, and Rs 2,800/MMBtu throughout the year for SSGC consumers. Because prices for exporters are well above the cost, there is no subsidy to the export sector and, if anything, the export sector is again being made to subsidize the government’s debt and consumption in other sectors of the economy.

However, since we do not have enough indigenous gas to meet the entire country’s demand, the question of gas pricing is really one of resource allocation. By the law of price and demand, sectors that are subject to lower prices will consume more gas. So, do we want to allocate more gas towards productive uses, that will add value, earn foreign exchange, mobilize government revenue, stabilize the external sector, provide jobs, and create opportunities for productive investment that create future returns and benefit generations to come, or do we want to continue to burn away our precious resources in nonproductive activities?

The answer, based on prevailing policies, seems to be the latter. The energy sector provides vulnerable segments with cheap and underpriced electricity and gas but does so by systematically dismantling productive sectors that provide jobs to the same people, enabling them to purchase the same energy, efficient appliances and much more without any subsidies.

But this logic seems to completely escape the naysayers. Our policies continue to suppress exports while protecting unproductive non-traded sectors to substitute imports—a strategy that has terribly failed in Pakistan and many countries around the world.

The country’s international image and economic potential have deteriorated so severely that even strong and long-standing bilateral partners like Saudi Arabia and China have become wary of putting their money in Pakistan. For all our efforts to bring in foreign investment, nothing is materializing and how can it in a country where even domestic investors are increasingly parking their money in the safest and least productive of assets?

Pakistan’s gross external financing requirements, including current account deficits and amortization of debt, are, on average, projected at around $27 billion annually over the next 5 years. Prospects for receiving foreign investment remain bleak, and foreign investment in non-export sectors that do not generate returns in foreign currency is a liability in any case.

This is where we stand now: The foreign exchange shortage continues to persist, and exports for FY24 are likely to remain well below the FY22 peak of $32 billion. Following a brief appreciation, the exchange rate is depreciating again, which, coupled with the increase in gas prices, could very well reverse the downward trajectory of inflation, and result in a prolonged period of high interest rates. All of this will continue to cripple real economic growth and diminish the chances of recovery.

To come out of this vicious cycle of crisis after crisis and achieve sustained economic growth, a fundamental strategy of fostering competition and increasing exports must be adopted at all policy levels, across all sectors of the economy. Exports are competitive only if export sector input costs are at par with competing economies. Any form of taxation, either direct like sales tax or indirect like cross-subsidies, cannot be exported. The choice is simple: Export or perish.

By Shahid Sattar | Syed Absar Ali

Distortions caused by a distraught policy landscape — from high energy costs to an industry-wide liquidity crisis — have made it next to impossible for Pakistani exporters to compete in international markets.

To put things into perspective, Bangladesh exported more in ready-made garments ($15.7 billion) in the past four months than Pakistan’s total exports since January of this year ($13.3 billion).

While Pakistan has no shortage of rhetoric around increasing exports, policy makers remain dangerously oblivious to the fact that export sectors require a distortion-free environment to enable them to compete in international markets.

Currently, they are provided with anything but a level playing field.

Energy, on average, accounts for between 12 and 18 percent of input costs across the textile and apparel value chain. A cross subsidy of Rs 10.84-16/kWh embedded in power tariffs for industrial makes them almost twice the average for major textile exporting countries in the region (Figure 1A). Similarly, manufacturers across the country are faced with constant gas shortages with no end in sight while the impact of the gas pricing reforms, that place RLNG/gas rates well above a regionally competitive level (Figure 1B), is yet to be seen and evaluated.

The industry is also faced with a severe liquidity crisis. Due to rampant exchange rate depreciation and inflation experienced over the past year, the same dollar-denominated export order requires around 40% more rupees to process.

However, there is a severe shortage of working capital, and what little is available comes at exorbitant interest rates. Non-bank credit across the supply chain is a lifeline for Pakistani businesses, but with interest rates at over 22 percent investors are finding it more profitable to simply park money in banks. And over 70 percent of banking credit is being used to finance the government’s fiscal deficits, crowding out borrowing by the private sector.

The liquidity crisis is further propagated by around $1.3 billion (Rs. 370 billion) being stuck in the tax refund regime at any given time. FBR persistently delays issuance of sales tax refunds despite a 72-hour commitment under law and refuses to issue other refunds, including income tax refunds, non-FASTER refunds, custom duty drawbacks, etc., that have been pending for years. There is no logical reason for this except that the government needs this money to manage its own troubled cash flows, but at what cost?

Then there is the issue of close to no fixed capital investment in up-gradation and expansion of production capacity—one of the reasons for a long-term decline in manufacturing productivity. According to industry estimates, 50 percent of spindles in the textile sector will be scrapped without replacement over the coming year.

This means that Pakistan will not have enough upstream capacity to produce high-quality yarns that can be used in modern air-jet looms in downstream processes. The sizable investment that was made in up-gradation and expansion under TERF and other export financing schemes was either left incomplete due to restrictions on L/Cs on import of machinery or is sitting idle due to high energy and other operating costs.

If fixed capital investments remain abysmal, we will see an increase in imported intermediate products and a decline in domestic value added in exports over the coming months and years, further adding to the economy’s balance of trade deficit and external sector vulnerabilities.

Another issue is that of polyester staple fiber (PSF) prices. Domestic PSF suppliers—the basic raw material for man-made filaments and synthetic fibers—are exhibiting a ‘monopolistic’ behavior, keeping PSF prices artificially high.

This is made possible by heavy protection in the form of prohibitive import and anti-dumping duties on imports of cheaper and higher quality PSF.

This has created a “cotton-bias” in the industry, rendering it vulnerable to exogenous cotton supply and price shocks, and is a major challenge to export diversification within the textile sector export basket.

Add to this the plethora of bureaucratic red tape and regulatory sludge that exporters must regularly put up, Pakistan’s textile sector prices and turnaround times are simply too high to be able to compete with firms from regional textile and apparel hubs.

However, it is still not too late: given how the international policy landscape is shifting, the textile sector is still well-positioned to take advantage of these shifts, given a conducive policy environment at home, but further inaction could very well result in continued deterioration. Two important examples are discussed below.

First, the Carbon Border Adjustment Mechanism (CBAM) in Europe is expected to become fully functional at the end of this decade. Accordingly, by 2030, imports to the EU will be taxed for the energy emissions generated in their production outside the EU, effectively imposing an import tariff on any exports to the EU depending on their energy emissions.

To overcome CBAM-related taxes requires net-zero energy emissions across the export sector value chain. Bangladesh has already started to incentivize this: a recent policy requires new buildings with a rooftop area of over 92.2 square meters to have net-metered solar power to be eligible for a grid connection.

But in Pakistan, industrial consumers are subject to a cap of 1MW on solar net-metering. Furthermore, the textile sector has pledged to generate its own electricity using clean geothermal energy, but this requires B2B contracts with a wheeling charge of no more than 1 cents/kWh, all inclusive. The government refuses to increase the cap from 1MW up to 5MW or allow B2B contracts, only to protect its own distorted revenue streams.

Second is the Western movement to decouple from China. According to the USFIA’s annual textiles and apparel industry benchmarking exercise, 80 percent of the largest apparel and clothing firms in the United States are planning to reduce sourcing from China over the next two years, and shift from a “China plus Vietnam plus Rest of the World” sourcing model to an “Asia plus Rest of the World” model.

Once again, Bangladesh and Vietnam have already taken advantage of this, and their shares in international textile and apparel markets have gradually increased since around 2014, while those of China have declined (Figure 2).

Both countries are also offering very attractive incentives to further expand their textile and apparel manufacturing capacities. In Bangladesh new ready-made garment factories pay income tax at preferential rates of 10-12%, with many firms being eligible for further exemptions of up to10 years.

In Vietnam, new projects are offered preferential income tax rates of 10 percent for 15 years, including a 2-year tax holiday and a 50 percent reduction for the subsequent 9 years. In both countries, these are in addition to other incentives such as duty-free import of raw materials and reduced tax rates on export earnings.

India, to counter the growing importance of Bangladesh and Vietnam, is setting up seven mega textile and apparel manufacturing parks with full vertical integration. These include ‘plug and play’ facilities, all sorts of ancillary infrastructure, common processing houses, design centers, testing facilities, workers’ hostels and housing, and training and skill development facilities. Additionally, $36 million has been allocated to each textile park to provide a rebate of up to 3 percent of annual turnovers to newly established factories.

This begs a very simple question: Why would any investor anywhere in the world choose to invest in Pakistan when this is what they are being offered right next door, in a much more stable and export-oriented economic environment? The answer is they would not, which is why our entire economy is functioning on a hand-to-mouth, loan-to-loan basis with abysmal investment — foreign direct or domestic — in any sort of productive activities.

The way forward is simple:

The government must ensure a distortion-free supply of inputs to export sectors, whether energy or raw materials. It must remove the cross-subsidy embedded in power tariffs for exporters, allow B2B power contracts with a wheeling change of 1 cents/kWh all inclusive, raise the cap on solar net metering for all industrial consumers from 1MW up to 5MW to support the move towards net-zero, and ensure adequate supply of gas/RLNG at regionally competitive prices.

On PSF, import duties must be rationalized and irrational anti-dumping duties removed entirely. All imported inputs for the textile sector must be duty-free at the point of entry because duty rebates are economically inefficient and cause a loss of purchasing power to the exporters when they are inevitably and indefinitely delayed.

FBR must get its house in order, issue all pending tax refunds at once, and honor the commitment of issuing all FASTER refunds within the stipulated timeframe of 72 hours. Customs procedures for exports and export-sector imports must also be simplified and processing times reduced to enable faster turnaround times for export orders.

“Furthermore, there is an overall need to cut down on regulatory sludge, reduce the government’s economic footprint, and rationalize fiscal expenditures and revenues within a growth-oriented framework. This will reduce government borrowing, bring down inflation, allow for a reduction in the policy rate, and free up credit for private sector investment.”

To take full advantage of emerging opportunities, incentives offered by competing economies must also be matched or exceeded to stimulate investment in up-gradation and expansion of manufacturing and export capacity, both for domestic and foreign investors alike.

These may be bitter pills for policy makers to swallow but the only alternative is another crisis on the horizon—one we really cannot afford.

By Shahid Sattar | Noreen Akhtar

Net Zero is an international agreement for climate action that aims to achieve a balanced state of greenhouse gases in the atmosphere through emissions reduction and emissions removal from the atmosphere.

The Paris Agreement and IPCC (Intergovernmental Panel on Climate Change) underline the importance of net zero to meet the goal of 1.5°C by 2050 – the climate benchmark for the world’s average temperature that should not exceed that of pre-industrial times by more than 1.5°C.

The Paris Agreement requires states to “achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century”.

Significant reduction in GHG emissions is required to limit the ever-rising global warming, as the climate crisis cannot be tackled without transitioning to net zero. This transition requires clear and sustainable financing mechanisms as well as robust and long-term net zero targets in all major GHG emitting sectors, including energy, transport, and agriculture.

Requiring businesses to go green and carbon neutral by developing Science Based Targets and decarbonising their value chains is critical to not only avoid irreversible ecological catastrophes caused by climate crisis but also fulfil major compliance demands from countries importing from Pakistan.

 

Climate change affects countries in an inequitable manner thus posing existential threats to the already dwindling economies and vulnerable communities. Therefore, net zero has the potential to be a climate justice tool if its targets redress the injustices fairly (Khosla et al. 2023). Climate-vulnerable but low-emissions countries such as Pakistan are required to strengthen their climate actions and cut their emissions.

However, this unfair burden of emissions removal requires ambitious inclusive governance processes to support a transition towards SDGs.

Pakistan is experiencing massive losses from climate change. Net zero targets, therefore, are crucial for Pakistan to not only enhance resilience to climate impacts but also mobilize the global community to strengthen the component of fairness for mitigating climate change.

Pakistan’s updated climate pledge has set a “cumulative conditional target” of limiting emissions to 50% of what it expects its business-as-usual levels to be in 2030. Moreover, due to mounting global compliance requirements and to retain its status in the global market, Pakistan’s largest export sector – the textile industry – has taken promising initiatives to achieve net zero emissions targets in collaboration with other institutions.

Net zero coalition

Net Zero Coalition, also known as Net Zero Pakistan was convened by Pakistan Environment Trust in 2021. It is a collaboration among leading textile firms, non-governmental organizations, sector experts, and public institutions to enhance corporate climate action to achieve net zero by 2050. Through this coalition, the private sector aims to accelerate its sustainability efforts, decarbonize value chains and advocate for climate action and justice. Net Zero Pakistan is one of the first initiatives from the global south to be recognized by the UN’s Race to Zero campaign.

Net zero and Pakistan’s energy sector Overview

Globally, three-quarters of the GHG emissions come from the energy sector. The International Energy Agency (IEA) states that under the Net Zero Emissions (NZE) scenario, CO2 emissions fall by 40% by 2030 and to net zero by 2050, methane emissions from fossil fuels reduced by 75% by 2030 and solar and wind become leading energy sources of electricity globally. However, this is accomplished only if key pillars of decarbonization are adopted through a range of policy approaches and technologies. These pillars are energy efficiency, behavioral changes, electrification, renewables, hydrogen, and hydrogen-based fuels, bioenergy, and CCUS (Carbon Capture, Usage, and Storage).

 

The energy sector is the largest GHG emitter in Pakistan. A heavy reliance on fossil fuels for primary energy supply (67.9% in 2022) has exposed the country to energy insecurity, and GHG emissions. Despite Pakistan’s substantial solar and wind potential, these resources have been underutilized, often due to vested interests and unfounded concerns about “surplus capacity”. To achieve the goals set in the 2019 Alternative and Renewable Energy (ARE) Policy and the 2021 National Electricity Policy (NEP), competitive bidding for new climate-friendly power generation projects and discontinuing the old practice of direct contracting and cost-plus tariffs are imperative.

Pakistan’s energy intensity of GDP is comparatively high in the region, signaling substantial room for demand-side efficiency improvements in alignment with the global decarbonization targets. With an energy intensity of 4.6 megajoules per dollar in 2018, compared to 4.4 MJ/$ in India, 2.6 MJ/$ in Turkey, 2.5 MJ/$ in Bangladesh, and 1.8 MJ/$ in Sri Lanka, there is a significant scope for enhancement. Moreover, Pakistan’s energy efficiency improvement rate of 1.2% over 2000–2018 falls short of the SDG7 (Affordable and Clean Energy) global target of 2.6%, emphasizing the need for accelerated progress in this regard.

While Pakistan is already grappling with challenges such as policy inconsistency, resource allocation issues, and a stressed economy, the country must immediately harmonize its economic needs with the overarching sustainable and climate energy objectives. The following approach is recommended to transform the energy sector sustainably to support climate action.

Decarbonise the industry first

In the quest for net zero, electricity is the new oil. Interventions such as advancement in the electrification of public transportation, implementing solar PV for distributed generation, tube well operations, and utilization of space heating and cooling using heat pumps (Heat & Cool ACs) in winter and solar geysers are crucial to establishing a sustainable and environment-friendly electricity system in Pakistan.

Also, exploring the potential for geothermal as a carbon-neutral source of energy will be a win-win situation for all. However, all of this entails investment and government support in the form of reasonable wheeling charges and an enabling environment.

Export Industries, on the other hand, can achieve net zero without any financial support except by increasing net metering limits to 5MW and expediting wheeling at 1 cent/kWh. It will not only help Pakistan maintain its GSP+ status but also give benefits of net zero products in the EU and GCC augmenting exports with cheaper green electricity and zero carbon products.

Decarbonise the power sector

Ensuring a stable, reliable, and continuous energy supply within an isolated grid, while simultaneously pivoting towards net-zero, necessitates meticulous planning and implementation of contingencies. There’s a requisite for robust infrastructural investments, innovative energy storage solutions, and an adept integration of renewable energy sources to minimize the vulnerabilities associated with isolated grids. Moreover, resilient policies and strategies should be sculpted to ensure that the transition toward decarbonization does not jeopardize energy security, particularly in scenarios where renewable sources may be intermittent or variable.

Conclusion

Pakistani exporters must realize that net zero is no more a voluntary environmental and sustainability initiative; it is a requirement for compliance with the upcoming environmental regulations such as the EU’s Carbon Border Adjustment Mechanism (CBAM).

“As the EU is placing stringent obligations that require importers to import climate-friendly products with less emissions, achieving net zero is a matter of survival for the industry and exports in the global market. An energy system established on net zero targets is crucial for Pakistan to not only counter climate catastrophe and ensure access to climate justice but to also achieve access to sustainable, equitable, and economically feasible energy sources.”

By Shahid Sattar | Engr Tahir Basharat Cheema

No other commodity in Pakistan creates more economic distortions than electricity. Normal goods, public goods, inferior goods, and Giffen goods are the few kinds of goods that exist in economics.

Such is the scale of the crisis in Pakistan’s energy market—if it can be called a market at all—electricity cannot be classified under any of these.

We are in a place where the discourses driving decisions on issues with implications for the entire economy have become so severely misinformed that the record must be set straight.

It has been recently claimed that “Pakistan’s consumer tariff is based on the principle of equity: it transfers resources from the rich to the poor; from richer regions to poorer regions; and from federal pool to poor consumers in poorer regions”.

Apart from the oblivious mischaracterization of facts, such as that there is no nomenclature providing for “rich” or “poor” consumer tariffs and that there is no “federal pool”—only a growing pile of circular debt backed by large and persistent fiscal deficits—this statement runs contrary to all economic norms and public policy rationale.

Pakistan’s power sector is characterized by a state that is partially unable, partially unwilling to mobilize revenue generation capacity and is therefore bent on exploiting its unholy monopoly in the power sector for a pretend redistribution of income, no matter how damaging the consequences.

Around 68 percent of domestic consumers in Pakistan fall under the protected category and another 25 percent are lifeline consumers. Together they account for 73 percent of domestic power consumption.

The remaining 7 percent of domestic consumers—often referred to as high-end domestic—pay full tariffs and account for 27% of around 56,000 GWH of total domestic consumption.

The size of the subsidy given to protected and lifeline consumers is between Rs. 900 billion and Rs. 1 trillion rupees, both according to the Power Division and by our own estimates. All else aside, it is not mathematically possible for high-end domestic consumers — i.e., “rich” consumers—to pay for a subsidy of Rs 900 billion.

This begs the question, who is really paying for this subsidy? The answer is: it depends. Directly, it is a combination of high-end domestic, commercial, and industrial consumers with a cross-subsidy embedded in their power tariffs.

 

But once we consider the economic linkages that exist between all agents of the economy, everyone is paying for it—including and especially the protected and lifeline consumers whom it is meant to benefit.

Because electricity is an input across all sectors of the economy, taxes embedded in electricity prices are always passed on to the final consumers.

First, this adds to the lack of productivity and competitiveness in domestic activities, thus requiring even higher levels of protection from imports, fuelling distortions in domestic markets.

Second, and more importantly, it results in a loss of welfare for consumers across the board, but substantially more so for the poor than for the rich because the rich—by virtue of their wealth—are always willing to pay more for any given commodity than the poor.

But what is even more dangerous is when such taxes are imposed on export sectors. In the case of exports, the final consumers are international buyers with relatively elastic demand.

When the price of electricity for export sectors rises significantly above that faced by competing firms in other countries, demand disappears, and the industry inevitably collapses. This is what is happening in Pakistan.

Power tariffs for industrial consumers contain a cross-subsidy ranging from Rs 10.85/kWh, according to government sources, to Rs 16/kWh, according to our own estimates that are largely consistent with those from research institutions like the Pakistan Institute for Development Economics. This makes the power tariffs faced by Pakistani exporters almost twice the regional average (Figure 1, below).

• Tariffs in Pakistan can fluctuate between 14 to 16 cents/kWh based on prevailing exchange rates. 14 cents/kWh is based on $1 = Rs. 280.

** 80% of industry in Bangladesh is energized through competitively priced gas.

*** The bulk share of the Indian textile industry is located in the state of Maharashtra.

With energy costs accounting for around 12% of total input costs during the RCET regime, our estimates suggest that a rise in power tariffs from 9 cents/kWh to the current 14 cents/kWh reduces firms’ net profitability from an average of 8 percent to only 1 percent and crowds out the export sector. To connect this with reality, one only needs to look at the abysmal state of FY23 profits reported by publicly listed textile firms, and the continued decline in textile exports (down 10% in FY24Q1, year-on-year).

Not only have exorbitant power tariffs had a direct impact on export firms and the millions of jobs they generate, but the effects have spilled over across the entire value chain.

Over 60% of production across the country is halted and Faisalabad is completely shut; mill owners are scrapping their machinery at Rs 120/kg to pay outstanding electricity bills and leaving the sector, and cotton prices are plummeting because there is no downstream demand.

“There is broad consensus on a need for deep-rooted structural reforms to save our ailing economy from this destruction. However, what is poorly understood is that deep-rooted structural reforms are a precarious and continuous process, the utmost prerequisite for which is a relatively stable macroeconomy that is currently absent in Pakistan. Achieving this level of stability requires a sustained increase in exports to build up economic buffers necessary to shield the economy from exogenous and endogenous shocks during the reform process.”

The only realistic avenue to achieve this over the near and medium term is to reform how electricity is provisioned to export-oriented sectors.

First, export-oriented industries must be provided with a separate power tariff category, excluding economic inefficiencies like stranded costs and cross-subsidies.

This will provide competitive electricity tariffs that don’t inhibit the ability of exporters to compete in international markets. Second, the government must initiate a move towards a free-market and distortion-free power sector by allowing B2B contracts for power wheeling at a wheeling charge of 1 cent/kWh, all-inclusive.

And finally, the cap on solar net-metering for industrial consumers must be increased from 1MW up to 5MW to provide 5,000MW at the point of usage and move towards net-zero emissions in exports — required by 2030 to continue exporting to key Western markets.

Otherwise, the Power Division must explain the unjustified loss of livelihoods to the nation.

By Shahid Sattar | Noreen Akhtar

The GSP+ scheme has been extended for Pakistan for four additional years. However, the threat is not over. It is essential to note that the extended GSP+ is more stringent and failure to the effective implementation of all the mandatory conventions can lead to the withdrawal of the status. Continuation of the GSP+ extension is subject to whether Pakistan will ratify additional conventions and advance its current efforts of compliance with the compulsions.

Background

The EU granted Pakistan the GSP+ in December 2013, which came into effect from January 2014 onwards. This preferential tariff-free status provided a competitive advantage to Pakistan in the global market as the largest GSP+ beneficiary.

Not only Pakistan’s total exports to the EU observed a remarkable gain (more than 60% – around $10 billion in 2021 compared to $6 billion in 2013), but GSP+ also enhanced Pakistan’s capabilities to grow in a sustainable manner, diversify its economy and create employment opportunities. It accelerated the country’s efforts in improving compliance with major human and labour rights and environment and good governance-related international conventions.

Pakistan’s textile industry is the largest beneficiary of the GSP+. More than 80% of total exports to the EU from Pakistan are textiles. In 2021, Pakistan exported more than $7.7 billion worth of textiles to the EU. The top textile export products include trousers, not knitted; bed linen, not knitted and not printed and jerseys, knitted.

There are two special arrangements and one general arrangement under the EU’s GSP scheme. General arrangement applies to lower or lower-middle-income countries that receive duty reductions for 66% of all EU tariff lines.

EBA (Everything but Arms) is a special arrangement that applies to LDCs (Least Developed Countries) that receive full duty-free access to all products except arms and ammunition. GSP+ is the second special arrangement that applies to developing countries that ratify 27 core international conventions on human and labour rights and environment and good governance. These countries receive zero-duty access to the same 66% of all tariff lines covered under the GSP general arrangement.

Areas of improvement

PRIME’s recent study estimates that if GSP+ is revoked, Pakistan will lose more than one-third of its exports to the EU (more than $3 billion in terms of trade loss in 2021). This will pose existential threats to Pakistan’s largest export industry – the textile sector. Other resulting threats such as loss of employment opportunities and decent livelihoods, gender discrimination, and non-compliance to human and labour rights will significantly hinder Pakistan’s advancement to accomplish sustainable development.

The EU’s previous reports on GSP+ monitoring as well as ILO’s recent publication on Pakistan’s compliance with labour standards indicate that significant progress in terms of human and labour rights is crucial for Pakistan to boost its economy sustainably.

Fundamental human and labour rights such as freedom of association and collective bargaining, elimination of forced and bonded labour, abolition of child labour, and elimination of discrimination in occupation must be protected. The global community has serious concerns pertaining to non-compliance to occupational health and safety as well as a lack of tripartite consultations and social dialogue.

The ILO has added two more conventions (the Occupational Safety and Health Convention, 1981 (No. 155) and the Promotional Framework for Occupational Safety and Health Convention, 2006 (No. 187)) to its list of conventions on fundamental workers’ rights. Both conventions have not been ratified by Pakistan. However, the analysis of the current compliance progress indicates that Pakistan may be required to ratify these treaties in addition to other conventions to be added under GSP+.

Pakistan must strive to avoid revocation of GSP+ status by ensuring compliance with the EU requirements and utilizing the status further. There is a greater scope in diversifying export products within the textiles and exploiting untapped trade potential with countries other than the conventional export destinations such as Germany, Spain, and the Netherlands. Further, GSP+ removes tariffs on more than 66% of all tariff lines. However, these tariff lines are not being fully exploited. These untapped tariff lines with no penetration and easy competition should be fully explored.

Moreover, Bangladesh’s graduation from LDC to the developing country in 2029 thus losing its EBA status under the GSP scheme offers a generous opportunity for Pakistan to expand its textile exports.

“Upon graduation, Bangladesh will experience major trade losses to the EU due to the removal of the duty-free market access. PRIME’s analysis of trade loss indicates that Bangladesh will suffer market loss in women’s and men’s trousers and jerseys which Pakistan also exports to the EU substantially. A massive potential lies for Pakistani exporters to divert these trade losses in their favour.”

Additionally, digital traceability is another crucial obligation to ensure transparency in the supply chain. The textile industry must digitize its supply chain to disclose the data to verify that the manufacturing conditions are healthy and the impacts on the environment are minimal. Significantly low female labour force participation (FLFP), mounting industrial emissions, and lack of textile waste management are other areas requiring enhanced and sustained efforts to meet compliance targets.

Conclusion

A robust consideration of recommendations from the EU, ILO, and WB on compliance with fundamental requirements on human and labour rights and environment and good governance is crucial for Pakistan to avoid GSP+ discontinuation.

So far, the EU has not declared the new conventions under GSP+ for Pakistan to ratify and comply with; however, it is evident from the concerns raised that Pakistan will be expected to make more efforts in areas such as fundamental human and labour rights requirements, traceability, and female labour force participation.

Therefore, all relevant authorities must act together to promote rigorous compliance with the EU requirements and ensure that the Ministry of Commerce’s National Compliance Centre (NCC) is fully operational to guarantee sustainable and fair trade with the EU.

By Shahid Sattar | Absar Ali

The World Bank recently warned that Pakistan’s economy is on the edge of a precipice. Any more of the same will take it to a point of no return.

While the emergency financing arranged in June bought us some time, exports are struggling to recover, and the current account deficit has started to widen following the withdrawal of import restrictions.

As curbs on open market FX trading and smuggling have been enhanced, over $2 billion worth of demand for imported commodities will soon return to the formal sector.

Because the economy’s ability to earn foreign exchange remains abysmal, this will render the current rupee appreciation short-lived, trigger another steep depreciation, and give rise to another episode of high inflation.

Commercial and industrial activities will become further depressed, leading to further economic collapse.

The textile sector, for instance, is responsible for around 60 percent of exports and employs 40 percent of the labor force. It also supports numerous other sectors such as cotton and retail through domestic linkages.

In 2020, export sectors benefited from regionally competitive energy tariffs of 9 cents/kWh and zero-rating on sales tax.

As US-China trade tensions escalated, and manufacturing in China came to a near halt amid Covid-19 lockdowns, the textile sector captured a large share of the surplus international demand, and textile exports went from $12.5 billion in FY20 to $19.3 billion in FY22—an increase of over 54 percent in just two years.

However, due to the crisis experienced since mid-2022—starting with a steep exchange rate depreciation, followed by the withdrawal of competitive power tariffs, rising inflation and heightened uncertainty—the industry was unable to sustain this momentum.

Pakistan’s share in international textile markets was lost to regional competitors including Bangladesh, India and Vietnam, and textile exports fell to $16.5 billion in FY23.

Since February 2023, over 50 percent of production capacity has been sitting idle and more than 15 million workers—around 19 percent of the labor force—have become unemployed.

Continued exchange rate volatility, delays in sales tax refunds, and power tariffs of over 13 cents/kWh are now forcing manufacturers towards permanent closure, and the country towards a premature deindustrialization.

Big businesses are leaving Pakistan, and before looking for more FDI we must first persuade them otherwise.

There is broad consensus that a robust economic recovery and return to sustainable growth requires inflation to be reined in to the SBP target range of 5 to 7 percent, the exchange rate must be stabilized, and interest rates must be brought down to 5 percent.

However, the government is repeatedly failing to facilitate progress towards these goals.

Let us be very clear: A sustained increase in exports is the only way to achieve this and requires the provision of internationally competitive energy tariffs and restoration of liquidity in export sectors. Contrary to the government’s position, cost-of-service tariffs are NOT a subsidy to exporters.

Rather, the current tariff structure extorts subsidies from exporters to pay for the government’s own failures and inefficiencies in the form of, for example, cross-subsidies to lifeline consumers and payment of stranded costs to Discos.

While domestic consumers have no option but to pay for these inefficiencies, international buyers simply substitute our products with those of regional competitors who are afforded power at significantly lower prices. This further lowers our exports and leads to prolonged balance of payments crises.

Exporters must be provided with competitive power tariffs of 9 cents/kWh if we are to fix the economy.

This will operationalize over 50 percent of textile sector production capacity that has been idle since February 2023, and allow technological investments made over the past 2 years to start generating returns.

The resulting increase in exports will be realized within the current fiscal year and partially offset the impact of the import recovery on the macroeconomy.

This must be in addition to other export facilitation measures, such as relocation of international buying houses to Pakistan, that will improve the matching process between our exporters and foreign buyers, considerably reduce the cost of doing business, and attract investment towards productive export sectors.

Conditional on a favorable policy environment, the textile sector has committed to adding 1000 new garment plants to localize forward linkages for yarn and cloth manufacturers (that comprise the majority share of current textile exports) and significantly increasing the share of domestic value-added in exports.

This will bring in $5 to $7 billion worth of investment and add around $20 billion to annual exports over the next 3 to 4 years.

There has also been considerable progress in improving backward linkages. Last year, Pakistan imported around $2 billion worth of cotton for textile manufacturing.

Owing to the efforts of the Punjab Government and APTMA there has been large-scale mobilization to improve the acreage and yield of Pakistan’s cotton crop and reduce the need for cotton imports.

While these efforts will provide much-needed economic relief, they must be complemented by a broader cultural shift towards exports to achieve long-term external sector stability and bring economic prosperity.

This requires a continuous process of reforms, especially in the power and fiscal sectors to address misallocation of resources and distorted taxation regimes that impose high penalties on productive sectors.

Significant investment must also be made in developing internationally competitive human capital, and policies should encourage entrepreneurship and promote ease of doing business at every level of the economy.

If the ongoing crisis is to be finally resolved rather than postponed, the government—supported by all segments of society—must take every step possible to facilitate a sustained increase in exports. There is no other way.