Exports: key to sustainable economy
Shahid Sattar, Asad Abbas and Emaan Ahmed
December 17, 2019
It is encouraging to see evidence that Pakistan is on the road to recovery in terms of economic stability and growth. With a26% quantitative increase in textile exports, the first current account surplus in decades amounting to $20 million, and a place among the best performing stock markets in the world, Pakistan seems to be doing surprisingly well. A recent assessment of credit ratings by Moody’s Investors Service reforms these statistics, deeming Pakistan’s economy to be stable and on the road to recovery.
This news is reassuring, given that the incumbent government was met with the task of reviving an economy in tatters, with an unsustainable balance of payments and complications in financing of external obligations.
How did the economy landed in these dire straits in the first place? The faulty consumption-led growth policies, irrational tariff structures, imposition of duties on import of raw materials and artificially set exchange rates are to blame. In addition to all this, the unsustainable mechanism of borrowing beyond our means precipitated an inevitable day of reckoning.
This reckoning revealed itself in the form of a high interest rate, double digit inflation, deterioration of primary and fiscal deficits, continuous private sector losses, cutbacks in investments, large-scale unemployment, losses in consumer purchasing power and a subsequently lower standard of living.
Taking the worrisome state of affairs into account, the strategies employed to revive the economy included floating the exchange rate to a more realistic level, providing regionally competitive energy to major exporting sectors and issuing pending refunds accumulated under previous governments. These initiatives all played a significant role in spearheading the stability we see today.
This stability has not been attained without a price, and given that we are now at a much better vantage point, there is a need to steer towards a sustainable growth strategy primarily based on exports. This is a crucial step in quelling future dependency on loans.
Progress, particularly in terms of necessary expansion and development, is likely to be difficult if the aftershocks of the recent imbalances in our economy are not systematically addressed. The oft-repeated mantra that the export sector has not shown the desired growth despite the reduced cost of doing business blatantly disregards the root cause.
The aftershocks are broadly two-fold: quantitative and qualitative.
An assessment of quantitative impediments to the textile sector becoming regionally competitive highlights certain urgent causes for concern, along the lines of inhibitory energy tariffs, a renewed set of zero-rating woes, avoidance of crucial refunding and forced duties on cotton imports – all of which inhibit the urgent need to restore a sustainable Balance of Payments and to curtail the dependence on external funding.
Although the Ministry of Energy’s efforts to aid industrialists should not be dismissed, the elephant in the room is yet to be addressed: a sustainable energy tariff for industries. The 25 percent increase in electricity tariffs as a quarterly adjustment coupled with further add-ons is likely to be debilitating. Despite notifications clearly stating that an all-inclusive tariff will be implemented, these developments
will not only shatter confidence in government policies but will also seriously hamper viability. Furthermore, the energy rates have to be fixed for a minimum period of 5 years so that investments in expansion and modernization can be planned and executed.
The withdrawal of zero rating has resulted in the constriction of investible capital in the market, while the cost of borrowing to meet such capital demands has also significantly risen, giving investors little to no incentive to carry on their business activities. Profit margins in the industry are currently around 5-6 percent at most, whereas the funds blocked in GST are of the order of 12 percent of sales, leading to the current liquidity crisis.
As a consequence, there is a dire need to sensitize the FBR regarding its delayed provision of refunds on income and sales tax over the last couple of years. A sum of Rs.100 billion has been collected over a period of five months as sales tax from the textile sector and is yet to be refunded, while the payments for the technological upgradation scheme 2009-14 is also pending. The majority of these refund applications are rejected by the system due to Form-H and unannounced boundaries for acceptance in the FASTER system. Moreover, those applicants whose sales tax returns and forms have been accepted are not being refunded within the stipulated time of 72 hours.
Collectively, these factors give way to lowered market confidence among the industry and a reluctance to subscribe to these subsidized loan schemes in the future. Meanwhile, there are factors such as fully utilized capacities of textile mills, and order books that are overflowing with unmet requirements. Many of our exporters have decided to close their production lines due to a lack of sufficient funds to run these lines feasibly, rendering the opportunities created for an increase in market share unattainable.
Another quantitative impediment to the thriving of our textile sector is the much decreased volume of cotton crop. The current cotton arrival estimates fall far short of what is needed to fulfil domestic requirements of the textile industry, and these shortages force the entire value chain to rely on imported cotton, resulting in further inefficiencies in the manufacturing process. This year alone, the import of a record 6 million cotton bales is required to maintain the previous year’s production and export levels.
This has caused losses worth over Rs 1 trillion to the economy and resulted in the need to import cotton, which is further tainted by a 3 percent customs duty, 2 percent additional customs duty and 5 percent sales tax on its import.
With the increased burden of paying these duties on cotton imports, sustaining competition with giants like China, India, Bangladesh, Vietnam and Sri Lanka becomes an impossible task. It is therefore crucial that these duties be removed if the objective of increasing exports is to be achieved.
This brings us to a qualitative assessment of the inhibiting factors. The cotton crisis is not only stiffing our growth when it comes to numbers, but also due to the deteriorating quality of locally produced cotton. This deterioration can be attributed to seed quality and ginning practices, which are far behind those adopted by other regional players. Most industries have institutionalized advanced scientific methods such as genetically modified seeds and modern ginning practices that have a far higher potential.
Additionally, regional players have acquired more advanced machinery that is cutting edge and has immense potential to maximize productivity at lower costs, while Pakistan’s investment in technical machinery has dropped to the dismal level of 44 percent of what it was in 2005-2006. Investment in technology showed only a 1 percent improvement, whereas regional competitors achieved impressive increases from 2006 to 2015.
================================================================= Investment in Technology (2006-15) ================================================================= Countries Spindles % Change Shuttle Less % Change (Mins) Looms (000) ================================================================= China 55.7 63% 465 78% India 25 28% 78.6 13% Bangladesh 4.29 5% 42.9 7% Pakistan 2.95 3% 7.3 1% ================================================================= Total 88 100% 594 100% =================================================================
Technology upgradation programmes that boost capacity and modernization are essential if we wish to globally competitive. The government support in the form of tax incentives is to be a crucial factor in attracting investments in this regard. Such incentives are widely available to our competitors like Vietnam, China, India and Bangladesh.
Other qualitative factors which need to be considered include a global shift in consumer preferences, from cotton-based apparel to synthetic manmade fibers. In the world market, the consumption of MMF against cotton has tilted to a ratio of 70:30, whereas a decade ago it was quite the opposite. Presently, the most dominantly consumed man-made fabric is polyester. Meanwhile, polyester is heavily taxed at the input stage in efforts to protect the Lotte Purified Terephthalic Acid (PTA) plant. This plant is still running on outdated technology which is no longer used in the manufacture of PTA anywhere in the world, bringing us back to the crucial matter of technological upgradation and how the lack thereof can prove to be disastrous.
Given the importance of considering consumer preferences in an industry like textiles, the protection given to Lotte needs to be reduced to an appropriate level, and the duty on MMF yarn needs to be adjusted to provide incentive for the domestic MMF industry to thrive and fulfill industry requirements. A flourishing MMF industry has the potential to play a crucial role in enabling Pakistan to compete internationally, and would prevent job losses for over 100,000 people.
The amalgam of these unresolved issues is resulting in immense pressure for the textile industry to remain competitive, and this by default will have grave consequences for our economy. There is an undeniable need for a broader long-term policy that ensures investors’ confidence and provides them with a business and investment friendly environment, in order to actualize the goal of export-led growth in the foreseeable future.