On the edge of a precipice

October 16, 2023

On the edge of a precipice

October 16, 2023

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.


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