In FY23, textile exports plunged by $2.8 billion (15 per cent decline) compared to FY22, derailing positive developments achieved over the last two years. This decline, along with a provisional 13pc decrease in June 2023 compared to June 2022, requires a closer examination of causes like energy costs, liquidity crises, tax refund issues, import restrictions, non-implementation of policies, market dynamics, competition, and supply chain disruptions.

Recognising and addressing these factors is crucial to reverse the decline. However, a misinformed narrative has distorted Pakistan’s textile sector’s image, making it difficult to comprehend associated challenges and formulate well-informed policies.

Devaluation does not increase exports

Constructive developments in Pakistan’s export sector are being hindered by a number of obstructions, including problems with the devaluation strategy intended to increase exports.

A hundred new textile units were set up due to TERF, of which approximately 50pc are currently operational

Pakistan is sensitive to currency changes because of its heavy reliance on dollar-linked inputs and foreign markets, which drives up the cost of imported inputs and reduces the profitability of exporters.

To meet production demands and reduce currency impact, the industry needs a two-fold increase in working capital. However, a lack of available capital and interest rates of 22pc prohibit borrowing and export growth, making it challenging to maintain export levels in dollars.

The non-payment on time of the Federal Bureau of Revenue refunds further restricts the recycling of funds, limiting liquidity for investment and growth.

Policy stability

Unreliable information and non-implementation of approved policies undermine confidence, deterring investments and stifling the growth of exports. The industry has not witnessed the implementation of textile policies from the first one in 2014-2019 to the current 2020-2025 policy. If these policies had been fully implemented, it is estimated that textile exports could have increased by 25pc to 40pc annually.

TERF: a catalyst for growth

Pakistan’s exportable surplus is currently only in textiles, the bulk of which is largely directed towards exports. However, to increase the exports, there is a need to increase the capacity for creating an exportable surplus.

To increase that exportable surplus, investments in modern machinery are required, for which the Temporary Economic Refinance Facility (TERF) was introduced. A hundred new textile units were set up as a consequence of TERF.

Approximately 50pc of them are currently operational. Once all the units start working, an additional exportable surplus of$8-10 billion is expected.

These units, set up under TERF, are mostly downstream and rely on the already installed spinning and weaving capacity for intermediate products. The types of machinery added through TERF are state-of-the-art and aimed at increasing the sector’s efficiency. Hence, the country stands to gain through higher value addition.

For this capacity to operate, energy inputs at competitive rates are required, without which all these projects will not be viable anymore. New projects, upgradation, and capacity enhancement are stranded because of the non-provision of electricity/gas connections to start production.

There is more than $5bn worth of installed capacity, most of which has not been energised. This affects the long-term productivity and global competitiveness of the industry and carries a risk of banks defaulting as the industry cannot service debt.

The funds provided through TERF were not gratis. A concessional fixed interest rate was applied for 10 years, allowing for the approval of Rs425 billion for investment in local and imported plant and machinery. Land and building investments were not covered.

The total investment generated by TERF is projected to surpass Rs800 billion. Commercial banks diligently evaluated each project before issuing letters of credit for the machinery portion only.

Regrettably, certain elements are attempting to cast aspersions on this scheme, aiming to portray it as a criminal endeavour. Such actions significantly threaten policy continuity, investment climate, and trust in the government. If this trend persists, it will hamper progress and perpetuate Pakistan’s current negative economic outlook.

Debunking the subsidy myth

High energy costs increase operating costs, making it difficult for manufacturers to maintain competitiveness. The discontinuation of the Competitive Electricity Tariff (RCET) has had a devastating impact on the export industry, negatively impacting the balance of payments and the economic outlook.

Export oriented businesses suffer from cross-subsidies and stranded costs in the power tariff system, depriving them of the support essential for competitive success. Energy sources that are reliable and affordable are vital for keeping the textile industry competitive.

The textile sector operates on a high volume, low-margin business. Even a small difference of 5pc in costs can significantly impact profitability, as witnessed by the discontinuation of the RCET. The high energy costs have consumed the sector’s profitability, stressing the sensitivity of the industry to apparently small changes in margins.

One critical reform required is forming a separate tariff category for exports without cross-subsidies/stranded costs. Establishing such a category would promote fair competition and encourage sustainable export growth within the guidelines set by the International Monetary Fund.

Disparity in Gas/RLNG

Pricing Punjab-based industries in Pakistan, which account for over 50pc of installed capacity, have substantial operational issues due to differences in gas accessibility and pricing between Punjab and Sindh.

While Sindh-based Export-Oriented Units (EOUs) benefit from subsidised gas supply, their operations are hindered by high gas prices, a lack of supply, and erratic electricity supply. These inequalities have a negative impact on operating capacity, shutdowns, unemployment, and circular debt.

A uniform gas price of $8 per metric million British thermal unit for the export industry and a reassessment of distribution based on value-added contributions to the GDP are two urgent actions that must be taken. A competitive electricity tariff applicable across the country would, to some extent, overcome the gas price differential.

Under collection of sales tax

By tackling tax evasion and underreporting, implementing retail-level taxing measures in Pakistan’s textile industry can increase revenue collection.

To find these glitches and execute targeted solutions, comparisons of domestic sales to under-invoiced imports need to be analysed. Because of the current sales tax collection and refund system, new projects and export growth are hindered by growing inventory and capital expenditures.

These problems can be solved by only charging sales tax at the point of sale for all domestically sold goods, which would capture the sale of all smuggled items.

It is critical to balance the general sales tax rate to decrease the danger of smuggling while assuring optimal revenue collection. Other vital initiatives include addressing the problems with used clothing imports and bringing unregistered dealers into the tax net.

The writer is a patron-in-chief of All Pakistan Textile Mills Association

Published in Dawn, The Business and Finance Weekly, July 24th, 2023