When they first came into office, the Nawaz Administration’s pronouncements on the textile industry were a libertarian’s dream come true. Commerce Minister Khurram Dastgir was repeatedly quoted in the press as saying that the exporters had nobody but themselves to blame for slowing exports and declining global competitiveness. Gone were the days, it seemed, when the All-Pakistan Textile Mills Association (APTMA), the representative body of the textile industry, could successfully argue its way into government favours.
Yet, after three and a half years of resisting, it appears that the Nawaz Administration finally gave in. In January 2017, Prime Minister Nawaz Sharif signed off a Rs 18,000 crore stimulus package for Pakistani exporters (the largest beneficiary of which is the textile sector) that gave APTMA most of what it asked for.
So what changed? Why did the prime minister give in to the textile industry’s demands now? And what exactly did APTMA ask for and what did it get? More importantly, what does the country get out of spending Rs18,000 crore in taxpayer money?
The macroeconomic background
When the Nawaz Administration took office in May 2013 in the first peaceful democratic transfer of power in the country’s history, it inherited a macroeconomic mess. Economic growth, as measured by the gross domestic product (GDP) growth rate, had come to a virtual standstill and had averaged less than 2.5% over the past five years. Per capita incomes were stagnating, and poverty – after having declined for a decade – was on the rise again. And that is before one even begins to discuss the mess that was the country’s hodgepodge of an energy sector.
The one area that was doing well, though, was Pakistani exports, including textiles. For the calendar year 2013, Pakistan’s exports touched $25.1 billion, close to their highest level ever. Textile exports hit close to their peak, at $13.8 billion. More importantly from the new government’s perspective, growth over the past decade had been robust. Overall exports had been growing at 7.7% per year for the past ten years (through 2013), textile exports had been growing at 5.2% per year during that same period, and non-textile exports had been growing at an astounding 12.2% per year during that decade.
Perhaps it is unsurprising that the one area that the prime minister felt he did not need to put out a fire was in exports. And so when the textile industry approached him, with the same talking points it had been using in years past, it was easy for the government to feel that there was little urgency in needing to act.
By the end of 2016, however, it was abundantly clear that the policy of benign neglect was not working. While the rest of the country’s macroeconomic indicators had stabilized, exports were clearly suffering. In the three years the government had been in office, exports had declined by an average of 6.6% per year, down from $25.1 billion in 2013 to $20.4 billion in calendar year 2016. Textile exports were down 3.5% per year during that period and non-textile exports were down a distressingly high 10.8% per year over that three-year period.
So when in September 2016, APTMA Chairman Aamir Fayyaz approached the government for an assistance package to help the textile industry and boost exports, the prime minister and his cabinet were far more receptive.
Yet even at that moment, the prime minister was not easily convinced, not least because of resistance from the finance ministry and the Federal Board of Revenue (FBR). It took four months of painstaking negotiation to hammer out the deal. At one point, the prime minister asked Fayyaz and Finance Minister Ishaq Dar to sit in one room and work out the details of the agreement in detail while he continued to seek input from other cabinet ministers and the FBR on the pros and cons of the deal.
That effort appeared to pay off in January 2017, when the prime minister announced the Rs18,000 crore stimulus package aimed at textile exporters and which seeks to grow Pakistan’s textile exports at over 10% per year to hit $20 billion by 2020.
While the market and journalists alike appear ecstatic at the prospect of the effects of this package, Profit decided to skip the euphoria and ask the man behind the plan what he asked for, what he got, and what he hopes to achieve from this stimulus package.
The textile worldview
To talk to a Pakistani textile exporter is to step into a singular worldview. Industry participants are convinced of the economic value of what they do for a living and feel that the government has been insufficiently supportive of their businesses and therefore are betraying the macroeconomic interests of the country at large. APTMA office holders tend to be the most fervent advocates of this worldview.
“The textile industry has linkages forwards and backwards; it is linked to agriculture through cotton which is the only cash crop of Pakistan, with cottage industry, as well as the entire fashion industry,” said APTMA Acting Secretary General Anisul Haq, perhaps confusing the meaning of the term “cash crop”. (All major crops grown in Pakistan are cash crops.) “The textile industry has always been the engine of growth for any country. Link this industry to all these other sectors and you will see how much impact textiles have on the economy,” he added.
He is not wrong about the importance of the industry to Pakistan’s economy, and certainly its exports, since textiles account for about 60% of the total value of good exported by Pakistan.
The case for the stimulus
Aamir states that negotiations between APTMA and the government began in September 2016. Every month, federal officials sat down with textile lobbyists for two and a half hours to discuss the industry’s proposals and the government’s counter-offers. How Fayyaz made the case to the prime minister is practically a case study in how to make a winning argument.
“We said to the prime minister that we appreciate the fact that, over the past three years, your government has achieved a certain level of macroeconomic stabilization,” said Fayyaz. “When this government came into power, Pakistan’s foreign reserves were almost depleted, power outages were 10 to 12 hours per day, and gas was not available in Punjab throughout the winter months. GDP growth had come down and the economy was in shambles. So we appreciate that the government has managed to recover several of these losses. But we also strongly urged the PM and his team that the country had to focus on export-led growth.”
Yet even while praising the government’s efforts, Fayyaz pointed out that the gains were more fragile than they appeared. “Even though foreign exchange reserves are much higher than three years ago, it is all borrowed money that has to be paid back with interest. We have to earn that money, which we believe is done either through exports or through foreign remittances.”
Pakistan’s annual remittances from expatriates total $19 billion, the bulk of which are sent by low-wage workers in the Middle East. Fayyaz believes that those economies are slowing down and hence growing the current account surplus through remittances is unlikely. That leaves exports as the other way to increase reserves without borrowing. Unfortunately, on that front, Pakistan’s performance has been less than stellar.
“In the last three years we have been losing our export markets. In 2013, our exports were $25 billion. Now they are down to $20 billion,” said Fayyaz. According to him, the main reason for this decline is the loss of competitiveness of the Pakistan’s industries, which he blames on the high costs of doing business in Pakistan.
“In the textile sector, our main competition is from India, Bangladesh and China. Our cost of doing business is going up against these countries so we are gradually becoming uncompetitive and losing our market share,” he said.
Among those higher costs? A higher minimum wage and higher energy costs, says Fayyaz.
“Our minimum wage is Rs 14,000 a month, approximately $135. In Bangladesh it is $68. Our energy cost is around Rs11 per kilowatt-hour (kwh) while our competitors are getting it at about Rs7 per kwh. We are getting gas at $9 per million British thermal units (mmbtu) while Bangladesh is getting it at below $5 per mmbtu.”
In making his case for why Pakistani business faces higher costs, Fayyaz was at times prone to exaggeration. For example, he claimed that energy costs as a proportion of total production costs for Pakistani textile companies was 35%, a claim contradicted by the financial statements of publicly listed textile companies, which put the number around 10%.
“We are getting electricity at 1.5 times the price and gas at twice the price as our competitors in the region. Translate its effect as a 35% contributor to a production process and you will see how difficult it becomes to control costs,” he said.
Higher costs, he said, translate into not only an uncompetitive and expensive end-product, but also lower profits that can then be reinvested into upgrading and improving the industry’s infrastructure, a vicious cycle that he maintains the textile sector needs the government’s help to break out of.
One area where the textile lobby acknowledges the government has already helped to reduce costs is financing. “A while before the government announced this package; they have provided the opportunity of long term finance at 5% for 10 years. You can adjust the payments and periods but you can get finance at a 5% cost,” said Fayyaz.
What the industry demanded
The industry fundamentally made four demands, two of which the government accepted outright, one of which the government mostly accepted, and one that the government did not.
Demand 1: Tax-free imports of cotton
The first was to have the ability to have tax-free imports of raw materials, particularly cotton, into the country. “If the main raw material that the industry needs is pricey, then how can you expect the final product to be competitive?” said Fayyaz.
The existence of this demand contradicts the textile industry’s claim that its prosperity helps Pakistani cotton farmers. The reality is that many of the value-added textile manufacturers, particularly those that make readymade garments, do not use local cotton and instead import their cotton from other countries. This is because their buyers do not trust the quality of Pakistani cotton and prefer them to use cotton imported from other countries.
In making its case to the government, the textile lobby had claimed that it plans to use more of the country’s local cotton, much of which is exported to other countries, as part of its own raw material for higher-value exports. Indeed, Fayyaz said: “One aim for us is to convert more local raw materials into finished goods. By doing that alone we can gain $12 billion and this is other than our exports targets of 10% annualized growth.”
Presumably that $12 billion figure refers to the additional value of exports compared to the $4 billion in raw cotton and cotton yarn the country exported in 2016.
However, when confronted with the question of why the industry is asking for exemption from paying taxes on imported cotton when it is claiming that it will use more local cotton, Fayyaz did not give a clear answer, instead changing the subject to the fact that Bangladesh got tariff-free access to the European Union before Pakistan did.
“The demand for imported raw materials by foreign buyers has many reasons. We have had GSP Plus status [for European Union markets] only since 2014, while our competitors like Bangladesh have had that advantage for decades now. Our products were taxed and more expensive so buyers went to other countries’ products instead.” Bangladesh does not grow its own cotton and also has to import cotton, but this is a factor that Fayyaz did not address.
He also considers the ‘bad press’ as a contributor to the shift in demand from our raw materials to other countries’ products. “When Pakistan is being painted as an insecure country to go to and do business with, and when the buyer isn’t coming to Pakistan, it is difficult to get customers for value added products. Therefore, we only sold raw materials for which the buyers didn’t have to come here.”
Nonetheless, despite the incoherence of the case for the demand for tax-free imported cotton, the government agreed to the textile lobby’s demand, although they added some conditions that purportedly seek to protect the interests of local cotton farmers. The government will allow tax-free imports of cotton into the country after the local cotton harvest is over in December.
Fayyaz claimed that this measure would not discourage local cotton farmers. “Our local cotton price is derived from the international price. So just because the imports have become cheaper, the local produce’s cost would not be affected. Therefore, we have asked the government to waive this duty after the local farmers have harvested their cotton crop.”
It is unclear how APTMA expects a lower-priced imported competitor to not have any influence on the cotton crop in Pakistan.
Demand 2: Tax-free imports of man-made fabrics
The textile lobby’s second demand was that the government should allow the tax-free imports of those man-made fabrics (MMFs) that are not produced in Pakistan. Fayyaz said: “Only polyester is made in Pakistan. All other MMFs are imported. One of our demands was to make all those imports tax free and the government accepted this demand as well and taxes on all MMFs apart from polyester have been abolished.”
Demand 3: Tax rebates for exporters
APTMA considers this a partially fulfilled demand, even though the government essentially agreed to the textile lobby’s proposal for tax rebates on exports. The rebates are essentially a payment the government would make to exporters after receiving a payment for their goods sold abroad. The purported reason for the payment is to compensate the exporter for any local taxes they may have paid in manufacturing their product for export.
APTMA had asked for rebates increasing with the value addition levels of the exports, set at a 5% rebate for yarn and grey fabric, 6% for processed fabric, 7% for textile made-ups, and 8% for textile garments. The government essentially agreed to the demand, but just modified it to reduce each of the rebate numbers by 1%. So the final rebate rates announced the government were 4% for yarn and grey fabric, 5% for processed fabric, 6% for textile made-ups and 7% for textile garments.
This incentive is also conditional on the industry fulfilling its promise of higher exports. Fayyaz said: “The prime minister was concerned with our ability to deliver results and when we assured him that we will be able to increase the textile industry’s exports by 10% annually, he was bold enough to take this decision right then and there.”
The rebate will be given only if the exports are shown to have increased. In six months’ time, individual businesses will report their results and only those who have achieved a 10% annualized growth in those six months would receive this rebate.
Demand 4: Subsidized energy
The one demand for which APTMA showed the greatest creativity into crafting proposals was seeking subsidized energy costs. It suggested using a weighted average cost of energy across all provinces which would raise prices in Sindh and Balochistan but lower them in Punjab and Khyber-Pakhtunkhwa. The lobby suggested having an exchange rate adjustment in energy costs, and also asked for a removal of all government taxes and surcharges on electricity and gas billed to textile exporters. The government, however, was in no mood to alter its energy policy, which it believes will ultimately result in a greater supply of electricity at lower costs to all consumers.
Needless to say, the textile industry was not pleased at being rebuffed at what they saw as one of their most critical demands.
Fayyaz lamented: “No matter where the theft or losses happen across the country, the tariff payers are paying that money. I don’t mind paying those surcharges as a domestic consumer but when we are in a competition with international producers, we need the slack of not paying the cost of what we are not even consuming.” He said that manufacturers use independent electricity feeders and have to pay the bills on time, so they do not deserve to be made subjected to the surcharges and other such costs.
However, he said, “The prime minister said that in the future our energy costs might decrease. We also told the PM that we will continue to press upon this issue as energy costs remain one of our biggest hurdles in cost reductions.” He appears hopeful that if the textile industry participants continue to pressure the government, the administration will eventually give in
The non-demand: Exchange rate depreciation
The textile sector had also initially considered asking for the government to allow the rupee’s exchange rate with the dollar to depreciate in order to improve competitiveness. Most independent economists, as well as analysts at the International Monetary Fund, believe that the Pakistani rupee is an overvalued currency. However, it was made clear to APTMA that Finance Minister Ishaq Dar considered the exchange rate to be nonnegotiable and was not willing to even discuss it as part of the negotiations. Hence, APTMA did not even end up including it in its formal list of demands once the talks with the government actually began.
What the country gets in return
For his part, while the prime minister was willing to listen to the industry make its demands, he was also keen to make one of his own: insisting that the public’s money being spent on the incentive package yield tangible results for the country and its economy. On that front, the textile lobby promised to raise Pakistan’s textile exports to $20 billion by 2020.
That would require a 12.8% annual growth rate in exports from 2016 export levels, which the lobby, for some unspecified reason, has been rounding downwards to 10% per year.
“The PM asked us about the results we could give if our proposals were accepted. We told them that if we are granted the concessions and returns that we are demanding from the government, we can deliver 10% annual growth in our exports,” said Fayyaz.
The $20 billion number does not appear to be based on any econometric or financial analysis, but on an anecdotal survey conducted informally by the APTMA management of its members. “We consulted with our colleagues and promised 10% growth if the government committed to what we were demanding. In the next year we can achieve $1.2 billion increase, approximately $1.35 billion increase in the year after and so on and eventually reach the target of $20 billion textile industry exports in 2020,” said Fayyaz.
The textile lobby is keen to emphasise the macroeconomic benefits of raising exports. “Note that with $7.5 billion increase per annum, we wouldn’t need to borrow from IMF or World Bank. In the last IMF two-year package, they loaned us $6.5 billion. So we can make much more with exports than we have to borrow.”
The APTMA chairman appears to be mixing up foreign exchange reserves with the government’s external debt and borrowing obligations. While the government’s IMF loans had the effect of raising the country’s foreign exchange reserves, the cause of turning to the IMF in the first place was a balance of payments crisis when the government ran out of money to pay off its external creditors. If the textile industry is able to raise exports by an additional $7.5 billion a year, it will stabilize the country’s foreign exchange reserves, but will not do anything to the government’s debts or the possibility of a debt crisis.
“I always maintain that economic security is the most important thing for attaining national security. If we are begging for economic security then our national security is compromised,” said Fayyaz.
What will it take to achieve $20 billion by 2020?
While many in the industry, particularly the officer bearers of APTMA, appear to believe that government incentives will be enough to achieve the growth needed to hit the $20 billion target by 2020, Fayyaz acknowledges that meeting that target requires significant investments on the part of the industry itself, something that many players have failed to do in the past.
“There are certain companies – big and small – who have never reinvested in their machinery,” said Fayyaz. “In textiles, technological advancement is happening all the time. So if a company today is still using the plant they established in 1980, in which let’s say 1,200 labors are working, today a new plant of the same capacity can work with 600 or even 250 people. So irrespective of what the government does, if someone hasn’t reinvested in the technology they are never going to make money. There are also some people in the industry who have not developed any innovation in their product. They are still making the same thread. The world has moved far ahead. There is innovation in yarn, in fabric, in processed fabrics. So those who haven’t innovated are also losing at that. Then there is also the issue of economies of scale. At a certain scale today a company is not viable. If I take the example of spinning, a plant with 15,000 spinners is not viable. They have to compete in the world with India, with China, where there are 200,000 spinners under one roof.”
However, the APTMA chairman is also convinced that the investment needed to move the industry forward need not come from Pakistani companies alone. “We are also trying to get Chinese to invest in Pakistan. They don’t have the GSP Plus status so their exports are 11% more expensive than ours. Add to that the 7% rebate they would get if they bring their operations to Pakistan, and their margins would improve instantly by 18%. So we are trying to get them on board as well.”
So should the country be skeptical of the textile industry’s ability to live up to their word or optimistic?
Fayyaz said that there are some people who feel like they have had enough with the textile industry and now they wish to move their investments somewhere else. But there are also many industry players who are willing to construct brand new spinning wheels today. Such plants are more energy efficient, have higher productivity and have lower labor costs, so they will be profitable. However, those who are still running the plants established by their third generation ancestors, for them there is little hope even from this package. “So if you are prepared to do your part as well and expand or improve your operations, now you have the chance to benefit from the rebate and duty removals. The lower operational costs of new investment coupled with low cost financing opportunities and the 4% rebate to be provided by government will definitely add to the profits for such players.”
Despite many challenges and pressure exerting factors prevalent in the country for the past few years, there have been some composite units who had always done good and remained profitable. Fayyaz mentioned such units as another factor that would help in improving exports. “The composite units have many advantages over other factories, in their value chain, supply chain, cost savings as well as leave time benefits. They have different accounting processes as well and have the liberty of counting profits only on their final product.” This not only allows them a wider maneuvering range but the customers also prefer to work with such companies. They have more control over their quality, production process as well as time routines so it is better for clients. Aamir believes that many members of APTMA are already considering expanding their business vertically. Adding a backward or forward production unit or establishing a complete production chain would allow the companies to gain more customers, save more costs and achieve their exports targets as well.