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Why Regionally Competitive Energy tariffs are needed for textile sector!

Authors argue that the government proposal to remove the RCET policy and offer DLTL scheme of rebates to exporters instead is a highly illogical policy that spoils their efforts undertaken for the past two-half years, which has led to an expansion and growth of the textile sector.

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Shahid Sattar, Asad Abbas Shah, Eman Ahmed

Pakistan’s uncompetitive and inefficient energy mix has rendered economic growth elusive and raised pertinent questions about affordability. Our country’s energy tariffs have not been commensurate with the general population’s income levels, nor with regionally prevailing tariffs.

The regionally competitive energy tariffs provided in 2018 to support the textile sector- Pakistan’s largest manufacturing and exporting sector- reaped benefits instantly and led to impressive expansion and growth, both within the industry and for Pakistan’s economy as a whole.

The textile sector outperformed competition and expectations during the time of COVID-19 and lockdowns. However, hurdles frequently arise, hindering the sector’s smooth performance, giving way to economic failures. One such hurdle is the motion to remove regionally competitive energy tariff, a blunder that would sully all past efforts.

Providing the sector with an enabling business environment is crucial to maintain its role as a strong growth stimulus for the economy. Furthermore, the potential for higher value addition at subsequent phases of production enhances the sector’s ability to move Pakistan into tertiary production and industrial growth, but without competitive energy, this will remain a distant dream.

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Regional energy costs disparity

Despite unreliable energy supply and higher tariffs, the textile sector has been operating at full capacity and receiving increased orders, leading to the revival of non-operational units and creating new jobs.

Textiles have been heavily supporting the economy, yet illogical energy tariff hikes and policies hamper the industry’s profitability. In the past, the textile sector commended the Prime Minister for making Pakistan’s energy tariffs competitive with those in Bangladesh and India, but the current rate is 9 cents/Kwh, which is still well above the average of 7 cents in the region.

The government has offered to offset the high energy tariffs with a DLTL package, but this is an unsustainable solution. Only direct exporters can benefit from it, whereas 80 percent of textiles comprise the chain.

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Given the higher energy tariffs of our region, a domestic producer will not opt for local inputs while they can import them cheaply and without duty through DTRE and Bond. This policy, if followed through, will lead to rapid deindustrialization.

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So far, the textile sector has managed to meet demands, but growth has remained elusive, as high energy tariffs, power shortages, and inconsistent government policies have kept the sector stagnant. Despite limitations, the sector has performed well during the period of Covid-19 and posted a growth of almost 11 percent in exports during January 2021.

In terms of cost of conversion (where the cost of raw material is subtracted from the total cost of production); energy cost is the leading component, especially in spinning and weaving. Thus, it is pertinent to comprehend the importance and relative share of energy in the conversion cost.

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Due to severe competition among regional countries, a minor cost difference in relative terms brings a huge impact on the international market. Exporters face the brunt of the pressure from high energy tariffs, thereby reducing market share and leaving Pakistan far behind its regional competitors.

This is also one of the prime reasons for the stagnation of exports, a fact which was duly acknowledged by the government when it announced regionally competitive tariffs back in 2018.

However, over the last few months, there have been promising levels of export growth and positive impacts on industrial expansion and job creation. Minister for Commerce and Investment Abdul Razzak Dawood recently tweeted that the country’s exports have crossed the 2-billion mark in four consecutive months.

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According to provisional figures, our exports for Jan 2021 are up by 8 percent to $2.14 billion, compared to $1.98 billion in Jan 2020. The ex-ports for Jul-Jan 2020-21 increased by 5.5 percent to $14.245 billion as compared to $13.507 billion during Jul-Jan 2019-20.

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Our cumulative exports for seven months of FY 2020-21 are showing a rising trend. The impact of this export growth on Pakistan’s economic stability cannot be overemphasized. Exporters have achieved this feat despite difficulties, leading to a great degree of textile sector expansion.

Value-added exports, including readymade garments, knitwear, and other major exports, have shown substantial increases in quantity and value. Large Scale Manufacturing (LSM) in Pakistan grew by 14.5 percent in November 2020 as compared to the same month in 2019, data released by the Pakistan Bureau of Statics-tics (PBS) showed.

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It is important to note that the SBP data depicts a 5 percent drop in Textile exports, whereas the PBS data shows 10 percent enhanced exports over the last six months up to December 2020.

The difference is entirely due to a disconnect in the realization of proceeds and the change in terms of payment from suppliers due to COVID-19. The enabling environment resulting from these tariffs attracted billions in investments in the sector.

According to SBP, out of all Temporary Economic Refinance Facility (TERF) applications, around 60 percent came from the textile sector alone. Furthermore, the sector has experienced a $1.60 billion investment during the first 6 months of the current fiscal year.

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The demand for new investment from the textile sector is partially attributed to regionally competitive energy tariffs and concessionary markups. The large investment in machinery, skill, and product development, along with supporting policies from the government, are key areas to focus on to unfold the export potential of the textile sector.

A recent PIDE study, “Importance of Regionally Competitive Energy Tariffs for the Textile Sector of Pakistan”, highlights that energy tariffs in Pakistan are high due to operational and commercial inefficiencies, governance issues, ineffective planning, poor policies, and sub-optimal energy mix.

The unit energy price covers all the inefficiencies and is higher than the cost of service for industrial consumers. Moreover, the study finds that an electricity tariff above 7.5 cents / kWh is regionally uncompetitive. The industrial demand for providing electricity at 7.5 cents / kWh and Gas / RLNG at $ 6.5 / MMBtu is unassailable.

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The impetuous responses from some governmental offices to withdraw the RCET policy or gas suspension have weakened business confidence among producers. The table of regional energy tariffs shows the disadvantageous position of the Pakistani textile sector in terms of competitiveness in the event of withdrawing the RCET policy.

The regional average electricity tariff rate is 7.4 cents/kWh, and receiving a 9 cents/kWh tariff rate can provide a momentary respite to the textile producer but not a long-lasting one. The PIDE study has also pointed out that the share of energy in 2018 was 36.4 percent while during 2020, a percent decrease was observed in conversion costs.

This shows that regionally competitive energy tariffs have categorically raised the production cost in Pakistan. The share of energy in the cost of conversion shows that Pakistan’s textile industry is incurring 2.4 percent higher energy costs than India and 7.8 percent higher than Bangladesh.

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Drawbacks of DLTL scheme

The current dialogue surrounding regionally competitive energy tariffs suggests replacing RCET with a Duty Drawback on Local Taxes and Levies (DLTL) scheme. It is proposed that this scheme will be offered to Export Oriented Units (EOU) of zero-rated sectors.

At the exporting stage, while filing a return, they will receive a refund against the energy tariffs paid during the production process. This scheme cannot work effectively and will render the sector uncompetitive.

Competitive Energy tariffs

It is only rational to provide direct concessions based on the unit cost of service of energy in terms of competitive energy tariffs, rather than providing indirect concessions in the shape of DLTL. DLTL is made further complicated and thus more inefficient as it brings in extra costs of documentation, time, and delay.

The refund mechanism will incur time and delay costs as the release of refunds takes place at the end of the year. It is pertinent to mention that the Government of Pakistan has only recently released the DLTL claims pending from 2014.

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Furthermore, the documentation process for refund claim submission is unnecessarily complex, requiring an audit and verification of claims by a bank.

The textile sector is now expanding at an impressive pace and needs unprecedented support to maintain its growth, so direct and timely provision of relief in terms of the energy package will have long-term benefits for the entire economy.

In the undesirable case of replacing competitive energy tariffs with DLTL, the textile industry would end up needing to pay electricity tariffs at 14 cents / kWh. Meeting these higher energy costs will result in higher domestically produced output.

Thus, the output price will also be uncompetitive; any downstream unit in the value chain will prefer imported inputs instead of expensive domestic inputs. In this case, local units at the higher end of the value chain will be at risk of closing down.

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This phenomenon would be disastrous for the spinners, and it would be tough for them to remain in the market. It is impractical to depend on a DLTL scheme for energy tariffs as a method to support the whole value chain.

The benefits of such a scheme are seldom shared by the value chain and are likely to neglect the industry’s more pressing needs. Vertically integrated units have the most to gain from such a scheme, representing only a minuscule chunk of the industry.

Most textile units are not directly involved in the export process and are, in fact, far removed from it as they operate downstream. Therefore, not only would they attain no benefit from such a scheme, but they also stand to lose domestic market share.

Therefore it is an established fact that the withdrawal of RCET or the implementation of the moratorium on gas would be highly illogical policies. They would shatter investors’ confidence and spoil the efforts towards development and value-addition to make economic growth attainable for Pakistan.

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The expansion and growth of the textile sector over the years has been a direct benefit of the RCET policy, and the facts and figures given in PIDE’s study further cement this statement.

Consistent implementation of this policy is therefore essential to remain competitive, achieve sectoral expansion targets, and broaden the customer base.

Mr. Shahid Sattar, is the Executive Director & Secretary General of All Pakistan Textile Mills Association (APTMA), the largest exporting group in the country, has previously served as Member Planning Commission of Pakistan and an advisor to the Ministry of Finance, Ministry of Petroleum, Ministry of Water & Power

 Asad Abbas Shah is a Research Economist and a professional employee with more than 3 years of working with APTMA. 

Eman Ahmed is an Economic Analyst at APTMA. A recent graduate of the Lahore University of Management Science (LUMS), she obtained her BSc Honors in Economics and Political Science in 2019.

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