Unravelling of the Textile Sector

Shahid Sattar

09 December 2024

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Pakistan’s textile industry, a key component of the economy and a full-spectrum value chain, is unravelling under the weight of poorly conceived policies. The government frequently champions private sector-led growth in rhetoric, yet its actions are stifling competition and undermining the very firms they claim to support.

Instead of fostering market-driven progress, policies remain entrenched in short-termism and mismanagement, suffocating the private sector and driving Pakistan closer to economic collapse. The textile sector – a vital contributor to exports and employment—now finds itself in a crisis, its decline symptomatic of broader structural failures.

At the centre of this are two policy measures: the elimination of gas supply to captive power plants (CPPs) by January 2025 and the withdrawal of zero-rating for local supplies under the Export Facilitation Scheme (EFS). These decisions, taken under the guise of economic adjustments to meet IMF conditions, reflect a myopic focus on immediate fiscal concerns rather than the long-term health of Pakistan’s industrial base.

From cotton farming to spinning, weaving, and garment production, Pakistan is one of only three countries with a full textile value chain that supports an entire ecosystem of employment, sustaining millions of livelihoods and billions in revenue.

However, this value chain is fragmenting thanks to short-sighted policies that actively exacerbate the challenges faced by this sector.

The removal of zero-rating for local supplies under the Export Facilitation Scheme has hit upstream segments of the textile industry – such as spinning and weaving – particularly hard. These segments, critical for creating intermediate goods used in finished textile products, now face an 18% sales tax, while imported inputs remain duty-free and exempt from sales tax.

This imbalance creates an uneven playing field, making imported inputs cheaper and more attractive than domestically produced goods.

The consequences have been immediate and dire: domestic yarn production fell by 40% year-on-year in 2024, while yarn imports surged to an unprecedented 27 million kilograms in November 2024, up 391% YoY.

The resulting erosion of local manufacturing capacity has destabilized the entire value chain, jeopardizing jobs, exports, and the trade balance.

Compounding this problem is the inefficiency of the sales tax refund system, which has failed to provide exporters with timely and adequate reimbursements.

Refunds, legally required to be processed within 72 hours, are often delayed by six months or more. Exporters typically recover only 60% of their claims, according to the World Bank’s 2022 Country Memorandum.

These delays and partial refunds add an additional interest cost of 10-15% to working capital required for procurement of intermediate inputs made in Pakistan, eroding competitiveness and forcing exporters to substitute domestic inputs with imports to avoid cash flow constraints.

While recent months have seen a modest increase in textile exports of approximately $200 million, this is concentrated in a handful of large companies and attributable to a low base effect from when Pakistan’s economic crisis was at its peak last year.

It does little to offset the broader challenges and financial unsustainability facing the industry and economy. In fact, the limited progress underscores the fragility of the sector, as critical segments of the value chain continue to face deindustrialization, threatening its long-term viability.

If the government genuinely aspires to foster private sector-led growth, it must offer the private sector breathing space it so desperately needs.

One way forward would be to adopt a progressive sales tax structure akin to India’s model. This system applies a graduated tax rate of 5-12% on raw materials and inputs as they progress up the value chain, with final consumer goods taxed at the higher rates of 12-18%.

Such a structure not only ensures robust revenue collection under the value-added GST regime—where input taxes are fully refundable—but also provides a fairer, more efficient tax framework that bolsters local industries.

By aligning taxation policy with industrial development goals, this approach would safeguard domestic producers while maintaining fiscal discipline.

Energy policy missteps are another major source of the crisis. The decision to eliminate gas supply to captive power plants reflects a fundamental misunderstanding of Pakistan’s energy and industrial dynamics.

Captive power plants, which many industries rely on, provide a stable and cost-effective alternative to the national grid, which is both expensive and unreliable.

Grid electricity costs in Pakistan range from 14–16 cents/kWh, significantly higher than the 5–9 cents/kWhin regional competitors like China, Bangladesh, India, and Vietnam.

Moreover, the grid is plagued by frequent interruptions, voltage fluctuations, and frequency instability, rendering it unsuitable for precision industries such as textiles.

The government argues that diverting gas from CPPs to the grid will optimize resource allocation and improve efficiency. Yet this rationale fails to account for the efficiency of CPPs, particularly those using combined heat and power systems, which operate at 80–90% efficiency.

In contrast, government-run RLNG plants achieve net efficiencies of just 40–52%, as the grid suffers from substantial transmission and distribution losses. Forcing industries to rely on the grid would not only increase their costs but also destabilize their operations, pushing many firms toward closure.

The cumulative effects of these policies threaten a cascading collapse of the textile value chain.

As spinning mills shut down due to exorbitant energy costs, weaving units are next in line to fail. This domino effect will ripple through the entire sector, crippling the cotton sector, destroying livelihoods, and plunging the economy into deeper instability.

The textile sector, which accounts for $3–6 billion in annual exports, is vital to Pakistan’s foreign exchange earnings. Its collapse would exacerbate an already precarious balance of payments crisis, further depleting foreign reserves and undermining economic stability.

The broader energy landscape of Pakistan is a result of decades of mismanagement and inefficiency. Circular debt in the gas and power sectors now exceeds Rs. 5 trillion, a testament to years of poor governance, unrealistic pricing models, and unplanned capacity additions.

The decision to eliminate CPPs is emblematic of this broader failure, conflating systemic issues with short-term fixes that only exacerbate inefficiencies. Instead of addressing the root causes of circular debt and grid inefficiency, policymakers are imposing measures that threaten to dismantle the very industries that underpin the economy.

To provide industrial sectors with competitively priced energy and allow them to compete in international markets, Pakistan must adopt a comprehensive, market-driven approach that prioritizes efficiency and transparency.

The continuation of RLNG supply to industrial self-generation facilities is essential, with measures to ensure ring-fenced RLNG pricing for stability, rationalized unaccounted-for-gas (UFG) rates in line with actual UFG of RLNG consumers, and the elimination of cross-subsidies that force industries to subsidize gas consumption in other sectors like fertilizer.

Additionally, industries must be granted the right to import their own RLNG, with transmission and distribution facilitated through wheeling on the Sui companies’ network. This would enable greater flexibility and reduce dependence on an inefficient centralized system.

Further reforms should grant industries the right to establish bilateral contracts with local gas fields, consistent with government policies that allow third-party access to 35% of domestic gas resources from new discoveries.

In the power sector, the operationalization of the Competitive Trading Bilateral Contracts Market (CTBCM) is imperative, enabling industries to engage in B2B contracts for power procurement.

This must be supported by rational Use of System and wheeling charges that exclude cross-subsidies and stranded costs. Such a framework would ensure access to competitively priced electricity while adhering to international environmental regulations and supporting net-zero targets.

Particularly, the distinction between gas used for power generation and other industrial applications must end, as in-house power generation, often through cogeneration systems, is an integral part of the industrial process.

Many industries utilize cogeneration not only for power but also for heat, steam, and hot water, making energy an essential input to manufacturing. It is not the government’s role to dictate how this input is used within industrial premises. A uniform gas tariff for industry is not only fair but essential for sustaining industrial competitiveness.

Importantly, all these recommendations are grounded in market principles without any reliance on subsidies. They represent a clear pathway toward creating an energy system that supports industrial growth while maintaining fiscal discipline.

By fostering a competitive, transparent, and market-oriented energy framework, Pakistan can provide its industries with the tools they need to drive economic recovery and sustainable development.

It is also important to address the flawed structure of the winter incentive package for incremental consumption that could otherwise be an excellent means to stimulate demand on the grid.

The package has been designed to fail as it is exceedingly complex and difficult for industrial consumers to comprehend and implement.

The estimated savings for the industry under the package amount to only 5-6%, which is inadequate for meaningful rejuvenation, particularly when savings are capped at 25% of incremental consumption over base units.

Power consumption among APTMA members was down by approximately 40% YoY in October 2024, and 60% compared to the year before, with similar trends in other LSM industries.

To benefit from the incremental package in its current form, industries must first recover their reduced consumption to previous years’ levels, which is calculated based on the 50-30-20 weighted average of the past three years for the same month. After this, they are required to increase power usage by an additional 25% to fully maximize benefits.

This mechanism is highly unrealistic, as increasing power consumption is tied to manufacturing demand, which depends on confirmed orders. Scaling up production also involves significant costs, including labour and other overheads, which far outweigh the limited relief offered by the 25% incremental savings.

The 25% cap on incremental consumption is also unnecessarily restrictive. Current demand remains highly suppressed due to skyrocketing tariffs over the past two years, meaning the tipping point for higher generation costs is still far off. Removing the cap would allow industries greater flexibility to benefit from the package.

Furthermore, the proposed Rs. 26.07/kWh tariff is misaligned with actual marginal generation costs, which, based on expected winter demand levels of 8,000-13,000 MW, is closer to Rs. 17/kWh.

The higher tariff figure provided by CPPA-G appears inflated and fails to create a meaningful incentive for industries to increase energy demand on the grid. A revised tariff closer to Rs. 17/kWh would encourage significantly higher consumption and support the government’s energy demand and transition-to-grid objectives.