The new PM apparently has a different idea about managing the economy than Dar; as he sidelined the Finance Minister within days of assuming role. The business community is seeing this as an opportunity. The Pakistan Business Council (PBC) presented a detailed overview of the economy to PM Abbasi last week in hopes that he may correct the policy framework to improve the manufacturing base.
The crux of the PBC presentation is that the country is de-industrializing prematurely. The council is spot on; and the need is to mend policies to undo the trend. The question why is this happening? What are the deterrents to manufacturing growth? Why do SMEs shy away from investing in green field manufacturing projects?
A simple snapshot of taxation distribution explains half of the problem—manufacturing contributes 13.5 percent to GDP while its share in taxation is at 58 percent. On the flipside, retail and wholesale (the primary vote bank of PMLN) constitutes 18.5 percent of GDP while the sectors contribution merely 1 percent in tax revenues. Similar is the story of agriculture.
Manufacturing pays 4.3 times of taxes relative to its size. Why would anyone want to invest in such a heavily taxed sector? This explains why business conglomerates are making fresh investments in retailing; such as Nishat, Lucky and Packages groups have invested in Malls, hotels and dairy businesses while Sapphire has committed to build a retail clothing brand.
How many business groups have started any new venture in manufacturing? The only sector where local big guns in the last decade or so have taken a fresh start is power generation where the guaranteed returns in dollar terms are lucrative enough. A few of them have expanded their existing business lines; but none has perused green field manufacturing project apart from power generation.
The skewed taxation burden is narrated by the PBC; but the council did not explain the poor incentive structure as investment in power sector demonstrates that right incentive structure is the key. The businesses are opportunist and they simply invest where either they have expertise or the returns are too good.
Moreover, the cost of production in manufacturing is also inflated whilst the labour productivity is low. The high cost amid low efficiency structure have not only made our exports uncompetitive but is also replacing domestically produced goods by imports (even if some sectors like auto, fertilizer, cement, steel etc. are growing at the clutches of import protection). Though PBC does not talk about labour productivity, its calculations show that the gas and labour costs are almost double of that in India, Bangladesh and Sri Lanka.
In case of labour, the comparison is based on minimum wage which the incumbent government is increasing every year. The need is to lower the costs for exports to become competitive.
Industry contributes 21percent of GDP in Pakistan as compared to 30 and 40 percent in India and Indonesia, respectively. Dar policies have damaged further the manufacturing potential—retained earnings are being discouraged by higher taxes to disincentivize capital formation which is already too low. A strong policy shift is needed by new PM. The tax structure should be encouraging capital formation, and new export avenues should be incentivized like power sector. The existing exporting sectors should get gas at rates comparable to competitors. Importers should move away from full and final taxation regime to discourage under-invoicing.
FTAs should be renegotiated which have worsened trade balance; especially the one with China. There should be less tax on input production to promote value addition – for example making yarn and fabric easily available for value added textile that does well in foreign markets. Ultimately, we need to break lobbies, generate employment, and export surplus to get this economy on a growing track.
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