Make in Pakistan: 'Make in Pakistan': A journey to reindustrialize Pakistan

The Pakistan Business Council (PBC) is a research-based business advocacy body composed of over eighty of the most prominent businesses, both local and multinational, operating in Pakistan. PBC's membership has a very significant economic footprint and therefore a long-term commitment to sustainable, growth-oriented policies. The combined sales of its members represent every 9th Rupee of GDP, they contribute 25% of Pakistan's annual tax revenue and generate 40% of the country's exports. Together they employ over 2 million in their value-chains.

PBC is neither a chamber of commerce nor a trade body. Its advocacy is driven by what is good for the country and is free of sectoral or investor origin biases. A majority of its 28 full time resources in Karachi and Islamabad are engaged in research, which amongst others, includes trade, fiscal, energy, capital markets and corporate law. Additionally, it partners external research organizations, the academia and domain experts in developing its advocacy. The primary thrust of the PBC is "Make in Pakistan" with the objectives of creating jobs, promoting value added exports and encouraging competitive import-substitution. One of the key enablers of this is a level playing field for the formal sector. Therefore, it also focuses on broadening the tax base, tackling under invoicing, smuggling and Intellectual Property infringement.

Role of Manufacturing

For a country of 215 Mn people and at its stage of development, manufacturing plays an important role in the economy. There is a very close correlation between the rate of growth of manufacturing and that of Pakistan's GDP.

Pakistan is Deindustrializing

The role that manufacturing plays in Pakistan's GDP has been declining over the years, whilst countries like Bangladesh, that are not as richly endowed with manufacturing inputs, continue to industrialize. This is a "wake-up" call. Unless we address the key causes, we will lose jobs and export share.

Import Reliance Even for Essentials

Despite a 215m population, of which 130 m fall in the middle three quintiles, Pakistan has not been able to leverage scale to make manufacturing competitive. Import reliance has grown sharply

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               Imports     Imports     Growth
                 2007*       2016*   Multiple
                 US$MN       US$MN
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Footwear            34         103         3X
Pumps               47         171       3.6X
Glassware           13          74       5.6X
Tiles               50         170       3.4X
Blankets            17          46       2.7X
Fans                25          69       2.7X
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Falling Share of World Exports

If a country does not make enough, it will not be able to export. With declining manufacturing, Pakistan has been losing share of world exports, whilst countries like Bangladesh and Vietnam have grown theirs by between 2 to 7-fold.

Recurring Trade Imbalances, IMF Programmes and Pakistan's Global Standing

Due to deindustrialization, growing reliance on imports and falling share of exports, Pakistan has been suffering from recurring crises on the balance of trade and the external account. As a result, it has spent more years under the IMF programme, since independence, than out of it. Unless fundamental reforms are adopted, Pakistan will continue to be reliant on handouts and multilateral assistance. No country can sustainably gain and maintain economic and political autonomy without financial solvency. All stakeholders with a vested interest in Pakistan's stature and global standing need to come on a common platform to agree and implement these reforms.

In a "Do-NothingNew" Scenario, trade balance will revert back to FY19 levels

"If you keep doing the same as the past, you get results very similar to the past. For radically different outcomes, we have to try new solution.

Two Main Thrusts for "Make in Pakistan"

Pakistan is fortunate in having a population size to permit scale. This can be leveraged to Competitively produce goods and services that lead to lower import reliance. At the same time, it needs to focus on gaining global competitiveness to address export opportunities.

BUILDING DOMESTIC SCALE

Cascading Tariffs

When import tariffs are used primarily to raise tax revenue and not to support industry and raw materials, intermediate inputs and finished goods are taxed at virtually the same rate, domestic industry is unable to compete with imports from countries that have greater scale and productivity, especially if these countries enjoy preferential tariffs under a Free Trade Agreement. The footwear industry is a classic example in which a ready-to-wear pair of shoes was subject to the same duty as the components of the shoe. The net result was that Pakistan's shoe imports grew significantly. The Finance Bill for 2020 proposes to differentiate in rates through cascading tariffs. When this is applied across the spectrum of goods that are or can be produced in Pakistan, it will go a long way to creating a favourable environment to support domestic manufacturing. However, indefinite protection is not proposed for any sector, even if industry in Pakistan has to incur many costs which are the responsibility of governments overseas. These include provision of water, gas, electricity, sewage facilities and security at competitive cost.

One National Standard

Until a recent decision by the Council of Common Interests (CCI), each province, post the 18th Amendment had the power to enact food and other standards. Thus, there could be four different standards in the main provinces, a fifth for the federal capital territory and two more for Azad Kashmir and Gilgit Baltistan. For a national food manufacturer, it would be impossible to meet the requirements of seven different standards within Pakistan and yet have the scale to be competitive globally. Whilst the decision of the CCI is pending implementation, it will strengthen domestic manufacturing and make it easier to do business.

The same needs to be done for environment standards where again it makes no sense to potentially have seven different standards.

Investment Incentives

Pakistan significantly lags its neighbours in private sector investment. Whilst some of this is on account of shortage of power, which, if not the cost of energy, is now addressed, there is a need to invest in both capacity and diversification of manufacturing. It is regretful that tax credit available for investment in plant and machinery until the FY19 Finance Act has been withdrawn and despite pleas by PBC and others, not restored in the current Finance Bill.

Supportive Fiscal Regime

Industry which represent about 20% of GDP carries 56% of the national tax burden. Ninety percent of the top-1000 tax payers are subject to minimum tax on turnover. Just 10% pay income tax on actual profit. Minimum tax based on turnover is fundamentally flawed in that it is not a tax on profit. A standard rate of tax at 1.5% of sales fails to differentiate between the underlying profit margins of different sectors. Post Covid when profitability of industry generally is poorer than hitherto, continuing to extract minimum tax on turnover is grossly unfair and unreasonable.

Tax payers have been forced to become unpaid tax collectors by the FBR through imposition of withholding taxes. Two-thirds of annual income tax is now collected by industry through withholding taxes. There are 74 different types of such taxes, which require a 51-page guide to fully understand. Severe penalties are levied for errors. In many cases the withholding tax rate is far higher than the minimum tax payable on sales. The Finance Bill 2020 has attempted to rationalize rate of withholding tax at the import stage, which is a good start.

As mentioned earlier, competitiveness is a function of scale and productivity. Scale is promoted through capital retention and consolidation of business. Whilst many of the group taxation provisions that applied prior to the Finance Act 2016 have been restored, withholding tax continues to apply even if tax on inter- corporate dividends has been removed.

Minimum tax on turnover is levied even in tax holiday periods and for industries to be located in SEZs. This defeats the purpose of a tax holiday.

Controls over under-invoicing, misdeclaration, smuggling, counterfeiting and adulteration

The leakage of national tax revenue as a result of under-invoicing, misdeclaration and smuggling is considerable. PBC's study shows that imports from just China are under-invoiced by $5 Bn annually. It is essential that Electronic Data Interchange (EDI) is agreed with the main trade partners to quell under-invoicing. Additionally, data on items prone to this practice should be made public and through an auction, such goods be disposed to the highest bidder provided the bid was 15% or greater than the declared value. On smuggling, the best control is to stop sales through outlets that are generally known to deal in them. Counterfeiting and adulteration, besides the loss of tax revenue are also harmful to health. Consumer courts should be empowered to hear the cases and private sector be allowed to join the prosecution.

Plug and Play Industrial Areas

Existing industrial estates are choked, lack adequate infrastructure and land, which is being encroached by housing, has become unaffordable for industry. The country badly needs new industrial estates where "plug and play" facilities are provided to enable a quick start of new plants. Much is talked about Special Economic Zones, but the walk on these is missing. Besides SEZs need to be near concentrations of population, be easily accessible to ports and road/rail networks and ideally be organized to achieve cluster concentration to develop supply chains that can be optimally integrated. Land in such industrial zones should only be leased and not sold to avoid real estate speculation. Much has been said about attracting Chinese investment into labour intensive industries, given the rising cost of labour in China. Slow progress on SEZs, where "plug and play" facilities would be available, is partly responsible for this. Taxation incentives are less important.

Availability and Affordability of Energy

For many years Pakistan suffered from power shortages and several manufacturing units closed as a result. Fortunately, sufficient power is now being generated but transmission and distribution need to be addressed.

The country appears to be some way off from providing industry energy at a competitive rate. Wheeling is still not permitted. Capacity payments, transmission and distribution losses and theft all contribute to higher cost to the customer. Whilst the five core export sectors are being provided electricity at 7.5 c/KWh, which is competitive with the region, domestic industry is charged higher rates. Below-cost and low-cost supply of gas to some domestic consumers results in higher tariffs for industry. In a "chicken or egg, which came first" dilemma, consumption is subsidized instead of promoting jobs and disposable income.

Port Handling and Inland Logistics

It presently takes 200 hours to clear a container from the port as it involves multiple regulatory authorities, working in silos, with duplicating documentary requirements.

The National Single Window initiative of the government will go a long way to improve this. The time and cost of moving goods across the country is not competitive, because of an unreliable railway system, poor roads and an ageing trucking fleet. The latter is mostly in the informal sector.

Private Sector Credit Especially for the SME

As the government crowds out the private sector, bank lending to the private sector is limited and banks are reluctant to take risks with SMEs. There appears to be no direction that the State Bank can give to banks and government borrowing is unlikely to decline. The SME bank has also failed to perform its task. One option is to use vendor financing to provide credit through larger companies to their supply chain SMEs.

Inter-Provincial Competition to Attract Industry

Unlike many countries, the provinces in Pakistan do very little to compete to get industry to establish their factories and offices, aside from developing industrial estates. Since the minimum wage across the country is identical, provinces could offer to subsidize wages, offer reduced property taxes etc.

IMPROVE GLOBAL COMPETITIVENESS

Competitive Exchange Rates

A constant exchange rate for several years promoted imports and made exports less competitive. With competitive exchange rates now in place, the role of exchange rates in managing the external account has been restored. Devaluation is not a cure-all for exports, it is just one of several factors that make exports competitive. Pakistan's labour cost expressed in US$ prior to the adjustment in exchange rate was uncompetitive vs regional players. This has largely been rectified, though productivity remains an issue.

Energy at a Competitive Cost

See note under Building Domestic Scale. Whilst the five core export sectors have been assured electricity at 7.5 c/KWh for a limited time, this assurance needs to be renewed to ensure they remain competitive. Secondly, as more sectors are added to the core, they should also be provided this reduced rate.

Global Standards and Certification

It goes without saying that goods offered for exports need to accord with global standards, also as these are used as non-tariff barriers by some importing countries. The standard certification agencies require testing and evaluation equipment and processes that also accord with global requirements. This is particularly so for edible products. One way to ensure that industry standards come up to global expectations is to set local standards that are closely aligned with global.

Global Skills and Productivity

Industry needs to gear up the skills and capabilities to be globally competitive and improve the productivity, quality and costs of its offerings. Whilst in Textiles, this can be led by larger companies, in many other sectors, the Export Development Fund should be utilized to improve productivity. Clusters such as Sialkot have an advantage in this respect.

Diversification and Sophistication of Products

Pakistan has not only been slow to diversify its sectoral reliance, within the dominant textiles, it has not addressed the shift in preference from 100% cotton to man-made fibres or graduated up on value-addition. Within agriculture, rice continues to be the main export, whilst horticulture has not received the attention that its potential promises. The contribution of services has been stagnant and its export does not attract any drawback or rebates. The core export sectors need to be expanded to include Pharmaceuticals, Meat, Poultry, Fruits, Vegetables and Fisheries

Diversification and Development of Non-Traditional Markets

With more than 50% of its exports destined for North America and Europe, Pakistan needs to diversify to non-traditional markets, of which Africa has a strong potential. Pakistan is underrepresented in Africa relative to India in the number of in-country trade and investment officers. It has just one trade agreement with Mauritius, a small country vs thirteen of India's. The Pakistan private sector, particularly the larger exporters are used to serving less risky North America and Europe. It is less inclined to take credit and other risks associated with dealing with Africa. The country therefore needs an Export Credit and Guarantee institution to address this gap and open up new vistas for exports. Export Houses (such as Mitsubishi in Japan) can also help integrate SMEs into global value chains. The model for this can be developed with assistance from Japan and the IFC. Commercial banks are traditionally reluctant to take direct exposure to SMEs. Vendor financing using larger exporters and Export Houses could offer a way around this.

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PAKISTAN SIGNIFICANTLY UNDER-REPRESENTED IN AFRICA
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Africa's Total Imports 2018 US $ 577 Bn. 10
Largest importers $367 Bn; 10 Largest Import             Pakistan         India      India Multiple
Items $362 Bn                                                                              Pakistan
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Exports to Africa US$ Bn 2018                              1.5             26.9                 xl8
Share of Africa's Total Imports                           0.25%            4.7%                 xl8
Share of Imports into 10 largest Import Markets            0.2%            3.8%                 xl9
Share of 10 Largest Import Items                           0.2%             4%                  x20
                                                       (almost all
                                                          Rice)
Number of Trade Agreements                                  1
                                                       (Mauritius)          13                  xl3
Number of in-country Trade & Investment Officers            4               18                   x5
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Wash Export Prices Clean of Taxes and Levies

If Pakistan's exports are encumbered by taxes and duties, they will be less competitive than countries that have processes to ensure that export prices are clean of such levies. Larger exporters can operate bonded manufacturing facilities and use the DTRE scheme to avoid paying or claim back taxes and duties incurred. However, the SME lack scale, sophistication and resources to do this. It is proposed to address this by issuing and periodically updating standard drawback rates per unit of export of various export items. SMEs that generally rely on an extended value chain for supply of inputs, will be saved from lengthy process of identifying and claiming levies incurred at various stages of this supply chain.

Automate Rebates and Drawback

Presently exporters need to file claims to obtain rebates and duty drawback. Since exports are all documented and export proceeds are received through banks, it should be possible to eliminate the need to file claims that take a long time to be processed. Banks should be authorized to credit rebates and duty drawback. To provide added assurance, their credits could be audited on a sample basis.

Obtain Market Access into Japan, Canada and Australia

Gaining parity with Bangladesh into Canada, Japan and Australia would open up prospects of $3.2 Bn of exports.

Greater Global Integration

Unlike Vietnam and other countries in Asia, Pakistan is not well integrated. Politics limit integration with our immediate neighbours and we have not ventured with any success to reach out to ASEAN or the EU. The latter has granted Pakistan GSP Plus status, which will expire in 2023. We have had an agreement with China which has been renegotiated to our advantage, opening up $11.3 Bn of exports at zero duty, about twice the previous level.

Export-Oriented FDI

Unlike Pakistan, Vietnam has attracted export-oriented FDI from companies such as Samsung (which account for 25% of its entire exports). This allowed it to accelerate diversification of exports as well as utilize the extensive networks of these foreign investors to market abroad. Pakistan's FDI, on the other hand, has mainly relied on FMCGs that are attracted by the demographic dividend from consumption by a large middle class. They do not export significant percentage of their turnover and rely on imported inputs to grow their domestic businesses. There is no FDI in Textiles, Pakistan's principal export sector, nor in agriculture. Pakistan needs an FDI policy which differentiates in favour of exports and import substitution and for those investments which bring technology and know-how not available in the country or comes in sectors where local investors lack capital or risk appetite. An example of the latter would be oil and gas exploration.

Branding

Whilst exporters are permitted to retain up to 10% of export proceeds to spend on market development, for which there is no accountability, if they wish to utilize part of this retention to acquire brands or other capital assets, they need State Bank or ECC permission. This needs to be reviewed as there is no foreign exchange outflow beyond what is already permitted to be expensed.

Building brands abroad often requires investment greater than the export retention presently allowed. This should be allowed on a case to case basis.

Warehousing Abroad

Presently exporters are not permitted to ship for warehousing abroad, for example to hold for eventual sale to customers of online portals, such as Amazon. With the growth of such portals, the rules designed to cope with commodity exports need to be revised.

PROGRESS ON MAKE-IN-PAKISTAN

In the last two years there has been progress on "Make-in-Pakistan," but there still remains more to do. Manufacturing has suffered of late due to the state of the economy and most recently from the impact of Covid-related lockdowns. But there is hope.

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Progress    Key Recommendations
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?   Competitive exchange rate
?   Renegotiate FTA with China
?   Cascading tariffs to encourage local value-addition
?   Withdraw presumptive taxes on imports and stem under-invoicing and smuggling
?   Make energy available at a competitive cost to industry
?   Separate fiscal policy and tax audit from the collection of taxes. Simplify and document
?   Encourage capital formation and scale through consolidation
?   Promote investment and capacity addition
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Make-in-Pakistan is not just about Manufacturing

It is a misconception that Make-in Pakistan is just about manufacturing. Given its objectives of creating jobs, promoting value-added exports and encouraging import substitution, it covers all activities in and beyond manufacturing which meet these objectives. Foremost, it includes agriculture. If you don't grow enough of what the country and the world needs, you can't meet the objectives of Make-in-Pakistan. Also crops like Cotton are the backbone of our textile industry, the largest employer outside agriculture. We spend significant amounts in importing edible oil and pulses. Promoting cultivation of edible-oilseeds and pulses would create import substitution. Meat, Poultry, Fruits and Vegetables have significant scope for exports. So do minerals and fisheries.

The services industry not only facilitates manufacturing but also has a direct export potential. We have not accorded export of services the same importance as we do to goods. With Pakistan's large population it is important to recognize that manufacturing alone cannot absorb everyone. Pakistan has a large number of freelance software developers. The cost and quality of software developed in Pakistan compares favourably with our neighbour. Yet we provide no rebate to export of software.

Pakistan has a large number of professional accountants and accounting and other outsourcing has scope to develop in the country. Philippines earns about $28 Bn from export of services. Back office and call centres already operating in the country can be encouraged further to generate valuable foreign exchange.

Make-in-Pakistan is a Journey, Not a Destination

Make-in-Pakistan is a journey. The end is not in sight and may never be as further vistas will surely open to produce more exportable goods and services and as we develop the ability to become less import reliant. The government and business need to work together to accomplish this and PBC will continue to offer guidance through its research and by showcasing sectoral potential and achievements.

Copyright Business Recorder, 2020