Improving value-added exports: some suggestions

A new team has taken over the Ministry of Finance in Islamabad. Let us hope they will be more amenable to issues facing the value-added sectors, particularly the small and medium scale ones. They form the backbone of the value-added exports in not just textiles but across the board, sports goods, leather, surgical instruments, cutlery, jewellery, furniture, etc. Unfortunately, not one of their representatives has been included in the advisory council.

There is an anti-export bias amongst the bureaucracy and the economic thinkers of our country. Actually, the whole upper class feels that Pakistanis are not capable of competing in world markets and therefore exporters keep failing despite the “billions thrown at them.” The newspapers keep publishing statements by ministers and high officials declaring: “40 billion allocated for the export sector.” This is not aid or grant to the exporters, as the headline implies, but simply the refunds due to the exporters for the taxes they have paid. In other countries, the export sector is not subjected to indirect taxation in the first place. This is what I call an anti-export bias. Take the exporters’ money away from them, make them beg and plead, then release some part of it in a grand gesture of magnanimity! The sales tax collected from exporters should go into a separate account and should never be counted as FBR tax receipts. Hence there will be no pain when refunds are paid out. Moreover, we shall not fool ourselves on the amounts we have collected as sales tax.

The fact is that exporting units have never been allowed a level playing field with our competitors in India or Bangladesh. The Far Eastern countries are way ahead in the game. Our export sector has always been hobbled by indirect taxes, or a massively overvalued rupee. No government has pursued a path of poverty alleviation through export growth like they have in Bangladesh, and the Far Eastern countries who are all flourishing today. On top of that ‘Jihadist Pakistan’ is not a good name to bear when we sell your goods to the world. Unpatriotic but true.

I would like to recount, briefly, the ups and downs in exports of the last two years. When the rupee was freely floated it depreciated massively giving a big boost to our export competitiveness. The exports stopped falling, as they had been in the previous five years and started improving. Then came the Sales Tax fiasco in July 2019. An across-the-board sales tax of 17 percent was imposed in July 2019; this included the vendors to the export sector. The exporters were to be refunded the sales tax in full on the goods they exported. That was the theory. From August to December 2019, the FBR could not get their computer to work and our sales tax refunds were stuck. Despite our best efforts the computer would not budge and most middle to small companies could not finance the huge amounts stuck with the FBR as refunds. As a result about 20% of the weaker companies shut down permanently. The others had to curtail operations considerably. Just the big companies managed to get additional finance from the banking sector and so kept going. Once the computer started working, and our refunds for the months of July to September got paid six months late, from January to March, the exports started perking up too. Despite Covid-19 and the resultant chaos from end of March onwards, our results for 2020, especially when compared to 2019, were significantly better.

The fact is that the value-added sector cannot finance the huge amounts that get stuck with the FBR as pending refunds. They do not have the reserves, or the profitability, or access to finance to do so. There is an across the board 17% sales tax to be paid on all inputs except salaries and wages. Considering normal conditions 14 to 15% of the monthly sales of the exporter would be his refund due at the end of each month. Typically, the refund for January should be filed for in early February. As per FBR rules, if any one of our vendors has not paid his sales tax to the FBR, our refund is stopped. Invariably amongst the dozens of vendors someone has defaulted, so our application for refund is stuck. As a precaution I first call around to find out if all my vendors have paid their dues. They are often late so under the best of circumstances the refund is applied for about 20 days after the close of the month, at the earliest. If the computer is in a good mood the application takes a month to come up to the payment stage. That is if all goes smoothly and there are no hiccups.

Then comes the next hurdle. The FBR has to release funds for sales tax refunds. When and what amount shall be released, and if released in full measure or just bits and pieces, varies from time to time. So exporters consider themselves lucky if they receive the refund for January exports in April. This means a delay of three months. At 15% per month roughly half the working capital of the company is now tied up in this futile activity. If the exporter is not computer savvy, and makes mistakes in his application, then much the worse.

This is the scenario if all goes well. If we are approaching a deadline like the 30th June or 31st December when the FBR has to demonstrate its tax collection ability then refunds get delayed. For the refunds are deducted from the tax collected, and therefore nobody wants to give it. If a company makes a mistake in its application, then they are really stuck. There is no remedy or appeal system to which an aggrieved exporter can resort to for help or redress. Almost every exporter has substantial sums stuck up with the FBR.

What industry or activity in the world would remain healthy if half or more of their working capital is frozen? On top of it all the efforts of the exporters are focused on getting the stuck refunds cleared, rather than promoting exports.

To their credit the ministries of Commerce and Industry have been pushing the FBR to be quicker but the system is designed in such a manner that the exporter will have to suffer. This adds to the cost of exporting which our competitors do not have.

I know that the government is bound by the International Monetary Fund (IMF) to levy an across the board sales tax. The Government insists that they cannot get out of that. However the IMF does not stop our government from refunding the levy quickly. We have followed simpler and quicker procedures in the past and these can be implemented again. The fact that they were misused by gangsters does not mean that the entire exporting sector of the country must suffer. The same computer can do a post audit of all refunds to see if any fraud has been committed.

The simple procedure that we are recommending is an across-the-board sales tax refund on the FOB value of the goods exported. The percentage of refund can be worked out industry by industry and now that the FBR has the data of the last few years, it will be simpler. This refund should become payable immediately after the export of any consignment. So if an exporter completes the shipment of an order in say end January he is paid his sales tax refund a week later. This will speed the refunds by at least two and a half months, freeing the bulk of the 50% of the working capital stuck with the Government. It will also reduce the chunkiness of the refund process. So companies will receive a percentage of the value of every export rather than wait for three months to get a big check. The uncertainty of the cash flow will have been smoothened out.

Copyright Business Recorder, 2021