Persistent decline of manufacturing sector

The latest monthly data for February 2024 on the Quantum Index of Manufacturing (QIM) has been released recently by the Pakistan Bureau of Statistics. There has been a decline of 0.51% in the level of output during the first eight months of 2023-24 as compared to the output in the corresponding period of 2022-23.

This decline has come after a quantum fall in output by the sector in 2022-23 of almost 10%. Earlier in the presence of Covid-19 and widespread shutdowns there had been a precipitate decline in production by the sector of over 11% in 2019-20. This was followed by a recovery in 2020-21 and 2021-22.

The base year for the QIM is 2015-16. The striking finding is that as of February 2024 the index stands at 118. This implies that the cumulative increase over the period of 7 years and 8 months has been only 18%. This is equivalent to an average annual growth rate of only 2%.

Clearly, the plunging of the GDP growth rate of the economy since 2017-18 is largely attributable to the poor performance of the large-scale manufacturing sector of Pakistan.

Historically, the leading sector in periods of fast growth has been this sector. A prime example is from the period, 1999-2000 to 2007-08, when the sector averaged an annual average double-digit growth rate of 10.7%. This provided a strong impetus generally and facilitated a GDP growth rate of above 5%. A high growth rate of the large-scale manufacturing has a number of favorable impacts on the economy. It is due either to higher import substitution or faster expansion of exports. Consequently, this generally implies some containment of the trade deficit.

The manufacturing sector is generally labour-intensive in Pakistan and employs almost one-fifth of the labour force, especially a higher share of relatively skilled workers. The large-scale and the small-scale manufacturing sectors combined account for almost 83% of exports, with the largest contribution by the textile industry.

A seldom highlighted contribution of the sector is to tax revenues. The large-scale manufacturing sector yields almost 60% of FBR revenues. The tax burden it faces is four times that on the economy as a whole.

There is need to study if the loss of growth in the QIM is generally across-the-board or limited to only a few industries. During the period, July 2023 to February 2024, a decline in output is observed in almost half the industries.

The biggest contribution to the overall negative growth rate of the QIM is by the textile and automobile industries of 1.75 and 1.14% points, respectively. The former industry has contracted primarily because of a decline in the volume of exports and domestic sales combined of cotton yarn and cloth.

The output of the automobiles industry has fallen by over 40% due to the severe restriction on imports of CKD vehicles in the presence of the foreign exchange constraint on the economy.

The earlier large drop of 10% in the QIM in 2022-23 was the consequence of a widespread decline. 11 out of 21 industries in the QIM saw a fall in output during the year. Big contractions were observed in textiles, petroleum refining, pharmaceuticals, automobiles, and transport equipment of 19% to as much as 50%.

The fall in 2022-23 is also largely attributable to the severe foreign exchange constraint which necessitated controls on the volume of imports of raw materials and intermediate goods. Vivid examples of this type of negative impact were visible in automobiles, iron and steel, electrical equipment and pharmaceuticals.

There are also other reasons, which have limited the performance of the manufacturing sector. The disproportionately high tax burden has already been highlighted. Tax rates continue to be increased. The standard sales tax rate has risen to 18% from 12.5% originally.

Regulatory duties have also been levied on imports. The time has come for a fundamental widening of the tax base to other sectors and some reduction in the burden on the large-scale manufacturing sector.

The manufacturing sector has also been hit badly by the quantum jump in interest rates. Exports face intense competition, especially in value-added textiles. Investments for technological improvements and rise in productivity are a basic requirement.

However, investment in the manufacturing sector has fallen sharply in response to the big rise in the cost of capital. Investment in the sector was only 0.8% of the GDP in 2022-23. This is a comparison of an over three times higher level of investment in the sector of 2.8% of the GDP in 2007-08, when the growth rate was at a peak.

More recently, cost factors have also started playing a major negative role. In particular, the extraordinary increase in electricity and gas tariffs has badly hit operations of existing production units. There used to be a differentially lower tariff of electricity to exporting units, especially in textiles. This has been withdrawn almost a year ago.

The growth experience since 2015-16 clearly demonstrates that if the GDP growth rate is to be raised above 2% to 3% only then is it crucial that the dynamism of the manufacturing sector be restored.

This will require appropriate changes in tax policies and the introduction of a regime of fiscal incentives for investment. Further, there should be shifting of part of the recovery of power generation and distribution costs to large domestic and commercial consumers.

The primary focus must be on export-led growth of industry. It is perhaps appropriate that the new government should design and implement a strategic five-year Industrial Policy.

Copyright Business Recorder, 2024