By all accounts, Pakistan’s textile and apparel export profile has been transformed for the positive over the last two years. Export volume growth in high value-added (HVA) segments such as readymade garments not only outperformed export volume increase in low value-added (LVA) yarn and greige fabric segments but has also demonstrated resilience in the face of headwinds such as extreme rise in cost of production and downward pressure on prices.
Nevertheless, a curious trend has been emerging in spite of both volume and value growth in high value-added (HVA) textile and apparel exports over the last two years. Working capital financing to HVA textile and apparel industries is in remission, while LVA segments are demonstrating some degree of resilience, relatively speaking.
Before diving deeper into details, a note of caution for readers. For the purposes of the following analysis, high-value-added (HVA) segments have been defined as finishing, made-up textiles, and wearing apparel, while the definition of low-value-added segments is restricted to spinning and weaving mills. While experts may disagree with the classification of the finishing segment as high value-added (and for good reasons), the outcome of the analysis using either classification would be similar.
Traditionally, the high value-added segments commanded a lower share in total textile lending, averaging at just 40 percent. Not surprisingly, the majority of the working capital borrowing obtained by the high-value-adding exporting industry takes the form of export-based trade financing, averaging at 70 percent of total working capital borrowing by the HVA segment. Within export-based trade finance facilities, the share of the concessional export refinance (ERF/EFS) loans also averaged 70 percent historically, reflecting the traditional reliance of the HVA segment on the concessional lending program.
Now to the meaty part. Over the last 24 months, total working capital financing obtained by the HVA segment has virtually remained stagnant, averaging close to Rs 550 billion. As the door of concessional export refinancing has now been shut permanently, working capital financing being obtained by HVA industries is now being reprofiled, largely replaced by either commercially priced pre-shipment foreign currency FE-25 loans, or post-shipment bill discounting lines. Even so, total trade-based export financing obtained by HVA Textile has declined during this period, with a decline of Rs44 billion in EFS-based financing replaced with Rs38 billion in FBP and FE loans. The bulk of these are FE-25/FCY loans, which intuitively makes sense as one type of pre-shipment financing replaces the other.
Meanwhile, total working capital borrowing by low value-added industry has risen at a healthy pace, rising more than 18 percent over the two-year period. Naturally, the share of LVA industries in export-based trade financing remains low around 40 percent. However, during the same period when total export-based trade financing obtained by HVA industries remained virtually stagnant, export trade borrowing by LVA segments rose by 20 percent, outpacing borrowing growth by the HVA segment in every loan category except FE-25/FCY loans. In fact, between Aug 22 and Aug 24, even concessional EFS borrowing by the LVA segment increased by 7 percent, which fell by 15 percent for the HVA segment during the period under review.
This raises many questions. First, so far as reported production volume trends are concerned, it is in fact the low-value segments that have been in remission over the last two years. According to the Large Scale Manufacturing Index (LSM) reported by PBS, both cotton yarn and cotton cloth production in the country was reported at a 20-year low during the latest the fiscal year 2023-24, down by nearly 30 and 20 percent respectively against the peak performance of two years ago, the fiscal year 2021-22. By all accounts, it is the low-value-added spinning and weaving industry – particularly the SME weaving industry – that has been hit the hardest by the abolition of the RCET escalation in energy tariffs, decline in raw material cotton production, and destruction in domestic demand.
More importantly, the spinning and weaving industries have historically not had similar access to concessional and export-based trade finance facilities. At least, not in the same manner as the high-value-added industry. This has historically been reflected in the low share of export trade finance facilities in total working capital borrowing by LVA segments, where as much as 70 percent of total working capital borrowing came from commercially priced cash and running finance (and other non-trade-based ST) facilities.
Although some may argue that the working capital requirements of LVA industries have escalated at a higher pace compared to HVA, that would simply not be true as the price of raw material cotton plateaued during the later part of the period under review (in fact has fallen in Rupee terms), having already peaked in the international market by mid-2022, and locally in the aftermath of 2022 floods. Moreover, lower local cotton output, along with a decline in production of both yarn and greige fabric should point towards lower working capital requirements, not higher.
In contrast, the demand for working capital by higher-value-adding export-oriented industries – where working capital borrowing also constitutes largely trade-based export loans (which are knocked off only against export payments), should have increased simply by virtue of the massive currency depreciation during this period, with Pak Rupee losing close to 26 percent of its value in the past 24 months. Moreover, a higher volume of exports should also indicate a demand for more working capital. Even if pricing has declined in dollar terms in the export market, the Rupee value of exports has not tanked.
One explanation that comes to mind is an oft-repeated theme in this space: that the capex bonanza of 2022-22 was used by the large-scale, previously low-value-adding industrial units to vertically expand down the stream into higher value-adding production. That SBP loan disclosures may still have classified these industries in their erstwhile LVA categories is a possibility. This is further corroborated by the fact that the share of export-based trade finance in total working capital borrowing by LVA industries has risen from 35 percent historically to up to 50 percent in recent months. So far as SBP is concerned, the low value-adding segment is now exporting more, and the proof is in the pudding.
This is of course not a definite explanation, and the subject warrants further attention. If APTMA’s claim regarding widespread shutdowns across spinning and weaving industries is true, then what explains the sharp rise in borrowing by the LVA segment, especially relative to HVA? Does this mean borrowing is now becoming concentrated in a few large-scale, vertically integrated business groups? If so, what does SBP have to say about the rising share of 30 - 40 odd big groups in textiles bank borrowing, while the rest of the industry is left to fend for itself?
More investigation is merited.
Comments