Inaction will kill industry

Pakistan’s textile industry has long been a major contributor to exports, employment, and value addition.

However, the withdrawal of zero-rating/sales tax exemption on local supplies for export manufacturing while imports remain duty-free and sales tax-free under the Export Facilitation Scheme (EFS) has created structural distortions that are eroding the competitiveness of domestic industry and leading to widespread closure of domestic spinning, with further downstream segments of the textile value chain soon to follow.

No country, let alone one aspiring for industrial and export growth, affords such preferential treatment to imports at the cost of its domestic industries and livelihoods of its people. Already grappling with economic instability driven by structural distortions, the government must urgently address this issue and create a level playing field for its local manufacturers.

The EFS anomaly incentivizes exporters to rely on imports, even when equivalent inputs are available locally, because doing so eliminates significant tax-related costs. Exporters using local inputs first must pay 18% sales tax, then face protracted delays in sales tax refunds, often waiting over six months.

Even then, only 70 percent of the tax is refunded, with the remaining deferred for manual processing on which there hasn’t been any progress over the last 4-5 years.

This results in a strong financial disincentive to purchase local supplies when the entire process can be avoided by importing the same under EFS. The disparity not only distorts the market but also disrupts the natural economic linkages that should bind domestic industries together.

The cascading consequences of this policy are significant. The spinning and weaving sectors have witnessed a sharp decline in demand for their products. These industries are already grappling with high costs of production, especially driven by prohibitive energy pricing compared to regional competitors.

The added burden of unfavourable tax policies has pushed many manufacturers to insolvency. 40% of spinning units have been forced to shut down. Weaving mills face similar challenges. The result is billions of dollars in sunk investments, declining industrial output, and the loss of hundreds of thousands of jobs.

This also has severe implications for Pakistan’s cotton economy, which is deeply intertwined with the spinning industry as its primary consumer. Cotton farming injects USD 2–3 billion annually into the rural economy, serving as a lifeline for some of the most vulnerable communities, particularly in marginalized regions like southern Punjab and Balochistan.

The collapse of the spinning sector would effectively decimate domestic demand for cotton, leaving farmers without a market to sell in. This decline would disproportionately impact rural households, many of which depend on cotton cultivation and related activities for their livelihoods.

Women, who make up a significant share of the labour force in cotton-picking, would be among the hardest hit, further deepening rural poverty and exacerbating inequalities in already fragile environments.

The broader ripple effects extend beyond individual farmers. Agricultural revival initiatives like corporate cotton cultivation are unlikely to succeed without a robust spinning sector to sustain demand.

At the same time, the IMF’s prohibition on crop support pricing has left farmers without guaranteed profitability, making cotton cultivation less attractive compared to other cash crops.

Compounding these challenges is the fact that Pakistan’s cotton—characterized by higher trash content, moisture issues, and smaller bale sizes—is not competitive in international markets. Its primary utility lies in local consumption, where it is blended with imported cotton, which makes the domestic spinning industry critical to sustaining the cotton economy.

By prioritizing imports and neglecting the local value chain, Pakistan is not only jeopardizing its industrial base but also destabilizing its rural economy, further amplifying the socio-economic fallout of these flawed policies.

In any industry, efficient allocation of resources depends on market dynamics rather than arbitrary policy barriers. The current system disrupts this natural order, diverting demand from local producers to foreign suppliers simply because the latter enjoy tax exemptions. This inefficiency increases the overall cost of production and undermines the competitiveness of the entire textile value chain.

Over time, as local industries shrink, the economy loses out on the multiplier effects of domestic manufacturing—job creation, backward linkages, and the development of ancillary industries.

The current policy environment is also incompatible with Pakistan’s broader economic objectives. Policymakers have repeatedly emphasized the importance of reducing reliance on imports, creating jobs, and improving the current account balance. However, the preferential treatment afforded to imports through EFS directly undermines these goals.

For every unit of raw material or intermediate input imported under tax exemptions, the country sacrifices opportunities for domestic value addition, employment generation, and foreign exchange savings. In effect, the policy acts as a subsidy for foreign industries, allowing them to capture domestic markets at the expense of Pakistan’s industrial base.

A sustainable solution requires creating a level playing field for domestic manufacturers vis a vis EFS imports. Ideally, the government should restore the EFS to its original framework as of June 2024, including the zero-rating/sales tax exemption on local supplies for export manufacturing and extend it beyond one-stage-back to the entire value chain.

This version of the scheme is aligned with the interests of all domestic manufacturers, be it exporters or their backward linkages, and minimizes the disadvantages faced by local inputs as even the June 2024 version of EFS disadvantaged standalone players over vertically integrated ones.

For instance, a vertically integrated manufacturer of garments can import duty-free cotton under EFS, produce the finished garment and export it while the same product, manufactured by standalone players across the value chain, would face sales tax and minimum turnover taxes at each stage of production thus increasing costs and making their product relatively uncompetitive.

However, in any case, domestically produced inputs for exports must be provided a level playing field. Therefore, if zero-rating cannot be provided to these then all EFS imports must be subjected to an equivalent sales tax as their locally produced counterparts. Alongside this, inefficiencies in tax administration be addressed.

The sales tax refund process needs to be expedited and fully digitized and automated to ensure that exporters receive their refunds promptly and in full. This would free working capital for businesses and significantly reduce the fallout of implementing sales tax on EFS imports.

The streamlined system would not only support the textile sector in the current context but also contribute to improving the overall ease of doing business in Pakistan.

Finally, the government must give serious consideration to adopting a graduated sales tax model. India employs a similar approach whereby lower tax rates apply to raw materials and intermediate inputs compared to finished goods. This would reduce the financial burden on players along the value chain, while shifting the responsibility to the end-consumer to pay the tax on consumption.

Such a model would yield several benefits. By reducing the tax burden at the production stage, it would minimize incentives for underreporting input purchases or engaging in off-the-books transactions, thereby improving transparency and compliance and minimizing golmaal. Additionally, manufacturers would benefit from lower production costs, enhancing the competitiveness of domestically produced goods.

SMEs, often constrained by cash flow issues, would gain greater capital flexibility to invest in production and expand operations. Importantly, the simplified tax structure would also broaden the tax base as compliance improves, leading to more stable and increased revenue collection without disproportionately burdening compliant businesses.

Allowing the current policy distortions to persist will accelerate the deindustrialization of Pakistan’s textile sector, with devastating consequences for employment, investment, and economic stability.

The textile industry directly and indirectly employs millions of workers, many of whom come from vulnerable socio-economic backgrounds.

As factories shut down or reduce operations, these workers are left without alternative livelihoods, further straining the social fabric of the country. At the same time, declining industrial output will undermine government revenue and weaken the fiscal position, creating a vicious cycle of economic decline.

The paradox of subsidizing foreign farmers and industries at the cost of domestic livelihoods is one that Pakistan can really not afford. Policymakers must recognize that the country’s economic future depends on the strength of its industrial base, especially given its unique demographic challenges.

With around 65% of the population under the age of 30 and the highest number of out-of-school children in the world, the majority of the workforce lacks the skills needed to thrive in sectors like IT or high-end manufacturing—industries the government unrealistically aspires to develop overnight.

Moreover, Pakistan lacks the resources and infrastructure required to upskill such a large, underprepared population to compete on a global scale in these advanced sectors.

Manufacturing, particularly in labour-intensive industries like textiles, is the most viable path to creating jobs and absorbing this demographic into the workforce.

Given the population’s characteristics and limitations, there is no alternative but to focus on bolstering the manufacturing sector to ensure economic stability and provide livelihoods. Promoting domestic industries is thus not a matter of protectionism. In fact, no one is asking for any protection, just a level playing field that has become a matter of economic survival.

The textile sector, which has historically been Pakistan’s engine of growth, must be supported through rational and fair policies that encourage industrial expansion, creation of backward and forward linkages, and value addition.

Restoring the EFS, adopting a graduated sales tax model, and ensuring parity in tax treatment for all inputs are critical steps toward achieving this goal. Policymakers must act urgently and decisively to correct these distortions before the damage further exacerbates.

Copyright Business Recorder, 2025