Unlocking the textile industry’s full potential

Pakistan’s textile exports have witnessed an 8.6 percent recovery in 2024, reaching US$17.45 billion in 2024 from US$16.07 billion in 2023, and approaching the pre-crisis US$18.67 billion in 2022.

At the same time, the composition of exports has shifted significantly towards higher value-added segments like apparel and home textiles.

Compared to 2021, export volumes of readymade garment have doubled, and knitwear has seen a 50% increase, while those of bedwear and towels have recovered to around 2021 levels after a 15-20 percent decline.

The change in export values, however, has been much lower at 16.74 percent for readymade garments, 6.83% for knitwear, 6.78 percent for towels, and -1.04 percent for bedwear due to a decline in unit values. If 2024 exports had been made at 2022 unit values, the headline figure would have been well over $21 billion.

While there is a recovery in the headline figure of exports, the economy is nonetheless losing out because of a surge in imports of raw material and intermediate inputs like cotton, yarn and cloth, and resultantly a decline in domestic value addition in exports.

Imports of yarn have surged as domestic manufacturing has been rendered uncompetitive due to high energy costs, which account for 35 percent of conversion costs in the spinning sector and were as high as 55 percent a few months back.

The situation is further exacerbated by the sales tax disparity between local and imported inputs for export manufacturing. The FY25 budget withdrew the sales tax exemption on local supplies for export manufacturing under the Export Facilitation Scheme, while imports remain sales tax free and duty-free.

When procuring domestically manufactured inputs, exporters must pay sales tax of 18%, which is refundable in principle but only partial refunds of 60% are issued (corroborated by the World Bank Country Economic Memorandum 2022) with regular delays of over 6 months as the FASTER system, which promised 72-hour refunds has been made dysfunctional. While progress was made on clearing sales tax refunds in FY24, over Rs. 180 billion of the industry’s liquidity remains stuck in the refund regime.

In addition to the broken refund regime, there is an administrative and time cost of an additional 6-10 months — from when inputs are procured and the final good is exported — associated with payment of sales tax and filing for refund that imports do not face.

These factors have prompted exporters to increasingly substitute domestically produced inputs like cotton, yarn and cloth with imported ones.

Monthly imports of yarn increased from 8 million KG in January 2024 to 32 million KG in January 2024, while those of greige cotton cloth increased from 2 million KGs to nearly 5 million KGs during the same period. At this pace, yarn imports are expected to triple from around 107 tonnes in FY24 to 290 tonnes in FY25 at a value of approximately US$870 million.

As a result, the domestic spinning sector is rapidly being wiped out, with over 100 units representing around 40 percent of production capacity having already shut down, and the remaining operating at below 50 percent capacity, with thousands of jobs lost.

The crisis is also spreading to further downstream segments like weaving. Standalone units (majority of them are small and medium enterprises) are specifically disadvantaged by the sales tax disparity since vertically integrated units do not have to pay 18 percent sales tax or 1.25% turnover tax at each stage of production.

Since spinning is the primary consumer of domestic cotton, its demise will wipe out demand for local cotton, threatening the entire cotton economy of Pakistan.

The end of crop support pricing under the IMF EFF 2024 and plummeting demand from the spinning industry leave farmers with high uncertainty around the profitability of the next cotton crop and, as a result, many are shifting to other cash crops.

Furthermore, Pakistan’s cotton quality is not suitable for export, and it is primarily consumed domestically where it is blended with imported cotton.

The survival of the spinning industry is therefore critical to sustaining the local cotton economy that channels around $2-3 billion to the rural sector each year. Destruction of the cotton economy will impact the most vulnerable segments of society, especially thousands of women dependent on cotton picking.

Overall economic losses from the decline of domestic spinning and cotton production would be huge given a multiplier effect of 6-7 times on domestic economic activity.

In addition to substantial employment losses, both directly in the textile sector and indirectly across related industries, the impact on government revenues would also be severe, with declines in tax collection from businesses, wages, and commerce.

Moreover, reduced income levels would dampen domestic spending, further slowing down economic activity and deepening the financial strain across multiple sectors.

Beyond the immediate threat to cotton and spinning, the broader textile industry continues to face unsustainable energy costs. Electricity tariffs in Pakistan are currently around 12 cents per kWh—far higher than the 5-9 cents/kWh in competing regional economies.

Gas price hikes over the last two years—from Rs. 1,100/MMBtu to Rs. 3,500/MMBtu—have also rendered gas-fired captive power generation prohibitively expensive, now costing over 14 cents/kWh, on par with the already unviable grid rates.

To further penalize industry, a grid transition levy of 5%—set to increase to 20% over the next 18 months—is being implemented.

Gas tariffs have already reached punitive levels, and any further increases through levies are entirely unacceptable.

The push for a forced grid transition is a lost cause—no manufacturer will shift to an unreliable and prohibitively expensive power supply. Rather, many have already switched to alternatives like furnace oil or coal fired captive generation, integrated with solar systems, to meet their energy requirements.

However, compared to gas this comes at a cost disadvantage and also leads to higher carbon emissions during production that are increasingly incompatible with international sustainability and environmental requirements.

Exporters are also burdened with a disproportionate corporate income tax structure. The FY25 budget brought exporters into the normal tax regime, imposing a 1 percent advance minimum turnover tax adjustable against a 29 percent final income tax, plus an additional super tax of up to 10 percent.

However, exporters are also still subjected to a 1.25 percent advance tax on export proceeds, including a 0.25% export development surcharge. This creates an unsustainable dual taxation system that imposes effective tax rates of up to 135 percent:

Textile businesses operate on low margins, and the imposition of both taxation regimes is discriminatory and financially unviable, as the advance tax of 2.25 percent on turnover leaves no liquidity for operations.

These challenges are economic issues with far-reaching consequences for Pakistan’s trade balance, employment, and industrial growth. The textile industry is the backbone of the economy, contributing over half of exports and employing millions, directly and indirectly.

However, despite some recovery in recent months, policies that erode domestic value addition, discourage local manufacturing, and impose excessive financial burdens on exporters are pushing the sector towards long-term decline.

Had the sales tax disparity not existed and domestic upstream segments not been rendered uncompetitive, the textile sector’s net foreign exchange earnings would have been $1.5-2 billion higher.

Instead, the increasing reliance on imported inputs and a shrinking spinning sector are reversing years of progress, reducing the country’s ability to capture value within its own supply chain. If these issues are not addressed urgently, Pakistan risks losing a major portion of its textile industry, worsening trade deficits, and widespread job losses.

Moving forward, the government must take a decisive action to address these issues. The industry is fully capable of achieving $25 billion in annual exports, provided that it operates under a policy environment that ensures competitively priced energy and a fair taxation regime.

The sales tax disparity must be eliminated—ideally by reinstating the Export Facilitation Scheme to its June 2024 structure, including the sales tax exemption on local supplies for export manufacturing. A more effective solution would be the full restoration of SRO 1125 zero-rating for the entire export-oriented sector, extending the sales tax exemption to all stages of the export value chain.

However, if these steps are not taken, then at the very least, parity must be ensured by subjecting imports to the same sales tax treatment as domestically procured inputs.

Similarly, high energy costs must be addressed through liberalization of the energy markets.

The industry must be allowed to procure its own gas and electricity, utilizing mechanisms such as third-party access to domestic gas resources and direct LNG procurement at international prices without the burden of domestic taxes, cross-subsidies and other inefficiencies.

On the electricity side, B2B power contracts should be facilitated with rational wheeling charges of 1-1.5 cents/kWh, free from legacy grid charges like cross subsidies and stranded costs that are unrelated to B2B consumers. These measures will not only ensure cost competitiveness but also support Pakistan’s transition to lower-carbon manufacturing, which is critical under evolving global environmental regulations like the EU CBAM and net-zero commitments.

Finally, the punitive advance income tax regime must be rationalized. If exporters are now placed under the normal tax regime, they should no longer be subject to the 1% fixed tax on export proceeds.

With shifting global trade dynamics — especially the US and the EU reducing dependence on Chinese manufacturing — Pakistan has a unique opportunity to expand its market share and attract investment in its textile sector.

However, this can only be realised if the business environment is competitive, with a supportive energy policy and a fair taxation framework. The government must act swiftly to remove these bottlenecks.

Copyright Business Recorder, 2025