Pakistan’s widening trade deficit will deepen without urgent policy reforms

Pakistan’s trade deficit has widened by 16% to USD 14.1 billion in the first seven months of FY 2025, compared to USD 12.2 billion during the same period last year (SPLY). On average, the monthly deficit has been increasing by 3%, currently averaging USD 2 billion per month. If this trend continues, the deficit could reach USD 26 billion by the end of the current fiscal year - or even higher at USD 27.8 billion.

While global trade, including Pakistan’s, faces uncertainty amid US-triggered tariff wars, Pakistan’s policy missteps have worsened the situation, leading to a significant shift in its trade dynamics.

A key concern is the growing reliance on textile imports - a sector that has always operated at a surplus.

This drastic shift is a direct consequence of regressive taxation policies and soaring energy tariffs, which have crippled domestic production and eroded competitiveness.

If left unaddressed, this trend could have severe long-term consequences for Pakistan’s balance of trade.

Exports vs. imports: a worrisome shift

During the first seven months of FY 2025, total exports grew by 10% to USD 19.5 billion, while total imports increased by 7% to approximately USD 33.3 billion. The petroleum and coal sectors led export growth, surging 85%, driven due to the zero-base effect of petroleum crude exports, followed by an 11% increase in textiles.

While these numbers may appear positive on the surface, a deeper look reveals a worrisome trend.

An analysis of import patterns indicates that the textile imports surged by 54% - the highest among all import groups. This stark reversal from same period in previous years, when textile imports declined by 38% in FY 2024 and 9% in FY 2023, highlights Pakistan’s manufacturing decline and the urgent need for corrective policy action.

What caused this shift?

During this period, cotton and cotton yarn accounted for 64% of total textile imports, up from 45% in SPLY- the highest composition ever recorded.

The primary reason is policy changes in the last budget. The Finance Act 2024 removed the zero-rating/sales tax exemption on local supplies for export manufacturing under the Export Facilitation Scheme (EFS), while imports remain duty- and tax-free. As a result, domestically sourced raw materials and intermediate inputs are now subject to an 18% sales tax, making local yarn more expensive than imported substitutes.

The consequences of this policy shift have been severe.

Domestic industry in decline, imports on the rise:

Over 100 spinning mills (~40% of production capacity) have shut down, while others are operating at below 50% capacity and are on the verge of closure.

Consequently, cotton yarn imports surged 276% in the first seven months of FY 2025 compared to SPLY. With an average monthly growth of 10%, they are projected to reach USD 737.4 million by year-end.

Even more concerning is that the surge extends beyond cotton yarn, with raw cotton imports rising sharply due to declining domestic production. During this period, imports soared to USD 1.12 billion - a 91% increase from USD 589 million in SPLY. At the current average monthly growth rate of 8%, total cotton imports are projected to reach USD 2.1 billion by year-end.

Given these trends, the combined import bill for raw cotton and cotton yarn is estimated to reach USD 2.84 billion - an 80% increase from last year’s USD 1.57 billion – posing a significant threat to Pakistan’s trade balance and the long-term viability of its textile sector, especially as protectionist policies disrupt global markets.

Pakistan’s trade deficit and the US tariff war: a brewing crisis:

Pakistan’s exports to the US are dominated by textiles and apparel. During the first seven months of FY 2025, exports to the U.S. totaled USD 3.6 billion, accounting for 19% of Pakistan’s total exports. Of this, 79% (USD 2.8 billion) consists of textile and apparel products.

Among these textile exports, 94% are value-added, including ready-made garments and home textiles, while only 6% are textile intermediates. Despite this, Pakistan lacks a preferential trade agreement with the US.

Fair trade is a two-way street, but Pakistan’s trade with the US tells a different story.

The US GSP programme, which expired in 2020, covered only 1.5% of Pakistan’s value-added exports to the US that year and has not been renewed. Meanwhile, Pakistan’s value-added textile exports face tariffs of up to 17% in the US market, while its cotton imports from the US remain duty-free, creating a one-sided trade relationship.

As the second-largest importer of US raw cotton - just behind China - Pakistan sourced nearly 50% of its total cotton imports from the US in FY 2024.

This calls for a proactive approach to securing fair trade terms and reciprocal market access with the US.

The unfair tariff burden:

The US policy of imposing blanket tariffs globally, including on Pakistan, is unjustified. With 19% of Pakistan’s total exports and 37% of its textile exports directed to the US, the existing 17% tariff - combined with a potential additional 20% - would significantly erode competitiveness. Pakistan primarily caters to low- to middle-income consumers in the U.S., making its exports highly price-sensitive. This is especially concerning given that Pakistan’s energy tariffs (12–14 cents/kWh) are much higher than those of competing economies (5–9 cents/kWh), placing textile manufacturers at a severe cost disadvantage.

Beyond textiles, overall trade relations will also be impacted. Pakistan has alternative sources for cotton imports, such as Brazil - its second-largest supplier - making it possible to diversify away from U.S. cotton if trade restrictions worsen.

Wider economic consequences:

An erosion of export competitiveness due to US tariffs and high energy costs will expose Pakistan to economic challenges far beyond a widening trade deficit.

In the short term (FY 25-26), declining exports will pressure the rupee, causing depreciation. As the rupee depreciates, the cost of essential imports - especially those with inelastic demand like energy, food, and raw materials - will rise, deepening the trade deficit and fueling imported inflation. Thus, depreciation will worsen the trade balance, a classic case of the J-curve effect - Economics 101.

In the medium term (FY 26-27), Bangladesh and India could capture Pakistan’s US market share with lower energy tariffs and competitive pricing. Even if tariffs on Pakistani exports are later removed, the damage to export competitiveness could be lasting.

With that, as US buyers shift to cheaper alternatives, investor confidence will weaken, reducing foreign direct investment in manufacturing and exports.

The fallout goes even further. In the long term (FY 28 & beyond), structural damage to Pakistan’s export sector is inevitable if alternative markets and policy reforms are not pursued. A persistently low export base amid trade restrictions will not only stall economic growth but also increase reliance on IMF bailouts. Worse still, a weaker rupee will make external debt repayments more expensive, leading to higher borrowing costs - all while dollar inflows remain insufficient due to declining exports.

Trade deficit projection: how bad can it get?

Pakistan’s trade deficit is growing at 3% per month. Without additional tariffs, it could reach USD 25 billion or as high as 27.8 billion by FY25. A 20% tariff hike would worsen the deficit, triggering long-term ripple effects - an outcome Pakistan must avoid in the current global environment.

If imposed, these tariffs would immediately hit Pakistan’s USD 6 billion exports to the US, exacerbating the trade deficit and impacting employment, particularly in textiles.

A way forward:

To protect its exports, the government must:

1. Proactively negotiate a Preferential Trade Agreement with the US that allows duty-free cotton imports from the U.S. to be used in value-added textile manufacturing bound for the US market. We have seen such an arrangement under Caribbean Basin Trade Partnership Act (CBTPA), where apparel assembled in the Caribbean and Central America using US-origin fabrics, yarns, and threads entered the US duty-free.

While some may question the timeliness of such a deal, India is set to begin FTA negotiations with the US this month despite tariff tensions. Pakistan cannot afford the economic fallout of a tariff war and must urgently pursue a trade agreement to secure long-term export growth and economic stability.

2. Restore the zero-rating/sales tax exemption on local supplies for export manufacturing under the EFS to prevent industry closures, especially as global trade becomes increasingly protectionist.

3. Reduce energy costs for textile manufacturers by bringing tariffs in line with competing economies to maintain cost competitiveness, ensuring exports remain viable even in the face of an exogenous shock.

4. Diversify export markets by expanding trade with Europe, Central Asia, and Africa, reducing overreliance on a single market and ensuring long-term market stability.

With structural challenges weighing on Pakistan’s economy, rising imports, soaring energy costs, and tariff uncertainty are threatening its export-led growth. The path is clear and evident - secure a US trade agreement, reverse harmful tax policies, and ensure competitive energy pricing. Inaction will further imperil Pakistan’s global trade position and entrench economic instability for years to come.

Copyright Business Recorder, 2025