If there is one economic indicator that would single-handedly be responsible for turning GDP growth negative during FY2023-24, it is the Large-Scale Manufacturing. The LSMI has witnessed six consecutive quarters of contraction (year-on-year), as reported in this space earlier this week, and possibly the longest period of manufacturing recession in the country. And within LSM, contraction in the heavy-weight textile industry is so substantive that it has the potential to bring down the whole economic house with it.

Textile is the single largest segment within LSMI, with an 18.16 percent share in the manufacturing index (which in turn has a nine percent share in overall GDP). And the contraction within textiles manufacturing isn’t just in tandem with the broad-based macroeconomic slowdown witnessed over the past 18 months. In fact, textile output during H1-FY24 – specifically, that of raw materials cotton yarn and cotton cloth –is at its lowest level in two decades!

Let that sink in for a moment. The textile sub-index has contracted some 29 percent since its peak 18 months ago, which is when the current economic downturn began with the slide in currency, and withdrawal of concessionary energy tariffs. During 2022-23, the decline in domestic yarn and fabric production was widely attributed to the largescale damage to the local cotton crop after the monsoon floods of 2022. That year, a 42 percent decline in domestic cotton production translated into a 14 percent contraction in cotton yarn manufacturing, kickstarting the ongoing debacle.

But the plunge wasn’t supposed to turn into a nose-dive;nor to be carried-forward into 2023-24. Reportedly, domestic cotton output during the current year has nearly doubled over last year and is already the highest in the last five years. Had cotton consumption by the yarn mills been anywhere close to the last five-year average, yarn production would have recovered by at least 20 percent, if not higher. Instead, yarn production slumped by an additional 18 percent during H1-FY24, tanking textile output to its lowest level in over 20 years!

If these numbers are truly representative, then the cotton value chain must be in a crisis, with farmers up in arms. Instead, newspapers report no such chaos. More significantly, according to the latest data reported by Pakistan Cotton Ginners Association (PCGA), 97 percent of the cotton arrivals received by the ginning industry in the current season have been sold off to buyers in the private sector, with zero purchases by the Trading Corporation of Pakistan and minimal stock held by the ginners. In fact, at 8.1 million bales, cotton offtake to yarn mills as of February 2024 is the highest in five years.

So, how is it that despite low demand and no need for market intervention by the regulator, cotton offtake by the industry has continued unabated? Industry insiders indicate that yarn factories built up inventory for raw material in anticipation of restoration of regionally competitive energy tariffs but have been hung out to dry by a federal government severely constrained by the conditions imposed by the IMF. And with no respite in the export slump – especially in the woven denim fabric segment due to loss of price competitiveness – there is very little hope of fortunes reversing in the short run.

Which raises a question.At a time of record high interest rates, how are yarn millers holding on their own, especially now that the downturn has lasted over one and a half years? Some clue is offered by trends in banking credit off take. According to data released by the State Bank, the value of bank loans obtained against pledge of cotton is at its lowest level since June 2022, despite a 15 – 20 percent price increase in the average unit price of cotton during the period. This could indicate that the yarn industry – which traditionally follows a highly-levered working capital model – are in fact financing their raw material procurement largely through internally generated cash. This means that despite pressures of inventory buildup, the industry is still protected from receiving margin calls from their bankers.

Moreover, the law of unintended consequences might also be at play. Although the end of the concessional finance bonanza also marked the end of fixed rate financing for the export-oriented industry - the long-term loans issued under the TERF scheme (for up to 10 years tenor) has helped ensure that the weighted average cost of debt for textile firms has remained well under 15 percent, despite benchmark Kibor aiming for 22 percent. More importantly, the long run trend towards consolidation and vertical integration in the industry – especially with big business houses entering into direct exports through setting up of apparel and garments manufacturing units – over the last decade means many big names in the yarn industry also receive direct foreign exchange earnings, with the added benefit of currency depreciation, which may be proving just enough to keep them afloat in these difficult times. A few, if not many, textile players may also benefit from setting up of in-house renewable energy units, mitigating the weighted average cost of energy to some degree.

If the output trends are any guide, the textile industry – especially the low value adding yarn and weaving segments – should at least be on the brink of the precipice, if not slipping off already. Standalone, non-integrated units must be especially at risk. But something’s gotta give soon – otherwise, textile, with its 27 percent share in banking credit to private sector – very much has the potential to bring the house down with it.