Late last week BR Research had a conversation with Pakistan’s organised retail sector represented by Pakistan Retail Business Council (PRBA) and Chainstore Association Pakistan (CAP), both non-profit bodies whose members operate in the space of clothing, footwear, leather, accessories and other facets of the  retail sector. The idea was to discuss the size and scope of retail sector in Pakistan, focusing on the sector’s recent growth, opportunities and challenges especially in the wake of Covid-19, and their expectations from the government. Edited version of the transcript is reproduced below.

BR Research: Before we talk about the situation at hand, can you walk us through the sector’s growth prior to Covid-19?

Ziad Bashir: Until the announcement of federal budget FY20, PRBC’s members were growing at around 20 percent annually. Some of the measures taken in budget FY20 not only curtailed our growth but reduced sales in the fiscal year to-date, well before the pandemic surfaced.

The biggest hit was the GST rate which was increased from 6 percent to 17 percent for non-integrated retailers, and to 14 percent for retailers whose point of sales terminals were integrated or directly connected with the FBR’s system. The second hit to formal sector players was the doubling of interest rate alongside huge increase in inflation. Lastly, tax rates on salaries were also increased which squeezed the disposable income of nuclear families, which in turn impaired our sales.

Rising inflation and higher tax rates for salaried class meant that disposal income of customers shrunk substantially, and they became even more cost conscious than the year before. Now they want to buy from the cheapest source possible. Increasing GST from 6 percent to17 percent forced customers to shift to the undocumented sector. Now, customers want to buy from formal sector retailers only when seasonal discounts are announced. As a result, our sales at full prices have reduced significantly.

BR Research: And what is the size of organised retail sector as against the total size of retail industry?

Shamoon Sultan: Total market size of Pakistan’s clothes, footwear, leather products and accessories, is about Rs2,000 billion. Of this, only 10 percent of the Rs2,000 billion retail sector is organised, which translates into Rs200 billion.

Organised retailers pay full tax collected, of which 50 percent is paid by just 15 companies. This is a serious disparity, putting organised players at a disadvantage to the unorganised sector. In terms of employment, the entire retail sector in the country directly or indirectly employs about 9-10 million people in the country, which means about 50 million people depend on retail, assuming five dependents per person employed in retail sector.

The industry has evolved significantly over last decade. A lot of money has been spent on marketing, branding and building stores to be where we are right now. Timing of the pandemic hitting Pakistan could not be worse for retailers. In Pakistan, 50percent of annual sales are realised between March and July/August primarily because of two Eids, Ramadan, summer vacation, and the spring/ summer lawn season. Generally, people spend more on summer clothing than winter.

The industry grew the most between 2012 and 2017, because the tax environment was very friendly at that time. But the problem began when the GST was raised to 14 percent. It must be appreciated that players in the formal sector are not real competition to each other. Our real competition is with the undocumented sector; which we want to tap since it is a great opportunity.

Ziad Bashir: I believe organised sector is even less than 10 percent, perhaps 5-6 percent. But even if we go by the number Shamoon quoted, the organised sector in Pakistan is much smaller compared to the region. The organised retail sector in India is around 22-25 percent; Turkey is at 33 percent, Malaysia at 45 percent; and Indonesia is at about 75 percent. The government needs to increase the size of the net by supporting the organised sector and bringing in unorganised players into the documented sector.

BR Research: What is the degree of informality in imported segment of the retail sector?

Abid Umer: There is far more informality in international brands segment, no thanks to various e-commerce websites, and Facebook-based sellers. There are too many cracks in the customs, that allow underdeclared goods to trickle in. These pose formal players who make full duty payment a very tough time in the market.

For instance, if you buy from Ali Express or online shopping malls such as Bluefox, Shop & Ship, international brands can be shipped in 7 to 10 days, which may not be declared or underdeclared. You can gauge the quantum of business from the fact that websites of a lot of international brands that are not officially operating in Pakistan are also available in Urdu language, whereas the list price is given in PKR as well. There is clearly interest for international brands from Pakistani consumers; the government needs to offer a level playing field to the formal sector who pay full taxes on the imported goods.

Yasin Paracha: I would like to add that if there is 10 percent documentation in the locally produced retail sector, then documentation in the imported retail segment is even lower; there is not much that is imported at full value declarations. As a result of these policies of regulatory duties, international brands are suffering even more.

Policymakers should realise that the benefit of having international brands in Pakistan is that it gives an opportunity to local producers to sell to these brands internationally as well, and thereby increase exports. But as a result of additional duties on imported brands, many of the international brands have exited from the market or are planning to exit; many have put Pakistan off the map until further notice.

BR Research: How were you able to compete with the unorganised sector before budget FY20?

Asfandyar Farrukh: Until July 2019, there was somewhat a level playing field, as the organised sector was collecting 6 percent GST from the customer against zero tax collected by the undocumented sector. But we were still able to compete due to economies of scale and other efficiencies, brand equity, product quality, after-sales service, and so forth. After July 2019, that differential has increased to 14 or 17 percent depending upon integration with the tax system.

Within the organised retail sector, members of the PRBC and the CAP combined represent almost 90-95 percent of the tax collected from the organised retail sector.

Retailers are the face of the economy. Domestic policymakers have failed to understand the dynamics of the retail sector, such as the fact that many allied sectors are connected to retail. Across the world, governments have decided to help the retail sector as first priority, after food and health of course. Granted, that retail sector is a much bigger part of those economies, but it is a huge part of ours as well. As a percentage of GDP, domestic retail sector is more than double of Pakistan’s exports.

BR Research: Has higher GST rate on clothing, leather, etc, also affected other aspects of broader retail sector within the organised segment?

Yasin Paracha: Let me just explain that from the perspective of customer experience. When customers go to a mall, they do not just buy a single piece of clothing. They expect a whole range of experience from footwear and beauty to accessories, fragrances, and food. As a result of increased tax burden on the organised sector after budget FY20, the whole of retail sector saw a hit across the overall retail industry including food, cinema and so forth.

BR Research: How has Covid-19 and the ensuing lockdown has affected the retail? What are your biggest challenges, how long can you sustain, and what kind of recovery do you see on the horizon?

Shamoon Sultan: Looking at the current situation, I don’t think we can sustain after 2-3 months. The recovery in retail, if China’s post-Covid numbers to-date are any guide, is very slow. Our initial analysis reveals that the sector may only see 30 percent recovery in this quarter, and it will take another 6 to 8 months before things go normal.

In Pakistan, most of exporters in value added textiles, such as home textile and denim, are facing delayed or cancelled orders, already visible in the data released for March 2020 export numbers. The next cycle of buying is going to be very weak. Even global brands elsewhere in the developing and emerging market are not able to cope up with liquidity challenges. They are forced to either delay or cancel the orders across the globe.

Asfandyar Farrukh: I would like to point out that as retailers in the organised sector we have very high fixed costs. We have high rentals, and we have high fixed salaries, some of whom are highly skilled workers and highly educated management staff on whom we have invested over the years. So far we are retaining them, but we don’t know how long we will be able to do so.

Rent costs varies depending on the size of the brand offering, but by and large rent costs about 5 to 15 percent of the sales depending on the scale of operations. For large players, it is about 5-6 percent of the sales, for smaller players who have smaller stores it costs about 15 percent of the sales. Staff costs vary from 10-20 percent of the sales, which exclude the cost of labour employed in manufacturing.

BR Research: What precise measures or endowments are you looking from the government?

Yasin Paracha: Broadly speaking, we want support in areas of liquidity and taxation. As far as liquidity is concerned, the central bank has already come up with packages for softer loans for us to be able to meet payroll expenses. We are looking forward to further possibilities to access liquidity at lower mark-ups. There is so much uncertainty. Whenever the stores reopen, we have no idea how things will pan out. So, liquidity is key.

The second area is taxation, which has already been discussed in detail. We are looking to go back where we were before the budget FY20 to make our products more competitive. We are also asking for the removal of minimum income tax, which is not a fair proposition especially at a time when businesses are operating at a loss.

Asfandyar Farrukh: Retailers generally plan well in advance for seasons and collections. As pointed out earlier, we rely on March to July/August season, because this is when we sell the most. Everyone in our supply chain has stocked up a lot of inventory.

We do not know how much of our current inventory will we be able to sell once the lockdown ends. Liquidity, therefore, is critical not just for our fixed costs but also to be able to manufacture next seasons’ inventory, and keep the wheels turning across our supply chain.

We are not particularly looking for softer loans for rental payment, but we are looking for agreement with landlords and mall owners to share the hit on rents in order to get through this crisis.

BR Research: Can you survive if lockdown on retail sector continues till July/August? And if your business does not survive, leading to layoffs then will soft payroll loans be of any help?

Abid Umer: Retail is only dependant on daily sales. We plan our sales a year in advance. And based on that, often for each individual store, we engage our designers, suppliers and so forth. Now we are stuck with huge inventories considering as much as 70 percent of sales are in spring/summer season and two Eids. Winter clothing is mostly outerwear, which is not too fashionable in Pakistan, which is also why winters is not the peak season for us.

Nearly all malls have given us a waiver for one-month rent. But this will not be enough. We have paid salaries for March 2020 and we may be able to pay for April 2020 as well, mainly in consideration of Ramadan. But if the situation remains the same after April 2020, then I don’t know how many of us will be able to pay salaries and be able to survive.

With nearly zero sales during lockdown, I don’t know how we may survive if we don’t cut down our expenses. Even after the lockdown ends, we don’t expect normal business; depending on product range, sales are expected to drop between 30-50 percent for retailers.

Shamoon Sultan: The notion that retailers have a lot of money and enjoy huge margins is a misconception. Retailers have seen a lot of pressure in Pakistan during the last 2-3 years, and nobody realises how much we spend on our marketing and store layout. The only reason we have been able to grow is due to brick and mortar expansion. We (Khaadi) were planning to open 15-18 new stores between July-April where majority of them were lined up to commence operations in the third quarter due to high demand season. But because of the pandemic we have been unable to open those stores.

One of the key things to look at is the number of new brands launched in the last five years compared to new brands in two 5-year periods before; you will note tremendous growth in brands and their stores If retail sector is crushed, there will be no new malls and new brands in Pakistan for a foreseeable future. It’s very important to sustain the next 6-7 months to just recover the losses and break-even. And then, we may at least climb back to the level where we fell from.

If we are unable to sustain, then retail industry will fall back to the unorganised sector. In 2000, when we started Khaadi, not even 1 percent of the retail industry was organised; now it is about 10 percent. The government has the ideal opportunity right now to help the documented sector, and kick-start the drive to lure undocumented players into the documented sector. If exports feel the pressure, it’s the local industry that will help meet the capacity.

Ziad Bashir: Once retail shuts down, cost of restarting operation is too high. It takes decades to develop a network of this size. One year like this can lead to 30-40 percent of the supply chain network to shut down as well. It will take a decade to restore the industry to the same level. The government needs to provide solvency and liquidity, so we do not have to shut down.

Asfandyar Farrukh: Right now, the government has an opportunity to document the sector. Unfortunately, in our country documentation cannot be done through stick, it must be done with a carrot. And when the unorganised sector will see lower GST and softer payroll loans for the organised sector, they might be incentivized to become part of the system. And that will also in turn expand tax revenues from the sector because there is no other way to raise revenue from the retail sector unless the sector gets organised. If the government does not support the organised sector, we might see a reversal in the trend toward unorganised sector.

Yasin Paracha: If brick and mortar stores are not open, our survival will be difficult. The longer the lockdown, the tougher the challenges.

BR Research: Should the lockdown be eased or payroll finance facility be expanded?

Yasin Paracha: Both. If the lockdown is not eased, our revenue is not going to start, and if the payroll finance facilities are not in place, we may not be able to pay off current liabilities.

BR Research: Do you think there is a need to work on e-commerce channel; will it help offset your brick-and-mortar sales?

Ziad Bashir: Right now, e-commerce channel is shut for us. That should be open anyways. But e-commerce cannot replace brick and mortar retail. Sales through e-commerce are currently about 5-10 percent of store revenue; that is my guestimate. Even if the potential of e-commerce is maximized, it can be taken up to 25 percent of store sales. We won’t be able to take it more than that.

Shamoon Sultan: If social distancing is going to be the new norm for a foreseeable future, say 1-2 years, the industry is going to be in a serious problem. It will take many difficult years to recover. When people will be stuck at home, then even for households whose disposal income may not shrink substantially, there will be little reason to buy new clothes through e-commerce.

Secondly, retail therapy is a reality that is under appreciated. Since Pakistanis don’t have a lot of options for leisure activities, they spend time and money on clothes, food and accessories instead, as a form of leisure or entertainment. And e-commerce doesn’t quite cater to those underlying consumer psyche or needs for retail therapy.

Yasir Paracha: E-commerce has a great potential. But the biggest thing stopping us is the payment issues - credit cards, payment gateways, etc. The easier it is to make payments -for example, the more credit cards exist in the economy -the more e-commerce will thrive. As long as cash on delivery model remains dominant, e-commerce growth in Pakistan will not be as fast as in other economies.