Research Paper on Pakistan

The textile sector needs massive investments in the value added sector to face the challenges of the post 2005 qouta free regime. Common belief in Pakistan is that the sector is quite vibrant and is investing heavily. While it is true that there have been substantial investments in the sector as a whole, bulk of the investments are in the spinning and weaving sectors and not enough is being invested in the value added sectors of finishing and stitching.

In the following brief presentation the impediments will be highlighted but a general structure of the industry as it stands today needs to be understood before the problems can be understood.

The spinning sector is a very mature and competitive sector. Pakistan today is a net importer of raw cotton. Every thing from Australian cotton, Egyptian cotton to US Pima is imported. In fact Pakistan today is the second largest importer of US Pima long staple cotton. This goes to show how competitive this industry has become. The weaving sector is broken up in two segments, the cottage industry comprising second hand sulzers and the shuttle looms and the organized weaving sector comprising the most modern air jet weaving sector. The unorganized sector continues to grow since it is considered a cottage industry and free from all regulations like levy of sales tax etc. These produce lower quality products. While investment requirement in the new weaving machines is high, these are the future and produce specialty and high quality products. The capital requirement is very high. Over the years many spinning mills have moved into this sector and have integrated their units to this next step. This sector is also quite competitive and moving in the right direction. The pace of investment in this sector remains slow, despite being profitable. In the last 2 years China is believed to have invested in 14000 looms compared to about 1000 in Pakistan. There can be no 2 views about the fact that the future in the industry belongs to vertically integrated units rather than development of the cottage industry. So why is the spinning industry slow in integrating vertically?

The next requirement is for setting up of finishing mills both in the knits sector and wovens sector. Many of the projects set up in the knits sector are not world scale, with not the state of the art machinery and their cost of productions are not competitive. In the woven apparel sector there is in fact a shortage of quality finishing plants. Many people are bringing in used machinery which has literally been discarded by the developed world. It is a matter of fact that Levis does not approve any finishing plant for woven apparel products made for them. The fabrics need to be imported. Tommy also does not approve a single dyeing mill which meets its quality requirements. The exception to the rule is the home textiles where the organized sector has invested heavily and has a significant share of the global market. What does this say for the future of the textile industry of Pakistan particularly when countries like China are investing and gearing themselves massively for the quota free regime. China is aiming at 25% global share of the textile market by year 2005. Pakistan on the other hand is fast developing its unorganized sector and picks up every piece of junk machinery available in the developed world.

So the question is why is the organized sector moving in natural direction. What are the impediments to its investments, particularly when the spinning sector seems saturated and the interest rates are low and there is ample credit availability. The following paragraphs will briefly discuss the impediments in growth of the textile sector.

1) Unimaginable amounts of stuck up refunds of sales tax refunds due to shortage of funds.

The sales tax refund rules provide for 50% of the refund within 15 days of filing for the refund in a certain format. The balance refund is payable within 40 days.
Can one imagine that refunds, at the time of writing this report are being processed for refund applications received in end October. That means that at best the refunds due in September, refund applications for which are filed in October are under process. Pakistan is the 4th largest producer of raw cotton in the world and the bulk of the cotton comes in the months from September to December during which time the industry purchases its requirements for the bulk of the industry. The pretext of the delayed refunds are scarcity of funds. When the government withholds huge payments of its industry, how can the industry invest.
The refund rules provide for refund in a certain time frame the government should follow the laws made by itself.

The wisdom of imposing sales tax on raw cotton is not understandable. The government mobilizes huge resources to collect billions of rupees of tax in lieu of sales tax on raw cotton only then to mobilize even more resources to refund these and in the process squeezing the industry out of liquidity which it badly needs to gear itself for the future. In fact, perhaps the BOI can get the figures from the CBR as to what is the gravity of the issue. Also the government should analyze what the net collection from the textile sector is. This would demonstrate net collection of sales tax from the textile industry. Given the fast growth of the cottage industry, it would not come as a surprise if the sales refund claimed exceeds the sales tax collected after accounting for the administrative expences for collections and refunds.

Since writing of this report, the CBR has agreed to expedite refunds of sales tax for the spinning sector. This will provide a lot of relief to this sector, but what is needed is a long term clear policy and a policy under which sales tax is not with held unnecessarily. Furthermore a long term policy is required for the whole sector.

Suggestion for resolution of this problem

As a first step the BOI must make sure that refunds are made within the time frame provided in the exisiting laws. The BOI must together analyze together with the CBR and take the textile industry in confidence in analyzing what is the net collection of the sales tax from the textile industry and if it is necessary to go through the process of collecting such amounts only to refund the amounts.

2) Cumbersome requirements and frequent changes in reporting requirements for the of reporting for sales tax.

There are frequent changes in the sales tax rules which require submission of Additional details and unnecessary details. An example is section 73 of the sales tax act, whereby the seller has to make sure that the payments received by him against sales is from the business account of the buyer. The seller needs to have the account number of the buyer. In cases of payments made by pay order/bank drafts also the seller needs to prove payments through the business account of the buyer. The same section requires that payment must be received with 120 days of date of invoice. The CBR should be concerned with collection of its taxes and should not be allowed to force business decisions and levy penalties which may occur due to a bad market or circumstances beyond the control of the buyer and seller. Also new refund rules vide SRO 575 have been made applicable since August 2002, whereby not only have rules been changed, the language is vague And complicated but also the data was to be submitted in a certain computerized Programmed supplied by the CBR. The programme was untested and had to be Modified resulting in delayed submission of returns. The real issue is that instead Businesses working on their business plans their main focus and time is spent on Their businesses the business men today spend time on meeting the sales tax Requirement for this is the most important task as an inefficient sales tax Management can drive a business out of business.

Suggestion

Remove unnecessary reporting requirements of sales tax. Simplify the sales tax
With consultation of the stake holders and then freeze new changes.

3) Import Duties on machinery and equipment

When machinery is imported there is a duty leviable. Duty exemption is available under various SROs which require undertakings that a certain percentage of the production is exported in the next 5years. It has to be understood that machinery imported by any segment of the textile industry is ultimately exported in one form or the other. When an undertaking is given that the production from that unit will directly be exported, it may be depriving the local industry of the required raw material. An example is that finished woven fabrics. These are projects which require huge investments and there is a shortage of much required quality finished fabric in the country. There have been only a few projects set up in the last few years. The production from these would feed the local industry. In order to get the required duty exemptions, the investors commit themselves to export the fabrics themselves rather than supply to the local garment factories. It is needed that this requirement of direct exports be dispensed with and the project is also allowed to supply to local garment factories for ultimate exports. If quality fabric is available locally, it would encourage setting up of stitching factories. Finishing projects specially have a rather long gestation period. Certain projects set up in the last 2 years valued in excess of a billion rupees have taken more than 2 years to come to even break even levels. Pakistan does not have the necessary know how and there fore these type of projects need to be encouraged instead of levying taxes on import of machinery. What this law does not consider is that it is forcing the mill to export the fabric to another country rather than making the finished fabric available of the domestic industry. The local stitching industry does not have availability of good quality fabric while the fabric maker is forced to export the fabric in order to meet the requirement of export to be elegible for duty free import of machinery.

Suggestion

Machinery imported for any segment of the textile should be completely duty free without any compulsion of exports. Machinery imported by the textile sector is in one way or the other imported for the purposes of ultimate export and the industry should be freed from all the record keeping and periodic audits. For the projects already set up, the present requirements of duty free import under SRO 554 should be amended to allow indirect exports

4) Income tax

Presently on exports a withholding tax is deducted as full and final settlement of tax liability. If a unit exports more than 80% the assessee can pay the withholding tax on the local portion and is not required to file returns. If the tax laws are amended so that a withholding tax at the same rate as export, is deducted on local sales also becomes the full and final settlement. This law actually already exists but the procedure is for indirect exports and payment is made through a SPO ( Special Purchase Order). The procedure is quite cumbersome and difficult to comply with. The difference between the organized sector and unorganized sector will be removed. But the real benefit would be that the producers would be free from tax issues and can concentrate on what they should be spending time on, i.e their business development. It is my opinion that even the tax revenue will increase.

5) Need for making a strategy at the National level to encourage more mills in the organized sector to integerate vertically.

The BOI and the ministry of Commerce should clearly define and develop a strategy for the era of quota free regime. A goal should be made to encourage an X number of mills in the organized sector to move upstream into manufacture of made ups. This may involve review of the present quota policy. It should be stressed that in the quota free regime it is the integrated mills that will be able to gear themselves for the new competitive regime. Unless the industry readies itself now, there will be a lot of difficulties in the future. Unfortunately the quota policy has discouraged vertical integeration since quota has been given on performance and apart from a small qnty available through auction, qouta can only be bought with cash payments at exhorbitant rates. This has discouraged much of the organized textile sector to do busiess in the value added sector.

6) A clearly defined policy to fight anti dumping cases, and a permanent team is required to be set up for negotiation of better terms of trade.

In future there will be a lot of actions against exports from Pakistan, such as anti dumping duties. The industry finds itself in a panic when ever a new action is initiated. A permanent body needs to be set up comprising prominent lawyers, government officials as well as business who are well conversent with dumping laws. It should also be clearly defined that when an action is initiated who will bear the legal costs. A case in point is the recent dumping investigation initiated by the EU. First, at the beginning of 2002, EU removed all duties on made up exports from Pakistan. The advantage was fully taken by the industry through increasing exports, of course through investments. However the surge in exports was not welcome by producers in the importing countries. There was an apprehension of dumping investigations, however Pakistan made no attempt, diplomatic or otherwise, so that the dumping complaint not be entertained by the EU. Instead one fine day the exporters received intimation that the complaint was filed and accepted for investigation. After this, there were discussion within the industry as to who will pay the expences for the investigation, with the government refusing to pay any thing. It is suggested that a very strong permanent panel be formed to face these matters. In addition, the more competitive Pakistan’s exports are the more the industry will grow through investments. A permanent team needs to be created which develops strategies for better market access and better terms of access for our products into imported countries. Various international treaties signed by various countries have brought tremendous benefits to even non textile based countries. Exoorts from Jordan to the US are duty free into the US. This has brought tremendous investments in Jordan. Investments in textiles made ups in African states is booming, due to the African Tearty signed by them with the US which allows duty free imports into US goods which are manufactured in the African states. Pakistan needs to organize and see if it can improve the terms of trade. A permanent body, again comprising competent lawyers, government officials and knowledge and capable business men. There are many issues on which the exporting country can negotiate with the importing country. For example, Pakistan today is the second largest importer of US PIMA cotton. The products made from this go to the US after processing. Can Pakistan not develop a strategy to build up a lobby within the US comprising cotton exporters that products made with US cotton in the US can come in duty free to the US. Pakistan is sure to invest in some massive infrastructure projects in the future. Can this not be linked with again some better terms of trade benefits for its textile exports. Steps such as these can be part of Pakistans over all investment and export strategy.

In summary, the textile industry is perhaps on of the few industries in the country which does not depend on any government subsidy or tariff protection to survive. Unfortunately, instead of making itself ready for the quota free regime, the industry is too involved in the day to day issues of taxation, whether it is sales tax refunds, import duty, DTRE rules income tax assessments etc. These are the only subjects of discussion of businesses with the ministries of Finance, Commerce, CBR, EPB and all other government functionairies. The above suggestions are basically to further deregulate the industry and make it more focused and let its entrepruners devote all their attention to business development rather than divert their energies in fulfilling government compliance regulations. Simple tax laws and regulations will go a long way in boosting investments. In addition through the above suggestions the government needs to improve its market access and better terms of trade for exports of Pakistani products abroad.