The nature of challenges in textile and clothing sector-I

This policy brief is a follow-up to the research report titled: The Elimination of Textile Quotas and Pakistan-EU Trade. That report focused on two major areas. First, it developed a detailed profile of Pakistan's textile trade with the European Union-15 (EU-15) countries during the quota regime in effect until the end of 2004, and compared it to the textile trade of the EU with the major export competitors of Pakistan.
Second, it conducted a rigorous empirical analysis of the effects that elimination of quotas (beginning January 1, 2005) could be expected to have on different categories of Pakistan's textile exports and on different categories of the EU-15 prices of textile imports.
Among others, the two major findings of the report were: (1) Pakistan had an advantage only in a limited number of textile and clothing items and faced immense competition from China, Turkey and India during 1995-2004; (2) as such, after the abolition of quotas, exports from Pakistan to the EU-15 would potentially be higher in only a few items.
This policy brief begins with an analysis of the actual export performance of Pakistan and its competitors after the removal of quotas. It then goes on to consider the nature of challenges that Pakistan's textile and clothing sector has been facing. The purpose is not to give an account of past policies related to the textile and clothing sector.
Rather, the goal is to locate key policy areas where concentration is required to improve and enhance production and exports of this sector in the future. The analysis in the brief is based on secondary data, earlier research findings, including Social Policy and Development Centre's (SPDC) report on the elimination of textile quotas, as well as the views of leading producers and exporters of textile and clothing in Pakistan.
The policy brief is organised as follows: Section 1 gives the recent export performance of Pakistan and of its competitors; Section 2 examines the shortcomings of the textile and clothing sector in Pakistan resulting from domestic policies; Section 3 looks at the problems as a result of the EU policies and requirements of international institutions; Section 4 takes a look at the current policies related to the textile and clothing sector and Section 5 concludes the brief.
RECENT EXPORT PERFORMANCE OF PAKISTAN AND ITS COMPETITORS The performance of a country regarding any indicator can be judged in two ways: first, by analysing the movement of that variable over a period of time and second, by analysing the evolution of that variable vis-à-vis the values of the variable that its competitors have managed to achieve.
As to the first, textile and clothing exports of Pakistan have performed well and have increased considerably over time. During 1995-2004, a period of quota phase-out, Pakistan's textile and clothing exports to the world increased from $5.6 billion to $8 billion; on average, an absolute growth of $0.28 billion per annum.
In the subsequent years after the removal of quotas, these exports increased to $10 billion in 2005-06; on average, an absolute growth of $1 billion per annum (Chart 1). Thus, the textile and clothing exports of Pakistan show an impressive performance as their per annum growth increased by 3.5 times after the removal of quotas.
The analysis would remain partial without looking at Pakistan's performance relative to its competitors. Charts 2 and 3, give the value of textile and clothing exports of Pakistan and its competitors respectively, in the world market. This comparison shows how the exports of Pakistan and its competitors changed during 2005, the year following the removal of quotas. Among Pakistan's competitors, China leads the world textile and clothing market.
The value of its textile exports that amounted to $33 billion in 2004, increased to $41 billion in 2005, thus showing an increase of 23 percent (Chart 2). Similarly, the value of clothing exports that was worth $62 billion in 2004 increased to $74 billion in 2005, which was an increase of 20 percent (Chart 3).
The value of textile exports from South Korea stood at $10 billion, India at $8 billion, Pakistan and Turkey at $7 billion each during 2005. Compared to 2004, the value of textile exports of Pakistan and India increased by $1 billion each and that of Turkey by $0.7 billion in 2005.
The clothing exports of Pakistan compared to those of its competitors are significantly lesser in value. In 2005, the value of clothing exports of Turkey constituted $12 billion, India $8 billion, Bangladesh $6.4 billion, Indonesia $5 billion, Romania $4.6 billion, Thailand $4 billion and Pakistan $3.6 billion.
In contrast to 2004, the value of clothing exports of India increased by $1.7 billion in 2005, while those of the remaining countries by $0.6 to $0.7 billion.
In textile exports, China's share in the world market grew from 17 percent in 2004 to 20 percent in 2005. Among the other countries, South Korea held a 5 percent share in the world textile market in 2005, India 4 percent and Pakistan and Turkey 3.5 percent each.
In clothing exports, China has captured more than one-fourth of the world market. Its share moved up from 24 percent in 2004 to 27 percent in 2005. Among the other countries, Turkey held a 4.3 percent share, India 3 percent, Bangladesh 2.3 percent, Indonesia 1.9 percent, Romania 1.7 percent and Pakistan 1.3 percent in 2005.
The data from 2005, the first year after the elimination of textile quotas, suggests that although Pakistan has been able to increase its share in world textiles exports slightly and has maintained its modest share in world clothing exports, it has not made any significant inroads in capturing markets relative to its main competitors, especially in the higher value-added clothing sector.
Given this state of export performance of Pakistan in the world market, the question arises: Will the textile and clothing sector of Pakistan be able to stand not only in the EU market but also in the world market in the medium to long term after the elimination of quotas? Or is it more likely, as many fear, that Pakistan will become a supplier of only raw material and low value-added textile products?
In the light of these apprehensions, it is imperative to study the factors that affect export performance and to analyse them as they are functioning at present. This policy brief seeks to examine such factors (ie the major issues, problems and bottlenecks) related to the performance of the textile and clothing sector of Pakistan.
ADDRESSING SHORTCOMINGS OF THE TEXTILE AND CLOTHING SECTOR RESULTING FROM PAKISTAN'S DOMESTIC POLICIES It should be stated at the outset that improvement and development of the textile and clothing sector requires an overhauling of the weaknesses present within the entire value chain.
Things can only be moved in a positive direction if support and incentives are provided across the board at an appropriate time and not just to a few components of the industry. The major policy decisions that are required to make the sector competitive are discussed in this section.
EFFICIENCY: COST OF PRODUCTION Efficiency is the increase in the value of output relative to the cost of inputs used. A change in the price of inputs might lead a firm to change the mix of inputs used, in order to reduce the cost of inputs and thus improve efficiency by increasing the quantity of output.
This implies that reduction in the value of cost of inputs or cost of production and increasing the quantity of output for a given quantity of inputs makes a firm efficient. And, the more efficient the firm is, the more likely that it will be competitive in the international market.
Prior to 2005, an exporter had to go through the trouble of first finding who was holding the quota and where he could buy from. The rules of business have changed after 2005, from quota to competitiveness in price, quality and quantity.
According to various textile producers and exporters, Pakistan was not ready as far as prices were concerned because it did not succeed in controlling its high and continuously increasing cost of manufacturing.
The major factors that influence cost of production are discussed below:
PRICE OF COTTON The basic raw material in textile and clothing is cotton. Pakistan is the fourth largest producer of cotton in the world and produces 18 percent of the world's cotton. There is an issue of price stability of domestic cotton.
Fluctuations in cotton price are created by changes in production, carry over of stock from previous year, total market demand, weaknesses in the estimation of expected crop size, variation in transport charges between markets and non-availability of alternate buyers. The other issues are access to forward-trading and hedging market, high inventory cost for ginners and a limited capacity for ginners to hold cotton (about 1.5 million bales) as carryover or buffer stock.
It is recommended that a system be established that assures stability in the cotton price as its instability affects both production and prices of the entire value chain.
COST OF UTILITIES Rising cost of utilities (electricity, gas and oil) is a big problem in Pakistan. Although, energy charges remained at Rs 1.29/kwh during 2001-05, different types of surcharges enhanced the tariff rates paid by the final user (the industry in this case).
In addition to the surcharges, there is another surcharge of 10.4 percent levied on supply charges (including: fixed charges, energy charges, F.A.S. and lower power factor penalty). Since the high cost is a significant part due to high surcharges, this becomes a policy issue.
Gas is an essential raw material for its textile and clothing industry. Its price has increased considerably since 2004, ie by 15 percent in 2005 and by 27 percent in 2006. And, if compared with that in 2001, it has increased considerably by 68 percent in 2006.
The producers complain that gas tariffs in Pakistan are high because: (1) the increase in gas well-head prices are linked to international price of oil and furnace oil; (2) the guaranteed return of 171/2 percent to Sui Northern Gas Pipelines Limited (SNGPL) and of 17 percent return to Sui Southern Gas Pipelines Limited (SSGPL) on average net fixed assets; and (3) the Gas Development Surcharge (GDS) is an important source of revenue for the government.
Textile and clothing sector consumes 20 percent of the gas (11 percent from SNGPL and 9 percent from SSGPL) but is paying more by providing cross-subsidies to the fertiliser sector and domestic consumers. So again, the high gas tariff in Pakistan partly reflects suboptimal policies and high surcharges.
The price of petroleum has also moved up sharply during the last 5 years, particularly, in 2005 by 23 percent and in 2006 by 27 percent. A comparison in these prices since 2001, shows a rise in rates by 76 percent in 2006.
Apart from the increase in international oil price, an increase in petroleum development levy and the General Sales Tax (GST) also affected these prices.
Thus, all these factors exert an upward pressure on the cost of production in Pakistan. For this, it is required to bring utility rates down to the extent possible through reduction in their tax components so that Pakistan can compete.
(To be continued)