The slump in LSM

The large-scale manufacturing (LSM) sector has historically been one of the most buoyant sectors in the economy contributing thereby to higher GDP growth. A stellar example is from the years, 2003-04 to 2005-06, when the sector managed an average annual growth rate of almost 16 percent. The helped in achieving a GDP growth rate of over 7 percent.

The opposite trend in output and value-added by the sector has been observed since then, as shown below:

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Period Average Annual

           Growth Rate 
              (percent)

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2000-01 to 2007-08 9.9

2007-08 to 2017-18 2.4

2017-18 to 2024-25 0.5

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During the last seven years the sector has managed growth rate annually on average of less than 1 percent. The last year, 2024-25, it saw a negative growth rate of 0.7 percent.

There has been a wide variation in the growth rate of individual industries in 2024-25. Only three industries, namely, cigarettes, beverages and cotton yarn, achieved high growth rates. However, the 13 percent growth rate in output of cigarettes was probably a reflection more of greater efficiency of the track-and-trace system.

Three industries have shown small positive growth rates of up to 1 percent. These are cotton cloth, fertilizer and paper and board. The overall growth rate of the sector has been turned negative by five industries, namely vegetable, ghee, sugar, cement, chemicals and steel products, with double-digit negative growth rates.

The almost 10 percent growth rate of the sector from 2000-01 to 2007-08 was partly the consequence of export-led growth. The textile sub-sector, within the large-scale manufacturing sector, has a share of almost 30 percent in the value-added by the sector. It achieved an increase annually of over 8 percent in the value of exports from 2000-01 to 2007-08. As compared to this, the growth rate in the value of textile exports has been below 4 percent during the last seven years. Emerging exports of manufactured goods showed exceptional buoyancy in the earlier period with a growth rate as high as 15 percent.

We come now to the very worrying manifestation of the slump in the large-scale manufacturing sector by the observed relationship between investment and growth of the sector. Lower growth has implied a lower incentive for investment and lower investment, in turn, has placed a constraint on the expansion in capacity and limited output growth.

The level of private investment in large-scale manufacturing has slumped at constant prices by 53 percent from 2017-18 to 2024-25. In fact, it is truly amazing that it is now even 10 percent less than the level of investment in 2000-01.The consequence is that the value of the capital stock in the sector, net of depreciation, has started declining since 2022-23. In effect, the capacity for higher output is increasingly limited. The absence of enough efficiency raising investments has limited the ability to promote exports or substitute imports.

Today, the extent of import substitution of manufactured goods is down from 70.2 percent in 2007-08 to 64.6 percent in 2022-23. Therefore, over 35 percent of the home demand for manufactures is met through imports, especially of consumer durables and machinery.

The fundamental question is what are the factors which have contributed to the slump in the large-scale manufacturing sector?

The first reason is the extraordinary tax burden that it faces, which has suffocated its growth. The sector has a share in the national GDP of 8 percent, but contributed 19 percent to federal income tax revenues and as much as 50 percent to indirect tax revenues in 2023-24.

Consequently, the overall tax burden of the sector was as high as 36.2 percent of the value-added by the sector. The overall tax burden of the economy was less than 10 percent of the GDP. In effect, the sector bears a tax burden which is four times the burden borne by other sectors in the economy.

The other persistent problem is the exponential increase in electricity and gas tariffs borne by industry. Since 2007 on average the electricity tariff has increased annually by almost 14 percent, while that of gas has risen annually by over 23 percent in the last four years. As compared to this the output price index of the sector during this period has increased by 10 percent. Therefore, these tariffs have contributed to a reduction in profitability and most industries have seen a significant decline in the return on equity.

The higher energy tariffs have placed our export-oriented industry with a significant loss of competitiveness. Today, the electricity tariff on industry is higher than that of Bangladesh, India and Vietnam by 59 percent, 25 percent and 104 percent respectively.

Another factor which has contributed to the fall in investment and consequently the growth in large-scale manufacturing is the hike in interest rates, which reached an all-time peak of 22 percent in 2023-24. Also, private sector access to credit has increasingly been crowded out by higher government borrowing.

Further, there is a new set of problems, which have emerged in recently years due to the external vulnerability of Pakistan’s economy. There have been times when intermediate inputs or consumer durables have been cut back sharply. For example, imports of automobiles were reduced sharply in the last two years.

A more recent problem is the artificial stability in the value of the rupee, which has reduced the profitability and competitiveness of exporters. For example, the Real Effective Exchange Rate (REER) of the rupee remained very high in the beginning of 2025 at over 104. An analysis of the determinants of exports since 2001 indicates that the optimal exchange rate policy is to keep the REER below 95.

Overall, we have a large number of factors which have contributed to a big loss of buoyancy and dynamism by the large-scale manufacturing sector. These include an oppressive tax burden, high and rising electricity tariffs, very high interest rates and an overvalued exchange rate.

There is a dire need for revival of industrial production and investment if the economy is to emerge from a low GDP growth rate of 2.5 percent to above 4.5 percent. The first task is broad-basing of the tax system away from industry to real estate, retail trade and agriculture. The target must be to reduce the sales tax rate by at least 1.5 percentage points annually over the next two years following the diversification of the tax base. Similarly, the excise duty structure should be rationalized.

A process of some reduction in electricity tariffs has started recently. This must continue and the higher rate with respect to the tariffs in competing countries must be reduced. Similarly, with the quantum reduction in the rate of inflation, the interest rate must to be brought down.

There is need to provide a more favorable environment for exporters. The return to full taxation at 29 percent on profits by corporate exporters must be withdrawn and the return to the final 1 percent fixed tax on export earnings. Further, the sales tax regime should be oriented toward favorable treatment of exporters.

Given the quantum decline in the level of investment, the time has come for a fiscal incentive in the form of a five-year tax holiday on investment throughout the country.

Finally, the exchange rate should be market determined. The IMF projection in the Staff Report on the 17th of May is that the rupee will be valued at Rs 315 per USD by the end of 2025-26.

There is need to once again emphasize that the large-scale manufacturing sector is potentially the key source of faster growth in the economy. There is need for an appropriate set of policies to achieve a significantly positive growth rate of the sector in 2025-26 as compared to the negative growth rate in 2024-25 and for the higher growth rate to be sustained in subsequent years.

Copyright Business Recorder, 2025