“Industries cross-subsidizing very cheap electricity to the domestic sector”
In this interview with BR Research, Abdul Razak Dawood – the Advisor for Commerce and Investment - talks about the federal government’s objectives as well as progress in boosting exports and import substitution; diversifying bilateral trade and connectivity; the status of GSP Plus extension, and why foreign investment has not been able to pick up. Below is the edited transcript:
BR Research: How would you rate your 2.5-year progress in terms of what you have achieved related to trade?
Razak Dawood: Let’s first look into what our objective was when we first came in. There was a big emphasis on trade rather than on manufacturing in the last decade. The first thing we wanted was to put manufacturing before trading, because we believed that it’s only through manufacturing that we can create jobs and create wealth. Within manufacturing, our aim was import substitution and achieving a critical mass so that we could start exporting more.
Our second objective was diversification to non-traditional exports, beyond textiles and leather such as engineering, IT, pharma, food processing, chemicals, etc.
Third objective was to move ahead with regional connectivity, which meant enhancement of our trade with Africa, Afghanistan, Uzbekistan, Central Asian Republics; retention of benefits that we’ve had with European Union; and more connectivity with USA, Japan, China and Korea.
On that score, I believe that the shift has started to take place on importance of manufacturing versus importance of trading. Today, I can say with a lot of confidence that in the last 2.5 years, not only has the deindustrialization stopped, but industrialization is now going on at a fairly good pace particularly in cities like Faisalabad, Sialkot, Karachi, etc., which are the hubs of textile and other exports. It is with some degree of satisfaction that we have moved forward.
In the case of import substitution, it takes place when the existing manufacturers start getting more demand locally. This demand comes when there is a curtailment on smuggling and there is equivalent local production. Smuggling has come down in Pakistan, not to a level that we want but undoubtedly down where sectors like engineering products, food processing have also seen increase in local production. Local production spurs when the cost of production comes down, and that has also happened because we have reduced the duties on raw materials for many products. And then, currency movement has helped promoting import substitution.
On exports diversification, we have not had major success except in the areas of information technology. Our IT exports are growing, but exports of engineering, chemical, food processing – though have moved in the right direction - have not improved the way I would like them to.
Also, our geographical diversification and connectivity is not as good as it needs to be. We will be paying more attention to the opening up of the Afghanistan and Uzbekistan trade in the coming months. In case of Africa, our products are already moving there; however, they are not getting to a level that we want due to dampening of demand created by COVID related economic challenges in African countries.
So, it’s a mixed bag in what we have achieved and what we have yet to achieve in the last 2.5 years.
BRR: No doubt that the reduction in duties and currency movement has helped lower the cost of production. However, the energy cost and the volatility of energy prices is one of the biggest impediments for industrialists to aggressively grow and expand. While there is enough electricity generation, we see that power tariffs rising. In such a scenario how would you ensure cost of production to remain at a level where businesses and industries can compete internationally?
RD: Unfortunately, Pakistan is not a low-energy cost country because we are running out of gas and we are facing difficulties in importing LNG at international prices. We have to look into the energy cost especially for the textile sector. One of the biggest reasons of the boom in the textile sector has been the reduction in the electricity rates. We gave them electricity at 7.5 cents per unit and gas at $ 6.5 MMBTU which was a very good price. Right now, we are giving them electricity at another reasonably good price of 9 cents per unit.
Now it’s time to take the decision in the budget whether to continue at the current rate, drop it or raise it. This is a big challenge before the Ministry of Commerce. My take on this is that we cannot afford to wait for the next ten years for energy costs to start coming down; we have to provide energy at a cheaper cost to the industries and bear that cost. I hope we will be able to come to a rational decision, because, we not only need to reduce raw material cost but also energy cost for stimulating exports and import substitution.
BRR: So, can we expect some sort of a direct subsidy mechanism for the export-oriented industry or industry at large in the upcoming budget?
RD: I wouldn’t call it a subsidy because the industry is already cross subsidizing the very cheap power to the domestic sector. In very few countries in the world, domestic rate of electricity is lower than the industrial rate. In most countries, industrial electricity is the cheapest. So, I would call it an internationally competitive rate - a rate that is competitive with what it costs in China, Thailand, Bangladesh, Vietnam, and Cambodia.
BRR: You mentioned that that opening up with Afghanistan and Central Asia is one avenue of diversifying geographically. And lately, we are seeing that there are talks of softening stance between Pakistan and India from both sides. How critical do you think are trade ties with the neighboring countries?
RD: Almost all the countries trade substantially with their neighbors. We are one of the few countries with very low trade with our neighboring countries. I am a big believer in regional trade, and that’s why Ministry of Commerce has gone on a fast track with Afghanistan and Uzbekistan to open up the whole of Central Asian Republic region. I am very hopeful that in coming weeks and months, we will put in place bilateral trade agreements with both these countries. I’m looking at a time when Afghan and Uzbek trucks will go all the way to Karachi, and our trucks will go right through to Afghanistan, cross the border of Uzbekistan and eventually sell to the Central Asian Republics.
Afghan transit trade historically has hurt our industry because the goods would get smuggled back into Pakistan. One of the things we want is to put in the agreement that in case of smuggling, we will reserve the right to put quantity restrictions.
As a ministry, we fundamentally agree that there should be trade with India. The talks with India are a very recent activity, and it’s a little too early to say how things will pan out. However, I am cautiously optimistic that if things move ahead, I will be very keen to take the matter forward. I’ve said it before that there will be gainers and losers in our trade with the neighbors; but I’ve always believed that gainers will more than fill the vacuum created by the losers.
BRR: Pivoting to the textile sector, the diversion of orders to Pakistan at a time when other key players were in lockdown helped the sector run on full capacity. Now that those countries have reopened; how confident are you that Pakistan will be able to retain the business? What steps at the ministry level are you taking to retain the newly acquired business?
RD: Yes, we did open up much sooner than others, and so we did get orders, and orders are still coming. There is no doubt that the challenges are there now that India, Bangladesh, and other textile exporters have also opened up, but I am still very hopeful that we will be able to hold onto the new market share that we have captured. Our textiles are competitive; and the good news is that under State Bank’s TERF investment program, the amount of investment that has started to come in is phenomenal. Our capacity of the next 12-18 months will certainly be much greater, which will help us maintain the higher share.
However, we have immense challenges in the textile sector beginning with raw cotton, yarn, lack of capacity and energy cost that we’ve already talked about. We have got to get our cotton production back to the previous levels. We are at the lowest level currently, but we are hoping to do better next year. Then we are also facing the issue of increasing yarn prices.
We will soon get over the challenge of lack of capacity. The way I see, our exports are moving in the right direction now, particularly in the more value-added products. I believe that we are very competitive in our home textile garments and knitwear. The new focus of the government on value-added as opposed to yarn and grey cloth is now beginning to show results. Our exports to the US are going well, and we are now moving up the ladder becoming one of the top ten exporters to the US.
But there are some serious challenges that all parts of the government - whether it’s the Ministry of Finance, the FBR, Ministry of Commerce or Ministry of Energy, Power Division - should be able to come together and be able to give a sound policy for the sector. I would say textile has many challenges but greater opportunities.
BRR: What’s the update on the textile policy?
RD: The policy will be out soon. Because the main element of the policy is the electricity tariff as we have had other issue of moving the industry from gas and towards greater consumption of electricity, we are concentrating on getting these issues sorted before we announce the policy. I hope that in the next month, we should get the policy approved. We are holding it back deliberately to get other issues out of the way.
BRR: Is revival of zero-rated sales tax regime for the textile sector in the offing?
RD: Now, it is completely off the table. At the time it happened, I opposed it. But today, I am not in favor either because so much work has gone into getting the refunds done quickly. It’s not a matter of zero-rating, but how quickly can you get refunds to the people. The ability to calculate the refunds is much improved now we have got to make sure that we have the availability of funds to pay the industry. That is where we should concentrate.
BRR: There has been some confusion over whether the country will be importing yarn from India and the other regional players or not. What’s the update?
RD: We are about to go to the ECC for the shortage of yarn – because of which the yarn prices have gone up – and the decision will come forward in the next few days
BRR: What the status of GSP Plus status extension?
RD: Everything is on track for GSP Plus status extension. The European Union has told us very clearly all countries will get tougher targets for the next two years, and we are working on it very much. There are issues on labor side, human rights side, international NGOs and issues on climate change that we need to address. Out of the 27 conventions, we are OK on all of them except five including the ones I’ve just mentioned, and these five areas are a greater focus for us to qualify for the extension. I am hopeful that just like in 2020 we were able to achieve it, we will achieve 2022 standards as well.
BRR: There exists a policy framework for trade related investment, and the government has been highlighting attracting investment in the exporting sector. Yet we have not seen any significant foreign investment in exporting industries. Why is that so?
RD: Foreign investment usually comes in after the local investors start investing. Today, the local investors are definitely investing huge amounts, which is a good sign. FDI is not coming in the way we want it to because of COVID as the investors are not willing to travel to Pakistan or are restricted by their own countries during the pandemic.
COVID has opened an opportunity for our exports, but it has put a dampener on our foreign direct investments. Things will get better as COVID clears up and I see a lot of activity under CPEC showing results.
BRR: What’s behind the growth in exports in the IT sector: COVID, government policy or the routing of money through formal channels. What are the prospects going forward?
RD: The demand for our IT exports is growing, especially on the services side. One of the reasons for the growth in IT exports links to our strategy during the pandemic. During the worst of crisis when the world was in a lockdown, we did not close our IT companies. All the IT companies were open for business, and that was the first major sign to the overseas customers that Pakistan is a country that you can rely on. India was in a complete lockdown; Philippines was shut down; but Pakistan was not.
Secondly, SBP’s efforts in ease of payments both inward and outward have certainly helped our IT businesses. And yes, thirdly, more people are moving to the formal sector, so that’s also where the money is coming in, which was previously coming in through other informal sources.
The bottom line is that direction of our export, import substitution, and diversification of geographies is absolutely correct. We have got to be patient to let it flower. It has not flowered yet. We have to be at it, and god willing, we will get there.