Strategic integration for value addition: The path to compete, win, and grow in textile exports

In the evolving Textile Value Chain (TVC) of Pakistan, the key to sustained exports lies in the traceability of the supply chain. Beyond being a cornerstone of the country’s economy, the TVC stands as its largest and one of the oldest manufacturing industries, contributing approximately 60% to the nation’s total exports and playing a crucial role in international trade.

Directly engaging nearly 40% of the manufacturing labour force — approximately 3 million people — and indirectly impacting 9 million more, the industry impressively contributes 8.5% to the GDP.

As the TVC navigates the complexities of integrating traceability into its operations, it faces a transformative journey that aligns with global trends, where traceability is not only a regulatory imperative but a strategic tool for optimizing business operations and ensuring accountability in far-reaching supply chains.

This way or the other, Pakistan needs to expand its market to sustain its export, and for this traceability through integrated factories is an inescapable component.

While textiles have long been a major player in Pakistan’s economy, approximately 80% of firms still operate in a non-integrated structure. Nevertheless, the industry successfully exports 70% of its total output.

In the integrated sectors, each participant contributes to the value addition of textile goods. The paradox of a long-standing economic powerhouse with predominantly non-integrated factories highlights both the resilience and challenges encountered by the Textile Value Chain (TVC) in Pakistan.

According to the records of the Textile Commissioner’s Organization, the textile sector comprises 408 units, including 40 composite and 368 spinning units. Together, these units house 13.414 million spindles and 140,000 rotors, with 9.5 million spindles and 112,600 rotors currently operational. The reported capacity utilization rates for spindles and rotors during July to March in fiscal year 2023 are 69.33 percent and 71 percent, respectively.

Pakistan is the fifth largest producer, third largest consumer and 4th largest exporter of cotton yarn in the world; however, the average size of spinning mills in Pakistan is comparatively smaller than the global standard, rendering them less competitive, particularly with small spinning units lacking modern technology and producing yarn counts below global market demands.

Integrated textile factories offer several advantages that contribute to their operational efficiency and product quality. Firstly, they achieve cost efficiency through economies of scale. They control the entire production process from raw materials to finished products, thereby reducing overall costs, especially through the avoidance of turnover tax at each stage.

Secondly, integration provides better control over the supply chain, ensuring efficient and streamlined operations. This leads to consistent quality throughout the production process, as integration allows for rigorous quality control measures. Additionally, the interconnected nature of integrated factories facilitates easier traceability, promoting accountability for each stage of production.

However, it’s important to acknowledge the disadvantages of integrated facilities as well. Firstly, establishing and maintaining such factories can be capital-intensive. Secondly, there’s a risk concentration issue, as a failure or disruption at one stage can significantly impact the entire production process. Lastly, integrated factories may have limited flexibility in adapting to market changes or technological advancements due to their comprehensive and interconnected nature.

In the context of multistage turnover tax, which is levied on the complete value of a product during each transition in the production and distribution process, non-integrated factories face increased gross taxes compared to their integrated counterparts.

This discrepancy arises from the unique tax structure in non-integrated industries, imposing a 1.5% turnover tax at each production stage. Consequently, as a product advances through multiple factories, cumulative taxation occurs. For example, if processed in four factories, the total turnover tax would be 6% (1.5% + 1.5% + 1.5% + 1.5%). The cumulative effect of turnover taxes, being non-recoverable in nature, leads to an increased cost for the final product. This dynamic renders the non-integrated sector less competitive, ultimately diminishing profits.

Moreover, sales tax collection mechanisms vary between integrated and non-integrated factories. Integrated factories often benefit from a sales tax advantage due to comprehensive reporting throughout the entire production process, while non-integrated units suffer in a reduced transparency, resulting in a diminished refund of sales tax at the final export stage (documented by the World Bank).

According to IMF reports, the inclusion of certain cost elements into the product price, facilitated by the sales tax capture refund on exported goods from non-integrated factories, renders the final product less competitive. This complexity in the tax landscape underscores the intricate dynamics influencing the competitiveness and operational efficiency of both integrated and non-integrated industrial entities.

The imposition of duties on raw materials exacerbates challenges for Small and Medium-sized Enterprises (SMEs), particularly as they struggle to avail duty-free benefits in the export duty structure. While large, well-integrated firms can take advantage of duty exemption schemes for exporters, smaller enterprises face difficulties utilizing these tools due to the complexity of application processes.

Consequently, SMEs find it challenging to compete, as these duties significantly inflate production costs throughout the manufacturing process, creating a barrier to competitiveness. Duty-related challenges not only limit the potential for innovation but also obstruct SMEs from aligning with the dominant global trends, such as that of MMF, which holds a 70% share in global trade. This hampers their ability to offer cost-effective products and contributes to the existing textile trade imbalance in Pakistan.

Access to credit presents another notable distinction. Financial institutions naturally consider SMEs as riskier due to their smaller size, limited track record, and insufficient collateral. Consequently, SMEs face difficulties in obtaining loans or credit on favourable terms, often lacking the necessary collateral to meet the criteria set by traditional lenders. Integrated factories, on the other hand, enjoy potentially easier access to credit, thanks to their more comprehensive and stable business model.

For example, SMEs could not benefit from the Long-Term Financing Facility (LTFF), designed for export-oriented projects with specified annual export values. This exclusion highlights potential challenges for non-integrated units to access certain financial incentives, paralleling the situation observed with the Export Refinance Scheme (EFS), where specific commodities, including raw cotton and various yarn types, are placed on the negative list, thereby restricting eligibility.

Flexibility is a key aspect worth noting, particularly in integrated textile industries, where importing for re-export can enhance efficiency and ensure a steady supply of raw materials. It’s an important consideration, albeit one that may heighten dependence on foreign suppliers. In contrast, non-integrated industries, might prioritize domestic sourcing for better control. However, when these non-integrated industries engage in importing for re-export, they could encounter coordination challenges.

Lastly, traceability in the Pakistani textile industry varies. Integrated factories benefit from easier traceability due to the centralized nature of their production process, while non-integrated factories may find traceability more challenging due to the involvement of multiple entities in different stages of production.

On the other hand, non-integrated textile factories offer several advantages, most notably specialization. By focusing on specific stages of the production process, these factories can achieve a high level of expertise and efficiency in their chosen areas which also results in them being less energy intensive.

This focused approach allows for targeted resource allocation, contributing to a more sustainable and energy-efficient manufacturing model. The model also allows for increased flexibility, enabling quick adaptation to market demands and technological advancements. Additionally, the distribution of risks across different stages mitigates the impact of failures, enhancing the overall resilience of non-integrated factories.

The discourse on integrated vs non-integrated textile units is also important in terms of sustainable practices. The impact of processes like picking, transportation, and ginning on cotton quality is particularly relevant here. Integrated units, have the potential to implement more coordinated and sustainable practices across picking, transportation, and ginning.

This comprehensive approach allows for better control over the entire supply chain, leading to improved cotton quality and reduced environmental impact. In contrast, non-integrated units face challenges in maintaining consistent and sustainable practices throughout the entire cotton processing cycle.

Addressing sustainability concerns in picking, transportation, and ginning becomes imperative for both integrated and non-integrated units in Pakistan, emphasizing the industry’s need to adopt eco-friendly methods and ethical sourcing practices to ensure the production of high-quality and environmentally responsible textiles.

Non-integrated textile factories face severe challenges. Coordination and communication hurdles between different entities involved in the production process can lead to inefficiencies. The dependency on external suppliers introduces risks related to variations in material quality and delivery timelines.

In addition, higher transaction costs may accrue due to the need to manage relationships with multiple suppliers and entities. Pakistan’s standalone spinning units are increasingly becoming incompatible with the competitors. Globally, textile industry enterprises are moving towards full or partial integration, emphasizing a shift to value-added processes as a vital survival strategy.

To remain competitive and relevant in the evolving textile sector, Pakistan should align itself with this trend. The imperative for standalone spinning units to integrate and diversify their offerings, including high fashion garments and other value-added products, is highlighted by the significant difference in export potential between integrated and non-integrated units. Integration is not just a necessity but a crucial imperative for survival in the competitive landscape.

Pakistan’s textile sector, with 408 units and challenges in small spinning units, leans towards non-integration, emphasizing the need for addressing issues like outdated technology and credit access. In contrast, Bangladesh’s textile industry, represented by the Bangladesh Textile Mills Association (BTMA) overseeing 510 yarn manufacturing mills and 901 fabric manufacturing mills, demonstrates a higher level of integration, fostering collaboration across different stages.

Meanwhile, India’s textile landscape, marked by over 3400 mills and an extensive capacity, indicates a substantial degree of integration.

In conclusion, the imperative for an integrated track and trace system within Pakistan’s textile value chain (TVC) is underscored by its pivotal role in shaping the future of this critical industry. The current landscape, characterized by a significant yet limited number of integrated textile factories, emphasizes the necessity of integrating non-integrated facilities, particularly Small and Medium-sized Enterprises (SMEs). This strategic shift is paramount to fully unlocking the potential offered by the GSP+ status and expanding into untapped markets, such as the European sector for Man-Made Fibers (MMF).

A positive initiative by the Government of Pakistan is the establishment of the National Compliance Center, aimed at enhancing labour compliance, social responsibility, and environmental standards. In collaboration with the Ministry of Commerce, this initiative is the first of its kind in Pakistan and has garnered support from political leaders, industry representatives, and international development partners, including the ILO (International Labour Organization).

The center adopts a cluster approach, addressing various industry concerns such as traceability, sustainability, and quality assurance. This development signals a pivotal step in restructuring business practices, compelling SMEs to comply with the NCC for improved traceability and adherence to labour and environmental standards.

While this step addresses the issues of labour compliance, social responsibility, and environmental standards to some extent, it doesn’t explicitly tackle the factor of profitability between integrated and non-integrated industries for the further expansion of Pakistan’s export base. However, more comprehensive measures and strategic policies are required to bridge this gap and foster sustained growth in the export sector.

Copyright Business Recorder, 2024