Posted on

Drive cautiously down China’s Belt and Road

KarachiPort

By Shahid Yusuf

China’s Belt and Road Initiative (BRI) aims to create a Eurasian economic corridor and a string of economic hubs anchored to Chinese cities,  thereby generating a development dynamic that is advantageous to China’s growth. The investment and trade generated by BRI could enable China to sustain a growth rate of 6 to 7 percent and double its GDP between 2010 and 2021. As of end 2016, $900 billion worth of BRI-related projects were planned or under implementation – with loans and credits from Chinese banks amounting to $1.2 trillion (not all for BRI projects). Chinese agencies claim that the BRI will eventually absorb between $4 trillion and $8 trillion.

But what are the benefits and risks for countries accepting BRI-linked financing to build transport and energy infrastructure?

To this day, the BRI remains a patchwork of projects without a well-articulated strategy backed by solid analysis of the potential benefits for China and countries that will borrow from Chinese entities to finance large infrastructure projects. This is critical if the politically less-than-stable countries in Central and South Asia with a poor track record of sound policymaking are to benefit from BRI. In order to service BRI loans, the investment in transport and energy infrastructures plus any associated technology transfer must attract private investment in tradable goods and services and increase export earnings from exports.[1] Whether such a virtuous spiral of investment and exports will ensue, is far from certain. Moreover, infrastructure building and mining on the scale envisaged could lead to severe environmental degradation absent the enforcement of strict regulations, which are either not in place or enforced with a light touch.

There are other reasons for proceeding cautiously down the Belt and Road. The terms and conditions of loans extended by Chinese entities are less than transparent. Furthermore, the governance and finances of the more than 50 Chinese state-owned enterprises that are responsible for major BRI projects are opaque, and their capacity to manage and implement complex transnational projects is untested. Contractual relations with such entities could prove to be tendentious if projects fail, the quality of work and materials is poor, or if lax environmental standards cause damage. The Tharparkar project in Pakistan is a case in point.

This context elicits the following questions and concerns that deserve closer attention and more systematic study.

Can China finance BRI projects to the tune of several trillion dollars from its own resources? And if not, will China need to tap the international bond market for the bulk of the financing? By doing so, its indebtedness would increase and it would absorb considerable risk associated with lending for long-term projects in countries such as Uzbekistan, Pakistan, Sri Lanka, and Laos. In the end, given the current state of China’s forex reserves, will the outlay on BRI be an affordable but not game changing $25 billion per year?

China’s neighbors worry that the purpose of BRI infrastructure and connectivity is to further Chinese exports and geopolitical ambitions. Many are already on the slippery slope to deindustrialization and BRI could accelerate the process. Existing light consumer manufacturing would be imperiled and the likelihood of diversifying into more complex products would be greatly diminished because of China’s competitive advantage in a wide range of manufactures.

European experience suggests that cross-border transport infrastructure has not led to regional convergence. If anything, it has tended to increase regional disparities by making existing hubs more dominant and disadvantaging nearby regions in the hubs’ shadow. Rail links between Milan and Naples have strengthened hub economies while contributing little to the development of Southern Italy. A study of road infrastructure building in Portugal came to similar negative conclusions: greater accessibility did not improve the cohesion and purchasing power of less developed parts of the country.

To service loans from China and other borrowers, countries on the receiving end of infrastructure investment will need to greatly expand their exports and run trade and current account surpluses. Given recent trends in manufacturing and slower growth of world merchandise trade, is that likely? In 2016, China ran a trade surplus amounting to $250 billion with participants in the BRI. Could countries such as Pakistan (which runs a $13 billion trade deficit with China) possibly narrow and reverse the trade gap and run surpluses with its hyper competitive neighbor?[2] If they do not, what is the return to these countries in the form of long term gains from infrastructure? In other words, how much growth could BRI projects unlock by way of tradable goods and services? Furthermore, if highly indebted countries are unable to repay these loans, what are the consequences for Chinese firms and for their bankers?[3] Taking over assets that will need to be marked down would involve absorbing large losses.

What is the risk of BRI exacerbating the resource curse in countries such as Kazakhstan, Turkmenistan, and Afghanistan? Could the creation of the BRI trade corridor render them even more resource dependent and stunt their non-resource based tradable sectors?

So far, China’s projects in its own Western provinces have at best yielded modest returns. The profitability of China’s foreign direct investment in developing countries has also been low. This suggests that the cross-national infrastructure projects intrinsic to BRI will be costly to build and the financial returns are likely to be meager, at least in the medium term. Political changes in destination countries could easily affect project outcomes. Political risk could discourage participation by investors from developed countries.

Geopolitical issues need to be factored in. China’s actions have alarmed some of its neighbors – India in particular.[4]  Chinese closeness to and support for Pakistan could contribute to continuing friction between Pakistan and India. Political tensions within and among countries, sporadic violence (as in Pakistan’s Baluchistan Province), and arms races in South, Southeast, and East Asia may undermine the BRI – as will continuing discord in the Middle East. How might these developments and others affect growth prospects is a key question.

Shahid Yusuf is Chief Economist of the Growth Dialogue at George Washington University and an adjunct professor at Johns Hopkins University.

Note: The views expressed in this article are the author’s and do not necessarily represent those of Pakistan’s Growth Story.

[1] Premier Li Keqiang referred to technology transfer as China’s, “golden business card”. Financial Times (2017, July 18th p.9).
[2] Between 2006/7 and 2015/16, Pakistan’s exports to China went from $575 billion to $1.63 billion. Meanwhile China’s exports to Pakistan increased from $3.5 billion to $12.1 billion (Source: http://fp.brecorder.com/2017/03/20170314153866/). Figures in the Financial Times indicate that China’s exports amounted to $16.5 billion in 2015.
[3] Down the road, servicing the loans from China will be burdensome for many countries. Chinese firms have already encountered problems with projects in Myanmar, Sri Lanka and Indonesia. Chinese SOEs that are spearheading BRI, such as the China Railway Corporation, are themselves increasingly in debt to Chinese banks – CRC’s debts amount to $558 billion and these are rising largely because much of China’s 22,000 high-speed rail network runs at a loss (Source: https://www.ft.com/content/9a4aab54-624d-11e7-8814-0ac7eb84e5f1?mhq5j=e3, https://www.ft.com/content/156da902-354f-11e7-bce4-9023f8c0fd2e?mhq5j=e3).
[4] In response to BRI and disputes along its northern border with China have induced India to launch its own initiative extending from Africa to Southeast Asia variously called the “Spice Route” the “Blue Revolution” and SAGAR – “Security and Growth for all in the Region”. India is also investing $300 million to lease the 2,000 acre tract of land which is the site of the largely deserted Mattala Rajapaksa Airport adjacent to Hambantota Port in Sri Lanka in order to prevent a Chinese takeover of the facility and to control China’s access to the port that it has leased for 99 years (Source: http://www.businessinsider.com/india-and-china-are-fighting-for-control-in-sri-lanka-2017-12, https://www.reuters.com/article/us-sri-lanka-port-india/india-eyes-airport-in-sri-lanka-near-chinese-belt-and-road-outpost-idUSKBN1CI0KI).

Posted on

Why CPEC is a wake-up call for Pakistan’s agriculture

Agriculture

Sharmin Arif and Ijaz Nabi

Many media reports and opinion columns treat the China-Pakistan Economic Corridor (CPEC) as a cure-all. The reality is more complex. The benefit we get from CPEC depends on how much effort we put into using the opportunity. This point was stressed at a recent panel, “What CPEC means for agriculture” hosted by the Consortium for Development Policy Research (CDPR) on November 10th. Following are key points from the discussion.

Why CPEC opens an opportunity in agriculture

CPEC, as elaborated by panelist Hasaan Khawar, policy analyst and CDPR Fellow, is part of a larger economic and strategic initiative whereby China seeks to connect its economy to Europe, Africa and the Middle East through land and sea routes. CPEC is one of the six such routes which connects China to Pakistan through two routes linked to our sea ports: the eastern route and the western route.  Clearly, China knows what it is doing and is here to invest, but Pakistan needs to respond to create the conditions to maximize returns from investments for both economies.

There are seven areas of cooperation for benefiting from the routes, and agriculture is one of them. China’s plan is mainly to invest in our agriculture inputs – specifically fertilizers – as well as in post-harvest infrastructure. Such cooperation in agriculture between China and Pakistan poses challenges and opportunities.

A forthcoming study by International Growth Centre (IGC), cited at the discussion, highlighted that China has become the world’s largest food market with 1.3 billion consumers, and it’s worth $1 trillion. In ten years, it is expected to reach $1.5 trillion. China is undergoing rapid urbanization which is depleting both labor for agriculture and land for growing enough food for its citizens. It has recently struck 80 deals in international food markets worth $12 billion. The U.S., Australia and Brazil have increased their agriculture exports to China three-folds. Russia, recognizing its geographical advantage of being located closer to China, has overtaken the U.S. as the largest wheat exporter to China.

Pakistan, China’s neighbor in the southwest, has yet to take advantage of the opportunity in agricultural trade with China. This is despite the fact that multinational corporations are racing to set up operations in countries close to China for exporting perishable goods in the shortest time and lowest costs. This is unfathomable, as Pakistan is seated on fertile plains, making agriculture a natural source of business for Pakistan’s economy.

CPEC is a wake-up call for Pakistan to energize its agriculture sector through exports. The overall agricultural export basket of Pakistan is mostly reliant on cotton textiles, comprising 70 to 80 percent of total exports. Of that – leaving out cotton and livestock – agri-exports to China account for a negligible portion of other products. Pakistan’s share in the Chinese ballooning market for agriculture imports remains miniscule and will continue to shrink unless addressed effectively.

CPEC will reduce the logistics costs of trade in agriculture products with China. But this will not automatically translate into greater exports for Pakistan. This is because not only does our agriculture sector need to be revamped to improve product quality, but at the micro-level, farmers need to be given better access to formal credit for investing in expensive inputs. Pakistan needs to utilize all available tools to attract foreign businesses. The private sector must accelerate efforts to negotiate new deals with international food companies for export opportunities.

What will it take?

Panelist Arif Nadeem, head of the Pakistan Agricultural Coalition (PAC) and former Secretary of Agriculture, Government of Punjab, pointed out that irrigation costs are a massive 40 to 50 percent of the total production costs of Pakistani farmers. Furthermore, ground water quality has deteriorated sharply, negatively affecting yields. These irrigation challenges need to be addressed, including an overt focus on wheat and sugar cane production, which wastes water resources that can be used for other, more economically viable crops, such as oil seeds, which require much less water for irrigation and lesser input costs. In short, Pakistan’s agriculture needs an overhaul focusing on comparative advantage based on its land and water resources. Additionally, the latest irrigation technologies need to be adopted to produce more crops per drop of water.

Pakistan’s agriculture needs to become part of an eco-system comprising key players from the public and private sectors to help farmers grow high quality produce which can be stored in warehouses that come with crop insurance. Farmers should be able to use their crops as collateral for getting short-term loans from banks for sustaining their investment cycles. This should be accompanied by commodity exchange systems to ensure that farmers don’t have to undergo distress sales, which adversely affect profitability.

The federal government has to improve market access to China. This requires an examination of tariff and non-tariff barriers to trade with China. Currently, the federal government is re-negotiating the Free Trade Agreement with China. However, even though the tariff for seedless citrus fruit is favorable, Pakistan has not shifted toward its production and therefore has not taken advantage of the opportunity. Furthermore, despite the fact that China’s rice imports are mostly non-basmati, there is still significant room to increase exports of basmati rice to China. The major impediment here is the non-favorable tariff regime. No preferential tariff is applicable on any rice category in Pakistan, rendering it non-competitive. Tariff and non-tariff barriers also affect other product categories such as fruit juices and vegetables, which hinder Pakistan’s exports to China.

Pakistan’s agriculture must respond to Chinese food consumption habits, which will entail a move from traditional products to high-value products. The government is making efforts to achieve this and is emphasizing the importance of shifting from cereal production to horticulture, as China’s growing urban population demands more fresh produce such as fruits and vegetables.

The government needs to allow market forces to determine prices for farmers’ produce and eradicate exploitation by middlemen who control access to information. Commodity exchange programs for farmers need to be set up that link multiple sellers to multiple buyers and implement alternate marketing mechanisms to save the farmers from distress sales.

Moderator Naved Hamid concluded the discussion by emphasizing that for Pakistan’s agriculture to benefit from CPEC, the federal government must reduce the tariff and non-tariff barriers to improve access to the rapidly growing Chinese market of agriculture produce. The provincial governments must play their part and improve farmer access to modern inputs and market information and encourage arrangements that collateralize agriculture produce, provide crop insurance and reduce distress sales by farmers. China has its own interests in mind, and unless we can meet their needs through a better managed farming sector, we will not be in a position to demand their technology or investment for developing our agriculture sector.

Sharmin Arif is a communications assistant at the Consortium for Development Policy Research.

Ijaz Nabi is Chairman of the Board of the Consortium for Development Policy Research and Pakistan Country Director at the International Growth Centre.  

Posted on

Garments exports, job creation, and growth in Pakistan: The way forward

Textiles

By Ijaz Nabi

Insufficient export performance is a major contributor to balance of payment crises that slow job creation and economic growth in Pakistan. The textiles and readymade garments industry has the potential to significantly improve overall export performance and create jobs for the million-plus new entrants into the labor market every year. Garments currently account for half of Pakistan’s exports, 30 percent of value added in large scale manufacturing, and 40 percent of industrial employment,

To help make Pakistan’s garments exports more competitive, the International Growth Centre (IGC) commissioned several studies to assess the performance, growth potential, and hurdles faced by firms in the readymade garments sector – the highest value-addition, least energy intensive, and highest job-creating segment of the textiles industry.

Here are some key findings from the research:

A lack of competition is resulting in low value products

The 2013 study, “A Comparative Analysis of the Garments Sector in Pakistan”, found that a lack of competitiveness has resulted in the garment sector supplying low value products to international markets. To come to this conclusion, the study built a profile of garments manufacturers in Pakistan based on a survey of 234 randomly selected firms from Karachi, Lahore, Faisalabad, and Sialkot (all major industrial centers) and compared it to similar firms in Turkey and Bangladesh. Researchers gauged the relative quality of garments manufacturing across the three countries based on indicators of competitiveness such as product mix, diversity of export destinations, expertise of the work force, cost of production, functioning of regional manufacturing clusters, and effectiveness of government policy.

While Pakistani firms have shown good growth in recent years, they lag behind comparator country firms on many important indicators of competitiveness. Pakistani firms are consequently focused on the low price segment of the market with insufficient export diversification. Using the global value chain framework, the study shows that most Pakistani garments manufacturers supply low value products to retailers, brand manufacturers and brand marketers with only a few having the capability of design manufacturing. For the large number of small firms this is due to the high cost of upgrading technology and, in turn, poor access to formal finance to do so. The agglomeration benefits of cluster formation, that might increase capabilities of firms located in Karachi, have not been realized due to poor law and order that increases transaction costs. The severe energy crisis has also not helped. Strengthening capabilities will be vital to becoming part of the value chain of a global garments market that is estimated at $133 billion, growing at 12 percent annually and with China poised to vacate its share of 26 percent of the market.

How successful garments manufacturers operate, and what they need to improve

A follow-up study, “Garments as a Driver of Economic Growth”, conducted detailed interviews with 20 knitwear and 13 woven garments manufacturers located primarily in Karachi and Lahore. This provided rich insight into the growth path of firms, the critical turning points, and the entrepreneurial ingenuity that enabled firms to take advantage of opportunities. It also revealed the biggest policy constraints to improving exports as perceived by firms. Analysis of the interviews shows that garments is a modernizing industry connecting educated, aware Pakistani entrepreneurs with rich consumer markets through well-established brand names. Many firms produce to global standards, some have developed niche markets, and a few have advanced design capabilities. Information technology is used extensively to overcome connectivity hurdles and reduce turnaround time. Resourcefulness and ingenuity have enabled successful firms to mitigate the economic and political risks perceived by importers in placing orders with Pakistani manufacturers.

There is a strong belief among successful firms interviewed for the study that Pakistan could increase its global garments share manifold and make a significant contribution to exports and employment. However, it is stressed that the success of a few firms is not enough to realize the scale effects of a modern garments industry. That will require committed policy intervention to enhance the international competitiveness of the sector as a whole. The areas that need policy attention are: Customs procedures, the skills gap, government incentives and policy consistency, law and order, facilitating buyer visits, and negotiating market access.

Policy implementation: Where it worked and where it struggles

A third study, “Implementing Polices for Competitive Garments Manufacturing”, tracked the policy process to assess the influence of analytical work in changing policy. It also assesses the impact of one of the recommendations of the earlier study (improve market access) on export performance and expands the case studies to include firms in Sialkot, a cluster of innovative firms manufacturing sportswear not covered in the previous research. Firms’ assessment of the policy implementation process was recorded in additional interviews conducted in all three of Punjab’s industrial clusters: Lahore, Faisalabad, and Sialkot.

The Punjab Chief Minister’s provincial growth strategy, 2013-18, stressed the importance of export-led industrialization for employment generation and drew upon the studies cited earlier  that argued for a large role of garments in achieving that objective. Keen to engage in the rollout of a comprehensive program to support garments manufacturing in the province, the Chief Minister chaired a meeting¹ of senior Punjab policy makers, civil servants, garments manufacturers, and researchers affiliated with the International Growth Center (IGC) and the Consortium for Development Policy Research (CDPR). During the meeting, the recommendations of the previous IGC/CDPR studies were endorsed and the Chief Minister announced a steering group headed by Chairman, Planning and Development, to oversee the implementation of policies in each of the recommended areas that were further fine-tuned as: market access, trade policies and customs procedures, skills, energy, and cluster formation. Five sub-committees were formed to roll out the policies.

Did the roll out work? Following the subcommittee implementation of market access reforms that strengthened federal submissions of evidence of compliance to the European union, Pakistan was awarded the GSP plus status in December 2013. As a result, Pakistan’s garments exports to the EU grew much faster (11 percent annually) than exports to the rest of the world (1.5 percent). Progress is also satisfactory on cluster development as Quaid-e-Azam Apparel Park takes shape. Along with improved market access, this will promote Chinese investment in Pakistan’s garments manufacturing through the China-Pakistan Economic Corridor (CPEC). On skills, the Punjab Skills Development Fund is developing training programs tailored to the needs of the garments industry. While there has not yet been substantial improvement in the energy situation, large investments are being made in power generation in Punjab which will bring about significant improvements in the coming months.

Less impressive is the progress in the critical area of trade policies and customs procedures. Imports of raw materials remain heavily regulated, duty drawbacks are cumbersome and customs procedures continue to be burdensome. The anti-export bias in exchange rate management is worsening with the continued appreciation of the rupee.1 One step in the right direction, however, is the recent easing of access to raw materials for garments manufacturers and better customs procedures in CPEC special economic zones.

The need to address the difficulties faced by garments manufacturers in the area of trade policies is critical but lies in the federal domain. Provincial governments, even Punjab with its strong political affiliation with the federal government, will need find ways to work with Islamabad to improve the overall policy environment for garments manufacturers so that the sector can realize its full potential for export growth and employment generation. This includes better macro-economic management to avoid balance of payments crises that shrink the policy and fiscal space to support growth.

Ijaz Nabi is Pakistan Country Director at the International Growth Centre and Chairman of the Board of Governors of the Consortium for Development Policy Research.

1 Hamid, Naved and Mir, Azka Sarosh. ‘Exchange Rate Management and Economic Growth: A Brewing Crisis in Pakistan’, The Lahore Journal of Economics, 22: SE (September 2017): pp. 73-110.

Posted on

Engaging with Pakistan’s exporting firms to improve trade prospects

Gwadar-port-2

By Salamat Ali and Ghazan Jamal

Pakistan’s struggle to improve its exports is no secret, nor is the growing pressure on the government to stem this downward trend. In 2015-16, according to the Trade Development Authority of Pakistan (TDAP), the country’s exports fell by over 12 percent compared to the previous year, to a mere USD 20 billion.

Key to making export friendly policies from the government’s side is to better understand the nature of exporting firms in Pakistan. A recent study by Salamat Ali partly does that by investigating the impact of trade costs on the composition of Pakistan’s exports and the behavior of its exporting firms.

In the study, trade costs are defined as the cost associated with transporting the product from the factory to its destination. That includes freight charges, border costs both at Pakistan and the destination market, and other customs-related surcharges. The study examines the World Bank’s trade cost dataset, exporter dynamics dataset (EDD), FBR’s national data sources, Centre d’Etudes Prospectives et d’Informations Internationales (CEPII), and other open data sources collected by the World Bank and UN Conference on Trade and Development (UNCTAD).

The study has four key findings: First, exporting is a rare activity in Pakistan. Only 23 percent of all firms in Pakistan export their products.

Second, due to the high cost of exporting and a lack of competition in the domestic market, on average, even exporting firms sell 70 percent of their output domestically.

Third, among exporting firms only a few export multiple products to multiple markets. In fact, most exporting firms concentrate on the same few markets with the same products.

And finally, the survival rate of Pakistani exporting firms is very low. Many firms and products exit the exporting market after a few years. This is especially true of exporting firms that are based in relatively remote areas from seaports.

It would not surprise anyone that the data shows that as trade costs increase, exports go down. This is shown in the graph below, where Pakistan’s bilateral trade costs and exports to the destination country are plotted:

Figure 1: The relationship between exports and trade costs
ExportFirmsFigure1

A regional breakdown of the same as represented in Figure 2, which shows that Pakistan’s trade costs are lowest with Northern America and Eastern Asia, and these correspond to two major destinations for Pakistani exports as well. On the other hand, Pakistan’s trade costs are highest with Southern Africa and the Caribbean and these correspond to some of the lowest export destination for Pakistani products.

Figure 2: Pakistan’s exports and trade costs by regionExportsTradeCostsPakWorld

Contrary to popular belief, in 2015, Pakistan’s border-related costs associated with exporting and importing a 20ft container was much lower than some other countries in the region like India and Bangladesh. This shows that our customs and port operations are more efficient than these countries. The comparison can be seen in the table below.

Table 1: Pakistan and comparator countries’ border-related costs of exporting and importing

Parameters Pakistan Bangladesh India China Singapore
Cost of Exporting a 20ft Container 765 1,281 1,332 823 460
Cost of Importing a 20ft Container 1,005 1,515 1,462 800 440
No. of Export Documents 8 6 7 8 3
No. of Import Documents 8 9 10 5 3

However, our bilateral trade costs are comparatively much higher, putting our exporting firms at a disadvantage. The table below shows these figures for Pakistan comparing to other countries in the region:

Table 2: Bilateral trade for Pakistan, India, China, and the world

Year World Pakistan India China
2003 242 223 229 192
2004 236 211 213 177
2005 234 214 209 171
2006 232 216 201 168
2007 228 221 198 166
2008 230 233 194 166
2009 231 235 191 164
2010 222 224 183 153
Average 232 222 202 170

Source: Bilateral trade costs dataset, the UN-ESCAP

The concerning trend for Pakistan in this period is that as there is a clear downward trend in bilateral trade costs globally as well as in the cases of India and China. However, in the case of Pakistan trading costs have fluctuated without much improvement. This shows inconsistency of policy and the lack of a concerted effort to improve our export regime. These high costs mainly pertain to relatively large input tariffs on imports of intermediate inputs used for manufacturing for exports, poor transport network to connect manufacturing regions in the North with seaports in the South and high costs of other inputs such as electricity and natural gas.

The study lays out some very tangible steps that the government can take to bolster the country’s exports both in the immediate and longer terms. These are summarized as follows:

Engage more actively with larger exporting firms. The top one percent of firms take up 50 percent of all exports, while the top five percent of firms mediate over 75 percent of all exports. The top one percent comprise not more than 100 firms, and engaging with them to support their exporting activities can generate immediate results. This was the approach taken by South Korea at the time when it was looking to boost its exports as well.

Further liberalize the importing regime. This is because large exporters are also large importers. On average, 20 percent of imports are used to produce exports. Pakistan’s highest import tariff on inputs puts exporting firms at a great disadvantage globally. Moreover, the reduction in import tariff will increase competition in the domestic market and push inward-focused firms to explore international markets.

Make better use of new trade policy tools and explore potential trading partners. There are about 700 active free trade agreements (FTAs) globally and on average every country has 10 FTAs. However, Pakistan is only party to 5 FTAs namely with China, Malaysia, Iran, Indonesia, and Sri Lanka, and these countries also correspond to some of Pakistan’s main export destinations.

Improve trade-processing infrastructure. This is especially true for landlocked parts of Pakistan. As was observed earlier, the survival rate in the international market is particularly low for exporting firms operating out of relatively remote parts of Pakistan.

Salamat Ali is a senior trade associate at The Commonwealth’s Trade Division and an applied trade economist at the University of Nottingham.

Ghazan Jamal is a Pakistan country economist at the International Growth Centre.

Posted on

Has GSP plus status improved Pakistan’s garments exports?

GarmentTextileSectorFactory_Public

By Zara Salman

In December of 2013, Pakistan acquired the GSP plus status from the European Union, granting member states duty-free access to 96 percent of Pakistani exports to the EU. Pakistan was the second country in all of South and Southeast Asia to receive the trade advantage, giving it a 10 to 14 percent duty advantage over major regional competitors including China, India, Vietnam, Thailand, and Indonesia.

Between 2013 and 2015, Pakistan’s most important export industry – garments – increased exports by 10 percent. But Bangladesh and India increased their garments exports in the same period by 13 percent and 17 percent, respectively.[1] This shows that Pakistan has not yet fully exploited the benefits of the GSP plus status.

The garments sector has the potential to drive Pakistan’s export-led growth due to high value addition of exported products, high labor intensity, and low energy requirement. In 2015, garments accounted for over 20 percent of total exports. Once GSP plus status was obtained, the garments sector was expected to grow considerably from increased exports and other associated economic benefits. But has that really happened? What needs to be done to fully exploit the potential benefit of the GSP plus status?

A recent study[2] by the International Growth Centre provides evidence to answer these questions.

Impact of GSP plus in numbers

The most recent data confirms that the GSP plus status has positively impacted Pakistan’s garments exports to the EU compared to its exports to the rest of the world (Figure 1). In the first two years of GSP plus, garments exports to the EU grew much faster (at 11 percent per year) than garments exports to the rest of the world (1.5 percent per year).. Between 2013 and 2015, the EU’s share in Pakistan’s total garment exports has also increased from 50 to 54 percent. However, the benefits are probably less than initially projected.

Figure 1: Pakistan’s Garments Exports (2013-2015)PakGarmentsExports13-15.jpg
Source: UN Comtrade

Analyzing specific garment categories, exports of knitwear to the EU expanded faster (at 6 percent per year) than of woven (at 5 percent per year) after GSP plus status. [3] Yet, this pace of growth is only visible for the EU, as knitwear exports to the rest of the world grew slower than woven garments exports (6 percent per year versus 7.5 percent per year, respectively).

Figure 2: Pakistan Garments Exports by Categories
GarmentExportsbyCategory
Source: UN Comtrade

What is holding back gains from GSP plus?

Despite some evident growth in garments exports, the private sector does not seem too optimistic about realizing the full potential of GSP plus and has vocally expressed frustration at the challenges that remain.

Their biggest concern is the continued energy shortfall. In the last few years the industry has operated below 70 percent of full capacity  due to this deficit. Production costs have also increased as firms employ alternate measures to ensure regular energy supplies. The energy crisis is expected to lessen in the coming years as investments on energy projects planned under CPEC materialize. But in the interim, industry continues to struggle with meeting production targets.

Pakistan’s adverse business climate hinders investments in export manufacturing particularly by new EU-based clients. International buyers prefer suppliers from less risky countries, especially where physical engagement with firms is possible. Maplecroft, an international agency that ranks countries according to their investment climate, places Pakistan in the high-risk category. Pakistan fares much worse than Bangladesh on most categories (Table 1). Without a coherent strategy to improve the business environment, the gains of GSP plus will not be fully availed.

Table 1: Risk Rating for Pakistan and Bangladesh

Pakistan Bangladesh
Political Risk 8.34 7.21
Social/Compliance Risk[4] 8.82 8.46
Economic Risk 6.42 6.22
Infrastructure Risk[5] 9.47 9.62
Adjusted Country Risk Score 8.26 7.88
Overall Risk Rating Extreme Extreme

Note: The agency analyzes countries at different risk levels on a scale of 1 to 10 (1= Best and 10= Worst).

An important challenge faced by the industry is the tax regime and custom clearance procedures. The industry is subjected to a higher duty on raw materials compared to other countries, which makes the final product more expensive.[6] Due to cumbersome customs procedures and high duties on the import of artificial fibers and PTA[7] (a raw material for the manufacture of polyester), the garments industry has been unable to move from the existing cotton concentrated 80:20 mix to the globally demanded 50:50 mix in its exports.

The verdict

On the bright side, GSP plus status has allowed the garments industry to maintain its export shares – even improve them slightly – despite the many challenges. The new incentive package for exporters, announced by the Prime Minister in January 2017, may ease some of the tax constraints. [8] There is also some progress towards solving the energy crisis and lowering the tax burden.

But the desired benefit of the GSP plus status – substantially higher exports – will be realized only when the energy, tax and customs challenges are addressed comprehensively. Improving Pakistan’s business environment will also be key to attracting foreign clients including Chinese investors, given that the Chinese garment industry is relocating to lower-cost developing countries and Pakistan offers the additional advantage of easy access to European markets.

Zara Salman is a senior research associate at the Consortium for Development Policy Research.

[1] World Trade Organization

[2] Nabi, I & Hamid, N. (2016). Implementing Policies for Competitive Garments Manufacturing.

[3] Knitwear held a greater share of total world exports (at 53 percent) compared to share of EU exports (39 percent) back in 2013

[4] Includes labour and safety laws and human rights.

[5] Includes power, roads, climate change and disaster management

[6] The government, in response to the demands of the spinning industry, has imposed a duty on imported cotton yarn ranging from 5 to 15 percent, which makes products more expensive than that of competitors. Furthermore, taxes paid by exporters on local raw materials are eligible for refund but significant delays and costs are involved in the refund process. Although zero-rated tax regime has been introduced, billions of rupees pending with the FBR for earlier cases remain to be refunded.

[7] Firms face the problem of having to first pay import duties on small items such as tags, zips and other trimmings used in manufacturing of garments and then getting their refund, which is a hassle for them. Moreover, a 24/7 custom clearance facility is officially available, but staff is commonly absent and collectors are available only five days a week, which delays shipments and may lead to loss of clients.

[8] The package includes removal of both customs duty and sales tax on the import of cotton, of customs duty on man-made fibres other than polyester and of sales tax on the import of textile machine. In addition, garments exports will be eligible for duty drawbacks at 7 percent. However, exporters will get these incentives only if they increase exports by 5 percent from January to June 2017 and then by a further 10 percent during FY 2017-18.