De-industrialisation in fiscal 2001-2002
Pakistan's manufacturing sector reels from a multitude of external and self-inflicted setbacks. Cotton, textiles, ghee, automobiles, sugar, cement, fertiliser…
The performance of Pakistan's corporate manufacturing sector was far from impressive in fiscal year 2001-02, recording modest growth of just 4 percent against the 8.6 percent achieved the year before. The situation is not expected to improve in the near future. The forecast for the next fiscal year is that the current declining trend or a flat rate of growth will continue. Despite visible signs of recovery in the world economy, the adverse impact of post-9/1 1 events on Pakistan's industrial sector has not yet been overcome prompting fears that the country could be experiencing de-industrialisation. While new petroleum refining, fertiliser and automobile units were being established till just few years back, some of these, like the Fauji Jordan Fertiliser Company, have ceased operation this year. As a financial executive put it, "we do not hear of any new industrial projects coming up except those few with start ups in the late 1990s that are now coming into production". He adds, "There is not much demand from corporates for capital expenditure funding and commercial banks are diverting their liquidity towards consumer banking, particularly car lease financing, which, from a larger perspective, is nonproductive compared to export-oriented manufactures".
In the 2001-02 budget, growth in the large-scale manufacturing sector was targeted at 6.5 percent. As a result of developments after 11 September, the target was drastically scaled down to 3.2 percent. The fiscal year had begun on a positive note with growth in the sector exhibiting a rising trend until September 2001. The strong external impact on the economy is evident from the fact that the sector grew by 5.3 percent in the first quarter (July-September) of the outgoing fiscal year, but dropped to 0.6 percent in October and then registered a negative rate of 5.7 percent in November 2001, at the peak of Afghan war. The end of the war saw the sector rally, growing by 6.8 percent in December and 16.3 percent in January, and this is what helped the cumulative growth of corporate manufactures reach 4 percent last year. The main contributors to this modest growth were petroleum at 18.7 percent, food and beverages at 6.1 percent, textile and garments at 4.4 percent and tyres and tubes at 5.9 percent. Among the industries which registered negative growth were air-conditioners by 76.9 percent, bicycles by 7.6 percent, tractors by 9.6 percent, phosphatics fertiliser by 49.5 percent and cosmetics by 32.9 percent.
Profile and performance
Pakistan's corporate manufacturing sector consists largely of textile, fertiliser, engineering, leather, chemicals, petroleum and automobiles. The textile sector remains the backbone of the economy, contributing around 60 percent of total export earnings and is the major employer of industrial labour. Its linkages with the agricultural sector are very strong, and therefore the performance of the economy in general, is affected by the state of the cotton crop.
Cotton spinning in Pakistan involves 445 mills of which 50 are composite textile mills. In all, there are 7.2 million spindles and 64 thousand rotors in operation. In July-March 2001-02 capacity utilisation was 87 percent in spindles and 45 percent in rotors. The production of cotton yarn increased by 4.8 percent during this period to 1348 thousand tonnes, as against 1286 thousand tonnes in the corresponding period of the previous year. The value of yarn exports, however, declined by 12.4 percent due to depressed international prices.
The weaving and made-up sector, which manufactures hosiery, garments, towels, canvas and bedwear, has a total capacity of 252,892 machines against which utilised capacity was 211,000 units. Last year, the textile industry invested substantially in balancing, modernisation and replacement (BMR) for improving production quality and achieving greater value addition. However, it still needs annual investment worth USD 1.5 billion for BMR and expansion over the next three years to meet the post-quota World Trade Organisation (WTO) regime requirements beginning January 2004.
The hosiery industry has about 10,000 knitting machines with approximately 60 percent capacity utilisation and caters to both the domestic and foreign markets. Exports of knitwear earned USD 598 million in foreign exchange between July and March 2001-02, as compared to USD 668 million in the same period the previous year. The industry has in recent years switched to synthetic yarn, resulting in high value addition and product diversification for the export market.
Readymade garments attracted substantial fresh investment and many new units are being established despite problems like inelasticity in transferring input cost fluctuations to the end user and high value addition in competing countries. This sub-sector has seen 22.4 percent growth in its export volume. However, because of a 13.8 percent fall in unit value, dollar earnings increased by just 5.6 percent to USD 640 million during July-March 2001-02 from USD 606 million.
The towel industry, which is primarily export-oriented, has 6500 looms. Its exports increased by 16.7 percent in volume terms and by 11.3 percent in value terms in the first 10 months of 2001-02 fiscal. The filament yarn manufacturing industry has 25 units with a total installed capacity of 100,000 tonnes per annum against which it produces approximately 78,000 tonnes.
Pakistan's fertiliser industry has only 10 manufacturing units, of which five are in the private sector with an installed capacity of 3.7 million tonnes. The public sector units have a capacity of 1.9 million tonnes. Nitrogenous fertiliser alone has a capacity of 4.9 million tonnes. Due to excess carryover stock and decline in fertiliser off-take because of severe drought in the country, production decreased by 0.5 percent to 3700 thousand tonnes during July-March 2001-02, as against production of 3813 thousand tonnes in the corresponding period the year before.
The edible oil industry is concentrated in the private sector. There are 150 units with an installed capacity of 2.7 million tonnes. Ghee production in the first ten months of 2001-02 declined by 6.1 percent to 0.59 million tonnes. The production of cooking oil increased by 12.9 percent to 0.09 million tonnes. In the food industry segment, sugar, which has seen phenomenal expansion over the decades, is today plagued by a host of difficulties. In 1947 there were just two mills producing 10,000 tonnes of sugar. Currently there are 77 mills with a capacity of 5.5 million tonnes, which is twice the domestic requirement. The sugar season is over by May and estimates suggest that 2001-02 production increased to 3 million tonnes from 2.8 million tonnes in the previous year.
The problem of excess capacity is compounded by high inefficiencies in production partly because of the quality and quantity of cane available. In addition, there are problems such as the high price of cane, heavy taxes and bank charges to contend with. These combine to deprive the industry of competitive edge, as is evident from the fact that in 2001-02 a sugar surplus of 300,000 tonnes could not be exported. Productivity problems exist across the board, from the farm to the factory. Pakistan has the fourth largest area under cane production in the world yet it ranks only 15th in terms of yield and 11th in terms of sucrose recovery. Pakistan's sugar is simply too expensive to be exportable without hefty subsidies.
Like the sugar industry, the cement sector is in the doldrums, though there are some recent signs of improvement. There are 24 units currently with a total capacity of 16.3 million tonnes. Four of these units that combined have a capacity of 1.8 million tonnes are in the public sector, while the private sector plants have a capacity of 14.4 million tonnes. Total production during July-March 2001-02 was 9.8 million tonnes. Largely due to the high price of furnace oil and power, the cement sector recorded an overall loss of PNR 1.75 billion in 2000-01 against a profit of 160 million the year before. One possible option to reduce the cost of production is to switch to coal fuel, but this will take a long time to materialise because the bulk of the country's coal deposits still remain to be developed.
The automobile industry's annual capacity is 106,000 cars, 12,500 trucks, 1900 buses, 28,000 light vehicles, 33,000 tractors and 340,000 motorcycles. The industry's performance has been lacklustre over the last five years. In the outgoing fiscal year, the overall trend was mixed. On the one hand, the production of light vehicles increased by 15 percent, motorcycles by 5.4 percent, trucks and jeeps by 5.7 percent and cars by 3.6 percent. On the other hand, tractors declined by 26.2 percent and buses by 23.1 percent. The industry as a whole registered a marginal improvement of 1.9 percent in the first ten months of the current fiscal year as against 23.3 percent growth for the same period in the previous year.
According to the Federal Bureau of Statistics, the highest growth, 26.9 percent, was recorded in the petroleum sector. Export earnings more or less stagnated at USD 9 billion, about the same as the previous year. Overall, the economy had to export more in volume to earn the same monetary value, since unit prices had declined quite substantially. A few industries such as leather and automobiles showed a decline in production. Contingent factors have to a limited extent offset the general recessionary trend in the economy but these gains have been restricted to certain industries. For instance, by the end of April this year, 53,000 tonnes of cement were exported to Afghanistan, raising hopes of an improved performance next year. However, further exports to Afghanistan will have to wait until the situation there stabilises and donors fund major reconstruction work. Otherwise the industry can improve only if major infrastructure projects, such as ports projects and dams, are launched, which in turn will depend on the investment that can be attracted.
The policy muddle
Domestic and external factors contributed to the generally uninspiring performance of the manufacturing sector, and this appears to be a long-term tendency. Industrial production declined in the second half of the 1990s, with more than 4000 units being declared sick. Correspondingly, the banks that financed them were also getting progressively more sick. Even as many old units were getting obsolete, new investment to create capacity was not forthcoming. The share of the manufacturing sector in Pakistan's GDP declined gradually from 18.5 percent in 1993-94 to 16.8 percent in 2000-01 and to 17.3 percent in 2001-02.
Many of the difficulties faced by large-scale manufacture in Pakistan can be traced to the policy environment that has evolved over time. One of the major internal factors affecting the industrial sector's performance is declining domestic demand. This can be partly attributed to the 15 percent general sales tax, the resulting rise in prices forcing a reduction in consumption. Cronyism and bribery have come in the way of industrial growth in general and the development of an entrepreneurial culture in particular. The politicisation of financial institutions, licensing irregularities, bureaucratic procedures and delays, inconsistent policies and cartelised operations are serious entry barriers to genuinely competitive investors.
Capricious taxation and utility pricing policies have had severely damaging consequences for industrial performance in the 1990s. The high cost of utilities is largely due to donor pressure and the generous terms offered to independent power producers. Pakistan is perhaps the only country in the world where utility prices constitute more than a third of the input costs in industrial production. It is not surprising, therefore, that foreign investment has virtually dried up in the manufacturing sector. Local investors have kept their distance from the sector largely because industrial growth has been hampered by the withdrawal of protective measures, high tariffs on industrial raw material and low tariffs on finished products. The commerce minister, Abdul Razak Dawood, has publicly admitted that industrialists do not regard business in Pakistan as being profitable.
Other kinds of policy imbalances, particularly in the high-tech or engineering sector, have added to market distortions. For instance, the protective umbrella extended to the automotive industry makes it one of the most inefficient segments of the Pakistan economy. Car production does not exceed 40 percent of the estimated annual domestic demand and, given the high unutilised capacity, consumers end up having to pay for an overprotected industry's inefficiencies. The impediments to the development of local industry are many but the most important challenge is the built-in tendency to squeeze out maximum profits in the shortest possible time, leading to unhealthy business practices. This problem is not restricted to the car industry but manifests itself across the entire manufacturing sector.
Some policy relief has been offered to manufacture and if government claims are to be believed, more is on the cards. According to the government, in the last 30 months it has developed a strategy to revamp major sectors such as textile, fertiliser and engineering. It has also reduced duty levels from a maximum of 35 percent to 30 percent and has announced plans to reduce it to 25 percent from 1 July 2002, with further phased reductions to 20 percent, 10 percent and 5 percent over a period of time so as to ensure lower raw material costs. This new policy is designed to improve the global competitiveness of local products. In effect, the tariff will have dropped by 10 percent in two years and this marks a significant change from the 1980s when duty reached a peak of 120 percent.
The government has also been making much of its industrial policy reforms. A large number of public sector industries have been privatised, fetching the government PNR 10 billion. The government has also been able to secure a two-year extension in the implementation of WTO requirements, particularly those relating to the removal of support to domestic industry, originally scheduled to take effect from December 2001. This will provide local industry some breathing space. The official expectation is that this rescheduling will help stabilise the engineering industry, which is the largest segment after textiles. How far domestic industry can reorient itself to a post-WTO world in this grace period remains to be seen.
Despite all these claims and achievements, the industrial sector has continued to stagnate with no signs of early recovery; actually, new policy failures may have played their part in compounding the errors of the past. The reform measures are not as systematic as they should have been. A number of public corporations have been merged for rightsizing and some unviable agencies are being wound up, a process that has increased unemployment. The Asian Development Bank (ADB) has warned of possible de-industrialisation, pointing to the declining share of manufacturing in local employment, down to 11.2 percent at present. Increases in productivity through capital intensive investments will not improve the employment situation very much since such industries account for very little labour absorption.
Private sector investments are being extensively facilitated in the hope of an economic turn-around, but these will inevitably take some time to come online. The absence of a timetable to synchronise public sector disinvestment with private sector investment has only deepened the recession in the economy. This is evident in the sluggish demand for credit. In the first eight months of the outgoing fiscal year, the total bank credit lifted by the private sector was only PNR 49 billion, as compared to PNR 84 billion during the same period last year.
External and internal politics have aggravated the effects of failures at the policy level. Between October 2001 and April 2002 countrywide public protests against US action in Afghanistan and subsequent rallies in support of President General Musharraf's referendum brought production in many units to a virtual standstill. The escalation of military tensions on the eastern border with India made matters worse since it undermined investor confidence. Internally, the deep political polarisation in the aftermath of the referendum campaign has marred industrial peace in the country and made investors much more circumspect. External institutional pressures could also have had their impact in the general manufacturing downturn. Even the ADB was constrained to observe that the recent stagnation in the manufacturing sector was due to "the deflationary policies that the government has pursued as part of the agreement with the IMF".
Closure and revival
If the current stagnation degenerates into a steady deindustrialisation, the culpability for it must rest with the successive governments at the helm in Islamabad. One obvious area of concern is the number of closures that the manufacturing sector has seen, particularly in the special industrial zones. These zones were set up ostensibly to promote growth in the manufacturing sector and to this end were granted long-term tax concessions. But spiralling utility tariffs, unreasonable sales tax, and general infirmities in the planning and policy mechanism have turned these zones into manufacturing graveyards. And in the process the national treasury has foregone millions of rupees worth of taxes. To cite just one example, 145 industrial units out of total 200 in the Hattar Industrial Zone in North West Frontier Province have downed their shutters, resulting in the retrenchment of thousands of workers and adding to the bad loans of commercial banks and financial institutions. It is not surprising that the bad debt portfolio of the banking sector is a staggering PNR 280 billion.
Industrialists attribute the closure to exorbitant input costs for which they blame the government. According to the chief executive of Pak-China Fertiliser Company, in 1992 his unit was paying PNR 18 million in electricity charges per month, which increased to 32 million by 2000. Similarly, the gas bill of that unit increased from PNR 12 million to 24 million. The unit had no option but to shut down and over 700 workers were laid off.
Clear evidence of the failure of industrial policy is that Pakistan has too many industries which face problems of competitiveness. The one facing the most problems is also the country's most important industry – textiles, which will have to gear up for a new trade environment by the end of 2004 when the textile quotas for export to Western countries and Japan will be phased out. Pakistan then will have to compete with the entire range of textile exporting countries, all of which are modernising the sector. Some textile manufacturers in Pakistan have now woken up to this problem and are upgrading their units or adding modern ones. The governor of the State Bank of Pakistan claims that the textile industry has invested a billion dollars in modernisation in the last two years, largely from internal resources and not out of bank borrowings. But industry experts feel that this is not sufficient since over six billion dollars have to be pumped in if Pakistan's textile manufacturers are to withstand competition from China and India.
Textile giants have been talking of setting up a Textile Export Zone near Karachi. Many of the major industrial estates in the country are primarily textile centres. But this zone will be exclusively for exporters, who will need special assistance to compete in global trade. The first step towards improvement is a campaign for cleaner cotton since contaminated cotton is one of the main drawbacks of the textile industry. This is all the more important because though there has been hardly any foreign investment in the sector in the past. Of late some foreign textile manufacturers have been keen to shift their production to countries where cotton is readily available and labour is cheap. This makes Pakistan a potential candidate for direct investment. Chinese textile producers, for instance, are interested in joint enterprises in Pakistan. The government has responded positively and Chinese investors are to be allowed access to special industrial zones where they can have 100 percent ownership.
Similar offers to Japanese and South Korean investors in the past had failed to elicit any response. Clearly, therefore, such incentives alone are not sufficient if Pakistan is to attract foreign investment on a scale large enough to transform the textile sector into a globally competitive one. For one, cotton prices, which have traditionally been volatile in the country, should become more stable and the scope for price manipulation by growers and ginners has to be minimised. Cotton ginners have played a particularly harmful role since they have actively impeded the export and import of cotton at international prices. As a result textile mills are forced to pay much more than world market prices for domestic cotton, and that has affected the sector's overall export incomes. Pakistan's textile industry has to become more cost-efficient from 1 July 2002, when the average rate of import duty will start coming down, leaving the way open for foreign goods to capture the home market. Combined with increased competition in the foreign market, this could seriously erode the profitability of Pakistan's most vital industry.
Gearing up for WTO
Given the impending WTO schedules that will affect Pakistani manufactures, the most urgent requirement is an infusion of large-scale, productivity enhancing investments. Foreign direct investment (FDI) in the industrial sector was low in the second half of the 1990s, though there was a marginal improvement during 2001- 02. But the bulk of this investment was cornered by three industries. The oil and natural gas industry attracted USD 137 million, the transport and communication sector received USD 65.5 million, while the power sector got USD 34 million. Clearly, domestic investment must precede foreign investment if these figures are a portent of things to come.
But whatever be the state of fresh investment, there is no escaping the WTO schedules, which stipulate that the removal of protection for domestic industry will have to be completed by the end of 2003. Only the automotive industry has a reprieve till December 2006. The phase-out plan for all goods other than automobiles envisages a 50 percent elimination by June 2002, another 25 percent by June 2003, and the last 25 percent by December 2003.
Pakistan had so far followed a policy of progressive local manufacture of a large number of engineering goods, including plant and machinery, consumer durables, automobiles and auto parts, among others. Local manufacturers were encouraged to pursue indigenisation plans through concessional customs tariffs on the importation of raw materials and components. In the automobile sector, the car industry has achieved 50 to 70 percent indigenisation, the tractor industry 48 to 83 percent, motorcycles 77 to 83 percent, commercial vehicles 38 to 63 percent and buses 45 to 47 percent. Plant machinery and vapour generating equipment achieved 28 to 100 percent indigenisation, the metal industry 61 to 100 percent, electrical industry 79 to 100 percent and domestic appliances 68 to 100 percent. It was this policy that has so far given domestic industry some price competitiveness and enabled the limited export of engineering goods. This is now under serious threat since WTO member countries are required to eliminate such protective measures, which are inconsistent with the Trade Related Investment Measures (TRIMS) agreement signed by Pakistan in 1994. Pakistan is therefore compelled to review its indigenisation policy.
In these circumstances, Pakistan can ill-afford to create a negative environment for its established industries. The problems that the government faces in implementing the TRIMS agreement are numerous. They include the continuing post-nuclear test international economic sanctions imposed in May 1998, increasing law and order problems in the aftermath of the US intervention in Afghanistan, the drying up of direct and portfolio foreign investment, general economic slow down, an increased debt trap and unsatisfactory GDP tax ratios. Considering the abnormal level of sickness in Pakistan's large scale industries, the country will be hard put to even maintain the existing growth rate in manufactures and export. Pakistan's manufacturing sector is on watch and as much will depend on effective government stimulation as on energetic private initiatives to deal with the new world trading system.