Study warns of economic toll from rising local input costs

• Study advocates restoring export facilitation scheme exemptions.
• Delayed refunds harm exporters, undermine GST system credibility.
• Textile sector closures, job losses worsen economic challenges.

ISLAMABAD: The increased costs of local inputs can lead to economic losses equivalent to 2% of GDP (over Rs1.7 trillion), a new study has revealed.

The independent study led by eminent economist Dr Nadeemul Haque was done by Socioeconomic Insights and Analytics (SIA), The News reported on Tuesday.

To address these concerns, the study strongly recommends restoring the EFS (export facilitation scheme) to its pre-Finance Act 2024 form, reinstating the zero-rating/sales tax exemption on local supplies for export manufacturing.

This approach, deemed the first-best solution, would require no adjustments, allowing business operations to resume as before.

The study and its findings were also dispatched to FBR Chairman Rashid Mehmood Langrial on Monday by All Pakistan Textile Mills Association (APTMA).

Alternatively, the study suggests creating a level playing field by imposing an equal GST on imported inputs used in export manufacturing. However, this approach would necessitate a comprehensive overhaul of the refund system to ensure timely and full sales tax refunds to exporters, minimising the costs associated with delays and partial reimbursements.

"The one-sided imposition of the GST on domestic inputs will force adjustments in the local value chain that the findings suggest could be costly in the short run. The value chain is adjusting at its pace.

The estimates suggest that forced changes through making local inputs more expensive will impose excessive costs as large as 2% of GDP (over Rs1.7 trillion)."

The recent gains from exports may be at risk then. The losses incurred, both economic and socioeconomic, are staggering. The erosion of trust between industry stakeholders and tax authorities further complicates efforts to implement reforms.

Addressing these challenges requires a holistic approach that balances the needs of exporters, supports local industries, and ensures compliance through robust monitoring and reconciliation mechanisms."

As per the study, the high-value-added producers will not be affected by the extension of GST on domestic products as imports are free of tax. The upstream producers will of course have to compete against GST-free imports which are also not subject to any tariffs.

In economic terms, the upstream sectors are experiencing an erosion of their terms of trade because of this change. Those using imported inputs will move away from these domestic inputs. "Our consultations show that the costs of adjustment could be significant and at least in the short run place pressure on exports as well."

The study also finds that the misuse of the EFS regime is not widespread and could be effectively controlled through targeted adjustments.

Specifically, this includes rigorous enforcement of eligibility conditions for participation in the EFS, ensuring strict penalties for malfeasance, and reduction of the audit/reconciliation period from five years to six months, supported by robust online monitoring of transactions and algorithmic checks on inputs and exports.

The study highlights the urgent need for policy intervention to restore a level playing field for local inputs in export manufacturing vis-à-vis imported inputs.

Such action is essential to safeguard Pakistan’s textile sector and its vital contributions to the national economy. The study emphasises that the current policy not only threatens the viability of the formal textile sector but also incentivises the informal sector, which operates outside the tax net.

As a result, Pakistan’s textile sector has experienced significant closures, widespread job losses, and a decline in competitiveness, with ripple effects across the broader economy, including agriculture and services.

Producers continue to complain about delays in refunds as well as incomplete refunds. For its own credibility and efficient expansion of the GST system, urgent action must be taken to ensure a rapid refund of the GST system.

Several country examples are available and FBR has ample consultants working on the problem. "We are sure there is a recognition of the need for a good refund system. With this system in place, the hesitation of the producers to move to a full GST will be reduced. Indeed, this may be an important step to extend the base of the GST."

"Since this is not a study on the GST, Socioeconomic Insights and Analytics will not go into detail on how to fix the refund system, but there is a huge consensus on digitisation being the solution."

"Here it would only like to point to perhaps using algorithms to reconcile inputs and outputs and following the practice in many markets which allows instant refunds on select transactions to qualified people with the proviso to periodically reconcile the difference.

This could provide much-needed liquidity while ensuring tax collection. Algorithms can allow this to happen, and malfeasance is identified relatively quickly."

Data also shows that exports as a per cent of GDP are on a shallow declining trend which is very disturbing. Simulation exercises also show that policy instability, specifically change in tariffs and taxes, tends to adversely impact exports.

The Haque Tax Commission report also showed that tax policy stability is very important for investment and growth. The volatile policy has been an important impediment that the policymaker must bear in mind before changing past policies, especially taxes.