Going forward, manufacturers of export goods are importing a greater proportion of their raw materials than they previously used to, due to a comparative financial advantage which has made imported raw materials cheaper than the locally produced raw materials. However, this will prove to be disastrous for the local economy and manufacturing sector viability, since less value will be added within Pakistan and more will be imported. Consequently, a significant volume of business will be shifted outside Pakistan, limiting production volumes within the country owing to the declining demand of cotton, yarn and greige fabric produced locally.
When a company holding a DTRE, Bond or EOU license needs to buy raw materials like cotton, yarn or greige fabric, if it imports them, it does not have to pay sales tax or duties, whereas, if they buy the same material from domestic industry, it is required to pay 17% GST and wait for its ultimate refund after exports which entails a minimum wait of 9 months.
Under these circumstances, the domestic industry has no chance to compete with imported raw materials. In the past, since the entire sector was zero rated, domestically produced goods had a commercial edge on imports because of rapid availability and assurance of timely delivery and quality.
The new GST rules have distorted the level playing field that was operating and now heavily favors sales tax free imports. This distorted playing field applies to all the raw materials in the textile industry starting from cotton, yarn to greige fabric to PSF etc. In the case of cotton, local phutti prices are already depressed by Rs 300-400/maund. It is feared that the limited demand for domestically produced cotton may lead to a situation where the substantial amount of cotton crop in the fields may not even be picked up.
Currently, Cotton is subjected to 3 different type of duty and taxation systems. First of all, if cotton is imported through DTRE and EOU, etc., it is exempted of any duty or tax. Secondly, there is 5% sales tax on direct cotton import without any scheme, thirdly, a 10% sales tax is levied on domestic purchase of cotton. The highest level of taxation on domestic cotton purchases is actively promoting cotton imports over domestic cotton purchase.
Similarly, cotton yarn is available for imports at zero duty and sales tax through government schemes like DTRE and EOU. While the domestically produced yarn is subjected to GST. There is no commercial reason to buy local yarn as it is subject to 17% sales tax for which refund would have to be sought afterwards. Domestic Yarn industry used to supply bulk of the yarn to exporters, these indirect manufacturers are now at the brink of collapse as they have suddenly found they are no longer commercially viable for Pakistani exporters.
The concept that domestic industry should be allowed to supply to DTRE, EOU etc at zero rate sales tax is also not workable, as there is no way that the indirect exporters can recover the input tax used in their manufacturing process as there is no refund till the final export of the product. There is also an issue of apportionment of input taxes and any system which requires apportionment would surely lead to serious complications.
The cardinal rule is that when you have multiple tax rates for similar commodities in identical markets, the system is bound to be abused and will definitely fail. The 17% GST system can only survive if same rate is applied across the system. It appears that the government policies do not take into account the need to develop and support domestic industry and are actively substituting local production with imports.
If the current situation is not reversed on an immediate basis, cotton produced within Pakistan stands no chance to get a fair price and compete with cotton imports. The likelihood of cotton even being utilized to the extent that it has been produced this year is bleak. Under these circumstances next year's cotton crops are likely to be planted on a far smaller area. The government efforts to support cotton and to increase production to 20 Million bales are being sabotaged.
Similarly, deindustrialization and a massive loss of jobs is bound to occur as the government policies continue to favour imports over domestic production. Under the current circumstances since more inputs will be imported, net exports (difference between exports and inputs) will decline and the Balance of Payments (BoP) would be adversely affected. A company previously utilizing 20% of imported raw materials will now be importing almost 50% of its raw materials, substantially reducing the amount of "value-added" in Pakistan. Currently, exporters are not only claiming DLTL for value added in Pakistan but also on value-added on products imported through DTRE, Bonds and EOU, etc., in the guise of raw material imports, which is a rather unfair advantage to the foreign manufacturers.
After the withdrawal of the sales tax zero-rating facility on local sales, the major apprehension of the business community was timely payment of refunds. This issue has been addressed through implementation of the system of FASTER. According to the newly devised system of refunds, the exporters of five leading sectors are to receive sales tax refunds into their bank accounts within 72 hours under the Fully Automated Sales Tax e-Refund System (FASTER). Given the "Fast" system of GST refunds mechanized by the government, speedy refunds on exports should not be problematic and therefore, 17% sales tax on Bonded imports should be immediately enforced to protect domestic industry, jobs and economy. Failure to do so will further depress the Pakistan's economy and any hopes of recovery.