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Economic impact of abolished zero-rating

One of the most detrimental aspects of the federal budget FY20 has been the elimination of SRO 1125 and the imposition of General Sales Tax of 17% on the previously zero-rated export sectors. The immediate impact of the withdrawal of SRO 1125 is the transfer of Rs 600 billion from industry to FBR for an extended period of time, the irony of which is that out of the Rs 600 billion, Rs 500 billion is to be refunded. Abolition of SRO has also created unjustifiable discrimination against the domestic industry supplying input goods to exporting units against exporters importing their inputs through DTRE, EOU or Bonds which are available without GST while local supplies are subject to GST.

Withdrawal of zero-rated regime and imposition 17% of GST, along with steep depreciation of local currency, together have resulted in an unmanageable liquidity crunch for the entire export industry. At a time when the country is facing stagnant exports and balance of payment crisis, the ending of sales tax exemption under the zero-rated regime has triggered a ‘catastrophe’ for the country’s exports, Balance of Payments (BoP), domestic manufacturing and thus the overall economy.

It is difficult to comprehend that 17 percent sales tax has been imposed to mobilize Rs 100 billion additional revenue in the budget for next fiscal year, by the collection of Rs 600 billion from the industry and starting another refund cycle soaking up market liquidity. The government intends to implement the Bangladeshi model to provide refunds instantly through the central bank for exporters. However, asking businessmen to “first pay taxes and then later get refund” is an irrational policy measure. When tax has to be returned eventually, it is better not to collect those taxes. Firstly, the government already has to pay refunds worth Rs 200 billion to exporters, but it has no fiscal space for making that payment, abolition of SRO-1125 will further create unbearable burden on the industry. Secondly, there is no reason for exporters to believe that they will get their sales tax refunded in due time while their prior refunds still remain unpaid. The outstanding amounts are as follows:

From the perspective of local manufacturers, there is a substantial increased incentive to ‘cheat’ since the differential for ‘cheating’ and smuggling has increased tremendously. Duty-free imports and smuggled goods will substitute domestically produced products because of this incentive.

Another aspect of the removal of zero-rating is that sales tax-free imports through DTRE/ Bond/ EOU are detrimental to the survival of local industry. These schemes allow a registered exporter to import goods without duty and taxes and to purchase zero-rated input goods. No exporter will buy inputs from domestic manufacturers if he has to pay 17% sales tax and await its ultimate refund for many months when these can be imported sales tax free through these import schemes. This discriminatory treatment between the imported raw materials and locally manufactured similar input goods is resulting in the closure of the local industry which is not a long-run phenomenon but in months a great proportion of local raw materials industry is going to be closed. Rather than encouraging import substitution, we are doing the exact opposite by disincentivizing local production and promoting cheap imports.

For instance, 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 through these schemes, 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 10% GST and wait for its ultimate refund after exports which entails a minimum wait of nine months. The new GST rules have distorted the level playing field that was operating and now heavily favors sales tax free imports. 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.

Consequently, there will be de-industrialization and capital will drain from the country. This is likely to subsequently increase unemployment, while the government will face huge losses in foreign exchange. Moreover, the resultant liquidity crisis is hurting exporters. The export orders were taken on the basis of zero-rating; it is discriminatory and unjustifiable to deprive exporters and expose them to unforeseen loss in the business transactions by suddenly withdrawing the exemption after they have made legal commitments. Pakistan’s exports are likely to fall by over 30% percent solely because of this one policy measure.

Taking the case of Pakistan’s largest exporting sector textiles which accounts for almost 60% of national exports, 17% Sales Tax regime on exports has increased the cash flow requirement equivalent to additional Rs 25 to 30 billion per month on $ 1.1 billion (or Rs 170 billion) worth of textile exports each month. The laborious system of refunds based on receiving the export proceeds after dispatching the goods makes it difficult for industry to self-finance Rs 180 – Rs 240 billion to continue financing the export requirement. The refinance limit of Rs 480 billion has already been exhausted, which requires industry to finance Rs 520 billion through own resources which could very well have gone towards modernization and expansion.

Eliminating the sales tax waiver for the industry which is fragmented has increased the production cost for exports to colossal levels. Exports have become unviable due to squeezed liquidity and slim margins while the small- and medium-sized exporters are highly unlikely to survive this financial crunch.

On the one side, the government advocates promotion of exports and ease of doing business, but on the other hand problems have been created for industries. The government should decide its economic direction so that the country may move forward on the path of economic development by promotion of business and industrial activities.

To keep the businesses running this sales tax should have been imposed in a step-wise progressive manner as agreed in a 3-year period, starting from imposing 7.5 percent in this fiscal year, then increasing it to 12.5% next year and then finally reaching 17% level in the 3rd year. It is still in vital interests of the exports and economy that the government should consult stakeholders for initially imposing a rational percentage of sales tax to ensure adequate cash flow and hence timely fulfillment of export commitments.

(The views expressed in this article are not necessarily those of the newspaper)

Shahid Sattar and HiraTanveer, "Economic impact of abolished zero-rating," Business Recorder. 24-10-2019.
Keywords: Economics , Payment crisis , Sales tax , Fiscal year , Market liquidity , Irrational policy , Government policies , Foreign exchange , Economic direction , Exports , Imports , Stakeholders , Pakistan , GST , DTRE , EOU , BoP , SRO

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