ANALYSIS OF PAKISTAN INDUSTRY

Determinants of Exports in Textile Sector

TERM PROJECT REPORT
Submitted to: Dr Muhammad Zubair

Submitted by:

Muhammad Abid Abbasi 20191-26531

Yashal Alam 20191-25767
Raja Omar Farooq 20191-26728
 Table of Contents

1. Abstract.....................................................................................................................................3
2. Introduction..............................................................................................................................3

3. Literature Review.....................................................................................................................3
4. Objective & Methodolgy.....................................................................................................
5. Model....................................................................................................................................
6. Results & Analysis....................................................................................................................
7: Conclusion...............................................................................................................................
 Abstract:

Majority of Pakistan’s exports come from the textile sector. Despite facing problems of currency devaluation,
unfavorable economic conditions and high cost of borrowing, it has retained its place as the biggest contributor
amongst the exports of Pakistan. However, in recent years it has started to experience a decrease in value and has
been facing tough competition from counterparts like India and Bangladesh. It is because of the paramount
importance of textile sector to the national economy, it is imperative to find out what determines and impacts the
textile exports of Pakistan. Four main components were tested namely the Exchange Rate, Interest Rate, Cost of
Production and GDP Growth rate to find the impact they had on the textile exports of Pakistan. It was revealed
that exchange rate, GDP growth rate and interest rate had significant impacts on the textile exports of the country.

Introduction:

The Textile Sector of Pakistan makes up the majority of the share in the total exports done by the country over the course of
a year. It is termed as the most important, out of all in the manufacturing sector of Pakistan, with the potential of value-
addition in every stage it includes; such as cotton processing to ginning, spinning, dyeing of fabric and lastly finished
products such as garments. According to the Economic Survey of Pakistan 2021-2022, this sector alone is responsible for
employing about 40% of the total labor that works in the industries of Pakistan. In addition to providing employment on
large-scale level, this sector contributes the lion’s share in the exports of Pakistan, having maintained an average share of
61.24%. Furthermore, it is estimated that about one-fourth of all the industrial value addition comes through this Textile
Sector.

As a result of having the lion’s share in the national exports, this sector is a major source of foreign exchange, which are
crucial for developing countries like Pakistan in order for it to be sustainable and not resort to borrowing to finance the
trade deficit. Due to the country receiving increased trading access to markets in European Union countries and United
States of America, the textile exports of Pakistan have increased steadily. As mentioned above, at every stage of this sector,
the process of value addition is being done, with the spinning stage, which produces high-quality of yarn constitutes the
major share of all textile activity in Pakistan. Hong Kong, Japan and South Korea are the major export destinations of the
yarn produced by Pakistan. These countries then convert these products into finished goods having high-value addition and
earn foreign exchange through it, despite the fact that they are importing the yarn from Pakistan, which has a comparative
advantage in textile production over these countries.

This issue regarding not being able to export high value added products of textile has long persisted in Pakistan, despite the
country having a favorable environment for allowing it to produce and export finished textile goods to its exporting
destinations and thus earning an increased level of foreign exchange, instead of exporting semi-finished products to
countries which then process it further and charge higher level of prices internationally. This issue has persisted long
because of internal as well as external economic factors. Despite the fact that Pakistan has experienced an increase in the
level of exports in textile, the country has been unable to compete globally as well as its other counterparts; India and
Bangladesh have been able to. This is primarily because these countries have focused on providing favorable business
conditions and economic factors which have enabled their firms to focus on increasing value addition in their products, and
thus export performance. Moreover in recent years, due to unfavorable economic conditions of the country, it has been
estimated that 125 textile companies had decided to end operations due to the ever-increasing cost of production faced by
manufacturing sector of Pakistan. In addition to this, the production of cotton, which is the primary raw material, has been
facing a slow decrease, due to which firms have been forced to import cotton, in turn raising their costs associated with the
production even more. These business conditions have negatively affected the textile sector of Pakistan, and have affected
the value addition aspect as well as its export performance as compared to its counterparts.

It is because of the magnitude contribution of textile sector in the exports of Pakistan that the problem faced by this sector
automatically becomes an issue of national importance. And so the core objective of this study is to focus on which are the
main determinants of export performance in the textile sector of Pakistan and how the government can focus on these
determinants in order to help the textile sector of Pakistan to not only increase the volume of exports but also add more
value addition to its products and thus earning higher foreign exchange.

Literature Review:

There have been numerous research studies which have focused extensively on the textile sector of Pakistan and its export
performance. The issues affecting the level of textile exports as well as the overall problems faced by this sector has been
the core subject of various studies. According to Abida (2008), this sector was massive challenges on multiple fronts such as
high prices of inputs, non-availability and high costs of power as well as high levels of interest rates and devalued exchange
rate. Khan and Khan (2010) stated that due to high rate of inflation, devaluation of rupee which has a direct impact on the
level of exports, causing it to decrease as well as the high rate of unemployment are some of the biggest problems faced by
textile sector of Pakistan. In their study, they had presented solutions such as reduction of tariffs, lower levels of interest,
and special emphasis on the process of value-addition as the keys to overcome these challenges. Shah et al (2012) explained
how the increased levels of costs of production and worsening law and order situation has negatively affected this sector,
amongst all other manufacturing sectors of Pakistan, as it has reduced the level of investment in this sector. Many other
research studies as well as observations made personally and informal interviews with industry leaders have revealed that
the government should place utmost priority in providing the textile sector with tax reliefs and reduction of export and
import duties as well as take corrective measures to address problems in the energy sector so that the firms cannot only
ensure uninterrupted production but also decreases in the costs associated with their production processes. This driving
down of costs will then enable them to focus on the value addition, thus resulting in a higher level of foreign exchange.
Afzal (2012) analyzed the impact of high interest rates on the textile sector, and came to conclude that high levels of
interest rates induce a decrease in level of production thus affecting the national exports of textile. This situation also leads
to a reduction in the ability to compete in the international markets, which is not a good sign for the country.

During the decade of 1990’s, the textile sector of Pakistan was said to be one of the most automated and robust industrial
sectors in the subcontinent region, however as time went by and decade of 2000’s started, the share of textile exports of
Pakistan in the global textile exports declined from 2.2% to nearly 1.7% in 2017. This drastic fall that the country
experienced in the global commerce landscape were due to factors which were multitude in nature; ranging from decline in
the quality standards of the products to high levels of interest rates and energy tariffs as well as carless government policies
which encouraged imports rather than exports.

When examining the decade of 2010’s, a trend can be seen wherein from 2010 to 2014, textile exports of Pakistan
experienced a moderate growth after recovering from the aftermath of Financial Crisis of 2008 when it suffered badly, like
the textile sectors around the world. Arian (2019) studied that the years from 2008-2009 were a struggling time period for
this sector, as it experienced a negative growth of -0.70%. However this sector posted a quick recovery and was back on
track by 2012-2013, when it posted a growth of 13.02%. According to Ahmed (2018) the years which succeeded ranging
from 2013 to 2018, the textile sector showed a dismal performance, primarily due to the 61% increase in the power tariff. In
addition to this, there was the problem of allocating less funds to this sector, due to which the level of investment
decreased as businesses shifted to investments in other sectors like the real estate sector. Moreover the government did
not pass the impact of reduced prices of petroleum products to this sector, which could have helped to bring a decrease in
the firms’ production expenses as these firms are reliant on electricity for processing the cotton fiber and other production
processes.

The costs of production, as mentioned above plays an imperative role in determining the profitability and sustainability of
the firm, as research studies showed that the increase in energy tariffs not only had a negative impact on textile firms but
also impacted their export performance, when compared to counterparts. This can be evidently seen when during the years
of 2016-2017, it was reported by the Express Tribune (Rana, 2017) that the levies imposed on Gas nearly doubled as
compared to rival countries, which proved to be unfavorable for the industry. Moreover, Shibata (1983) concluded that
rising cost of electricity, which contributes greatly to the cost of production impacts the economic growth of the country,
and thus all of the sectors involved in a national economy.

A report titled “Textile Exports: Dismal Performance” published in 2019, reported that due to the decision of the
government to withdraw tax reliefs given to these textile exporting firms by previous governments, through the exemption
on finished goods of textile affected not only production but also had a negative impact on exports. In addition to this, the
government also discontinued the practice of providing credit facility on Value Added Tax, which discouraged the value
addition process by the textile firms, as firms revert back to semi-finished product, which fetched a lower level of foreign
exchange as compared to the finished types of products.

In addition to withdrawal of tax rates or in certain cases, bringing hikes in the tax rates, the textile sector of Pakistan was
also negatively affected by high levels of interest rates, and often unstable monetary policy implementation by the
government and central bank alike. Aslam (2019) stated several reasons for the decline of exports from textile sector
especially, but also the sector as a whole. The high interest rate was one of the most important reasons mentioned in that
study, because it impacts not only the day to day business activities, but also places a limited on future financing facility that
the business might need. Moreover, this hike in the interest rates discourages new investment and so the scope of the
business stays at the same place. In addition to this hike in the interest rate, the study also mentioned that the government
owes PKR 400 billion to the traders, in form of tax refunds for exporters. These traders are then facing liquidity problems,
finding it difficult to convert these types of investments into cash, giving way to a repayment crisis. Khan (2017) added that
due to lack of readily available credit facilities, not only the textile but all of the industrial sectors of Pakistan have suffered
badly. According to this study, the shortfall of credit is around USD 2.9 Billion. Moreover, there are challenges such as weak
pricing negotiations mechanism for production inputs.

In addition to these problems of high interest rates, increased inflation rates which directly impact the cost of production
for businesses, another important factor is the exchange rate mechanism. The exchange rate defines the buying power of
one currency, which is national in terms of other currency, which is foreign. According to economic theory, depreciation or
decrease in the value of domestic currency helps to bring a growth in terms of exports as the products and services become
cheap in the global market, and so there is increased demand for it. On the other hand however, it causes the cost of
production to rise as inputs become more expensive. Moreover, it also causes firms to experience a fall in the business
profits. The currency market is a volatile market place and so the fluctuations in the exchange rate negatively impact the
business sector, as it directly impacts the profits. According to (Mehtha, Deosthali & Mehtha, 2012), the exchange rate of
US Dollar experienced frequent fluctuations against the Indian and Pakistani Rupee, which had an adverse effect on the
export performance of these countries. The impact of exchange rate volatility and its impact on the level of exports was the
subject of study conducted by (Mohamad, Nair & Jusoff, 2009) when they researched about the impact this kind of
fluctuations had on the exports of countries belonging to “Association of Southeast Asian Nations (ASEAN)” group. Ahmed
(2018) had also found out that due to the movement of exchange rate bringing adverse effects, some of the textile firms in
Pakistan had decided to end operations, and shut down completely. Ahmed (2018) cited devaluation of Rupee against the
US Dollar as one of the most important factor that damaged the prospects of textile exports from Pakistan.
Objectives & Methodology:

Objectives of Study:
The core objective of the study is to focus and examine the factors which determine the exports in textile sector of Pakistan.
It attempts to explain how the movement of exchange rate, interest rates as well as the cost of production impacts the
export performance of the textile firms in Pakistan. The paper also throws light on the important factor of GDP growth rate
and its role in export performance of textile sector.

Methodology:
The methodology that was used to test the relationship between the Level of Exports (Dependent Variable) and Exchange
Rate, Interest Rate, Cost of Production & GDP Growth rate (Independent Variables) was the Ordinary Least Square Method,
also known as OLS. The data used for the cost of production was the petroleum prices at the end of each year from 2010-
2020. Similarly, all the data ranged from 2010 to 2020. The type of data that was used was of secondary nature and the
sources of data included The World Bank, State Bank of Pakistan and Pakistan State Oil.

This paper used the yearly data from 2010 to 2020 to study the impact and the relationship the independent variables had
on the dependent variables. The variables are listed below

Independent Variables:

1. Exchange Rate
2. Interest Rate
3. Cost of Production (Petroleum Prices)
4. GDP Growth Rate
Dependent Variables:

1. Level of Exports

Research Questions:

The key areas on which this study focuses on and attempts to explore are:

How does the cost of production affect the Textile Sector exports in Pakistan?

What is the relationship between the exchange rate and Textile Sector exports of Pakistan?

What is the relationship between the interest rate and Textile Sector exports of Pakistan?

How does the GDP Growth Rate affect the Textile Sector exports of Pakistan?

HYPOTHESES:

H1: There is significant relationship between Textile Exports and Exchange rate.

H2: There is significant relationship between Textile Exports and Interest rate.

H3: There is significant relationship between Textile Exports and Cost of Production (Petrol Prices).

H4: There is significant relationship between Textile Exports and GDP Growth Rate.
HYPOTHESIZED MODEL:

Exchange Rate

Interest Rate Level of

Exports
Cost of
Production
(Petrol Prices)

GDP Growth Rate

General Equation

Y=a+b1x1+b2x2+b3x3+b4x4+….E

Where,

X1: Exchange Rate

X2: Interest Rate

X3: Cost of Production (Petrol Prices)

X4: GDP Growth Rate

Results & Analysis:
Dependent Variable: Y
Method: Least Squares
Date: 08/19/22 Time: 14:22
Sample: 2010 2020
Included observations: 11

Variable Coefficient Std. Error t-Statistic Prob.

C 15663.65 1303.759 12.01422 0.0000

X -26.24030 11.54876 -2.272132 0.0492

R-squared 0.364523 Mean dependent var 12766.82

Adjusted R-squared 0.293914 S.D. dependent var 1075.970
S.E. of regression 904.1259 Akaike info criterion 16.61478
Sum squared resid 7356993. Schwarz criterion 16.68712
Log likelihood -89.38129 Hannan-Quinn criter. 16.56918
F-statistic 5.162584 Durbin-Watson stat 1.797745
Prob(F-statistic) 0.049191

Y= Textile Exports

X= Exchange Rate

This is the OLS Method used on Y= Y=a+b1x1+E, wherein the Y represents the Total Exports and x1 represents the Exchange
Rate. The regression results showed that the model is a poor fit in nature as R-squared is less than 0.8. It also shows that
there is 36.45% change in exports due to the movement of exchange rate. Furthermore it also shows that if exchange rate
rises by 1 US Dollar, the textile exports of Pakistan are negatively impacted as it decreases by 26.240. In addition to this, it
also shows that probability value is less than 5%, it is 0.04 as shown in the table, which leads to conclusion that the variable
is significant as T-stat is less than 5% (-2.272), which means that the H1 is accepted. Autocorrelation is measured via Durbin-
Watson stat which is 1.797, which is around 2, meaning that the correlation exists.

Dependent Variable: Y
Method: Least Squares
Date: 08/20/22 Time: 00:12
Sample: 2010 2020
Included observations: 11

Variable Coefficient Std. Error t-Statistic Prob.

C 12886.94 1873.968 6.876821 0.0001

X -10.63069 163.0547 -0.065197 0.0594

R-squared 0.000472 Mean dependent var 12766.82

Adjusted R-squared -0.110587 S.D. dependent var 1075.970
S.E. of regression 1133.904 Akaike info criterion 17.06769
Sum squared resid 11571650 Schwarz criterion 17.14003
Log likelihood -91.87228 Hannan-Quinn criter. 17.02208
F-statistic 0.004251 Durbin-Watson stat 1.275374
Prob(F-statistic) 0.059442

Y= Textile Exports

X= Interest Rate

This is the OLS Method used on Y= Y=a+b1x2+E, wherein the Y represents the Total Exports and x2 represents the Interest
Rates, ranging from 2010 to 2020. The results reveal that the model is of a poor fit model as it is 0.0004, which is not near
value of 1. In addition to this, it also shows that 1% increase in the interest rates would negatively impact the textile exports
of Pakistan, by bringing a decrease of 10.63. This illustrates that a negative relationship exists between the Textile Exports
and Interest Rates, as when the interest rates increase, the cost of borrowing or capital increases, which means decreased
investment and increased debt payments. The probability value is more than 5%, which shows that the variable is
insignificant in nature, which also means that H2 is rejected.

Dependent Variable: Y
Method: Least Squares
Date: 08/19/22 Time: 15:03
Sample: 2010 2020
Included observations: 11

Variable Coefficient Std. Error t-Statistic Prob.

C 13533.30 1991.085 6.796946 0.0001

X -8.490119 21.73257 -0.390663 0.7051

R-squared 0.016675 Mean dependent var 12766.82

Adjusted R-squared -0.092584 S.D. dependent var 1075.970
S.E. of regression 1124.676 Akaike info criterion 17.05134
Sum squared resid 11384070 Schwarz criterion 17.12369
Log likelihood -91.78239 Hannan-Quinn criter. 17.00574
F-statistic 0.152618 Durbin-Watson stat 1.335536
Prob(F-statistic) 0.705132

Y= Textile Exports

X= Cost of Production (Petrol Prices)

This is the OLS Method used on Y= Y=a+b1x3+E, wherein the Y represents the Total Exports and x3 represents the Cost of
Production measured using the Petrol Prices. The results show that the model is a poor fit model in nature as R-squared
value is not near 1, it is 0.016. Furthermore, the results also reveal that a 1 unit of price increase in Petrol Prices would
result in a decrease of Textile Exports by 8.490. This shows that a negative relationship exists between the Prices of Petrol
and Textile Exports of Pakistan, as the increase in petrol prices would result in an increase in cost of production as well as
raw materials used for production. The probability value is more than 5%, which indicates that the variable is insignificant in
nature, thus H3 is rejected.

Dependent Variable: Y
Method: Least Squares
Date: 08/19/22 Time: 14:45
Sample: 2010 2020
Included observations: 11

Variable Coefficient Std. Error t-Statistic Prob.

C 11607.16 533.5913 21.75289 0.0000

X 327.9252 131.3141 2.497258 0.0340

R-squared 0.409305 Mean dependent var 12766.82

Adjusted R-squared 0.343673 S.D. dependent var 1075.970
S.E. of regression 871.6867 Akaike info criterion 16.54170
Sum squared resid 6838540. Schwarz criterion 16.61405
Log likelihood -88.97937 Hannan-Quinn criter. 16.49610
F-statistic 6.236299 Durbin-Watson stat 1.632701

Y= Textile Exports

X= GDP Growth Rate

This is the OLS Method used on Y= Y=a+b1x4+E, wherein the Y represents the Total Exports and x4 represents the GDP
Growth Rate. The results show that model is a moderate fit in nature as it shows a 40.93% change in Total Exports via
variation in GDP Growth rate of the country. It also means that 1% increase in GDP Growth rate would result in exports
growing by 327.92, which shows that there is a positive relationship between Textile Exports of Pakistan and GDP Growth
Rate of Pakistan. The probability value is also less than 5%, which goes on to show that the variable is significant in nature,
meaning that H4 is accepted. The Durbin-Watson stat of 1.632, also shows that the correlation exists.

When all the variables are tested as mentioned in the General Equation, the results as:
Dependent Variable: Y
Method: Least Squares
Date: 08/20/22 Time: 01:36
Sample: 2010 2020
Included observations: 11

Variable Coefficient Std. Error t-Statistic Prob.

C 19603.97 4446.621 4.408735 0.0045

X1 -32.61881 14.78398 -2.206363 0.0695
X2 -263.7733 270.2993 -0.975856 0.3668
X3 -0.010050 0.169895 -0.059154 0.9548
X4 -155.5633 215.7221 -0.721129 0.4980

R-squared 0.474262 Mean dependent var 12766.82

Adjusted R-squared 0.123770 S.D. dependent var 1075.970
S.E. of regression 1007.185 Akaike info criterion 16.97066
Sum squared resid 6086529. Schwarz criterion 17.15152
Log likelihood -88.33864 Hannan-Quinn criter. 16.85665
F-statistic 1.353132 Durbin-Watson stat 2.005111
Prob(F-statistic) 0.352065

Y=a+b1x1+b2x2+b3x3+b4x4+….E
Where,

X1: Exchange Rate

X2: Interest Rate

X3: Cost of Production (Petrol Prices)

X4: GDP Growth Rate

The table above shows the OLS Regression Method being applied to the equation below. The results illustrate that the
model is a moderate fit in nature as it is 0.474, which lies around the halfway mark of 1, being the perfect fit model.
Moreover, it shows how the variables of X2, X3 and X4 which represent Interest Rate, GDP Growth Rate and Petrol Prices
are insignificant in terms, as all of their respective probability values are more than 10% or 0.1. Although these results show
that there is no problem of autocorrelation as the Durbin-Watson stat is 2.005, which is above the threshold value of 2.

Key Findings:
 When all the independent variables are taken together, and OLS Regression is performed, the results show that only
the Exchange Rate has a significant relationship with the Textile Exports of Pakistan.

 However, when the OLS Regression is performed separately on each variable, the results show that Exchange Rate
and the GDP Growth Rate has a significant relationship with the Textile Exports.
Conclusion:
It can be concluded that the exports generated by the Textile Sector of Pakistan depends upon many factors, primary of
which is the movement of exchange rate, which greatly contributes towards the cost of production for the industry.
Moreover, the Petrol Prices as well as the GDP Growth Rate are also likely to bring an effect on the textile exports of
Pakistan as it seen that when the country experiences economic growth i.e. its GDP grows, the exports of all sectors, not
just textile of that particular country increase as a result of favorable economic conditions. Moreover, the Petrol Prices play
a significant role in the cost of production and so it impacts the performance of the firms in all sectors.

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