FeaturedNationalVOLUME 18 ISSUE # 40

A glimpse into LSM decline

The fiscal year 2023 witnessed a significant setback in the Large-Scale Manufacturing (LSM) sector, with a stark decline of 10.3 percent compared to the previous year. Barring the pandemic-induced year, this drop stands as the most substantial contraction in the sector’s historical records. This decline underscores the manufacturing industry’s precarious state, buffeted by ongoing challenges in the balance of payments and energy supply. Delving into the events leading up to this decline reveals a complex interplay of economic decisions and external pressures, painting a somber picture of the sector’s health.

The Large-Scale Manufacturing (LSM) sector for the fiscal year 2023 has experienced a notable decline of 10.3 percent when compared to the previous year. With the exception of the pandemic-affected year, this downturn stands as the most substantial drop in the historical records of the sector. This decline underscores the dire condition of the manufacturing industry, which is enduring severe blows from ongoing challenges in the balance of payments and energy supply.

The downturn commenced in July of the preceding year, when the finance minister and the Governor of the State Bank of Pakistan (SBP) took the decision to impose restrictions on imports deemed ‘non-essential’. This step was taken due to the government’s reluctance to embrace necessary austerity measures required to temper the broader economy.

Initially, these measures targeted imports of components for automobiles, mobile phones, and other machinery. The primary objective was to curtail import quantities in order to safeguard the diminishing foreign exchange reserves of the SBP.

Nonetheless, despite these measures, the reserves continued to dwindle, albeit at a slower pace. As the reserves approached a critical level of around $4 billion, the import restrictions were extended to encompass a wider range of manufacturing sectors. This unprecedented disruption in supply chains is reflected in economic data, manifesting as a significant 10 percent decline in the LSM sector.

Regrettably, no administrative action or drastic measures proved effective in stabilizing the value of the currency (the rupee). The devaluation of the rupee, coupled with ensuing widespread scarcities, has contributed to elevated inflation rates.

The situation was further exacerbated by the imposition of notably high tax rates on the manufacturing sector. Manufacturers began passing on the impact of these unusually elevated levies, including a super tax on specific taxpayer categories, to consumers, thereby fueling inflation even more.

This has led to a dampened demand, subsequently exacerbating the challenges faced by the LSM sector. One of the most substantial drops was observed in the automotive sector, which experienced a staggering 50 percent decline. Import restrictions and additional taxes and duties in this sector have stifled consumer demand.

Manufacturers were compelled to increase the prices of their products to counterbalance the rising fixed costs incurred due to suboptimal plant operations. A decline of 6-7 percent in the food and beverage sector suggests demand suppression, even though these sectors were relatively less affected by import restrictions. In the tobacco sector, a 29 percent decline occurred due to reduced demand and consumers shifting towards smuggled and informal local tobacco. This shift resulted from the doubling of federal excise duty (FED) on cigarettes in the formal sector, while the informal sector remained unchecked.

A similar trend can be observed in other industries, where it became increasingly challenging to import essential parts through official channels. In contrast, the informal sector continued to import finished goods using unofficial means, further hampering the formal manufacturing sector.

The policy of import restrictions persisted until recently, though there has been some gradual easing in accordance with International Monetary Fund (IMF) conditions. The question remains whether this easing is sufficient to restore normalcy to the LSM sector. Unfortunately, the answer is no. In the midst of the disruptions of the past year, energy prices have surged to a level that renders manufacturing uncompetitive. High interest rates have also rendered working capital prohibitively expensive.

This presents a troubling scenario. While the LSM sector may eventually recover from the lows experienced in FY23, FY24 is anticipated to be another challenging year. Escalating inflation will further erode demand, and the increasing costs of energy will continue to erode manufacturing competitiveness. Additionally, the growing influence of the informal sector will compound the difficulties faced by the formal manufacturing segment.

The inevitable outcome will be the loss of hundreds of thousands of jobs, as some have already lost their employment and others are likely to follow suit with the closure of more manufacturing units.

As the curtains draw on FY23, the Large-Scale Manufacturing sector finds itself grappling with a profound decline that echoes the dire straits of the industry. The journey into this downturn began with import restrictions and a struggle to stabilize currency values, compounded by high taxes and energy costs. Despite measures taken to ease the burden, the road to recovery remains arduous. While the sector may eventually regain some ground, the prospects for FY24 appear equally challenging. As inflation erodes demand, energy costs soar, and informal markets expand their influence, the formal manufacturing landscape is set for further turmoil. The inevitable casualties of this scenario will be the loss of jobs and the shuttering of manufacturing units, casting a shadow over the industry’s future.