The government has proposed an amendment to prohibit industries in export processing zones from selling 20% of their production in the domestic market. The facility has been available since 2001 under Rule 228(5), of the customs rules. Cabinet approval is expected in September 2026 as a part of the IMF’s Extended Fund Facility. However, abolition of the domestic sales facility is not equivalent to eliminating fiscal incentives.
This amendment raises an important distinction between fiscal preferential treatment and preferential market access. EPZ firms selling domestically pay applicable customs duties, sales tax and income tax. Since these firms are paying applicable taxes, it can not be viewed as fiscal incentive. The incentives that directly lower any EPZ firm’s cost of production relative to competitors outside the zone are precisely the type of preferential treatment that a level-playing-field reform should address.
The government’s own assessment of SEZs/EPZs noted that these firms were not creating any market distortion, and did not recommend withdrawing existing incentives. The IMF country review report October 2024, required an assessment of SEZs/EPZs and a commitment not to introduce new fiscal incentives. Subsequently, the government proposed phasing out the incentive in the second review of the EFF to prevent any leakage of customs duty and GST. The distinction matters: a policy aimed at correcting a distortion should identify and quantify that distortion.
There is also a sector-specific concern. Pakistan imported more than 430,000 metric tonnes of used clothing in FY2023-24, supporting sorting, reuse and recycling activity. Industry argues that a portion of lower-grade or residual material has no commercially viable export destination and that domestic sales make the processing of the exportable share commercially viable. Eliminating the channel could therefore impose additional handling and transport costs without necessarily generating additional exports. However, the processing and recycling of used clothing was not the objective of EPZs, which were established solely to promote manufacturing industries.
This does not mean the 20% facility should be preserved indefinitely. It is a form of preferential market access within sectors and should therefore be tested against the level-playing-field principle. The question is whether it creates a measurable competitive distortion after applicable duties and taxes are paid, and whether that distortion outweighs the benefits generated through investment, employment, recycling and exports.
The broader removal of unjustified fiscal incentives is the right reform. However, banning domestic-sales is a different issue and needs its own evidence base. A policy aimed at leveling the playing field should, at minimum, be able to identify the specific distortion it is attempting to correct.