Navigating EU’s digital mandate

This picture shows the European Union flags fluttering outside the European Commission building in Brussels. — AFP/File

The European Union (EU) is reaffirming its dedication to sustainability and transparency by enacting the Eco-design for Sustainable Products Regulation (ESPR).

This significant regulation mandates the introduction of Digital Product Passports (DPPs) for all businesses supplying or exporting goods to the EU. These DPPs will encompass essential information, including product identification, material composition, manufacturing processes, and adherence to environmental and human rights standards.

While the primary objective of this initiative is to advance sustainability, it also has substantial ramifications for global supply chains, including those in Pakistan. For Pakistan, a nation heavily dependent on exports especially in the textile, leather, and agricultural sectors, the implementation of DPPs presents both challenges and opportunities. Pakistani exporters currently benefit from preferential trade arrangements, such as the EU’s Generalized Scheme of Preferences Plus (GSP+), which provides tariff reductions in exchange for compliance with labour rights, and environmental and governance standards.

However, with the mandatory implementation of DPPs, the standards for compliance will be elevated. Under this regulation, each product exported to the EU will be required to possess a QR-coded passport that documents every aspect of its lifecycle. For example, a cotton-based garment exported from Pakistan must specify the type of cotton utilised, its origin, and the sustainability measures adopted during production. This degree of transparency aims to guarantee that all products entering the EU market are environmentally responsible, ethically manufactured, and traceable throughout the supply chain. Failure to comply with these requirements may result in trade restrictions, market exclusion or reputational harm for Pakistani exporters.

The implementation of the DPP system is anticipated to enhance transparency and efficiency within Pakistan’s supply chain while ensuring compliance with established sustainability standards. A fundamental aspect of this system is the verification of cotton origins through DNA testing. The government can address tax evasion and illicit trade practices by instituting stricter regulations at every phase of the cotton value chain.

The introduction of the DPP system will stipulate that imported cotton yarn must also undergo DNA testing to confirm its composition, thereby preventing the improper utilisation of the Export Facilitation Scheme (EFS). Test outcomes will be cross verified against the final export product to ensure consistency between input and output, as well as compliance with international standards. This initiative is projected to diminish fraudulent practices such as under-invoicing and the under-reporting of raw material imports.

Unregistered farmers and the under-reporting of domestic cotton production substantially contribute to revenue losses for the government. Pakistan has experienced an estimated sales tax loss of Rs28.8 billion in FY24 due to the under-reporting of nearly two million cotton bales. This tax loss extends to the cottonseed (Banola) industry, where approximately Rs4 billion in sales tax is lost annually.

The DPP system, by establishing a transparent digital trail for each stage of production, will render tax evasion more challenging and ensure the appropriate collection of levies. The cotton value chain comprises multiple tiers, ranging from raw imports and domestic raw cotton at Tier 4 to the ginning and spinning processes at Tier 3. These stages will now be mandated to maintain verifiable records through DPPs. The subsequent phase, encompassing weaving, knitting, dyeing, and finishing (Tier 2), will incorporate verified input data to ensure consistency and traceability. By the time the finished textile product arrives at wholesale and retail markets (Tier 0), all pertinent details regarding material composition, production history, and compliance with sustainability regulations will be embedded within the Digital Product Passport.

At the export stage, DPPs will be instrumental in verifying product authenticity and adherence to international regulations. The government will employ DNA test results from the import stage to compare with the final product, thereby preventing the misuse of the EFS. By ensuring accurate reporting and taxation at each level of the supply chain. In addition to promoting sustainability, the DPP system offers a significant advantage for Pakistan through improved tax compliance. The country has historically struggled with issues such as tax evasion, under-invoicing, under-reporting, and the improper use of export schemes like the EFS.

These challenges have resulted in substantial revenue losses for the government and have distorted market competition. By mandating that every exported product possesses a verifiable digital footprint, DPPs will introduce an additional layer of transparency to trade transactions. This will complicate the ability of businesses to engage in tax evasion practices. The digital nature of DPPs will ensure the comprehensive recording of all stages of production and exportation, offering tax authorities enhanced data for monitoring and enforcement purposes.

For DPPs to be effective in enhancing exports and improving tax management, Pakistan must integrate them into its legal framework. A vital step in this process would involve establishing DPP compliance as a legal obligation. By enacting such legislation, Pakistan would align its trade policies with European Union standards while ensuring that all exporters adhere to transparent reporting practices. Incorporating DPP requirements into local regulations would also facilitate a smoother implementation process by providing clear compliance guidelines.

The government could also bolster support for businesses by offering financial incentives, technical assistance, and capacity-building programs to aid their adaptation to the new system. Neglecting to implement these measures may result in Pakistani exporters losing their competitive advantage in the European Union market, poten-tially redirecting trade to nations that demonstrate higher compliance.

One of the principal challenges confronting Pakistani businesses is the necessity to adapt to digital record-keeping and compliance verification. A significant number of exporters, particularly small and medium enterprises (SMEs), continue to function within informal supply chains characterised by minimal documentation.

The implementation of DPPs will require a comprehensive transformation of existing business practices, which entails digital modernisation, investment in tracking technologies, and compliance with more stringent documentation protocols.

Pakistan’s textile and manufacturing sectors have frequently been criticised for labour rights violations, excessive water consumption and considerable carbon footprints. The Environmental and Social Performance Reporting (ESPR) framework will hold exporters accountable for their environmental and social impacts, thereby making it essential for businesses to adopt sustainable practices. While larger corporations may find compliance more manageable due to superior financial and technical resources, smaller exporters may experience difficulties due to the increased costs and administrative challenges associated with these new requirements.

The transition to a DPP-compliant export system presents significant opportunities for Pakistani enterprises despite inherent challenges. First, organisations that effectively integrate sustainability into their supply chains can establish themselves as ethical and eco-conscious brands, a quality increasingly appealing to European consumers. Enhancing transparency in sourcing and production processes can bolster brand reputation, fostering greater consumer trust and loyalty. Secondly, the emphasis on digital documentation and supply chain visibility stands to improve overall operational efficiency and mitigate risks. By adopting advanced technologies such as blockchain, RFID tagging, and artificial intelligence-driven analytics, businesses can not only fulfill regulatory requirements but also streamline their logistics, inventory management, and quality control mechanisms. Moreover, adherence to European Union regulations may facilitate access to new markets beyond Europe. Various regions, including North America and Japan, are progressively implementing stricter sustainability and traceability standards. Early adoption of DPPs could provide Pakistani exporters with a competitive first-mover advantage in these evolving regulatory environments, enhancing their global competitiveness.

The European Union’s ESPR and the mandatory Digital Product Passport system herald a new era of accountability in international trade. This development presents both challenges and opportunities for Pakistan. While achieving compliance necessitates considerable investments in digitalisation and sustainable practices, the benefits extend beyond trade alone. Greater transparency can fortify Pakistan’s tax system, mitigate illicit financial flows and enhance the country’s reputation in the global marketplace.

To fully capitalise on the benefits of DPPs, Pakistani authorities must proactively integrate these frameworks into the national legal system, provide support to businesses during their transition and cultivate a culture of compliance and sustainability. If implemented effectively, this regulatory shift has the potential to drive long-term economic growth, strengthen international trust in Pakistani exports, and contribute to the establishment of a more sustainable global supply chain.

The writer is a trade facilitation expert working with the federal government of Pakistan.

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