Following the accommodative monetary policy stance from the State Bank of Pakistan by keeping the policy rate at 7%, the federal government has also taken an expansionary fiscal policy stance in its federal budget for FY2022. All this bodes well for Pakistan’s Islamic banking and finance industry, which currently has a 17% share in the overall banking industry.
Following a negative 0.5% deceleration in FY20, the country has achieved remarkable growth of 3.94% in FY21. There are across-the-board tax cuts complemented by subsidies worth PKR682 billion and several exemptions in the recently announced Federal Budget for FY22. Furthermore, there is an increase in the budget allocation for the public sector development program to PKR900 billion, up by 43% year on year.
Tax cuts and increases in public sector spending will positively affect investment in manufacturing, construction and allied industries. With its emphasis on asset-backed financing, Islamic banking will have the opportunity to finance fixed assets and working capital in industries. The timely release of export-related refunds would also improve the working capital situation in manufacturing with the result that it would allow Islamic banks to receive their deferred sale price and rentals on a timely basis without adverse effects on infection ratios.
Microfinancing and consumer financing will also enjoy a boost given the increase in wages. Minimum wages are increased to PKR20,000 per month, and a 10% rise in salaries and pensions of federal government employees. Furthermore, among the tax cuts and exemptions, GST on 850cc cars is reduced to 12.5% from 17%. This bodes well for the car financing segment in consumer financing and will also increase business for Takaful companies in the form of mandatory vehicle insurance.
In stock investments, capital gains tax on disposal of securities is reduced to 12.5% from 15%. In addition, the capital value tax on trading is also reduced to 1.25% from 1.5%. This will reduce the cost of trading and also increase volume and liquidity in the market. Reduction in capital gains tax will also allow Islamic mutual funds to improve their earnings with a reduction in tax cost.
Withholding tax is removed from banking transactions. This will allow Islamic banks to manage the situation of commercial displacement risk in the business of payments. Now, bank transfers will not cost more, and hence, the use of banking channels for payments will also increase.
There is also an emphasis on direct intervention in social welfare programmes for inclusivity and to benefit the marginalized segments of the population from overall economic expansion. PKR260 billion are earmarked for Ehsaas Program (cash grants to low-income families), up by 24% from the previous year. In addition, PKR12 billion is allocated for collateral-free lending to SMEs and PKR10 billion for Kamyab Pakistan Program. Ehsaas program is an illustration of the potential of Islamic social finance. If it is institutionalised and marketed as cash waqf, it can further enhance the participation of the individual donors to fund and scale up the programme. Islamic banks can also chip in to provide Qard-e-Hasan to selected clients if they get mark-up-free funds for such lending from the government.
One hopes that the accommodative monetary policy stance will continue for significant part of FY22 given the still less than full capacity utilisation in cement, automobiles, and textile sectors, and the higher unemployment rate compared to the pre-COVID-19 period. Food inflation is mostly a supply-side issue, whereas energy inflation is in the government’s hand. The government enjoys the authority to approve the prices of oil, gas, and electricity.
Deposits in the banking industry are inelastic to interest rates. However, if the policy rate rises, it may entice banks to shift their allocations to sovereign securities rather than lending to the private sector in the real economy. Moreover, in a situation where gross fixed capital formation has not experienced sufficient growth in a low policy rate environment, a policy rate hike will further dampen the chance of substantial capital formation.
Two-thirds of the shortfall in the budget will be met by bank borrowing. It is essential that it does not crowd out the private sector and makes banks increase their investment-to-deposit ratio at the expense of lower advance-to-deposit ratio. Islamic banks are at a disadvantage with issuing Shari’a-compliant sovereign securities, such as sukuk, than conventional sovereign debt. Since the government had gone for long-term financing in the recent past, there was a case of using ijarah sukuk rather than conventional sovereign debt.
It is hoped that the budgeted allocations will be effectively and efficiently utilised transparently and prudently. This is as important as the announcement of allocation itself. If vaccination targets are achieved, lockdowns are avoided, coordination is improved between federal and provincial governments, oil prices do not rise too much, then remittances and exports remain on a high path, and accommodative monetary policy is a stable expansionary fiscal policy stance. Likely, the V-shaped recovery will not result in a W-shaped boom-bust cycle. High and sustainable growth will not only benefit the expansion of the Islamic banking and finance industry but the national economy as well.
