The federal budget proposals for 2011-12, if approved by the Parliament, would have a prime focus on nothing other than stabilising the fragile economic recovery in the crises-hit Pakistan where a double-digit inflation and the resultant higher interest rates, poor foreign financial inflows and the consequent ballooning debts keep haunting the short and long-term macroeconomic stability. Whatever the fiscal document unfolds for other sectors, its impact for the country’s capital market, the analysts believe, would range from negative to neutral.
The banking industry as well as stocks market are perceived to be totally “ignored” in the new budget with the latter inching towards 2005 and 2008-like crashes masterly on the back of daily low volumes that were unprecedented during the past eight years. Whereas the budget-makers appeared to have poured cold water on positive expectations of investors at the volumes-starved Karachi Stock Exchange (KSE) regarding the unpopular Capital Gains Tax (CGT), the cash-strapped Islamabad has, in the new financial plan, hinted that it would continue to rely on the banking system for budgetary borrowings during FY12.
Measures like keeping mum on the widely-expected deferment of unpopular taxes like CGT for individual investors at the country’s bourses and the avoidance of taxing investments by the commercial banks in the risk-free and heavily-weighted government papers are pointing at the same. The Budget FY12 measures for the banking sector include 0.1 reduction in withholding tax (WHT) on pay orders, demand drafts, maintenance of the taxation rate on corporate and investments in the government papers, permission for the banks to carry over of provisioning in excess of five percent on their loans to consumers and SMEs and 10 percent increase in tax rate on dividends received by the banks from the Asset Management Companies (AMCs). According to market observers, the cash-strapped government’s sustained reliance on local sources for financing 84 percent of its Rs850 billion budget deficit would mean more dependency on the local bank and non-bank borrowings.
“That would keep the interest rate high and resultantly the Net Interest Margin (NIM) would also remain strong,” viewed Mohammed Sohail, Chief Executive Officer Topline Securities.
Another analyst, Nauman Khan, suggested that in FY12 the economic managers would have to play a “balancing game” to meet the ambitious Rs849 billion, four percent of GDP, fiscal deficit target at one end, while providing impetus to the economic recovery to achieve the 4.2 percent GDP growth target.
The analysts said the banks would be seeing their deposit base slightly improving on the back of a reduced WHT, whereas the carry over of bad-debts in excess of five percent would also prove “slightly” positive for the banking sector.
About 10 percent tax increase on the dividends of AMCs is expected, the analysts said the move was unlikely to unveil any major impact owing to a nominal size of investment in the companies.
“If that means banks will be investing in funds then they need to hold their investment for more than one year to minimize their tax liability as the CGT on banks for more than a year is 10 percent which is less than 20 percent on dividends imposed in this budget,” said Sohail. Investors and other stakeholders at the country’s largest stocks exchange, KSE, were left disappointed by the new budget in which the government is believed to have “totally ignored” the volumes-starved equity market.
The analysts said impact of the new budget would range from negative to neutral on the Karachi bourse where the average daily volumes had come down to Rs4 billion from Rs40 billion. “The government has totally ignored this market once again,” said the analysts.
The Finance Bill FY12 envisages the individual investors to keep paying the long-resented 10 percent tax on their capital gains as well as the banks, insurance companies, mutual funds and other corporations would also continue to pay the CGT as per their specific rules.
All the new budget means for the CGT-hit corporate sector is a two-week extension in the deadline for their quarterly filling. No major changes have been made on the turnover tax on shares trading and taxes on the stock brokers.
“This would not only affect the market depth and volumes but would also have adverse implications on the government plan to privatize its units through the stock market,” Sohail said.
The analyst said the initial reaction at Karachi bourse would be negative as it was expected that the government might give relaxation to retail investors in CGT after failing to receive any substantial revenue due to eight-year low volumes.
After the recent round of meetings with Ministry of Finance and the FBR, it was expected that the CGT might be deferred at least for the individual investors who had been deserting the market causing volumes in FY11 to decline to an 8-year low of Rs 4 billion a day, down 50 percent from last year, he said.
Sohail, however, was upbeat that the budget also bore some medium-term positives for the equity market.
The analyst may be hinting at the measures like increasing the volume of tax credit for individuals investing in IPO to Rs 0.5 million, removal of 15 percent flood surcharge, bringing sales tax from 17 to 16 percent etc. One percent reduction in sales tax, the analyst said would help the government arrest the prevailing double-digit high inflation to some extent that would also reflect positively on the 14 percent discount rate.
The government, by enhancing tax rebate by 10 percent has also made the new companies pay 29.75 percent instead of 33.25 percent in the year of their listing. Other incentives include the announcement of 100 percent tax credit on corporate industrial undertakings up to 5-years after commissioning and 10 percent final tax on individual investors on investment in government papers, Market Treasury Bills, Pakistan Investment Bonds etc. This, the analysts said, would help in the development of debt market besides attracting foreign investment in the government securities. “This would shift some funds away from the equity market,” they said. “The budget would have some positive effects also in the medium term as mentioned in the accompanying measures taken by the government,” Sohail viewed. But, he warned, due to dull volumes, which currently stand at 10 percent of the average volume seen in middle of the past decade, the price discovery would be affected thereby creating hurdles for companies to raise capital through rights issues and new offerings.
