The economic observers foresee further deterioration in the country’s already depressed investment climate as the funds-starved federal government is planning to impose incremental taxes on the banks’ earnings.
The federal government, which this year (FY12) is bracing for a fiscal deficit of over seven percent due to rigid current expenditures and low tax buoyancy, is in a dire need for additional avenues of revenue and is, therefore, expected to impose incremental taxes, ranging from five to 50 percent, on the ever-profitable banking sector. The banks, both traditional and Islamic, have long been under fire for pocketing huge sums on account of their heavy lending to the cash-strapped federal and provincial government through investment in the risk-free and highly-weighted sovereign guarantees including the Market Treasury Bills, Pakistan Investment Bonds and Ijara Sukuk. According to central bank data, during July-April 27 the scheduled banks invested over Rs 603 billion in the government securities. This amount was Rs 324.401 billion or 116.5 percent more than Rs 278.38 billion they had invested during corresponding period in FY11. “The banks’ allocation of funds towards the government papers only propelled, naturally, because of the sustained arbitrage of high yield on government paper verses low-cost and relatively immune deposit base,” viewed Khurram Schehzad, head of research at InvestCap. The federal government, however, seems to have decided to retrieve some of the mammoth incomes the banks have made through investing in the government papers. A 15 percent incremental tax is, therefore, widely being expected on the banks’ T-bills returns that make up a significant portion of the banks’ balance sheets. The analysts, however, fear that the levy would impact the two sides, the government and the banks, marginally with the overall economy to bear the brunt. “Such inadequate measures against market economy and sector efficiency would only hurt further the already depressed investment climate in the country,” warned Schehzad.
The analyst said while allowing for such “anti-free-market” measures, one should look at the government’s own conflict of interest to first, inviting financial institutions to fund its burgeoning fiscal deficit on one hand, causing yields to stretch beyond sustainable level for extended periods hampering economic growth, and then trying and hammering down funding institutions for getting attracted to such high return, on the other.
He said the financial impact of the proposed by 15 to 50 percent taxes would range from three to 10 percent depending on the size of the bank and the volume of its investment in the sovereign guarantees.
“We have to make a number of assumptions to calculate only a proximity of the actual impact that the banks may have on their bottom lines in case of an expected 15 percent incremental tax on T-bills’ returns,” Schehzad said. In this regard, he assumed that the incremental tax would reduce the banks’ earnings on average by seven percent. While the ex-SLR investments and returns on T-bills, which makes more sense with incremental tax on ex-SLR earnings from T-bills, the banks’ earnings only get affected by a marginal three percent on average. The banks having larger contribution from T-bills earnings to their Government Investment Issues were expected to be affected the most. The mid-tier and lower-tier, the analyst said, would see their earnings decline by 9.1 percent and 9.8 percent, respectively. “We expect any extra tax on T-bills’ returns would yield a marginal Rs 8.7 billion for the government or total Rs 16.8 billion along with a potential five percent incremental corporate tax if imposed on the banks’ earnings in addition to 15 percent incremental tax on T-bills.” Opposed to the idea of incremental tax, the analyst said the resource-constrained government should take more appropriate action with lasting impacts including improving depositor/investor’s awareness on investment avenues, policies supporting competition amongst banks to cause material improvement in deposit rates, rigorous capital requirement, narrower cap on investment into government papers and the promotion of a regular bond/TFC market. Last but not the least, the analyst said, the secondary market/central bank borrowing should be one part of the source of funding for the government to bridge the fiscal gap instead of being the only source for that matter.
