Over the past few years, Pakistan’s economy is facing a bad patch. Some of the economic parameters are at a still and majority of them are deteriorating. The government is unable to fulfil the needs of the population due to this sluggish growth and widening fiscal imbalance.
The country’s current account deficit swelled by 43 percent to highest-ever level of $18 billion in the fiscal year ended June 30, 2018. It may deteriorate further during the current fiscal year thus creating serious challenges for the state. On top of this, Pakistan’s circular debt has almost doubled compared to 2013. The circular debt stood at Rs. 507 billion on May 31, 2018 the last day of the previous government, but it increased by Rs. 40 billion to Rs. 547 billion in June, 2018. To settle the high circular debt, the government has to raise funds through internal borrowings.
For the Government of Pakistan (GoP), the need for financing from both internal and external sources is now more critical than ever. How does the government plan to fulfill its financial obligations? How can this gap be filled? Who will provide billions of dollars and at what cost? These are the major questions that need to be addressed. Here upon lies a huge responsibility for the key financial institutions and stakeholders of the financial system to highlight the issues that the financial system is going to face and the remedies available to mitigate such crisis.
Quaid’s vision of Pakistan’s economic & constitutional requirements
Quaid-e-Azam, in his speech on the occasion of inauguration of State Bank of Pakistan on 1st July 1948, said: “We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice.”
Article 38 (f) of the 1973 constitution of Islamic Republic of Pakistan provides that to attain the promotion of social and economic well-being of the people of Pakistan: “State shall eliminate Riba as early as possible”. It is therefore the responsibility of the federal and provincial governments to take the necessary measures for promotion and sustainability of Islamic financial services industry resultantly eradicating the element of Riba. Significant legislative framework, that needs implementation in letter & spirit, has already been enacted by the federal government, most prominent of which being the decision of Federal Shariah Court. The court also specified a step by step approach to rid the country of destabilizing interest. Indeed it was a momentous event in the history.
Overview & outreach of Islamic banking
As per State Bank of Pakistan, Assets of Islamic banking industry increased by 2.8 percent (Rs 62 billion) during the first quarter (Q1), 2018 and were recorded at Rs 2,334 billion. Share of Islamic banking industry’s assets in overall banking industry’s assets increased by 1.1 to 13.5 percent. Net financing and investments in total assets of Islamic banking industry stood at 54.9 percent and 22.7 percent respectively. Branch network of 5 full-fledged Islamic banks, sub-branches and standalone Islamic banking branches of conventional banks have reached to 2,589 nationwide from Gwadar to Gilgit.
Financial inclusion and public inclination towards Islamic banking
State Bank of Pakistan together with other international institutions conducted first study of its kind — Knowledge, Attitude and Practices of Islamic banking in Pakistan (KAP), which concluded that religious sentiments of the public towards the financial system is instrumental and large proportion of general public is still unbanked mainly due to their belief that conventional banking is against their religious views and values, thus prohibited; but at their hearts, have a soft corner for Islamic banking.
The attitude of hoarding money by unbanked masses seems to cause serious damage to our financial system as the money remains unutilized and unproductive, not injected into the economy.
Islamic Financial Institutions in the country should, in addition to the prohibition of an interest-based system, aspire to the highest standards of fairness supported by the Islamic principle of equitable distribution of wealth. If numbers are any indication of this commitment, public inclination towards Islamic banking in Pakistan is on the rise. Only during the Q1, 2018, deposits from the public have reached Rs 31 billion with 1.7 percent growth rate.
Liquidity management & funds mobilization
In order to keep up with its pace of financial inclusion, liquidity management and funds mobilization, most important challenge is the deployment of excess liquidity for which Islamic banks need appropriate avenues for deployment of available funds in Shariah compliant manners. To safeguard customers’ funds, it is utmost important that the state extends maximum support by creating adequate avenues for Islamic banks to deploy the available fund pool. Creating such avenues is a constitutional and legal responsibility of the government as the same is bound to take adequate measures that lead to eradication of Riba. Despite the fact that deposits of Islamic banks are increasing, avenues available to deploy such funds to generate deserving returns are shrinking. While there is a limited corporate and commercial market, a relief comes from the Sukuk issue by the federal and provincial governments. In the last couple of years, a reverse relation has been observed between the growth in Islamic bank’s deposits and the Sukuk issuance by the GoP.
Below chart depicts growth in deposits and the shortfall in GoP Sukuk issue. This is an alarming situation as most of the Sukuks are maturing soon, leaving almost no room for the Islamic banks for further placements of their excess funds, posing a serious threat to the growth of this important sector of Islamic banking.
Since Government of Pakistan (GoP) is in serious need of funds from local and international lenders, Islamic banks in Pakistan, sitting on excess liquidity of Rs 700 billion can largely fulfill these requirements. It is a constitutional responsibility of the GoP to create opportunities for Islamic banks to deploy the excess liquidity and the best way is to place it in Government of Pakistan Islamic instruments i.e. Sukuk. GoP should issue the new Sukuk in the market to get financing internally from Islamic banks. On one hand this will help Islamic banks in meeting their certain SLR requirements; on the other hand banks can generate better returns for the depositors.
As of now there are four outstanding GoP Ijarah Sukuk issues, amounting to Rs. 385 billion that are maturing very soon.
Three Sukuks issued on Jinnah International Airport (JIAP) amounting to Rs 314 are going to mature within the next 11 months. Currently GoP Sukuk as percentage of total Islamic banking deposits are 20 percent. After maturity of JIAP Sukuk, percentage of GoP Sukuk will decline to 12 percent by December, 2018 and 5 percent by March, 2019 resulting in unavailability of adequate SLR eligible securities for IBs.
Diversification & internationalization
The GoP with shortfall in liquidity may also have an option to seek the financing options from the international investors through the issuance of Sukuk in international markets. Since there are various avenues available, the industry is heading in the right direction. Worth mentioning here is that standard setting bodies like Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) are working hand-in-hand with financial institutions, governments, investors and issuers to help deliver investor-friendly and globally replicable standards on Islamic finance and Sukuk specifically. Thus the market is broad and gives many options to the issuers. On the other hand governments may also discourage the financing from IMF only since there are other options (Sukuk) available in the international market, which is Shariah-compliant and a much better option for the government as these are competitively priced instruments in various categories and can cater the financing need of borrowers specially governments.
Recent resolution by the Senate
A resolution recently passed by the Senate reads “This House recommends that the government should take necessary steps to abolish Riba at the earliest and at least 30 percent of all new government debts should be replaced with Shariah-compliant mode”. The resolution was placed in the Senate on 9th July, 2018; the resolution was passed and appreciated by other parliamentarians. This is a significant development for the Islamic banking sector and indicates that, once implemented; better avenues would be available for financing and investments within the government through Shariah-compliant instruments. It will create a positive perception in public and thus financial inclusion from unbanked population is expected.
The way forward
The crucial need is that sufficient effort should be made at each level by the banking industry professionals, scholars and legislators to develop the Islamic banking industry from both supply and demand sides.
While it is of utmost importance to improve financial inclusion of the unbanked masses, it is equally important to develop the demand side market that can absorb the greater liquidity. Since it may take natural time to develop the commercial/retail market for Shariah-compliant products, the swift and more effective method is to enhance the large-scale transactions market that mainly include Sukuk. GoP, being the single largest borrower in the country, can help significantly. All such measures by the GoP shall be in line with its obligations to fulfill the constitutional provisions of eradicating Riba by promoting and safeguarding the Islamic banking industry.
Alhamdulillah, Pakistan has been blessed with world renowned scholars, advisors and policy makers who have the expertise in Islamic financial modeling, structuring and are respected globally due to their contributions towards the economic developments and support to governments in achieving their financial goals, sharing their knowledge to attain the long-term plans and advising in major reforms for various sectors.
For Pakistan’s economy to flourish there exist a dire need for favorable policies, and a more inclusive banking sector. We can enhance the productive capacity of the economy by bringing in more initiatives to tap the enormous potential of the country’s Islamic banking sector. As newer market players emerge, the industry and economy will both develop and prosper.