May 25 - 31, 2009

A vibrant financial sector is must for accelerating economic growth in any country. However, over the years, particularly when commercial banks, insurance companies, DFIs and asset management companies were operating under state control in Pakistan, higher corporate tax was maintained to boost government's earnings. Over the years corporate tax rate has been reduced but it is still higher. It is feared that the government, desperate for enhancing the revenue would not only increase the rate but may also impose some new taxes in the forthcoming budget.

The federal budget for 2009-10 is estimated to envisage an outlay of around Rs2.3 trillion. Since the budget is being prepared in the light of IMF conditionalities the government is not likely to offer many concessions. The growing fear is that new taxes will be imposed and rates of existing tax i.e. sales tax, central excise duty and corporate tax will be enhanced. However, the strategy is likely to prove counter productive because the financial sector is under stress. Due to reduction in private sector credit off take and increase in NPLs most of the financial institutions are expected to post either marginal profit or losses and collection from corporate tax is likely to decline. In such a precarious scenario and to maintain present level of revenue collection it is anticipated that the government would resort to increase rate of various taxes already being paid by the corporate entities.

Commercial banks are likely to be worst hit in calendar year 209 because of rising delinquent loans and increasing provisions. Declining credit off take has been partially compensated by rising government borrowing that too at the higher interest rate. With banks becoming less keen in soliciting new deposits their core business activity is being impaired. Cost cutting approach is being followed and if the pressure continues massive retrenchments cannot be ruled out.

Whatever may be the reasons NIB Bank has already relieved some of its employees, who have filed a case in the court of law. Salaries and perks of bank employees have been frozen, though said to be with the consensus of employees. NIB Bank may be the first casualty but if the economic recession continues other banks are also expected to resort to massive retrenchment.

It is believed that the people working for the financial sector are paid handsome salaries. One of the examples often quoted is the salary of the president of a commercial bank, drawing around Rs10 million per month. Total number of presidents of commercial banks exceeds two dozens. It is believed that senior management of commercial banks is also paid handsomely. This means that the employees of the financial sector not only have substantial purchase power but also are the major contributors to the national exchequer. Therefore, any cost cutting approach or retrenchment has the potential to lower revenue collection but also cause reduction in demand.

One of the fallouts of economic recession is that the sale of automobiles has reduced to almost half as compared to the recent past. This massive decline in car sales has not only affected auto and allied industries but financial sector is also facing the brunt. Not only quantum of auto finance has declined but delinquent loans and provisioning are also on the rise. Reduction in sale of automobiles has also affected collection of import duty etc. and car registration fees. On top of this reduction is the earnings of the financial institutions have also lowered corporate tax payment.

Reduction in car sales has also affected earnings of the insurance companies. With the reduction in premium collection and increase in claims payments (as a percentage of premium collected) is on the rise. Premium collection is also on the decline due to shrinking imports. On top of all this, increase in fire breakouts has reduced earnings of insurance companies. Persistent bearish sentiments engulfing the equities market has also impaired income of the insurance companies.

The worst impact of recession is decline in purchasing power of public in general. Sales of grocery items to petrol and from consumer durables to real estate have reduced substantially. With the shrinking purchasing power sale of virtually every item has been on the decline and so are the savings. Not only the inflow of deposits is on the decline people are not wiling to lock their deposits for longer duration. This does not allow the banks to enter into medium ad long-term lending.

The adverse impact of reduction in medium and long term lending is visible on the leasing sector. The number of leasing companies is on the decline and most of the leasing companies are carrying the huge load of accumulated losses. Many of the investment banks also face precarious financial position. Experiencing the credit crunch commercial banks have curtailed or virtually stopped extending credit to the leasing companies. As a result leasing companies were forced to stop underwriting fresh leases and use internally generated cash for debt servicing.

Stock market is one of the major sources for capital mobilization. Commercial banks and insurance companies also invest in shares of the listed companies and debt instruments. Stock market is persistently facing bearish sentiments and for nearly four months floor was imposed to contain massive decline. The market stated some signs of recovery but rumormongers once again pushed it into bearish mode by spreading the news of imposition of capital gain tax and enhancement in CVT.

It is true that the government has to increase revenue collection but this cannot be done without taking the business community into confidence. All sort of income irrespective of its source should be taxable but rates must encourage payment rather than evasion. The government must bring down the corporate tax, abstain from enhancing sales tax rates and avoid imposing news taxes on the financial institutions.