Islam and Institution of Interest Based Lending

Danial Pirani

In modern times, interest is regarded as the base for the stability of an economy. Nearly all institutions are, in one way or the other, connected to the interest based transactions. Interest is considered as an incentive to save money. Secular economic theory claims that the whole interest mechanism guarantees an efficient allocation of available funds. It keeps the flow of credit stable in the economy.

Today, nearly all financial institutions work on interest based transactions. They all share a common belief that interest based systems provide good incentives to invest and simultaneously earn as per the standard requirements, the result of which ultimately leads towards capital formation and economic growth.

But in real practical world, this is not the case every time. What if a person bears a loss?? Or what if he cannot afford to pay above the principal amount he borrowed?? In both the cases, one becomes a permanent slave of the creditor. He loses his identity and becomes bound to obey what the creditor commands. Today, Pakistan has to pay half of its tax revenues in paying interest alone.

In the earliest times, Aristotle – who is considered as a pioneer figure in secular philosophy – criticized the institution of interest. Thomas Acquinas also stated that the just price of money lent is nothing more than the principal amount lent itself. All Abrahamic religions denounced the institution of interest in clear terms. Even great thinkers like Martin Luther said: You cannot make money just with money.” Making money with money is referred to earning something in trade by selling what does not exist.

Thomas Aquinas said: “To take usury for money lent is unjust in itself, because this is to sell what does not exist and this evidently leads to inequality which is contrary to justice.”

In the interest based lending, the lender bears no risk in the enterprise of borrower and yet demand and is guaranteed a fixed return. Hence, it leads to an inequitable distribution of income.  This can be seen by taking an example of three people.  Suppose there are three people who consume all of their income in a given year. One of them starts with $1,000 in savings, a second with $100 and a third with zero.  At 10% interest per annum, by the end of the year, the first person has $1,100, the second $110 while the third person has zero in his account.  If the same scenario follows in the next year, the first person will have $1,210, the second $121 and the third will have zero.  Already, one can see how the distribution between them grows every year, even between the ones who have some savings of their own.  This scenario will be made even worse if the richest person will also to be able to add savings.  Suppose he adds one thousand at the end of each year.  He will have 1,100 at the end of the first year, he adds $1,000 and continues with his 10% interest and he will have $2,310 at the end of the second year, and so on.  This scenario ultimately leads to an autonomous inequality in society generated by no one, but suffered by everyone. Note that those in debt, paying interest that grows every year, have not been added to the equation.  In their case, as interest continues to grow, more and more of their overall income is consumed by interest, further exacerbating the skewed distribution of income.

On the behavioural side, the one receiving interest indirectly tags money as risk-free and work-free. This leads to a lifestyle mainly based on consumption. But more importantly, it leads to a very irresponsible attitude towards one own self and the society.

On the social equality front, the one paying interest becomes a slave of those who lent him money since the burden gets bigger over time. This leads dependency and leaves self-empowerment as mere fantasy and ultimately leads towards loss of self-identity, self-honour and destruction of humanity.

John Maynard Keynes, a well-known economist of the west, who unveiled the mysteries behind the great economic crisis on earth, also argued that the best way to revive the economy is to increase the money supply so that the rate of interest falls. A fall in the rate of interest would lead to higher investment, employment and output. In fact, Keynes held that ultimately an ideal economy is one wherein interest does not exist.

It is now that Economists like Milton Friedman, Kindle Berger and H.C. Simon hold fixed interest rates to be responsible for instability. Friedman contends that changes in rate of interest bring about either inflation or deflation and both are harmful to the society. He therefore argues “Our final rule for the optimum quantity of money is that it will be attained by a rate of price deflation that makes the nominal rate of interest equal to zero”. This proposition is known as Friedman’s Rule, and it is “one of the most celebrated propositions in modern monetary theory”.

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Limitations of Mainstream Consumer Theory in Economics

Salman Ahmed Shaikh

Mathematical tractability has restricted economic analysis of consumer behavior within a confined boundary of certain axioms. Often, these axioms are found to be empirically false. Even more importantly, these axioms and the analytical framework based on them is incapable of explaining economic choices in environment goods, public goods and social choice. Studies in behavioral finance have also documented information processing incapacities and biases that challenge some of the rationality assumptions.

In traditional mainstream neoclassical consumer theory, the consumer is supposed to maximize a utility function subject to some budget constraint. To conduct maximization analysis, certain axioms are imposed on the consumer choice set that enable mathematical tractability and optimization analysis. These axioms can be summarized into the following: completeness, transitivity, invariance of preferences, convexity, continuity of the utility function and monotonicity or local non-satiation.

Apart from Economics, other social sciences are not always thrilled to restrict consumer behavior analysis within such a framework only for mathematical tractability. Lehtinen & Kuorikoski (2007) defend the neoclassical methods for analyzing consumer behavior by arguing that the false assumptions are not potent reasons to abandon the mainstream methods and analysis. It is the empirical validity of predictions with observed behavior which gives the mainstream tools and methodology the credibility and wide acceptability.

However, the relevance and validity of these axioms are not trivial to Gowdy & Mayumi (2001). They opine that if consumer behavior does not conform to the set of axioms adopted in neoclassical theory, then one cannot make the leap from maximizing utility to constructing welfare measures of consumer surplus using Hicksian or Marshallian demand curves.

Thaler (1980) explains that since mainstream consumer behavior theory is based on a rational maximizing model, it describes how consumers should choose given the model and its assumptions; however, not necessarily describing how they do choose. Mainstream consumer behavior theory is normatively based and it only claims that it is also a descriptive theory.

But, in many cases, the mainstream consumer theory fails to predict the economic choices either because of rigid axioms or simplistic preference structure.

Sen (1977) explaining the shortcomings in the structure in neoclassical approach comments as follows:

“A person is given one preference ordering, and as and when the need arises this is supposed to reflect his interests, represent his welfare, summarize his idea of what should be done, and describe his actual choices and behavior. Can one preference ordering do all these things? A person thus described may be “rational” in the limited sense of revealing no inconsistencies in his choice behavior, but if he has no use for these distinctions between quite different concepts, he must be a bit of a fool.”

Gowdy & Mayumi (2001) correctly argue that monotonicity axiom is irrelevant in environment goods where the balance and coherence matters more than abundance. Health goods also require a balance for their effectiveness. Same is true when consumption is analyzed with respect to health effects. Moreover, just like the consumer choice implicitly maintains or should maintain a balance that satisfy balancedness with regards to health effects of consumption, the mainstream consumer theory will be much better off by giving due importance to the balancedness with regards to the ecology, biodiversity and intergenerational equity. This may require incorporating the attribute of ‘commitment’ in consumer theory (Sen, 1977).

Using an example from social choice, Sen (1977) states that even when individual voters have limited probability of affecting actions and when the costs of casting votes could be substantial in particular circumstances, people still take the pain to cast votes to document their true preferences. Sen argues that if this desire reflects a sense of commitment, then the behavior in question would be at variance with the view of man in traditional economic theory.

Furthermore, ‘Ultimatum Game’ reflects the fact that people tend to look at their choice outcomes relatively. Prisoner’s Dilemma highlights the fact that choices by each player in a self-centric way are not necessarily going to be best for them either individually or collectively.

On the other hand, there is another critique on the rational consumer theory that it is overly optimistic about the information processing capability of the consumer. On this, Simon (1957, p. 198) wrote:

“The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world — or even for a reasonable approximation to such objective rationality.”   

Furthermore, recent evidence in behavioral finance and consumer psychology points to the fact that consumer information processing capabilities are limited and prone to error. Alias paradox (1953) and Ellsberg paradox (1961) are good examples of this phenomenon.


Gowdy, John M. & Mayumi, Kozo (2001), “Reformulating the foundations of consumer choice theory and environmental valuation”, Ecological Economics, 39, pp. 223–237.

Lehtinen, Aki & Kuorikoski, Jaakko (2007), “Unrealistic Assumptions in Rational Choice Theory”, Philosophy of the Social Sciences, 37, pp. 115 -137.

Sen, Amartya K. (1977), “A Critique of the Behavioral Foundations of Economic Theory”, Philosophy and Public Affairs, Vol. 6, (4), pp. 317 – 344.

Simon, Herbert (1957), “Models of Man”, Wiley: New York

Thaler, Richard (1980), “Toward a Positive Theory of Consumer Choice”, Journal of Economic Behavior and Organization, l, pp. 39 – 60.

Allais, M. (1953), “Le comportement de l’homme rationnel devant le risque: critique des postulats et axiomes de l’école Américaine”. Econometrica, 21 (4), pp. 503 – 546.

Ellsberg, Daniel (1961), “Risk, Ambiguity, and the Savage Axioms”, Quarterly Journal of Economics, 75 (4), pp. 643–669.

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Potential of Islamic Finance to Lead New Financial Architecture

Salman Ahmed Shaikh

The financial crisis of 2007-2009 and ongoing sovereign debt crisis in Europe has challenged the conventional wisdom. Massive levels of debt and consumption beyond means and speedy financial innovation with lax regulation has put major economies in a deep crisis.

In the US, the share of total corporate profits generated in the financial sector grew from 10% in the early 1980s to 40% in 2006. These earnings are transaction costs for the productive sector. Financial institutions that were just supposed to be playing a supportive role to the productive economy got much bigger and unregulated through shadow banking practices. Recently, Piketty in his book “Capital the 21st Century” explains that the tendency of returns on capital to exceed the rate of economic growth today threatens to generate extreme inequalities.

Nevertheless, financial intermediation has a useful function to facilitate intertemporal consumptions decision by households and investment decisions by firms to encourage capital formation.

What is needed is a new paradigm that can put the focus back on productive enterprise, brings recovery with job creation, limit and regulate speculative financial instruments and improve corporate governance by influencing the incentives more deeply and proactively. In this paper, we analyze how Islamic finance principles and institutions can provide basis of new financial intermediation architecture.

During the last decade and half, the Islamic financial industry has seen tremendous growth even when the conventional financial institutions went into a deep crisis. Islamic finance is a fast growing industry all across the globe.Islamic banking assets with commercial banks globally crossed $1.7 trillion in 2013, suggesting an annual growth of 17.6%over the last four years.

The two most important problems identified in a post-financial crisis look back are perverse incentives and de-linking of financial sector growth and activities with the real sector of the economy. Islamic finance principles by basing all financial products with real assets fill the gap and this feature alone is a very important risk management tool inbuilt into the system.

In Islamic banking, there is inherent risk management technology. Floating rate rentals substitute the use of interest rate swaps. Credit Default Swaps (CDS) are not needed in most cases since almost all financial assets credit creation is backed by real assets and the bank has recourse to them. Delivery based trade contracts ensure that the transaction is not for speculative purposes only. Price hedging can be ensured through Salam and Murabaha already which are used for short term financing. In long term financing, the rentals are mostly floating.

However, to lead and sustain the growth momentum, Islamic banking has to overcome several challenges.

Islamic banks do not have complete product alternatives for all kinds of conventional finance solutions. According to the World Islamic Banking Competitiveness Report, there are 38 million customers globally with Islamic banks with average product holding of 2.1 which is significantly lower than class leading average of 4.9. This represents untapped cross selling potential in Islamic banking with existing and growing customer base.

While it is indeed appreciable that not all conventional practices are replicated as is by Islamic banks, but such lacking in solutions and alternatives cannot completely be attributed to this factor alone. Distress financing, educational financing, health financing and microfinance are areas where if Islamic product alternatives can be developed and adequately marketed, it will increase the size and scope of Islamic banking. Furthermore, it will validate the position of Islamic banks as having solutions for all classes and stratum in economy and not just for the big corporations looking to expand with lumpy assets acquisition.

While ease in deposit mobilization is a salient plus, it is also a challenge when financing operations have limited product alternatives, contractual frictions and non-Compliance risk. To manage surplus liquidity, it is important to have investable options for short term other than providing credit.

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Challenges for Islamic Banking in Pakistan

Salman Ahmed Shaikh

Islamic banking in Pakistan is an established industry with 10% market share achieved in just over a decade. There are 5 full fledged Islamic banks and 15 other commercial banks that operate Islamic banking windows alongside conventional banking in Pakistan.

Deposit mobilization had been much easier in Islamic banking in Pakistan as compared to using the deposits to provide finance. Islamic banks with assets backed financial products rely much more on formal documented manufacturing based industries where finance is required for plant and machinery, raw material and industrial equipment.

On the other hand, the financing operations that are overly dependent on asset backed debt based modes of financing create several issues.

First, in times of recession, Islamic banks in Pakistan have limited product range for firms that require finance in already ongoing projects in which lumpy investments had been made, but financing is required to meet rising variables costs of energy and utility expense.

Secondly, in recession, purchasing new assets for expansion is not the first things most firms would do or can afford to do. Hence, if Islamic banks remain stuck in debt based modes of financing, they will have to start offering buyback or sale and leaseback type of products which are not preferable or ideal from the Maqasid-e-Shari’ah perspective.

Third, over-reliance on debt based modes of financing requires firms to take initiative and increase their demand for such products from Islamic banking. Hence, the supply side response by Islamic banks is hindered and they may remain ineffective in bringing an economy out of recession by providing less restricted and flexible modes of financing like Mudarabah and Musharakah.

But, Islamic banks in Pakistan seem to be content with surplus liquidity. Instead of using the deposits by providing finance, they had increased investments. This has resulted in an FDR ratio of as low as 34% in recent months. This undermines their function of financial intermediation between firms and households.

It is surprising that we do not look at development towards Islamic economics ideals by looking at the size of equity markets, number of new IPOs and self-employed professionals. They are all avoiding interest directly. We need to get out of this mentality of only assessing progress towards Islamic economics ideals in the commercial practice of Islamic banks.

The path dependency is followed more rigorously in product design for commercial viability, but not when another institutional structure appears to conform to basic Quranic injunctions, but not the directly Fiqh defined parameters. For instance, the modern day venture capital funds, private equity, public and private corporations are time tested structures which avoid direct involvement of interest and for which sufficient covenants had been developed by ways of experience and legislation which render these structures highly usable in current times.

Banking penetration is 11% in Pakistan, then, 89% of the population is already interest free by not being directly involved in interest based banking. The number of firms using their own equity, family funds, partnership or capital markets for finance maybe much more in number than those opting for bank finance alone.

If commercial viability is a valid excuse when 89% of Pakistanis not use banking services in the first place, then, Islamic banking penetration in future will become an obstacle against itself when there will be an academic call to change the structure for Maqasid-e-Shari’ah compatibility.

Banks usually serve risk averse clientele. The equity investors are also in financial markets and are willing to take part in equity investments with no guarantee of either capital gains or dividends. In fact, they participate despite there being capital value tax and capital gains tax in Pakistan’s stock trade.

Banks hide behind the small number of rich depositors who in the first place, are only placing funds with banks as a secure way to park liquidity rather than as a means of investment. It is confirmed by the very low deposit rates in Pakistan which do not even makeup half of Pakistan’s inflation rate during the last 10 years.

Karachi Stock Exchange, the premier equity market of Pakistan has market capitalization of about $70 billion which is roughly one-third of Pakistan’s GDP. While corporate bonds have very little penetration and banking services are utilized by only 11% of population. Most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus money.

Still, no Islamic bank is in micro finance in Pakistan and not even in investment banking. Helping IPOs by investment banking operations is closer to fulfilling Maqasid-e-Shari’ah than getting trapped in path dependency and debt based product structures.

Islamic banks are in search of a distinct identity for themselves and to showcase their significant and marginal impact on the economy that can legitimize their economic merit over and above the conventional banks. Facilitating IPOs through investment banking arms can make them play an effective role and also pave the way towards increased use of equity financing over debt financing in Pakistan.

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Sukuk Market in Pakistan Set for Take-Off

Salman Ahmed Shaikh

Sukuk is an alternative Islamic finance instrument for conventional bonds. Sukuk is a certificate that represents ownership in underlying real asset(s). Islamic law does not permit interest and hence conventional coupon paying bonds are impermissible as per Islamic law. However, Islamic law allows sale and lease of real assets and the resulting income in the form of profit on sale or rental income stream on lease of assets. Holders of Sukuk share in the lease or profit income generated from the ownership of real assets that the Sukuk certificate represents.

A typical Ijarah Sukuk would work like this. For instance, if a manufacturer requires industrial equipment, it will issue Sukuk that can be purchased by institutional and/or retail investors. From the proceeds of Sukuk, the industrial equipment is purchased and is leased to the manufacturer. During the period of lease, the manufacturer will pay rents and that will generate income stream for the Sukuk holders who had invested in Sukuk. After the lease period is over, the manufacturer will purchase the asset in a separate contract and this will enable the Sukuk holders to be able to redeem their investment.

Sukuk could turn out to be an instrument of choice after the current financial crisis. Not only Muslim countries, but non-Muslim majority countries are also taking interest in it. UK treasury is issuing a Sukuk worth £200 million. It will become the first sovereign state outside the Muslim world to issue an Islamic bond.

In Pakistan, capital markets are not as developed and most of the formal sector financing takes place through banks. Savings rate is very low (12%-14%) and the inflation rate on average had remained above 10% during the last 10 years or so.

Capital market instruments require long term investment horizon and liquidity. Due to political instability and policy inconsistency, usually, the long term investments are not very popular among the investors. In the last few years, only a handful of IPOs had taken place. The bond market is also very small and dominated by sovereign issues than corporate bonds.

While risk averse investors had found comfort with bank investments even though banks do not offer inflation beating returns, most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus money.

There are many reasons why corporate bond market did not develop as per expectations in Pakistan. The national savings scheme instruments issued by the government of Pakistan are offering very attractive yields and they are default free. Some national saving scheme instruments are also tax-free and hence after-tax yield on such instruments are even higher as compared to the corporate bonds.

Moreover, the corporate sector itself has lost confidence and interest for long term big investments in the country ever since the episode of nationalization in the 70s. Afterwards, indirect taxation and removing import barriers had also made corporate investment more challenging in the 80s and 90s. Then, the rise of industrializing countries on the external front together with energy and security crisis in the domestic front had resulted in even more challenging times for formal corporate sector businesses, especially in the manufacturing sector. As a result, neither new IPOs nor corporate bonds had much of a success during the last 6-7 years in the country.

In Pakistan, 78 Sukuk had been issued so far for an amount of Rs 637.43 billion. Out of the total 78 issues, 32 Sukuk issues for an amount of Rs 100.10 billion had been fully redeemed.

Government of Pakistan (GoP) had issued Ijarah Sukuk on numerous occasions in past to meet its escalating borrowing requirements. Government sector companies like Water & Power Development Authority (WAPDA) and Sui Southern Gas Company Limited (SSGC) had also issued Sukuk in past. Karachi Shipyard has also issued an Ijarah Sukuk in 2007.

Sovereign Ijarah Sukuk issued by the Government of Pakistan (GoP) have been structured in such a way that it allows the government to mobilize funds. The Sukuk holders are also able to earn Shari’ah compliant income. It also facilitates Islamic banks to manage their liquidity as well as meet statutory liquidity requirement stipulated by the central bank of Pakistan.

In the corporate sector, Sitara Chemical Industries Limited, Wateen Telecom, Engro Chemicals, Dawood Hercules, Century Papers & Boards, Attock Generation Limited, Arzoo Texttile, Lieberty Power, Amreli Steels, Eden Builders, Quetta Textile, Pakistan American Fertilizers, PEL and Kohat Cement are some of the companies that had issued Sukuk in past. One private sector entity Maple Leaf defaulted on Rs 8 billion Sukuk in 2009. Maple Leaf default on its Sukuk liabilities had demoralized already minimal investor confidence. But, capital markets – especially led by a buoyant stock market – are experiencing resurgence in investor participation and interest.

Recently, K-electric (formerly KESC) issued Rs 6 billion Sukuk which is also listed on the Karachi Stock Exchange (KSE) and Lahore Stock Exchange (LSE). There was no Pre-IPO placement and the entire amount of Sukuk issue was offered to retail investors and it was fully subscribed in a matter of few hours.

In recent times, Meezan Bank also arranged the country’s first airtime-based Sukuk. These Sukuk use intangible assets such as minutes of mobile telephone use. The structure of these Sukuk is based on Ijarah and sub-Ijarah of services. Assets are airtime (minutes) represented by prepaid calling cards and identified by the serial number of each card.

On the regulatory front, Securities and Exchange Commission of Pakistan (SECP) had issued guidelines for the issuance of Sukuk. According to SECP, the issuer must not have over-due loan and the issuer’s as well as the instrument rating should not be lower than triple B minus (BBB-).

SECP has decided that Sukuk would be offered in three types, that is Sukuk-1 of up to Rs 750 million for a tenor of 13 months, Sukuk-2 of up to Rs 3,750 million for a tenor of three years and Sukuk-3 of Rs 1,500 million for a tenor of five years.

The SECP explained that the subscription period would be for three months. The rate of return on Sukuk-1 will be 1 month KIBOR plus 100 bps, Sukuk-2 will be 3 month KIBOR plus 225 bps and Sukuk-3 will be 3 month KIBOR plus 275 bps. KIBOR is Karachi Interbank Offered Rate and used as a benchmark in pricing time based intertemporal financial products just like the use of LIBOR in the international markets.

The government of Pakistan has been running a huge budget deficit – at present Rs 1.77 trillion or 8.6% of GDP. In the past, the government used the M2 motorway to raise $600 million through an Ijara Sukuk (based on leasing) for a period of five years.

In case of Pakistan Railways, the government could develop a long-term Sukuk programme to raise $10-20 million over a period of 10 years to modernize and expand railway infrastructure.

Through issuance of more Sukuk, the investment class assets universe will expand and it will enable the Islamic-conscious individual and institutional investors to effectively diversify their portfolios. Treasuries of Islamic banks will also have an expanded set of investment avenues. It will increase liquidity of these Sukuk and generate wider interest among all investors in the economy to consider investing in these investment vehicles.

In most developing countries, the governments pay more than 50% of their tax revenues in servicing debt and spend very little in development. Often, these governments trim development spending to cover other non-discretionary current expenditures. Islamic banks can finance the Government of Pakistan (GoP) for the purchase of infrastructure that can be used in development projects.

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Positives and Negatives of Pakistan Budget 2014-15

  Salman Ahmed Shaikh

Recently, Finance Minister of Pakistan, Ishaq Dar announced budget for Pakistan economy for the fiscal year 2014-15. Below, we try to briefly analyze the positives and negatives of the budget.

Positives of Budget include the following measures:

  • Corporate tax rate reduced to 33%.
  • Maximum general tariff rate of 30% is reduced to 25%.
  • For textile sector, tax credits is allowed on garments (4%), Made ups (2%) and Processed fabrics (1%). Plus, an extension of duty free import of machinery for another two years. A training program with a cost of Rs 4.4 billion is also announced to enhance the quality of final products. Mark-up on long-term financing facility is also reduced from 11.4% to 9%.
  • For retailers, sales tax at 5% is announced in case of monthly electricity bill up to Rs 20,000 and at 7.5% of the monthly electricity bill exceeding Rs 20,000. For other retailers that operate international franchises or operate in air-conditioned malls, normal GST regime will be applied.
  • To encourage electricity generation from local coal, it is proposed to exempt the profits and gains of coal mining projects in Sindh supplying coal exclusively to power generation projects and also to tax their dividends at a reduced rate of 7.5%.
  • For domestic electricity consumers, it is proposed to collect adjustable advance tax at 7.5% on the monthly bill of above Rs 100,000.
  • To discourage perpetual declaration of losses or very low income using tax avoidance means by companies, an alternate corporate tax at 17% is proposed to be imposed on accounting income. The companies shall have to pay ACT or corporate tax whichever is higher. In order to facilitate companies that have genuinely low income for some period of time, the ACT paid is proposed to be carried forward up to 10 years.
  • To broaden the tax net, it is proposed to make obtaining NTN a compulsory condition for obtaining commercial/industrial electricity and gas connections.
  • In order to discourage CGT avoidance in bonus shares, it is proposed that bonus shares be treated as dividend and tax shall be deducted at the rate of 5% on the ex-bonus price of the shares.
  • Currently, foreign institutional investors in stock exchanges are neither voluntarily paying due taxes on capital gains by filing returns nor are they subject to deduction of tax like many other investors. It is proposed to bring FIIs under the WHT regime.
  • 10% raise is announced in government employees’ salary. Minimum wage is also raised by Rs 2,000, minimum pension by Rs. 1,000 and BISP funds per family are also raised from Rs 1,200 to Rs 1,500.
  • Export Refinance Rate is reduced from 9.4% to 7.5%. Export focused bank is to be established as well.
  • Karachi-Lahore motorway, agriculture credit and insurance and 10% reduced GST on tractors are further steps in the right direction.
  • Government, through SBP, will provide guarantee to commercial, specialized and micro finance banks for up to 50% loss sharing.
  • Rs 81.12 billion allocation for establishing new hydropower projects.
  • FED from telecommunication services is withdrawn from those provinces which have imposed GST on telecom services. In areas where FED shall continue to be collected, the rate is proposed to be reduced from 19.5% to 18.5%. WHT on telephone services is also reduced from 15% to 14%.
  • Additional tax for those persons who did not file income tax returns – 5% for dividend income, 5% for interest income above Rs 500,000, 0.2% for cash withdrawals from banks and 0.5% in case of advance CGT collected from the seller of immovable property.
  • The rate of tax on advertising agents has been raised to 10% from 5%; exemption from deduction of WHT be withdrawn on foreign news agencies; the rate of tax on dividend distributed by Mutual Funds to companies in respect of interest income shall be 25%, instead of 33%, applicable to companies.
  • Five-year income tax exemption will be given for setting up processing plants for locally-grown fruits in Balochistan, Malakand Division, Gilgit-Baltistan and Fata. Customs duty and sales tax will also be exempted on import of equipment for these areas.


Negatives of the budget include the following measures:

  • Current expenditure has been estimated to be higher than the revised estimates for 2013-14 by 8.3%, while development expenditure is lower by 2.4%.
  • PSDP was originally Rs 540 billion for 2013-14. Now, Rs 525 is erroneously but deliberately compared to the revised lower allocation of Rs 425 billion for 2013-14. Comparing the original allocations, PSDP allocation has actually gone down by Rs 15 billion.
  • Again defense expenditure and interest payments on debt will eat up almost 80% of tax revenues.
  • Corporate tax rate is now reduced to 20% if the investment is in a new industrial undertaking to be set up by 30.06.2017 and at least 50% of the project cost including working capital is through FDI in equity. While tax relief is good, but existing local investors are discouraged this way.
  • WHT on marriage functions is being reduced by 5% from 10% level.
  • Advance tax of 1% on the purchase of immoveable property may encourage people to under report property value further.
  • No mention of how to control debt to GDP ratio.
  • Tax to GDP ratio is destined to be brought to 13% without any significant measures to increase tax net. There is heavy reliance on WHT. For documentation and tax liability computation; FBR is heavily relying on proxies like electricity bills. But, even in urban and especially in rural areas and small cities, electricity theft is easy.
  • 10% FED on locally made motor vehicles exceeding 1800cc has been withdrawn while customs duty on used imported cars has been increased by 10%. Automobile sector had been pampered for decades. While subsidies on basic essentials are reduced, but continuing further protection to the uncompetitive sectors defies justification.
  • KSE earned around 50% returns in last 2 years consecutively. No reason why CGT be kept low if there are gains of this much magnitude and especially if participation is dominated by institutional investors.
  • Rupee appreciation will make exports expensive. Plus, oil import bill will put further pressure on rupee. If rupee has to be kept at the current level, then poor people must be provided with relief on inflation front. Inflation of 9% is still very high given just 4% growth.
  • Finance Minister said introduction of 3G and 4G technology would create jobs for about 9,00,000 youth in the next four years. It seems very ambitious given that the increase will be about 5% of total non-agricultural employed individuals. It is not explained how it will be achieved?
  • Fiscal deficit which was 8%+ suddenly comes down to 5.8%. This is strange especially when the tax revenue target was also underachieved and expenditures did not come down.
  • Investment to GDP ratio was targeted to rise by 20%. That too is not explained clearly especially amidst very lower returns on bank deposits, higher government domestic borrowing, higher inflation, lower real growth in per capita incomes and security and energy crisis.
  • Import to GDP ratio has climbed and exports to GDP ratio has declined in last few years. That is due to stagnant exports growth, decline in manufactured exports as a ratio of total exports and heavy reliance on imported sources of fuel.
  • More than housing at the moment, people need to be provided with long term relief by resolution of energy crisis. Saving poor from death is important than laptop, higher education and even housing at the moment.
  • For FY15, the government will borrow Rs 914 billion from domestic sources, Rs 508 billion from external sources and Rs 289 billion will be saved by four provinces from their budgets. Pakistan debt to GDP ratio exceeds 60%. But, in Pakistan, banking population is just 12%. Banking assets to GDP ratio is lower as compared to other developed regions. So, when government finances more than 50% of its debt from domestic loanable funds market, it leads to higher interest rate more elastically and that crowds out private investment. Private sector financing to GDP ratio in last 8 years or so substantiates that.
  • Tax on services is raised from 6% and 7% for corporate and non-corporate taxpayers respectively to 8% and 10%.
  • FED on cement is levied at 5% on retail price while the cement sector was already paying sales tax, running at 70% capacity and may face decline in export demand further in post NATO exit 2014 scenario from Afghanistan.
  • Education budget allocation in real terms declined by 11%. 75% of it is concentrated in higher education where people have better means of securing scholarship themselves while primary and secondary education is not given equal attention.
  • Steel sector tax rate has been enhanced from Rs 4 to Rs 7 per unit of electricity. Steel, cement and other LSM sectors usually have procyclical demand, so in an effort to take-off the economy towards growth, pre-production incentives shall precede more taxation.
  • Tax concessions are post production incentives. Right now, industries with liquidity constraints need pre-production incentives like 1) cheaper financing sources from banks and capital markets, 2) improved infrastructure support, 3) political and policy stability and most importantly, 4) increase in energy supply that can make the industries competitive.
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Course on Principles of Islamic Economics at IBA in Summer School 2014


Recently, IBA has launched a course on “Principles of Islamic Economics” in IBA Summer School 2014. I have the honor to conduct this course.

It will be a 12 hour course with 6 classes of 2 hours each on Tuesday and Thursday for 3 weeks in July (Ramzan).

Classes will be held in IBA City Campus, Garden Kiyani Road, Karachi.

Click here for Course Outline

Click here for Course Registration

Looking forward to welcome you and I hope it will be an interesting and enriched learning experience.

Best Regards

Salman Ahmed Shaikh

Posted in IEP Updates And Review | Tagged , , , | Leave a comment