WHEN the income tax on bank profits come down to 46 per cent on July 1 from 58 per cent last year, will the depositors have better returns on their savings or the borrowers lower rate of interest on their loans or both?
The question has arisen as the finance minister proposes to reduce the income tax on bank profits by another 4 per cent from July 1 following the cut of 8 per cent he made for the current year from its peak of 58 per cent which has been the exasperation of bankers.
The plea of bankers is that the tax for banks should be brought down to the rate for the rest of the corporate sector so that they could give a better deal to the depositors and the borrowers. The World Bank and the IMF too back that demand. And with a top banker as the finance minister of the country, the government has accepted that in principle and has chosen to reduce the tax rate step by step and began with an eight per cent cut this year. The government does not want to reduce the ready availability of a larger revenues too quick.
The government had believed earlier that giving permission to a persons to open a bank was more like issuing a licence to print money and hence it should have a large share of their profits as income tax.
The same argument was used by the provincial governments and local bodies to levy taxes on banks. And the banks complained the cumulative tax on them by the federal, provincial and local governments was a hefty 70 per cent and hence they could not be generous to the depositors or borrowers.
While provincial governments have been talking of reducing the number of their taxes along with the efforts to boost their revenues we do not know what kind of taxes and how much of each the various tiers of the local government could come up with. But there will be checks on excesses on their part.
Of course, the heavy taxation is only one of several reasons advanced by banks to give a low returns on bank deposits as low as 4 per cent on savings which has since then been raised to 6 per cent by the public sector banks and that angers the depositors.
The non-performing loans of over Rs300 billion which is around 40 per cent of the total bank advances, which are increasing with more loan defaults as the economy is not picking up fast is advanced as another major reason. The third reason is the large staff of the public sector banks and too many loss-making branches. Hence the banks have been trying to reduce their staff and the United Bank has gone for more massive load-shedding in this regard than other banks. And they say they have not done enough because of the tough social economic conditions in the country, and the political fall-out of large sacking of staff with reduced golden hand-shake benefits.
The government has also come up with the argument that inflation had come down to around five per cent and hence a reduction in the interest rate on deposits is proper. The State Bank of Pakistan has also reduced its interest on treasury bills and Pakistan Investment Bonds. The last batch of 10-year PIBs were picked up by the State Bank on Wednesday at 11 per cent accepting only Rs3 billion out of the Rs9 billion offered.
Such sharp reduction in interest rate on savings has hurt the pensioners and others depending on the interest income from their savings. Those who has sought the golden hand shake in various institutions and hoped to live on the interest income have also been hit hard by the fall in deposit rates.
On that basis the government has also reduced the interest rate on the defence savings certificates and the special savings certificates by a third of their old rates which had made them popular and reasonably rewarding.
All that had made the term finance certificates (TFCs) popular with the higher income groups. Then the CBR said that income from TFCs would be taxed like other incomes of their holders and that outraged the TFC-holders, who had expected to pay only the usual withholding tax of 10 per cent.
The State Bank of Pakistan says the average rate of lending by banks in 2001 was 13.631 per cent and the average rate of interest paid on deposits 6.58 per cent with a 7.05 per cent the gain for the banks.
If banks were functioning normally a gap of two per cent would have met their needs. In far worse conditions a four per cent gap should be more than adequate but the difference between the borrowing and lending rate now is over 7 per cent. The bank gains more than the depositor.
Better management of banks and a more deft handling of the loan portfolios and reasonable strength of staff should be able to narrow the large gap between the two key rates. The State Bank of Pakistan under Dr Ishrat Hussain has been striving for that with his sympathy for the lower income groups.
After the banks reduced their interest rates on deposits and heavier tax levied on TFCs, the savers find few attractive alternatives. The Karachi Stock Exchange is good for large investors and the smart speculators who are on the ball most of the time. And the rates for the national savings schemes have also come down. So they have to stay with the banks.
Five private sector banks have failed leaving the depositors and small share-holders in the lurch. Some other private sector banks, still surviving are on the border line. Hence the depositors feel more secure with the public sector banks with the official guarantees for their deposits. But that guarantee will vanish with the privatisation of banks, beginning with the United Bank which is to be followed by Habib Bank. Hence small depositors have more worries as the last thing they want is insecurity of their deposits when they depend on their income from them for their living or survival.
Anyway an eight per cent plus four per cent cut in the tax on bank profits should benefit the depositors perceptibly. If that does not take place the government may be slower in reducing the tax further to 35 per cent, which means it has to come down further by 11 per cent.
Meanwhile many of the corporate pre-budget suggestions sent to the finance minister have called for reducing the corporate tax to 25 per cent from 35 per cent to give a boost to the economy and speed up corporate growth.
Attractive interest rates on deposits well-above the inflation rate, at least three per cent above is essential to boost the savings rate in the country which is among the lowest in the world. The savings rate has to be boosted to make larger funds available for investment which is imperative now. Two of the major reasons for the low savings rate are the high inflation which had left little of the income for savings and the low interest on savings far below the real inflation rate.
Now there is a great deal of talk about large funds being made available to the low income groups or no income groups through the Khushhal Bank, the Small Business Finance Corporation and other bodies. But the interest rate at which credit is offered now 16 to 18 per cent is high and the people are uneasy about borrowing at such rates when they are not very familiar with the business they are entering into.
Efforts have to be made to bring such interest rates to around ten per cent and lower later to make such scheme popular and successful.
Reducing lending rates and increasing the deposit rates by shrinking the intermediation charges of the banks should have a very high national priority now if the economy has to grow fast and the endemic poverty has to be reduced on a sustained basis. And the earlier that dual process begins the better for the economy that needs more and more of its various log-jams to be cleared quick.