The incumbent finance minister is keen to undo the adverse impact of a few policies run by the previous finance head (Dar) to have more engaged formal economic activities. One such example and the low hanging fruit is to reverse the impact of tax on banking transaction tax imposed on non-filers.
The idea of the transaction tax was two folds - one was to increase the tax revenues and the other was to incentivise the non-filers to file by penalising them. But the adverse impact of documentation was not well thought of. Spanning over three years, neither the tax revenues increased significantly nor the tax filing enhanced meaningfully. On the flip side, the informality in the economy increased disproportionately.
In FY15, the income tax filers were 1.12 million while in FY18 (data complied till 15th Oct 2018) is standing at 1.23 million. The number was 1.39 million in FY17. Thus, there’s not much to talk about the increase in filing returns through this mechanism. The tax collection on banking transaction is mere Rs20-25 billion, which is too low seeing the cost - one trillion rupees, in excess to past averages, was added in the informal economy.
As per the numbers run by a financial services house, there is an abnormal surge in currency in circulation (CIC) and prize bonds since the imposition of banking transaction tax in FY16. The CIC stock was Rs2.5trillion in June-15, which had increased to Rs4.4 trillion by June-18. The tale of prize bond holding is similar - jumped from Rs523 billion to Rs846 billion in three years. The prize bonds are bearer - as good as cash notes in bigger denomination, easy for tens of millions rupee transactions without any trace.
The above numbers are not reflecting the true picture of enhanced informal economy as unfortunately there is no data on Foreign currency holding (FCY) held in the form of cash.
There are two main components of monetary aggregates (M2) addition - bank deposits and currency in circulation. Lower the ratio of CIC/ M2, higher is the documented economy. In the developed world, the cash holding is around 5 percent while in India its almost in double digits; and in Bangladesh the ratio is at 15 percent.
Pakistan's historic CIC/M2 ratio, which was already high at 22 percent (avg: FY05-15), quickly moved to 27 percent. Similarly, prize bond holding disproportionately increased relative to other NSS instruments. Had the ratios remained at their historic levels, the formal economy would have been higher by a trillion rupees. And one may wonder how much of cash is being held in foreign currencies.
The numbers are mind blowing and manifest the short term approach of then finance minister. The buzz is that there are cash houses formed in Lahore for traders to deposits daily cash and withdraw at the time of need. Many SME businesses, especially traders are dealing through informal community based banking channels, prize bonds, and foreign currency.
The fiscal policies should have been designed to lower the already high currency in circulation ratios; but it was done in a flipped manner. The tax reform commission recommended Dar to abolish the tax, but he could not care less. Now, the same recommendations are passed to Asad who is thinking to act upon them.
is abolishing transaction tax sufficient? It's easier for money to exit while much harder for it to come back. The fear of FBR has to go out of the minds of businessmen. There should be a system based approach in filing income and sales tax returns, and the number of sales tax withholding agents has to be reduced to incentivise transactions through formal banking channels
Concurrently, some other regulatory and enforcement measures are to be introduced. The prize bonds should be registered to trace the money trail. There should be some mechanism of declaring the cash held in lockers, technology can be used to enforce it. The currency counting machines should be registered with no allowance of using unregistered machines in informal cash banks.
All above mentioned measures would stop the excess cash in the economy - perhaps another amnesty scheme to be offered to get the huge sums of cash back into the system. With all these efforts, the CIC/M2 ratio may come down and remain at its historic average of 20-22 percent.
Asad Umar mentioned in one his speeches to bring it at Bangladesh’s level i.e. 15 percent. This has a potential to add Rs1.1 trillion in economy in addition to what we get from bringing ratio back to its historic levels. The total potential is around Rs2 trillion, which can increase the bank deposits by one sixth.
The numbers are big and it may take years to reach these levels given that the policies are right and FBR is no more harassing. And once the money is flowing, the government paper rates and bank lending rates will come down; it happened in 2002-04 when the foreign money was flowing in the economy. Let's see what wonders the domestic cash money can bring, if it is played right.