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The currency in circulation (CIC) – money out of the banking system, has always been high in Pakistan relative to other emerging and developed economies. Too high informal economy of Pakistan is an issue well known to all. The problem of CIC exacerbated after the imposition of withholding tax (WHT) on banking transactions(mainly for non-filers). The ratio of CIC to monetary aggregates (M2) was hovering at 22-23 percent during FY09-15, it jumped to 26 percent in FY16. Thereafter, it’s on the rise and stood at 28 percent in FY19.

The acceleration of CIC to M2 continued in the FY20. It’s a point of concern for the government. This is adversely affecting the SBP’s ability to lure savings in formal channels by keeping real interest rate positive in days of high inflation. The side effect of high rates is significant decline in the growth of the private sector and heightened the borrowing cost of the government.

It is of utmost important to lower the CIC to M2 ratio for better transmission of monetary policy and for availability of credit for productive sectors through banking channels. For that, government has to forgo the collection of Rs15-20 billion per annum fetching from the WHT 0.6 percent on banking transactions. The rationale given at the time of imposition of banking transaction tax was to encourage non-filers to file. The tax was deemed to be a penal tax to discourage non-filers.

There is no significant change in the filing of tax returns which increased from 1.12 million in FY15 to 1.39 in FY17. Thereafter, other tools were also used to enhance the tax net through offering two amnesty schemes, and lately through concentrated efforts of documentation. The point is that transaction tax has not yielded much in terms of enhancing the tax net. The revenue generation from the tax is not significant either. However, the cost of money going out of the system is hurting.

IMF does not like this tax. The advice to phase out this WHT is reflected from various staff reports. The Fund’s concern is that it could trigger financial disintermediation. The buzz is that the Fund might ask again government to remove this tax in upcoming FY21 budget. That would be a right advice. Government should do away this tax to enhance the component of money supply in the banking deposits.

During the past one year or so, there are other reasons cited for further hike in CIC to M2 ratio. The government’s effort to crackdown on non-tax payers is making the people to keep higher amounts in cash. Earlier the anecdotal evidences were of converting these into foreign currencies. Now with currency adjustments, the reverse is happening. People are converting dollars into rupees.

There is an opportunity cost of keeping cash. Higher are the interest rates, higher is the cost. The alternate avenues to invest are drying down. The FATF compliance is making it hard to park the informal money into real estate and other sectors. The trend was also to keep the money in prize bonds. With the condition of these becoming bearer, the avenue is closing.

Anecdotes suggest money used to be laundered out of the country through cash carriers and hundihawalaNow not only these transactions are becoming difficult, but more importantly to park the money abroad in real estate or in other assets is becoming increasing difficult. Sooner or later, the money has to come back into the system. It’s advisable for government to expedite it by reducing the frictions. One road black is WHT tax on banking transactions.


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