Capital markets are driven by liquidity and the recently announced fiscal bill falls short of addressing key liquidity concerns including the mounting inter-corporate debt in the power sector which is not only hampering the power sector, but also continues to hurt the entire economy.
The bill approved by the Parliament focuses on modest growth; through the rationalisation of the tax mix, abolition of federal excise duty (FED) and the removal of special excise duty on a number of items, along with a token one percent reduction in general sales tax to 16 percent.
Support from the International Monetary Fund (IMF) for the balance of payments and proceeds under the Coalition Support Fund (CSF) from the United States of America have so far helped the economy stay afloat. However deteriorating relations between Pakistan and the US in the aftermath of the killing of Osama bin Laden are choking the funding to the country, which may turn the economic situation for the worse.
No austerity measures have been undertaken despite calls for such steps by reputed economic experts. With the elections around the bend, government appears all set to dish out cash grants to shore up its vote bank. Revenue mobilization measures lack teeth and in all likelihood, the wealthy and powerful will once again manage to evade the tax net.
The positive announcements for the capital markets in the budget for 2011-12, were few and far in between. The following are the most relevant announcements and their likely impact on the country's capital markets:
Removal of Capital Value Tax on Modaraba certificates/shares/instruments of Redeemable capital:
This move will also encourage the listing of Modaraba certificates, TFCs, Commercial Paper and facilitate their trade through BATS. It shall bolster upcoming debt issues and enhance debt instruments marketability to all kinds of investors.
Impact: Short-term: Neutral to Positive, Long-term: Neutral to Positive
-- Tax Credits for enlistment on stock exchange
New listed companies would be able to enjoy 15% tax credit of their tax payable in the respective tax year.
Impact: Short-term: Neutral to Positive, Long-term: Positive
-- Total Tax relief for 100% equity financed projects
No mentionable mega project has been initiated in the country based on 100 percent equity financing for a long time in Pakistan so this step is unlikely to draw new initial public offerings (IPO). Generally the capital structure of large scale projects involves debt financing to achieve an optimal level of debt to maximise the shareholders earnings from the business.
After all it is the shareholder's capital which is at risk, as creditors enjoy preferential rights over them. The equity holder has a limited liability up to his shareholding in the project (however actually unlimited liability, as almost all banks take Personal Guarantees from the sponsor directors).
Impact: Short-term: Neutral to Positive, Long-term: Neutral to Positive
-- Tax Credits for shares & life insurance
The holding period enhanced to 3 years from 1 year bodes well for the stock markets. Life insurance premiums have also been included in this relief meant for individuals.
Impact: Short-term: Neutral to Positive, Long-term: Positive
-- Tax Credits for Approved Pension Schemes:
The maximum limit of Rs 500,000 for claiming tax rebate has been removed. This measure was long overdue and will likely bode well for long-term economic growth. However serious pension reforms need to be undertaken by the government and the SECP needs to move towards market-based mechanisms.
Non-funded defined benefit pension schemes are causing anomalies in the present system and will become a major headache for the federal government since the actuarial pension liability is already close to Rs 1 trillion, forcing government to raise debt as well as taxes to pay this liability.
Impact: Short-term: Positive, Long-term: Positive
-- Advance Tax against Capital Gains Tax
Small investors were not exempted from capital gains tax (CGT). Instead minor relief has been given to them by extending the time limit for depositing advance income tax to 21 days instead of 7 days after the close of the quarter.
Impact: Short-term: Neutral, Long-term: Neutral
-- Profit on Debt
Withholding tax on government securities has been announced as full & final tax for individuals as well as foreign investors like other fixed income instruments. This may result in liquidity flows towards risk-free assets, away from the equity markets.
Impact: Short-term: Negative, Long-term: Negative
-- Dividend received by a Banking Company from it AMC
To discourage banks from setting up asset management companies (AMC), and capitalising them through the issue of bonus shares, withholding tax on dividends from AMCs to the holding bank has been doubled to 20 percent. The move may hamper profitability prospective for banks.
Impact: Short-term: Neutral, Long-term: Neutral to Negative
-- Withdrawal of sales tax exemption on agricultural inputs
Tractors, pesticides and fertiliser have been subjected to GST on domestic and import stage. The resultant increase in cost will likely be passed on to consumers, straining the farmer's ability to afford these inputs.
Impact: Short-term: Neutral to Negative, Long-term: Negative
-- Challenges and outlook for Capital Markets:
Although structural reforms have become a dire necessity, the government has remained largely unable to move in this direction given the ongoing war on terror, last year's floods and a host of other challenges. The central bank has also remained unable to contain inflation despite a towering policy rate of 14 percent, largely due to excessive government borrowing from SBP.
Inflation and high interest rates have knocked out participants from local capital markets and trade volumes are paltry. Foreign liquidity has driven gains in the oil and gas sector but may dwindle if current socio-economic crises persist. Domestic investors also appear reluctant in injecting funds in to the markets at current levels. The year appears fraught with perils for the country's capital markets.
The writer is a Senior Vice President at Arif Habib Investments. He can be reached at tanweer.haral@arifhabib.com.pk