The Securities and Exchange Commission of Pakistan (SECP) has proposed exemption of income tax on debt securities (bonds and Sukuk) issued by Pakistan Mortgage Refinance Company (PMRC) for a period of 10 years. Budget proposals of the SECP for 2018-19 revealed that in Second Schedule Part-I, a new clause be inserted as 144: "Any income derived by any person on debt securities, bonds and Sukuk issued by Pakistan Mortgage Refinance Company (PMRC) including any gain on disposal of such debt securities, bond and Sukuk for a period of 10 years."
The description of budget proposals revealed that the exemption of income tax on the income and gains derived by investors on their investment in debt securities (bonds) and Sukuk issued by PMRC (collectively referred to as "PMRC Bonds") to refinance residential mortgage market; and exemption of Capital Gains Tax on gain on sale of PMRC Bonds by the investors; however, a holding period should be defined in case of capital gain tax.
The impact of the proposal is to obtain easy access to housing loans at reasonable cost, to obtain attractive and affordable housing loan packages characterized by fixed rates for longer periods, to achieve the government of Pakistan's policy of encouraging home ownership to middle and low-income groups, to encourage property development by developers and related spin-off effects such as the creation of employment and stimulation of the local economy and economic activity in construction industry through mortgage financing may result an additional collection in general sale tax and duties.
Similarly, with the sale and purchase of homes, the provincial governments will also be generating stamp duties and transfer fee as per the provincial tax rates. PMRC's bonds will provide high quality papers to investors and an attractive channel for investment for the pension funds, insurance companies, mutual funds and banks with large surplus long-term funds, seeking long-term investment assets.
PMRC's Bonds and Sukuk will contribute in development of corporate bond market and capital market.
The SECP said that in Pakistan, HFCs, banks and DFIs have no long-term fixed rate funding option. They rely on short-term deposits and short-term bank borrowings to finance their mortgage portfolios. Some Primary Mortgage Lenders (PMLs) consciously keep the size of their mortgage portfolios, small to avoid increasing the corresponding maturity mismatch risk. To minimize interest rate risk, PMLS offer only adjustable rate mortgages (ARM) with rates typically tied to 1-year KIBOR. These products pass the interest rate risk onto individual borrowers who are not equipped to handle it. In high interest rate/inflationary environments, upward adjustments in mortgage rates significantly increase borrower delinquencies. This in turn increases the non-performing loans of the banking sector. As a result, banks have adopted a cautious attitude towards mortgage lending. This was the case in Pakistan after the 2008 financial crisis. The lack of long-term funding has also resulted in the PMLS offering mortgage tenors/terms that are typically for 15 years instead of the 25-30 years' term needed to make housing finance more affordable for borrowers, particularly for the middle and low-income borrowers. The lack of sustainable long-term funding is another reason why Pakistan has no specialized housing finance company operating in the private sector despite a vast market opportunity.