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BANKING LAW
Submitted To:
MISS. UZMA
Project On: BUDGET AND MONETARY POLICY OF STATE BANK OF PAKISTAN Submitted By: SALMA BASHIR SANA KHALID NASIBA WARIS SAMEERA SOBIA IKHLAQ KIRAN ZAHRA SABA KHURSHED 126 127 139 1542 1548 1550 1541
Section: C (Morning)
Semester 6th
The State Bank of Pakistan (SBP) is the central bank of Pakistan. While its constitution, as originally laid down in the State Bank of Pakistan Order 1948, remained basically unchanged until January 1,1974, when the bank was nationalized, the scope of its functions was considerably enlarged. The State Bank of Pakistan Act 1956, with subsequent amendments, forms the basis of its operations today. The headquarters are located in the financial capital of Pakistan, Karachi with its second headquarters in the capital, Islamabad.
History
Before independence on 14 August 1947, the Reserve Bank of India (central bank of India) was the central bank for what is now Pakistan. On 30 December 1948 the British Government's commission distributed the Bank of India's reserves between Pakistan and India - 30 percent (750 M gold) for Pakistan and 70 percent for India.
The losses incurred in the transition to independence were taken from Pakistan's share (a total of 230 million). In May, 1948 Muhammad Ali Jinnah (Founder of Pakistan) took steps to establish the State Bank of Pakistan immediately. These were implemented in June 1948, and the State Bank of Pakistan commenced operation on July 1, 1948
Departments
Agricultural Credit Audit Banking Inspection Banking Policy Banking Supervision Corporate Services Economic Policy Exchange and Debt Management Exchange Policy Human Resource Information System Islamic Banking Legal Services Payment System Research Statistics Real Time Gross Settlement System (RTGS System) Small and Medium Enterprises Training and Development Department (TDD)
MEMBERS
1. Central Board of s Chairperson 2. The Secretary Finance Member 3. Mr. Khair Mohamed Junejo Member 4. Mr. Ehsen Rashid 5. Mr. M. Yaqoob Vardag Member 6. Mr. Mohsin Aziz Member 7. Dr. Wasim Azhar Member 8. Mr. Kamran Y. Mirza Member 9. Mr. Alman A. Aslam Member 10. Mr. Riaz Ahmed Secretary
Functions
Under the State Bank of Pakistan Order 1948, the state bank of Pakistan was charged with the duty to "regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in Pakistan and generally to operate the currency and credit system of the country to its advantage". A large section of the state bank's duties were widened when the State Bank of Pakistan Act 1956 was introduced. It required the state bank to "regulate the monetary and credit system of Pakistan and to foster its growth in the best national interest with a view to securing monetary stability and fuller utilization of the countrys productive resources". In February 1994, the State Bank was given full autonomy, during the financial sector reforms. On January 21, 1997, this autonomy was further strengthened when the government issued three Amendment Ordinances (which were approved by the Parliament in May 1997). Those included were the State Bank of Pakistan Act, 1956, Banking Companies Ordinance, 1962 and Banks Nationalization Act, 1974. These changes gave full and exclusive authority to the State Bank to regulate the banking sector, to conduct an independent monetary policy and to set limit on government borrowings from the State Bank of Pakistan. The State Bank of Pakistan also performs both the traditional and developmental functions to achieve macroeconomic goals. The traditional functions may be classified into two groups: 1. The primary functions including issue of notes, regulation and supervision of the financial system, bankers bank, lender of the last resort, banker to Government, and conduct of monetary policy. 2. The secondary functions including the agency functions like management of public debt, management of foreign exchange, etc., and other functions like advising the government on policy matters and maintaining close relationships with international financial institutions.
Regulation of liquidity
The State Bank of Pakistan has also been entrusted with the responsibility to carry out monetary and credit policy in accordance with Government targets for growth and inflation with the recommendations of the Monetary and Fiscal Policies Co-ordination Board without trying to effect the macroeconomic policy objectives. The state bank also regulates the volume and the direction of flow of credit to different uses and sectors, the state bank makes use of both direct and indirect instruments of monetary management. During the 1980s, Pakistan embarked upon a program of financial sector reforms, which lead to a number of fundamental changes. Due to these changed the conduct of monetary management which brought about changes to the administrative controls and quantitative restrictions to market based monetary management. A reserve money management programme has been developed, for intermediate target of M2, which would be achieved by observing the desired path of reserve money - the operating target.
bank was required to maintain capital and unencumbered general reserves equivalent to 8 per cent of its risk weighted assets. The "Rules of Business" for NBFIs became effective since the day NBFIs came under State Banks jurisdiction. As from January, 1997, modarbas and leasing companies, which is also specialized type of NBFIs, are being regulated /supervised by the Securities and Exchange Commission (SECP), rather than the State Bank of Pakistan?
Introduction to budget
An estimate, often itemized, of expected income and expense for a given period in the future. A plan of operations based on such an estimate An itemized allotment of funds, time, etc., for a given period. Forecast of governmental expenditures and revenues for the ensuing fiscal year. In modern industrial economies, the budget is the key instrument for the execution of government economic policies. Because government budgets may promote or retard economic growth in certain areas of the economy and because views about priorities in
government spending differ widely, government budgets are the focus of competing political interests.
Structural measures: Adoption of Harmonized Commodity Description and Coding System - 2007 Version. Necessary additions/deletions and amendments made in Pakistan Customs Tariff.
Sect oral industrial incentives: In order to enhance local industrialization, capacity building, production competitiveness efficiency and product present ability, duty rates on raw materials, parts and components for manufacturing of the following items/products have either been reduced or eliminated: CNG compressors. Paper and paperboard. Items/equipments which have dedicated use in non-conventional/ Alternate renewable energy resources like solar, wind and bio tech. Gum base. Transformers, submersible motors, electricity meters, switchgears and electric bulbs and tube lights. Light engineering products. Polystyrenes and their raw materials. Energy saving lamps and its raw materials/ parts. Petroleum bitumen/ asphalt. Footwear. Football bladder. Aviation equipments.
New sectors/sub-sectors have been added under the incentive regime for local manufacturing. Existing exemption regime available to different industrial segments has been deepened. Reduction/elimination of duty for introduction of Second Generation Tariff Policy Reforms for: Gems & Jewelry Furniture Marble & Granite Horticulture Surgical equipment/medical devices.
Poultry feed items, poultry vitamins, evaporation air coolers, insulated sandwich panels and silos for storage of poultry have been exempted from duty. Increase in duty rates:
In order to safeguard the local industry from an onslaught of foreign goods duty rates have been increased on import of poultry meat, welded stainless steel pipes etc. Duty rates on vehicles have been increased around the effective rate of CVT which has been merged in customs duty. For up to 800cc cars there was no CVT, therefore rate of duty against these vehicles has not been changed. Revenue measures: Levy of 1% Special surcharge on imports excluding vegetables/pulses, edible oil/ghee, crude petroleum, furnace oil, HSD, medicines, fertilizers, imports under chapter 99, temporary imports etc. Merger of Capital Value Tax (CVT) in Customs duty. Levy of regulatory duty on export of specified metals and articles thereof.
Relief measures: Amnesty scheme for condo nation of delays in submission of installation/ consumption certificates etc. Amnesty from payment of fine/penalties and surcharges on payment of principal amount.
Other measures: Downward revision of 5 yrs. capping to 3 yrs. for import of old/used cars/jeeps. 5 yrs. tariff plan for auto sector. Reduction/elimination of duty rates on specified diesel generating sets. Inputs used by the newspaper industry are being provided at concessionary rate.
Duty rates on equipments for broadcasting sector have been reduced to 5%. Extension of incentives for expansion and up-gradation of existing hospitals. Inclusion of PSF in DTRE scheme, payment of duty drawback and R&D Support .
Legal changes:
Legislative changes have been suggested for simplification of law/ procedures. Section 25 and 25A of the Customs Act have been amended to address the phenomenon of under invoicing.
Zero-rating of sales tax on sewing machines and bicycles. Zero-rating of sales tax on sewing machines and bicycles is aimed at providing relief to the general public.
Exemption of sales tax on cottonseed oil: Cottonseed oil is the only locally produced vegetable oil subject to sales tax. To bring it at par with other local vegetable oils and to provide relief to the oil mills, sales tax on cottonseed oil has been exempted. Sales tax zero-rating on writing inks and exercise books: To promote education and to make available essential educational items at reduced cost, sales tax on writing ink and exercise books has been zero-rated. Amnesty scheme for waiver of default surcharge and penalty. To encourage the taxpayers to clear their outstanding tax liabilities and to reduce the legal disputes, amnesty of default surcharge and penalties has been announced. Taxpayers who wish to avail the amnesty may deposit the principal amount of tax by 30.06.2007. Abolition of excise duty on motor gasoline and jet fuel. In order to rationalize the taxation on POL products, excise duty @ Rs. 88/- paisas per liter on motor gasoline and Rs. 6/- paisas per litre on jet fuel has been abolished. The products remain chargeable to sales tax. Abolition of excise duty on petroleum bitumen. To fulfill the increasing demand of bitumen in the country due to extensive roads construction, it is important to make the imported bitumen compatible with locally produced bitumen. Therefore, excise duty @ Rs. 2000/- PMT on bitumen has been abolished. Customs duty is also being revised downwards . Zero-rating of sales tax on trailers and semi-trailers. To promote the domestic production of better trailers and semi-trailers for the improvement of goods transport, it is proposed to zero-rate sales tax on trailers and semitrailers. Abolition of excise duty on exchange companies and health insurance.
To promote the flow of remittances through official channels, excise duty @ 5% on exchange companies has been abolished. Moreover, to provide level playing field to nonlife insurance companies in the field of health insurance vis--vis life insurance companies, excise duty leviable @ 5% on health insurance has been abolished. Exemption of sales tax arrears of industries located in FATA/PATA. The industries located in FATA/PATA are closed because of sales tax arrears created as a result of the relief provided to the industries by Peshawar High Court which was later on decided against by the Supreme Court. To provide relief to the industries in FATA/PATA, it is proposed to exempt the arrears of sales tax against the units subject to the condition that disputed excise duty and customs duty is duly deposited by them. Zero-rating of utilities of rice exporters. Local supply of rice is exempt being agricultural produce. Exports are also zero-rated but the exporters have to obtain refund of small incidental e.g. sales tax on utility bills. To boost the industry, it is proposed to zero-rate the utility of rice exporters. Exemption of sales tax on glass bangles. To provide relief to the traditional bangle industry of Sindh, glass bangles have been exempted from sales tax. Abolition of excise duty on cable TV operators. To boost the media industry and to provide cheaper entertainment to the general public, excise duty @ Rs. 8/- per connection per month leviable on cable TV operators has been abolished. Zero-rating of sales tax on uncooked poultry meat. To decrease the cost of doing business for the organized sector in poultry meat processing, sales tax on uncooked poultry meat has been zero-rated. Exemption of sales tax on surgical tapes and ultrasound gel. Medicines are exempt from sales tax. Therefore, the scope of exemption has been extended to two more medicinal items which are surgical tapes and ultrasound gel.
REVENUE MEASURES
Extension of scope of excise duty on financial services
The existing levy of excise duty @ 5% on non-fund banking services is being extended to include all non-fund services except cheque book issuance charges, Umra and Hajj service charges, cheque return charges and utility collection charges. Rationalization of excise duty on international air travel. For the facilitation of passengers various levies on international air travel i.e. excise duty, foreign travel tax and Government airport tax are being clubbed together in the name of Air Travel Tax. (ATT). The rate is same but exemption for passenger coming from abroad is being withdrawn. Increase in retail price of cigarettes to increase the incidence of tax. Cigarettes are chargeable to excise duty on the basis of retail price. To complement the growth in cigarette industry and to enhance excise duty collection without disturbing the present three tier system for the purposes of levy, retail price of cigarettes is increased by 7%. Increase in rate of sales tax from 15% to 20% on specified raw materials. To discourage the informal manufacturing in iron and steel, plastics and paper, the rate of sales tax on import and supply of their raw materials as well as some specified chemicals is being increased from 15% to 20% which will induce the informal manufacturing sector to be compliant to obtain input tax adjustment as the end products remain chargeable to sales tax @ 15%. Withdrawal of input tax adjustment on the supply of utilities (electricity and gas) to the residential colonies of manufacturers. In the light of best VAT practices, input tax adjustment is being disallowed on supply of utilities (electricity and gas) to the residential colonies of manufacturers. This measure will also settle many legal disputes. Withdrawal of zero-rating of chemicals of multiple usage. Under SRO 525(I)/2006, a large number of chemicals used in the five major export oriented sectors have been zero-rated. Keeping in view the multiple usage of some of the chemicals are also used in other industries, such chemicals are being taken out of zerorating notification. Collection of sales tax of CNG stations from gas distribution Companies. To rationalize the collection of sales tax on supplies made by CNG stations, the responsibility to charge and deposit sales tax is being given to the gas distribution companies. CNG stations will not be required to remain registered with sales tax or keep any records.
STREAMLINING MEASURES Abolition of sales tax on advance payments To simply the sales tax regime, sales tax leviable on advance payments received by registered persons is being abolished. Now the registered persons shall be required to charge sales tax at the time of delivery of goods. Restriction of input tax adjustment To check the mal-practices in input tax adjustment, the adjustment of input tax is being restricted to 90% of output tax. The system of adjustment notes and adjustment advices causing problems for the taxpayer is being abolished. Provisions for payment of sales tax refund along with duty drawback. The scope of sales tax refund is now being limited to zero-rated supplies or exports only. A scheme is being envisaged whereby the exporters of five zero-rated sectors shall be able to obtain sales tax refund on packing material, chemicals along with customs duty drawback. Withdrawal of special procedures for commercial importers, iron & steel sector, restaurants, biscuits and confectionery.
With a view to remove distortions in the sales tax system a number of special treatment
procedures are being abolished. Now commercial importers, iron & steel sector, restaurants and biscuit and confectionery sector shall operate in standard sales tax procedure of payment of due tax after adjusting the input tax on purchases from the output tax charged on supplies.
Introduction of concept of withholding agents in sales tax.
To plug the revenue gap in Government supplies and to collect the due tax from general orders supplies and wholesalers, the system of withholding of sales tax by the Government agencies is being introduced . Immediate refunds to Large Taxpayers against bank guarantees. To expedite the sales tax refunds of large taxpayers registered in Large Taxpayers Units, a new procedure has been issued whereby they can claim their sales tax refunds within three days of filing upon submission bank guarantee equivalent to refund amounts. Enhancement in period of record retention. Based on international best practices, the period of record retention is being enhanced to five years from existing three years.
Single sales tax return. Abolishing the various sales tax returns and a separate invoice summary, a single sales tax return has been introduced and invoice summary has been made an annexure to the return for facilitation. Levy and deposit of excise duty in the manner of sales tax. Excise duty shall now be leviable on supplies instead of clearance as done in sales tax and shall be deposited with the return on the 15th day of the following month. Linkage of registration threshold of manufacturers with utility bills. Apart from the existing registration threshold of supplies of Rs. 5 million per annum, a new parameter based on utility bills is being introduced by amending the Sales Tax Act, 1990. Whereby the manufacturers having utility bills of more than Rs. 600,000 per annum shall also be required to obtain sales tax registration.
10. Permanent Establishments of non-resident Exploration and Production Companies exempted from withholding tax on supply of crude oil and gas. 11. E&P Companies exempted from WHT on imports (other than vehicles). 12. Review of Law Relating to Holding Companies. 75% share holding required if none of the companies is a public listed limited company. 55% share holding required if one of the group companies is a public listed limited company. Group relief restricted to domestic companies. Companies engaged in trading will not qualify for relief. Current tax year losses can be surrendered by holding company to a subsidiary or between subsidiaries which fulfill the requirements of share holding; Inter corporate dividend - liable to 10% adjustable withholding tax.
19. Separate Schedule for Banking Companies introduced. 20. Maximum limit of investment in IPOs to avail tax credit enhanced from Rs. 200,000 to 300,000. 21. Presumptive Tax Regime introduced for service providers to exporters/export house under the Trade Policy withdrawn. 22. Set off of brought forwarded losses in the event of amalgamation/merger of companies withdrawn. 23. Withholding tax on sale of goods made adjustable for listed public companies. 24. Tax in respect of income from construction contracts out side Pakistan to be charged at the rate of one per cent of the gross receipts provided that such income is brought into Pakistan in foreign exchange through normal banking channel. 25. Withdrawal of withholding tax on payments to travel agents on sale of air tickets where withholding tax on commission is already deducted. 26. Payments received by non-resident news agencies, syndicate services and individual contributors/writers not having permanent establishment in Pakistan will not be subjected to withholding tax on services provided. 27. Advertising services provided by owners ofnewspapers/magazines in the noncorporate sector taken out of Presumptive Tax Regime. 28. Withdrawal of CVT on import of cars and power of attorney executed between first relations. 29. Withholding tax @ 5% on purchase of locally manufactured cars. 30. Federal Excise duty also to be included in the value of goods for withholding tax purposes at the import stage.
Withholding tax on import of edible oil reduced from 3% to 2%. Import of polyester filament fiber yarn to be subjected to 5% withholding tax. Import of Bitumen, pesticides/wedicides and FWT to be subjected at reduced withholding tax rate of 2%. 32. Employers authorized to give credit of tax withheld from employees under different withholding provisions during the tax year. Also authorized to adjust tax credit allowable to salaried taxpayers having salary income only. 33. Ginners provided option to pay WHT at the prescribe rate. 34. Exclusion of companies (Large Import Houses) importing bulk industrial raw material from presumptive tax regime. 35. Professional Firms to be taxed at par with other AOPs.
C. REVENUE GENERATION:
36. Withholding tax on non-corporate commercial and industrial consumers of electricity made minimum tax liability. 37. Withdrawal of exemption to Mutual Fund on CFS interest income. 38. Companies to pay advance tax in the first year of operations.
D. SIMPLIFICATION:
39. Small company redefined with following characteristics; - Paid up capital = 25 (M) - Annual Sales = 250 (M) - Employment Limit = 250 persons 40. Presumptive tax regime for Compressed Natural Gas (CNG) stations and withholding tax @ 6% of gas bill.
E. DOCUMENTATION:
41. Electronic filing of returns and withholding statements for corporate taxpayer made mandatory. 42. Filing of Wealth Statement mandatory for taxpayers having income of Rs. 500,000/- or more Commissioner authorized to call for the Wealth Statement.
Policy Objectives:
1 2 3 4 5 Industrial incentives for growth and expansion. Discouraging import of non-essential and luxury items. Minimizing the cost of doing business. Cascading principle in tariff rates maintained as guiding principle (primary raw materials @ 0%-5%, secondary/components @ 5-10% and finished goods @ 2035%). Amendments in Customs Act, Rules and Procedures for further simplification.
Relief Measures:
The local industry producing water dispensers, hooks & eyes, aluminum alloy, electric irons, mini choppers, vacuum cleaners, central heating gas boilers, mini ovens, gas heaters, gas stoves/cooking ranges with ovens, air handling equipments, central heating equipments, UPS, Chlorinated paraffin, chrysotile cement pipes, sheets & fittings and perforated steel products have been provided inputs at 0%, 5% and 10% rates of duty. 1 2 Fully dedicated CNG buses exempted of from duty. 3 Pharmaceutical industry given specified active ingredients, chemicals and packing materials at 5% duty. 4 Eighteen medicines used for cancer/heart treatment etc. exempted from customs duty. 5 Bitumen, JP4&JP8 exempted from duty. Duty rate on base oil for lubricating oils reduced from 20% to 10%. 6 Rice seeds, energy saving lamps, dredgers, specified solar energy equipments exempted from customs duty. 7 Power plants imported by WAPDA on temporary basis exempted from customs duty. Reduction of duty on calcium carbide from 15% to 5%, PTA from 15% TO 7.5%, PSF 6.5% to 4.5%, Caustic soda from Rs.5000/MT to Rs.4000/MT, Printing screens from 15% to 10%, nickel not alloyed from 5% to 0%, Textile buckram from 25% to 10%. 8 Manufacturers have been allowed to import samples duty free as per specified conditions in chapter 99 of PCT. 9 Seized/confiscated vehicles as on 31st May, 2008 may be released against payment of leviable duty/taxes and 30% redemption fine.
Revenue measures:
1 2 Duty rates on non-essential & luxury items have been increased. Hence, duty rate on dairy products, fruits, chewing gum, chocolate, processed food, fruit juices, aerated waters, ceramic products, air-conditioners/refrigerators, electric fans, toasters, micro wave ovens, televisions, furniture and lighting equipment etc increased from 25% to 35%. Duty rates on cosmetics increased from 20 -25% to
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35%. Duty rate on electric ovens/ cooking ranges etc. increased from 20% to 30%. Customs duty @ Rs. 500/ per set levied on import of mobile phone. Customs duty on betel leaves increased from Rs.150/kg to Rs. 200/kg. Duty rate increased on sulphonic acid from 10% to 15%. Duty rate increased on CKD/SKD of sewing machines from 5% to 20% A uniform rate of 30% specified for import of special purpose motor vehicles. Increase in duty rates on import of cars/jeeps above 1800cc from 90% to 100%. Fixed duty/tax rates on old and used cars/jeeps increased by 10%.
extended concessionary duty regime in line with SRO 565(I)/2006, as available to Pakistan based manufacturers. Specified industries/projects have been de-linked from the local manufacturing condition for import of required machinery, equipments and raw materials etc. Tariff based system (TBS) for auto sector has further been improved. Release of held up indemnity bonds is eased out.
Legal changes:
Following amendments have been proposed in the Customs Act, 1969: 1 2 Clause (ab) in section 21 of the Customs Act proposed to be omitted. 3 A new section 3DD is proposed to be introduced in the Customs Act, 1969 for constituting a Directorate General of Post Clearance Audit (PCA) 4 A proviso is proposed to be added to section 155F of the Customs Act for suspension of unique user identifier of any person. 5 Section 156 is proposed to be amended to provide for penalizing the custodian of any goods for involvement in an offence under the Customs Act. 6 Section 179 of the Customs Act is proposed to be amended for allowing adjudicating officers to decide cases within 120 days. 7 Section 194C is proposed to be amended for enhancing the limit of single bench of the Appellate Tribunal from five to ten million rupees. 8 A new sub-section 4A is proposed to be added in section 195C for redresser of grievances of an aggrieved person June 10, 2008
1. The basic limit of exemption from income tax in respect of salaried person is proposed to be increased from Rs.150, 000 to Rs.180, 000. In the case of women salaried taxpayer the basic exemption limit is proposed to be increased from Rs.200, 000 to Rs.240, 000. 2. The concept of marginal tax relief for the salaried persons is being introduced to cater for the negative impact of taxation under the present flat tax rate system. The marginal increase in salary income is proposed to be taxed at the rates not exceeding 20% to 50% allowing sufficient relief in tax payable. 3. Minimum tax payable on the declared turnover @ 0.5% is being proposed to be withdrawn. 4. In future instead of tax holidays, First Year Allowance in the shape of accelerated depreciation @ 90% is proposed to be allowed to the industrial undertakings established in the specified rural and undeveloped areas. 5. The value of accommodation provided to the salaried persons in small cities is proposed to be taken at 30% instead of 45% of the minimum time scale of the employees for the purpose of taxation. 6. At present inter corporate dividend in respect of companies entitled to group relief under section 59AA is exempt from tax. The facility is proposed to be extended to the companies eligible for group taxation under section 59B. 7. Exemption available to capital gain on shares of listed companies up to the tax year ending 30th June 2008 is proposed to be extended to 30th June 2010 without any change in the withholding tax and CVT regime. 8. To encourage amalgamation of banking companies, modarabas and insurance companies the facility of carry forward of accumulated loss is proposed to be allowed for a period of six years in the case of amalgamated or amalgamating companies. 9. Rice Exporters Association of Pakistan (REAP) is proposed to be allowed the facility of reduced withholding tax rate of 1% in respect of payments payable for supply of rice to M/s Utility Stores Corporation. 10. Income derived by a project approved by Designated National Authority (DNA) from transfer/sale of CDM emissions credit i.e. Certified Emissions Reduction (CER) etc is being proposed to be exempt from income tax. 11. In the case of bank no CVT is proposed to be charged on General Power of Attorney unless it is used into force the mortgage of property offered as collateral against a loan.
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12. In the case of a small company if turnover exceeds Rs.250 million, the income attributable to the turnover exceeding the said limit, is proposed to be charged to tax at progressive slab rate of 25%, 30% and 35%, so that the company is able to progress still retaining its status of a small company. 13. Income shown as unrealized gains in the case of non life insurance companies would be excluded from the taxable income and not charged to tax.
14. Proportionate relief is proposed to be allowed in the amount of penalty imposed
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in tax evasion cases where the appellate authorities reduce the quantum of concealed income and tax charged thereon. 1 15. A scheme for waiver of additional tax and penalty etc. is proposed to be introduced where the taxpayer is able to pay the principal amount of tax within a certain period.
REVENUE MEASURES:
1 2 16 At present gross rental income from property is chargeable to tax at a flat rate of 5%. It is proposed that no tax my be charged on income up to Rs.150, 000 and tax income from this source on progressive rates of 5%, 10 and 15%. However, in the case of a company basic exemption of Rs.150, 000 would not be available. 17 At present withholding tax rate of 5% and 1% is applicable in respect of commercial and manufacturer importers respectively. It is proposed to apply a uniform rate of 2% for both the categories of importers. 18 Withholding tax collected on electricity bills is being rationalized to collect the same @ 10% on bill amount exceeding Rs.20,000 per month which would be adjustable. Withholding Tax on bull amount of Rs.2000 and below would be collected at the previous rates. 19 The pensioners, senior citizens and widows who are exempt from withholding tax in respect of profit from pensioners benefit scheme and behold fund would not be charged to tax at a rate not exceeding 10% of such profit. 20. Exemption from income tax available to Pakistan Cricket Board is proposed to be withdrawn. 21. In order to encourage and promote investment in the business and industries, scheme of investment tax is being introduced, allowing immunity from probe in respect of any moveable and immoveable assets on the value of which tax @ 2% is paid.
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22. The rates of advance tax, collected at the time of renewal of registration of private motor cars, are proposed to be rationalized by making about 30% to 40% Increase in WHT rates. 23. Withholding tax on monthly telephone bills exceeding Rs.1000 is proposed to be collected @ 10%. 24. Association of person and individuals having annual turnover of Rs.50 million respectively are proposed to be made withholding tax agents for the purpose of tax deduction on payments relating to on sale of goods, services rendered and execution of contracts. 25. The existing exemption regime provided under the Second Schedule of the Income Tax Ordinance, has been reviewed to delete all redundant and unjustified exemptions. 26. Profit transferred by a branch of foreign company out of Pakistan are proposed to be treated as dividend and chargeable to tax @ 10% as final tax. 27. The limit of donations eligible for tax credit in the case of individual/association of persons and companies presently admissible @ 30% and 15% respectively are proposed to be reduced to 10% of the taxable income. 28. It has been proposed that reinsurance premium paid to overseas insurance companies may be subjected to withholding tax @ 5% which would be a final tax. 29. Withholding tax on cash withdrawal from banks presently collected @ 0.2% is proposed to be collected @ 0.3% on cash withdrawal. 30. A new taxation system is being introduced for builders and developers, whereby the builder would be required to pay tax @ Rs.50 per sq. ft. of the covered area of a unit. The developer of open plots would be subjected to tax @ Rs.100 per sq. yard of the plot. 31. The facility of reduced tax rate to a cooperative society or a finance society is proposed to be withdrawn and would be treated at par with the company for the purpose of taxation. 32. Exemptions from income tax available under the other statutes are proposed to be withdrawn unless provided specifically under 2nd Schedule to the Income Tax Ordinance, 2001. 33. Payments made to media companies out side Pakistan are proposed to be subjected to WHT @ 10%, to be treated as final tax.
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34. Any payment made through a foreign currency account and exchange companies proposed to be included in the payments requiring deduction of WHT unless the CIT has allowed otherwise as provided under section 152 of Income Tax Ordinance, 2001. 35. From the next financial year WHT on purchase of locally manufactured motor car or jeep is proposed to be collected by a motor vehicle registration authority at fixed rates depending on the engine capacity. 36. Thin capitalization rule is proposed to be made applicable to branches of foreign companies operating in Pakistan. 37. The discrimination in tax rates applicable to exporters is being removed by withdrawal of provisions allowing deduction of tax at a rate lesser than 1%. 38. The tax collected from the members of stock exchange on sale as well as purchase of shares in lieu of commission income and trading of share is proposed to be made a minimum tax on income of such members/ brokers.
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TECHNICAL MEASURES:
1 1 39. The period of payment of tax due from a taxpayer is being reduced from 30 days to 15 days. 40. The provisions of section 115 of the Income Tax Ordinance, 2001 are proposed to be amended so as to ensure filing of wealth statement by a salaried taxpayer whose income is more than Rs.500, 000 even if he is not required to file a return of income. 41. Sub-section (6A) of section 153 is being amended to clearly state the intention of legislature that tax deducted in the case of non-corporate taxpayers on supply of manufactured goods shall be a final tax. Sub-section (6B) is proposed to be deleted. 42. To bring clarity in law, clause (46) of Part I of the 2nd Schedule to the Income Tax Ordinance, 2001 is being amended so that exemption is provided from deduction of tax on supplies made by PE of non-resident E&P companies. 43. To ensure correct recording of sale, Electronic Tax Register (ETR) are planned to be installed at selected wholesale and retail outlets with known high volume of business. For the purpose amendment is being proposed to be made in the Income Tax Law and Rules.
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44. In order to ensure quick disposal of cases remanded back by the ITAT to the CIT (A) for making a fresh order, a limitation of six months is being provided in the law. 45. The limit for payment of salary to be paid by an employer through cheque or transfer to employees account is being increased from Rs.10,000 to Rs.15,000. 46. A time limit of 90 days is being provided under the Income Tax Rules, 2002 for making an order by the FBR on receipt of recommendations from the Alternate Dispute Resolution Committee (ADRC). 47. In case of withdrawals from superannuation fund liable to WHT the deduction of tax is proposed to be made at the rate applicable to the year of withdrawal instead of average rate of the preceding three years. 48. In order to create linkages between voluntary and occupational savings schemes, the subscriber of a Recognized Provident Fund is proposed to be allowed to transfer funds to a voluntary pension fund scheme. 49. The provisions of 7th Schedule allowing deduction on account of nonperforming loans as per prudential regulation issued by the SBP are proposed to be deleted. From the next financial year such deductions would be allowed under sections 29 and 29A of the Income Tax Ordinance, 2001. 50. A person making payment to a non-resident would not be required to give a notice to the CIT under section 152(5) of the Income Tax Ordinance, 2001, if no withholding or withholding of tax at a lesser rate is provided under the avoidance of double taxation treaty. 51. Enabling powers are proposed to be given to the FBR to allow exemption from Withholding taxes required under different provisions of the Ordinance. 52. The term local authority as used in section 49 and elsewhere in the Income Tax Ordinance is proposed to be substituted by the term Local Government to bring clarity in the law regarding exemption from income tax. 53. The definition of Urban Area as given under section 7 of the Finance Act, 1989 for the purpose of levy of CVT is being amended to bring it in consonance with the changes made as a result of devolution plan
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MONETARY POLICY
Monetary Policy is the process by which the government, central bank, or monetary authority of a country controls Supply of money Availability of money Cost of money or rate of interest, In the words of Harry G. Johnson, "It is a policy of Central Bank to control the supply of money with the aim of achieving macroeconomic stability". Monetary policy is one of the tools that a national Government uses to influence its economy. Using its monetary authority to control the supply and availability of money, a government attempts to influence the overall level of economic activity in line with its political objectives. Usually this goal is "macroeconomic stability" - low unemployment, low inflation, economic growth, and a balance of external payments. Monetary policy is usually administered by a Government appointed "Central Bank". Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation. Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation.
Overview
Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). A policy is referred to as contractionary if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Further monetary policies are described as accommodative if the interest rate set by the central monetary authority is intended to spur economic
growth, neutral if it is intended to neither spur growth nor combat inflation, or tight if intended to reduce inflation. There are several monetary policy tools available to achieve these ends. Increasing interest rates by fiat, reducing the monetary base, and increasing reserve requirements all have the effect of contracting the money supply, and, if reversed, expand the money supply. Within almost all modern nations, special institutions (such as the Bank of England, the European Central Bank, the Federal Reserve System in the United States, the Bank of Japan or Nippon Gink, the Bank of Canada or the Reserve Bank of Australia) exist which have the task of executing the monetary policy and often independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, however, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight. However the monetary policy of China is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies. The other primary means of conducting monetary policy include: Discount window lending - lender of last resort Fractional deposit lending - changes in the reserve requirement Moral suasion- cajoling certain market players to achieve specified outcomes "Open mouth operations- talking monetary policy with the market
With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with gold, the idea of monetary policy as independent of executive action began to be established. The goal of monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold-backed currencies. To accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both their own borrowers, and other banks that required liquidity. The maintenance of a gold standard required almost monthly adjustments of interest rates. During the 1870-1920 periods the industrialized nations set up central banking systems, with one of the last being the Federal Reserve in 1913. By this point the understanding of the central bank as the "lender of last resort" was understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no small part because of the marginal revolution in economics, which focused on how many more, or how many fewer, people would make a decision based on a change in the economic trade-offs. It also became clear that there was a business cycle, and economic theory began understanding the relationship of interest rates to that cycle. The advancement of monetary policy as a pseudo scientific discipline has been quite rapid in the last 150 years, and it has increased especially rapidly in the last 50 years. Monetary policy has grown from simply increasing the monetary supply enough to keep up with both population growth and economic activity. It must now take into account such diverse factors as: Short Term Interest Rates Long Term Interest Rates Velocity of Money through the Economy Exchange Rates Credit Quality Bonds and Equities (corporate ownership and debt) Government versus Private Sector Spending/Savings International Capital Flows of Money on large Scales Financial Derivatives such as Options, Swaps, Futures Contracts, etc.
A small but vocal group of people advocate for a return to the gold standard (the elimination of the dollar's fiat currency status and even of the Federal Reserve Bank). Their argument is basically that monetary policy is fraught with risk and these risks will result in drastic harm to the populace should monetary policy fail. Others see another problem with our current monetary policy. The problem for them is not that our money
has nothing physical to define its value, but that fractional reserve lending of that money as a debt to the recipient, rather than a credit, causes all but a small proportion of society (including all governments) to be perpetually in debt. In fact, many economists disagree with returning to a gold standard. They argue that doing so would drastically limit the money supply, and throw away 100 years of advancement in monetary policy. The sometimes complex financial transactions that make big business (especially international business) easier and safer would be much more difficult if not impossible. Moreover, shifting risk to different people/companies that specialize in monitoring and using risk can turn any financial risk into a known dollar amount and therefore make business predictable and more profitable for everyone involved.
Economists debate the finer points of the implementation and effectiveness of monetary policy but one thing is obvious. At the extremes, monetary policy is a potent force. In countries such as the Russian Republic, Poland or Brazil where the printing presses run full tilt to pay for government operations, money supply is expanding rapidly and the currency becomes rapidly worthless compared to goods and services it can buy. Very high levels of inflation or "hyperinflation" is the result. With 30-40% monthly inflation rates, citizens buy hard goods as soon as they receive payment in the currency and those on fixed income have their investments rendered worthless. At the other extreme, restrictive monetary policy has shown its effectiveness with considerable force. Germany, which experienced hyperinflation during the Weimar Republic and never forgot, has maintained a very stable monetary regime and resulting low levels of inflation. When Chairman Paul Volcker of the U.S. Federal Reserve applied the monetary brakes during the high inflation 1980s, the result was an economic downturn and a large drop in inflation. Without much debate, the effectiveness of monetary policy, its timing and its eventual impacts on the economy are not obvious. That central banks attempt influence the economy through monetary is a given. In any event, insights into monetary policy are very important to the investor. The availability of money and credit are key considerations in the pricing of an investment.
central bank may have an inflation target of 2% for a given year, and if inflation turns out to be 5%, then the central bank will typically have to submit an explanation. The Bank of England exemplifies both these trends. It became independent of government through the Bank of England Act 1998 and adopted an inflation target of 2.5% RPI (now 2% of CPI). The debate rages on about whether monetary policy can smooth business cycles or not. A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a significant number of prices in the economy are fixed in the short run and firms will produce as many goods and services as are demanded (in the long run, however, money is neutral, as in the neoclassical model).
Developing Countries
Developing countries may have problems establishing an effective operating monetary policy. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is often because the monetary authority in a developing country is not independent of government, so good monetary policy takes a backseat to the political desires of the government or are used to pursue other nonmonetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarisation. Such forms of monetary institutions thus essentially tie the hands of the government from interference and, it is hoped, that such policies will import the monetary policy of the anchor nation. However, recent attempts at liberalising and reforming the financial markets (particularly the recapitalisation of banks and other financial institutions in Nigeria and elsewhere) are gradually providing the leeway required to implement monetary policy frameworks by the relevant central banks.
The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.
Monetary Policy Inflation Targeting Price Level Targeting Monetary Aggregates Fixed Exchange Rate Gold Standard Mixed Policy
Target Market Variable Interest rate on overnight debt Interest rate on overnight debt The growth in money supply The spot price of the currency The spot price of gold Usually interest rates
Long Term Objective A given rate of change in the CPI A specific CPI number A given rate of change in the CPI The spot price of the currency Low inflation as measured by the gold price Usually unemployment + CPI change
The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking the exact same variables (such as a harmonised consumer price index).
Inflation Targeting
Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range. The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar. The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee.
Changes to the interest rate target are made in response to various market indicators in an attempt to forecast economic trends and in so doing keep the market on track towards achieving the defined inflation target. For example, one simple method of inflation targeting called the Taylor rule adjusts the interest rate in response to changes in the inflation rate and the output gap. The rule was proposed by John B. Taylor of Stanford University.
Monetary Aggregates
In the 1980s several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. This approach is also sometimes called monetarism. Whilst most monetary policy focuses on a price signal of one form or another this approach is focused on monetary quantities.
rate within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a special case of the fixed exchange rate with bands where the bands are set to zero.) Under a system of fixed exchange rates maintained by a currency board every unit of local currency must be backed by a unit of foreign currency (correcting for the exchange rate). This ensures that the local monetary base does not inflate without being backed by hard currency and eliminates any worries about a run on the local currency by those wishing to convert the local currency to the hard (anchor) currency. Under dollarisation, foreign currency (usually the US dollar, hence the term "dollarisation") is used freely as the medium of exchange either exclusively or in parallel with local currency. This outcome can come about because the local population has lost all faith in the local currency, or it may also be a policy of the government (usually to rein in inflation and import credible monetary policy). These policies often abdicate monetary policy to the foreign monetary authority or government as monetary policy in the pegging nation must align with monetary policy in the anchor nation to maintain the exchange rate. The degree to which local monetary policy becomes dependent on the anchor nation depends on factors such as capital mobility, openness, credit channels and other economic factors.
Mixed Policy
In practice a mixed policy approach is most like "inflation targeting". However some consideration is also given to other goals such as economic growth, unemployment and asset bubbles. This type of policy was used by the Federal Reserve in 1998.
this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base. The central bank can control the circulation of money through the buying and selling of bonds. If they want to reduce the amount of money circulating then they sell bonds (which are actually pieces of paper) in return for currency/money. They are not allowed to withdraw money. In return they get a really High Interest Rate on their money.
Reserve Requirements
Reserve requirements are a percentage of commercial banks', and other depository institutions', demand deposit liabilities (i.e. chequing accounts) that must be kept on deposit at the Central Bank as a requirement of Banking Regulations. Though seldom used, this percentage may be changed by the Central Bank at any time, thereby affecting the money supply and credit conditions. If the reserve requirement percentage is increased, this would reduce the money supply by requiring a larger percentage of the banks, and depository institutions, demand deposits to be held by the Central Bank, thus taking them out of supply. As a result, an increase in reserve requirements would increase interest rates, as less currency is available to borrowers. This type of action is only performed occasionally as it affects money supply in a major way. Altering reserve requirements is not merely a short-term corrective measure, but a long-term shift in the money supply.
Discount Window
Discount Window is where the commercial banks, and other depository institutions, are able to borrow reserves from the Central Bank at a discount rate. This rate is usually set below short term market rates (T-bills). This enables the institutions to vary credit conditions (i.e., the amount of money they have to loan out), there by affecting the money supply. It is of note that the Discount Window is the only instrument which the Central Banks do not have total control over. By affecting the money supply, it is theorized, that monetary policy can establish ranges for inflation, unemployment, interest rates, and economic growth. A stable financial environment is created in which savings and investment can occur, allowing for the growth of the economy as a whole.
Interest Rates
The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no
perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market. In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate under its control, a monetary authority can contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the money supply.
Currency Board
A currency board is a monetary arrangement which pegs the monetary base of a country to that of an anchor nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are three-fold: To import monetary credibility of the anchor nation To maintain a fixed exchange rate with the anchor nation To establish credibility with the exchange rate (the currency board arrangement is the hardest form of fixed exchange rates outside of dollarisation). In theory it is possible that a country may peg the local currency to more than one foreign currency, although in practice this has never happened (and it would be a more complicated to run than a simple single-currency currency board). The currency board in question will no longer issue fiat money but instead will only issue a set number of units of local currency for each unit of foreign currency it has in its vault. The surplus on the balance of payments of that country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the (net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the hands of the central bank. The virtue of this system is that questions of currency stability no longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade, irrespective of economic differences between it and its trading partners. Hong Kong operates a currency board, as does Bulgaria. Estonia established a currency board pegged to the Deutschmark in 1992 after gaining independence, and this policy is seen as a mainstay of that country's subsequent economic success. Argentina abandoned
its currency board in January 2002 after a severe recession. This emphasised the fact that currency boards are not irrevocable, and hence may be abandoned in the face of speculation by foreign exchange traders. Currency boards have advantages for small, open economies which would find independent monetary policy difficult to sustain. They can also form a credible commitment to low inflation. A gold standard is a special case of a currency board where the value of the national currency is linked to the value of gold instead of a foreign currency.
Quantitative Methods
They consist of those methods which physically affect the amount of credit creation in the economy. They are as:
The fact that how flexible is the economic system. How rapidly, there will be the effect of bank rate on other variables of the economy, like prices, wages, Interest and output, etc.
Commercial banks should abide by the instructions of the central bank. If the central bank brings changes in the rate of interest, the commercial banks should also change the rate of interest. If commercial banks already have excess reserves then commercial banks will not depend upon central bank. It this way, they will not care for changes in the rate of interest from central bank. If economic activity is flourishing or economy is having boom, then the business class will be prepared to pay even higher rate of interest and inflation will not to be controlled.
Open Market Operation This is the second instrument of the monetary policy. Under this technique, the central
bank sells or purchases 'government securities. If the central bank finds that commercial banks are providing excessive loans which are creating inflation. To remove the inflation, the central bank sells the government securities. The commercial banks will purchase these securities to earn interest against such securities. In this way, the resources of commercial banks will go down. They will advance fewer loans. Accordingly, the inflation will be controlled, if there is deflation in the economy. To control the deflation, the central bank purchases the government securities. Then the monetary base of the commercial banks will increase their loaning power will increase. As a result, investment will increase; income and prices will go up. Limitations The problem is that, in most of the countries the money market is not organized where the securities could be sold or bought. The funds which are collected through sale of government securities should not be spent on unproductive fields.
In case of Pakistan, each commercial bank has to keep 5% of its deposit in the central bank. By changing the reserve capital, a central bank can control the supply of money by commercial banks. When there is inflation in the economy. To remove this inflation, the central bank will increase the reserve ratio. As a result, lending of commercial banks will fall. As a result the supply of money will decrease. On the other hand, if central bank decreases the 'reserve ratio, the commercial banks will be having more funds to advance. Accordingly, the deflation could be controlled.
Qualitative Methods
Moral Suasion
It is concerned with just as a moral request by central bank to commercial banks that loans should not be given for unproductive fields which create inflation. Loans should not be given for speculative purposes and hoarding. But such like requests could be effective in the developed countries.
Direct Action
The instrument of direct action is concerned with the policy of central bank against commercial banks. It can refuse to give loans to commercial banks. The central bank will not advance loan to commercial banks for the sectors which create inflation. Moreover, if commercial banks do not follow the instructions of the central bank, It will refuse to lend commercial banks
Publicity
The central bank of the country is the overall in charge of economic stability of the country. Its aim is to protect the economy from inflation and deflation. For this purpose, it analyses the whole economy. It keeps an eye over the activities of the commercial banks. If the commercial banks are found advancing loans which create inflation, their activities will be unhealthy for whole economy. The central bank can black list such banks. Thus to avoid such bad reputation in' future, they will be careful in advancing loans.
In the long run a central bank can only contribute to raising the growth potential of the economy by maintaining an environment of stable prices. It cannot enhance economic growth by expanding the money supply or keeping short-term interest rates at a level inconsistent with price stability. It can only influence the general level of prices. Ultimately, inflation is a monetary phenomenon. Prolonged periods of high inflation are typically associated with high monetary growth. While other factors (such as variations in aggregate demand, technological changes or commodity price shocks) can influence price developments over shorter horizons, over time their effects can be offset by a change in monetary policy.
A reduction in interest rates makes saving less attractive and borrowing more attractive, which stimulates spending. Lower interest rates can affect consumers and firms cashflow a fall in interest rates reduces the income from savings and the interest payments due on loans. Borrowers tend to spend more of any extra money they have than lenders, so the net effect of lower interest rates through this cash-flow channel is to encourage higher spending in aggregate. The opposite occurs when interest rates are increased. Lower interest rates can boost the prices of assets such as shares and houses. Higher house prices enable existing home owners to extend their mortgages in order to finance higher consumption. Higher share prices raise households wealth and can increase their willingness to spend. Changes in interest rates can also affect the exchange rate. Changes in spending feed through into output and, in turn, into employment. That can affect wage costs by changing the relative balance of demand and supply for workers. But it also influences wage bargainers expectations of inflation an important consideration for the eventual settlement. The impact on output and wages feeds through to producers costs and prices, and eventually consumer prices. Some of these influences can work more quickly than others. And the overall effect of monetary policy will be more rapid if it is credible. But, in general, there are time lags before changes in interest rates affect spending and saving decisions, and longer still before they affect consumer prices. We cannot be precise about the size or timing of all these channels. But the maximum effect on output is estimated to take up to about one year. And the maximum impact of a change in interest rates on consumer price inflation takes up to about two years. So interest rates have to be set based on judgments about what inflation might be the outlook over the coming few years not what it is today.
changes its dealing rate, the commercial banks change their own base rates from which deposit and lending rates are calculated.
The two situations warrant very different approaches. If inflation is of the demand pull type then tightening the monetary policy will, through dampening demand bring prices down. If, however, inflation is of the cost push type, then a tight monetary policy will make matters worse. And that is what has been happening in Pakistan over the last few years. Monetary policy has been used excessively to contain inflation, irrespective of whether it is of the demand pull or cost push type. Even if prices are rising due to hoarding, monetary policy has been used and advocated to contain inflation. Such a tight monetary policy has resulted in reducing the rate of growth of the economy, without reducing the rate of inflation. What should the government do to contain inflation? First, it needs to determine whether prices are rising as a result of demand pull factors or cost push factors. If prices are rising due to demand pull factors then tightening the monetary policy will be an appropriate policy. But if prices are raising due to cost push factors then we need to identify the factors that are pushing up prices and find alternatives to these. The excessive use of monetary policy to fix up every problem in the economy is hurting the economy. Monopolies and cartels have played a major role in restricting output and escalating prices in Pakistan. Most of the members of cartels are ministers and other influentials. It thus took several years for the government to convert the Monopoly Control Authority (MCA) into Competition Commission. The new government needs to make it effective, formulate a competition policy and enforce it. Competition policy is the appropriate policy to deal with the problems of monopolies, hoarding, excessive profit margins, etc.
Budget Deficit
The budget deficit for the first six months of FY07-08 was 3.6% of the GDP and the likely figure for the 12 month period is expected in the range of 6% of the GDP. Most of this was on account of increase in development expenditure in the run up to elections, energy related subsidies and the inability of the government to increase and diversify the tax base. The prime minister's decision to reduce the expenditure on the Prime Minister's House by
40% is a step in the right direction. Similarly, Shahbaz Sharif has announced 70% reduction in the non-development expenditures of the Punjab Government. Other such steps to reduce non development expenditure along with the Finance Minister's statement of looking into the possibility of reducing the defence budget are steps in the right direction. These need to be supplemented with resolve on the part of the government to curtail borrowing from the State Bank of Pakistan. And the Finance Minister has given a statement to this effect. This will not only reduce the budget deficit, but also ensure that the demand pull is not the major contributor to soaring of prices. Tightening of the monetary policy will no longer be required and appropriate policies that deal with cost push inflation will take care of the problem. On the revenue side, the government will have to tap new sources to generate receipts in order to bridge the gap. New sources for generating tax revenues should be those sectors of the economy where profits have increased in the past few years, but have not been brought within the tax net. These include agriculture and service sectors, especially oil companies, banks and financial institutions, portfolio investments with drawls of portfolio investments from Pakistan and real estate.
Agriculture Export of organic fruits and vegetables can fetch good prices in the international markets.
Instead of waiting for any type of land reforms that will redistribute land to peasants, which seems quite unlikely at present, it will be advisable for the government to distribute economically viable land units from fallow land to the peasants and provide bank credit to purchase inputs, manure, seeds, etc. Since this land has not been cultivated before, its yield will be good. These small farmers should be encouraged to organically produce food items like fruits, vegetables, rice, wheat, pulses, corn, barley, etc, both for the home market as well as for exports. This will make the country self sufficient in food, earn foreign exchange and thus reduce the deficit, improve the environment and health of the population by making healthy food items available to the population.
Industry
The government also needs to decide about the kind of industrial structure it should promote. Trying to produce a wide range of commodities and the grant of across the board fiscal incentives has given rise to a non viable industrial structure in the past. This necessitates that we evaluate our strengths and weaknesses objectively and dispassionately. Both the principles of static and dynamic comparative advantage should figure in such a policy formulation. The industrialization of the under-developed areas should initially be based on the static comparative advantage of these areas. This can be reinforced with industry-cum-area
specific fiscal incentives. Thus a viable industrial structure in the rural and hitherto under-developed areas will be created. At the same time, a dynamic comparative advantage should be nurtured in selected industries at the national level. Care should be exercised in the choice of these industries. First, these should be a select group of industries. Second, the country must possess some strengths in these industries. Third, the income elasticity of demand for the products of these industries must be high. This is the way to construct a viable industrial structure in Pakistan.
Water power
Water and power scarcity are going to pose a major obstacle to the strategies suggested above. Therefore, development of water and power development projects should be given top most priority by the government. Power policy of the government should have both a short term as well a long term plan. Since supply cannot be increased in the short run bridging the gap between supply and demand should focus on demand management and reducing transmission losses. Both commercial and domestic consumption of power has to reflect the fact that there is a serious power crisis in the country. Ostentatious consumption of electricity has to be banned with immediate effect. Lightening of wedding halls, hotels, public buildings should be banned. Celebration of religious and public events by lighting up buildings will have to be postponed to times when the balance between supply and demand has been restored. Till such time we will have to make do with decorating our buildings, lawns and parks with flags, buntings and balloons. Domestic consumption of electricity can also be brought down by educating the public and making them realize that it is in their own interest not to waste energy. In the long run the increase in supply should be through developing alternative sources of generating power like wind, nuclear, solar, etc, instead of oil. This will not only be environmentally friendly, but will also restore balance in the external account. Vertically integrated industrial units producing their own power and selling it to other units also will also increase the supply position as well as help to bring down the cost of production of domestic manufacturing. Water development projects are an absolute necessity for the agricultural development envisaged earlier. The government should try and bear the following in mind while developing water development projects. One, there are already great deal of controversies with regard to water development projects in the country.
Therefore instead of creating any further controversies, it will be better to start with projects which do not arouse the passions of the people of any province. Second, it will be preferable to start off with medium to small projects.
Institutional Backup
Economic research institutes in the country have to play their role by providing their input, evaluating government performance and providing policy guide lines. But these institutes are faced with a decline and/or are being used for political agendas. A public sector economic research organization has a PhD in Mass Communication as its head; another also has a head whose qualifications do not match the requirements of the research institute. Most of the research institutes in the country are under the control of a lobby that it has political ambitions. So the chattering class of the country is controlled by a lobby which will not be very charitable to the government.
Combination of these events has now induced a degree of recessionary tendencies and inflationary pressures across developed and developing countries. Central bankers are facing demanding task of weighing the tradeoff between growth and price stability. With the exception of few developed countries, most central banks have shown a strong bias towards addressing the risk of inflation and have responded with tightening of monetary policies. To avoid further complexities, both the Government and central bank have taken a set of fiscal and monetary policy measures over the last two months of FY08 to curb macroeconomic imbalances. After a careful assessment, the State Bank of Pakistan (SBP) had to take three rounds of corrective policy actions:
First, in July 07, SBP policy rate was raised by 50 bps to 10 percent simply to
allow for sterilization of excessive foreign inflows, which came in the last two weeks of FY07, and stem anticipated inflationary pressures. This measure did help in curbing the monetary pressures during JulyOctober 2007 as real interest rates rose and monetary growth decelerated. Continued foreign inflows ensured stability in exchange rate and built up of foreign exchange reserves. More importantly, Government borrowing from the central bank was largely on track; as it borrowed only Rs23.2 billion. In short, major economic variables were showing that monetary transmission mechanism was working. However, since November 2007 onwards, monetary tightening began to lose some of its steam. Massive liquidity was injected in the system as the Government borrowed from SBP almost Rs178 billion in November and December 2007. This led to softening of key interest rates and money growth accelerated. At the same time, rising international oil and food prices impacted the inflation outlook and in absence of
adjustment in domestic prices the financial burden of subsidies and high spending in other areas resulted in rising economic stress.
Second, in January 2008, SBP advocated the need for strengthening demand
management and raised policy rate by another 50 bps to 10.5 percent. However, international oil and food prices continued to rise to unprecedented high levels. The burden of the subsidies and rising consumption demand widened macroeconomic imbalances and exchange rate experienced significant pressure. Rising recourse to inflationary financing of the budget (by Rs338.3 billion during January 1 to May 24, 2008), started to induce loosening monetary conditions in the economy as net domestic assets of the banking system grew sharply. Also, external current account deficit rose substantially to US$5.6 billion during JanuaryApril 2008 compared to US$2.0 billion in the corresponding period of the last year.
account deficit and the repayments (both of public debt and private sector obligations) has depleted the reserves by US$6.5 billion during FY08 from all time high of US$16.4 billion along with the use of funds held in escrow accounts.
Governments excessive recourse to SBP borrowings to finance the fiscal deficit is now unsustainable
It is estimated that fiscal deficit for FY08 is more than double the targeted level, the Government financed its fiscal deficit from the central bank. Consequently, the year has ended with the SBPs financing of Rs688.7 billion, around 80 percent of the fiscal deficit. The stock of government debt to SBP Market Related Treasury Bills (MRTBs) has now reached to Rs1053 billion, almost 10 percent of GDP.
These challenges require well coordinated and immediate policy responses to further contain demand pressures in line with the economys capacity and resources.
Economic Environment and SBPs Policy Response during H2FY08 FY08 macroeconomic environment turned out to be challenging. Risks and vulnerabilities, highlighted in previous issues of monetary policy statements, unearthed themselves more visibly as the country was hit by a combination of global and domestic economic adversities
Despite economical shocks, Pakistans economy managed to register growth of 5.8 percent in FY08. Slowdown in the world economy has become quite visible and expected to continue even beyond 2008. Until the second quarter of calendar year 2008, the monetary policy responses of different countries have varied. More recently many central banks, especially in the developing countries, have raised their policy rates in order to curtail inflation and inflation expectations. Facing these global adversities, Pakistans macroeconomic vulnerabilities magnified in FY08. The twin deficits widened as the Government delayed pass through of rise in the international oil and food prices, growth moderated, and the combination of growing demand and reduced supply magnified inflationary pressures. Changes in economic variables are shown in table.
Forex reserves ( bln $) YoY M2 growth in % Avg. Inflation % NFNE (YoY) % 20% trim (YoY) % Real GDP growth in %
The second half of FY08 particularly proved difficult for Pakistans economy The foreign direct investment reached over US$5 billion in FY08, the developments in financial account such as the outflow in foreign portfolio investment and deferment of privatization program etc. meant that capital and financial account flows could not fully finance the external current account deficit. Consequently, almost 30 percent of the FY08 external current account deficit was financed by US$4.3 billion drawdown of foreign exchange reserves. Balance of payments pressures were also aggravated as the expenditures continued to rise, while revenue growth lagged. Almost 80 percent expenditure overruns can be attributed to the delay in pass through of international oil prices and other subsidies, while the remaining are due to underestimation in current expenditures. Automatic monetization of the fiscal deficit encourages fiscal imprudence and renders monetary policy to be subservient to fiscal policy. This mismanagement is the source of macroeconomic instability. It generated aggregate demand pressures and burdened the external current account deficits. Consecutive monetary tightening efforts to bring down inflation rate from 9.3 percent in FY05 to 6.5 percent in FY08 were disrupted. Continuous rise in all categories of inflation indices were observed, in particular during H2FY08. Though food inflation is the major contributor to the inflation (consumer price index, CPI), however, the nonfood group, which accounts for 59.7 percent in the CPI basket, also contributed significantly. Similarly, the inflation shows a continued uptrend, which reflects the sustained aggregate demand pressures on account of the Government overspending and the second round impacts of higher food and oil prices. This suggests that inflationary expectations have now become embedded and likely to exacerbate the macroeconomic stability, inflation outlook and longterm growth prospects.
The weakening macroeconomic situation necessitated the interim monetary policy measures by the SBP
After a assessment of the economic conditions which confirmed that the balance of risks clearly tilted towards inflation, in January 2008, the SBP raised its policy rate by 50 bps to 10.5 percent and increased the Cash Reserve Requirement (CRR) by 100 bps to 8 percent for bank demand liabilities (including deposits of maturity up to one year). The SBP, therefore, used its efforts to address these challenges by announcing multiple monetary policy measures on May 22, 2008. These included: Rise in the policy rate by 150 bps to 12 percent Increase in CRR and SLR to 9 percent and 19 percent respectively Floor on banks savings/PLS deposit rates at 5 percent L/C margin on all imports excluding oil and selected food products at 35 percent
The impact of a rise in external current account deficit on macroeconomic instability was complemented by a significant worsening of the fiscal position. The fiscal deficit rose sharply and is expected to be above 8.0 percent of GDP against a budgeted target of 4.0 percent for FY08. Subsidies are clearly unsustainable as they accounted for 47 percent of fiscal deficit and due to this the domestic consumption behavior has not adjusted to changing global realities. In the absence of additional financial resource from other than SBP, Government had to resort to the highly inflationary central bank borrowing for deficit financing. On the one hand, subsidies financed by central bank borrowings will exert its pressure on inflation this year, and on the other the eventual and unavoidable adjustment in domestic oil prices will also affect inflation outlook. Thus, recognizing this, the government is passing on the increase gradually to avoid painful consequences.
Strong aggregate demand pressures combined with increased passthrough of the persistent rise in commodity prices in international market continue contributing to high domestic inflation. In June 2008, the headline CPI inflation jumped to a 30 year high of 21.5 percent, on yearonyear (YoY) basis. This was mostly because of food inflation--contributing 62 percent.
Note: Provisional numbers for FY08. *Includes credit for commodity operations and net budgetary support; **Includes credit to private sector and public sector enterprises Source: SBP
In conclusion, at present the risks to inflation and overall macroeconomic stability emanating
from unsustainable twin deficits are far greater than risks to economic growth and necessitate stabilization measures.