In Pakistan there exists two distinct, but opposite opinions about the growth of Islamic banking in the country. The proponents are jubilant and claim that now a little less than 15 percent of total assets of the banking sector are now Shariah compliant. However, the other group insists that the quantum is paltry; keeping in view that the overwhelming majority of the population is Muslim. Therefore, it is necessary to first review the situation dispassionately and then come up a new strategy.
After the judgment of the apex court that Pakistan’s banking system was not Shariah compliant, the Government of Pakistan (GoP) came up with the proposal to introduce an Islamic banking system and let the conventional system run in parallel. A technical mistake was committed because no deadline was fixed for the elimination of Riba-based system. Therefore, the goals remained ambiguous; policies were imprudent and on top of all, implementation was not done in letter and spirit. The entire process shows lack of commitment on the part of the Government of Pakistan (GoP), I am sure those all the helm of affairs at the central bank will not subscribe to my analogy.
It is no secret that the GoP is the biggest borrower and also pays very handsome return on its risk free securities. Reportedly, foreign investment in the government’s debt instruments, including Market Treasury Bills (T-Bills) and Pakistan Investment Bond (PIBs) has surged to US$2.26 billion during the current fiscal year (FY20). According to State Bank of Pakistan (SBP), foreign investment in T-Bills has recorded largest single day inflows of US$536 million on January 16, 2019 in Special Convertible Rupee Account (SCRA).
Analysts say that with some improvement in exchange rate and current account, foreign investors mainly from the US and the UK are taking interest in government securities and heavily investing in T-Bills and PIBs. Foreign Portfolio Investment (FPI) flowed into T-Bills and PIBs after a gap of over two years, as investors responded to the continued increase in reserves buffers; sustainability of the exchange rate regime and the comfort offered by the inception of the IMF US$6 billion Extended Fund Facility program to support Pakistan’s balance of payment.
The SBP mentioned in a recent report that this investment was an outcome of the continued improvement in the country’s balance of payment position and reserve buffers, sustainability of the exchange rate regime; and the comfort offered by the inception of the IMF program. Economists said that massive inflows on account of government securities will also help reduce the pressure on external account and build the foreign exchange reserves.
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International investors have been investing in Pakistan’s equity markets for a long time. Such investments are considered portfolio investments, just like investments in debt instruments, and use the same framework of SCRA. Such investors have been able to move capital in and out of our financial markets without problems for the Pakistan economy.
The SBP believes that the shift to a market based exchange rate system has addressed previous concerns regarding the sustainability of the exchange rate regime and support to attract more foreign investment in debt securities. The central bank also says that risks posed by foreign investments in debt instruments are limited. However, SBP said that it continues to monitor developments in the financial sector carefully and stands ready to take action against any risks.
According to an analyst, bulk of the foreign exchange reserves held by the central bank is borrowed, even at very high rate. As the government is acquiring the foreign exchange by printing money, it is adding to inflation. As the inflation rate remains high, the central will continue to follow ‘tight policy’ or keeping interest rate high. The bizarre process will continue and the moment SBP decides to bring down the interest rate, influx will stop, on the contrary investors will start pulling their investment from Pakistan.
Let us also have a look at the lending to farmers; bulk of the amount is still Riba-based. It is often complaint that lending to farmers has remained low because it is based on ‘passbook system’. However, the central bank as well as the players has to accept their inadequacy because they have not adopted the options available under Islamic banking. It is also a fact that industrial sector, particularly big corporate, have remained the prime focus of Islamic banks, they have not gathered courage to cater to the needs of SMEs and farmers.
It is also suggested that as a first move conventional banks should be asked to convert their branches to Islamic banking with a clear mention of time line. Similarly, GoP and state owned enterprises should be asked to borrow under Shariah compliant system only.