Unexpectedly, the government imposed a windfall tax on banks’ profits from foreign exchange transactions
KARACHI: In an unprecedented move, the government imposed a windfall tax on banks’ profits from foreign exchange transactions. Analysts and bankers believe this was done to increase revenue collections to secure a deal with the International Monetary Fund (IMF), rather than to punish banks for engaging in excessive currency speculation. On the recommendation of the Federal Board of Revenue (FBR), the Federal Cabinet has approved a 40% tax on “windfall income” of banks from foreign exchange business in 2021 and 2022.
It is estimated that imposing a 40% tax on the total income earned from FX transactions by all banks in the last two years would generate revenue of Rs 44 billion for the government.
According to Optimus Capital Management’s calculations of the estimated impact of the retrospective windfall tax on banks, out of total income from forex transactions of Rs 164.541 billion, banks made a windfall profit of Rs 110.1 billion in 2021-2022.
The income of banks from foreign exchange transactions in 2021 was Rs 56.224 billion. In 2022, this profit becomes Rs 108.317 billion.
“It seems the government has approved this move under IMF requirements to get more tax, otherwise, banks are already taxed at about 50%,” said a senior banker on condition of anonymity. “
“This development could create challenges for banks as they operate in a complex foreign exchange environment, where customers may face difficulties in complying with State Bank of Pakistan guidelines and import payments,” Chase Securities said in a note on Tuesday. Maintaining relationships is already a challenging task.”
The central bank had repeatedly said that a tax on windfall profits of banks from foreign exchange operations engaged in currency manipulation was under consideration by the government.
Last year, Pakistan’s rupee saw extreme fluctuations and hit a record low against the US dollar, leading authorities to suspect manipulation by banks and exchange companies.
“Foreign exchange profits of banks to be taxed at 40% due to substantial currency rate fluctuations in 2021-2022. The government has now taxed it as the foreign exchange earnings of banks have been substantial in the last two years,” said Tahir Abbas, head of research at Arif Habib Ltd.
Banks are already subject to extremely high taxes on their profitability, Abbas said, and this new measure will only hurt them.
Amid the foreign exchange crisis, the government imposed limits on opening letters of credit (LC) for the purchase of specific commodities in an effort to reduce demand for dollars. The country has to import essential food items like wheat and oil to meet its demands and keep its economy running despite the falling inflow of dollars. According to bankers, the foreign exchange market had become unbalanced and distorted as a result of the huge disparity between supply and demand of dollars.
Banks transact in foreign currencies and maintain positions in it on behalf of customers or importers. In this case, banks followed SBP instructions to run short positions in an effort to support import transactions, bankers explained.
When banks expect a currency pair to decline in value, they will place short bets to minimize losses. Because they were pricing in that risk, banks operated short positions during periods of severe volatility and fluctuations in the local currency.
International banks had refused to validate letters of credit (LC) for Pakistani imports, especially petroleum commodities, before the IMF agreement. According to bankers, given the country’s volatile macroeconomic conditions and default risk as measured by credit default swaps, LCs confirming banks also gave rates as high as 8 percent to Pakistani banks.
Was this currency manipulation?
Originally published in news