Pakistan’s banking sector has entered a critical phase following recent changes to tax policy that are reshaping the financial landscape. While analysts have noted some positive aspects of the reform, including the removal of the Advance to Deposit Ratio (ADR) tax on income from government securities, the relief is tempered by a significant rise in corporate tax rates. This shift in fiscal policy has led experts from Arif Habib Limited to forecast a challenging year ahead for banks as they navigate the impact of these changes.
The ADR tax, which was previously levied at rates between 10% and 16%, has been eliminated under a new ordinance approved by the federal cabinet. While this move provides immediate relief to banks by removing a levy tied to government securities, the relief is counterbalanced by a sharp increase in the corporate income tax rate for banks. Effective for the fiscal year ending December 31, 2024, the corporate tax rate for the banking sector has been raised from 39% to 44%, a move expected to have significant implications for profitability and operational dynamics.
The tax reform introduces a double-edged sword for banks. While the removal of the ADR tax alleviates an ongoing financial strain, it comes at a cost. Analysts predict a 10% decline in banking sector earnings for the year 2024, followed by an 8% reduction in earnings for 2025 and a 6% decline in 2026. This adjustment is expected to generate an additional PKR 62-65 billion in government revenue, which will aid in bolstering Pakistan’s tax collection efforts amid its ongoing fiscal challenges. Despite the financial strain posed by the increased tax rates, analysts view the removal of the ADR tax as a positive step in terms of regulatory clarity. For over two years, the banking sector has grappled with frequent and sometimes unpredictable tax policies. With the ADR tax now eliminated, banks can refocus their efforts on core operations and strategic growth without the looming threat of ADR-related penalties.
The tax reform provides much-needed clarity in a turbulent fiscal environment. The ADR tax had forced banks to prioritize compliance with the ratio, often at the expense of other financial strategies. With this pressure relieved, banks are better positioned to streamline their operations and focus on long-term growth. However, the immediate financial implications of the corporate tax hike are felt across the sector, particularly in terms of earnings per share (EPS) and return on equity (ROE). Analysts have adjusted ROE estimates downwards from 20% to 18.8%, signaling a tough short-term road ahead for banks.
Despite these challenges, the banking sector is expected to adapt over time. The phased reduction in corporate tax rates, which will see a gradual decrease from 44% to 42% by 2027, offers a glimmer of hope for the future. As the banking sector adjusts to the new tax regime, there is optimism that the removal of ADR-related pressures will allow banks to optimize their lending portfolios, innovate, and recalibrate their growth strategies.
Looking beyond the immediate challenges, the long-term outlook for Pakistan’s banking sector remains cautiously optimistic. The phased reduction in corporate tax rates and the elimination of ADR tax burdens will create more space for banks to operate efficiently and pursue strategic growth initiatives. Despite the short-term earnings dip, analysts believe that the sector is well-positioned to recover and thrive as it adjusts to the new fiscal environment. In conclusion, while the road ahead may be challenging, the regulatory clarity provided by the tax reforms offers a solid foundation for the banking sector to adapt and innovate. As banks focus on operational efficiency and strategy optimization, the outlook for sustained growth remains positive, albeit with a cautious eye on the evolving fiscal landscape.