Pakistan Pledges To Abolish Interest in Five Years

Dar says FSC’s order on interest-free banking to be implemented

The government announced on Wednesday it would implement the Federal Shariat Court (FSC) decision, implying that it would transform the existing interest-based banking system to an interest-free model in the next five years.

Finance Minister Ishaq Dar said in a pre-recorded statement that the State Bank of Pakistan (SBP) and the National Bank of Pakistan (NBP) were withdrawing their appeals against the FSC, inferring that the government would implement the interest-free banking system by December 2027.

On the day Dar announced to honor the FSC decision, Finance Secretary Hamed Yaqoob Sheikh launched a new SDG and Climate Finance Facility to tap foreign loans from non-traditional international investors.

The finance ministry and the United Nations Development Programme (UNDP), in Pakistan, launched the Climate Financing Facility to mobilize private sector investments after the traditional financing by foreign creditors started drying up.

On the same day, Dar also announced that the Asian Infrastructure Investment Bank (AIIB) approved a $500 million loan. Pakistan has secured the loan at one of the highest interest rates of 4.9% by any multilateral creditor.

The three separate but identical events highlight the challenges facing Pakistan’s economy due to mounting requirements that make the government deeply dependent on domestic and foreign creditors to remain afloat.

In its April 2022 judgment, the FSC had also directed that future financial engagements, including the availing of loans and advances, between Pakistan and international financial institutions and other bilateral as well as multilateral providers of finance be carried out based on Shariah-compliant modes of finance such as the issue of Sukuk.

Dar said that Pakistan did not move forward towards an interest-free banking system during the past few years as it should have. He added that the decision to withdraw the appeals was taken after permission from Prime Minister Shehbaz Sharif and in consultation with the SBP governor.

In June this year, the central bank approached the Supreme Court, seeking modification in the FSC’s April 28 judgment that declared that riba was prohibited, according to the injunctions of Islam, so it should be eliminated from the country in five years.

At present, Islamic banks account for 19.4% of the country’s overall banking system in terms of assets, while in terms of deposits the share is 20%. Currently, 22 Islamic banking institutions are running five full-fledged Islamic banks, and 17 conventional banks have standalone Islamic banking branches with a network of 3,983 branches along with 1,418 Islamic banking windows.

In its appeal, the SBP argued that a mass-scale conversion of the banking system would require infrastructural investment and changes at a mega scale – at least five times more within the next five years in comparison with the current level which had been achieved in more than 20 years.

The government’s decision to withdraw the appeals would now require shifting from traditional banking to Islamic banking. But Dar did not give a framework for how he intended to implement the decision.

As a result of the FSC decision, Pakistan became the first Muslim country to officially declare modern bank interest as riba, declared haram by Qur’an. The FSC declared the laws allowing interests repugnant to Islam in 1991.
The federal government and certain banks and financial institutions filed 67 appeals against this judgment in the Shariah Appellate Bench of the Supreme Court.

The FSC has declared several laws of the country repugnant to the injunctions of Islam, as they have provided for charging or paying interest, which according to the findings of the FSC, fall within the definition of riba.

Dar said that the government would try to implement the Islamic banking system as soon as possible. “God willing, we will take Pakistan towards an interest-free economy”, he added.

Traditional borrowing continues

Dar took to Twitter on Wednesday to announce that the AIIB Board had approved a $500 million loan for Pakistan. The loan has been contracted at the Secured Overnight Financing Rate (SOFR), which currently stands at 3.8%.

Pakistan will pay 0.81% over and above the SOFR on account of a fixed spread and variable borrowing cost, taking the tally to 4.61%. Then there is a front-end fee of 0.25%, which is $1.25 million on a loan of $500 million. This brings the total interest rate to 4.9% – one of the highest by a multilateral institution.

Meanwhile, the finance secretary launched a new financing facility aimed at taking a pie out of the available climate change financing window in the world.

“This is a timely initiative for accelerating financing for development in Pakistan”, said Hamed Yaqoob Sheikh, while launching the facility. “We must call on the private sector and international stakeholders to expand the financing pool and reach out to marginalized populations”, he added.

UNDP Senior Adviser on Financing for Development, Haroon Sharif, said that the traditional financing sources were coming under pressure but huge sums of money were available for climate resilience initiatives that could be mobilized by pitching projects for investors.

Sharif said that under the new initiative, they were targeting $2 to 3 billion in financing in the next two to three years out of the potential investment of $96 billion that Pakistan could tap.

The IMF estimates Pakistan’s annual financing gap for the SDGs at $3.72 billion for 2022-23. Pakistan can also arrange $500 million through the green sovereign bond, as it may not be able to raise the planned $2 billion through traditional Eurobonds due to its junk credit rating.

Initially, the government and the UNDP identified three projects worth $112 million for financing under the SDG Investment and Climate Financing Facility.