The government announced on Wednesday that it will implement the Federal Shariah Court (FSC) ruling, which implies that it will transform the existing interest-based banking system into an interest-free model over 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, hinting that the government would implement the interest-free banking system in December 2027.

On the day Dar announced he would 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 Ministry of Finance and the United Nations Development Program (UNDP), Pakistan, launched the Climate Finance Facility to mobilize private sector investment after traditional financing from foreign creditors began to dry up.

On the same day, Dar also announced that the Asian Infrastructure Investment Bank (AIIB) had approved a $500 million loan. Pakistan guaranteed the loan at one of the highest interest rates of 4.9% of all multilateral creditors.

The three separate but identical events highlight the challenges the Pakistani economy is facing due to increasing demands that make the government deeply dependent on domestic and foreign creditors to stay afloat.

In its judgment of April 2022, the FSC had also ordered that future financial commitments, including the use of loans and advances, between Pakistan and international financial institutions and other bilateral and multilateral donors be carried out on the basis of Sharia-compliant modes. finance like issuing Sukuk.

Dar said Pakistan has not moved towards an interest-free banking system in recent years as it should have. He added that the decision to withdraw the appeals was taken after the permission of Prime Minister Shehbaz Sharif and in consultation with the SBP governor.

In June this year, the central bank approached the Supreme Court, asking for an amendment to the FSC judgment of April 28 which declared that riba was forbidden, according to the injunctions of Islam, so it should be eliminated from the country in five year.

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 operate five fully-fledged Islamic banks and 17 conventional banks having autonomous Islamic banking branches with a network of 3,983 branches as well as 1,418 Islamic banking windows.

In its appeal, the SBP argued that a large-scale conversion of the banking system would require infrastructure investments and large-scale changes – at least five times more in the next five years compared to the current level which had been reached more than 20 years.

The government’s decision to withdraw the calls would now necessitate a switch from traditional banking to Islamic banking. But Dar gave no framework on how he intended to implement the decision.

Following the FSC ruling, Pakistan became the first Muslim country to officially declare modern bank interest as riba, declared haram by the Quran. The FSC had declared the laws authorizing interests contrary to Islam in 1991.
The federal government and some banks and financial institutions have filed 67 appeals against this ruling in the Supreme Court’s Shariah Court of Appeal.

The FSC has declared a number of laws in the country contrary to the injunctions of Islam, as they provide for the charging or payment of interest, which according to the findings of the FSC falls under the definition of riba.

Dar said the government will try to set up Islamic banking as soon as possible. “God willing, we will lead Pakistan to an interest-free economy,” he added.

Traditional borrowing continues

Dar took to Twitter on Wednesday to announce that the AIIB’s board had approved a $500 million loan for Pakistan. The loan was contracted at the Secured Overnight Funding Rate (SOFR), which currently stands at 3.8%.

Pakistan will pay 0.81% on top of SOFR due to fixed spread and variable cost of borrowing, bringing the total to 4.61%. Then there’s a 0.25% upfront fee, or $1.25 million on a $500 million loan. This brings the total interest rate to 4.9% – one of the highest of any multilateral institution.

Meanwhile, the Finance Secretary has launched a new funding facility aimed at withdrawing part of the funding window available for global climate change.

“This is a timely initiative to accelerate development finance in Pakistan,” said Hamed Yaqoob Sheikh, at the launch of the facility. “We need to engage the private sector and international actors to expand the funding pool and reach marginalized populations,” he added.

UNDP’s senior development finance adviser, Haroon Sharif, said traditional sources of funding were under pressure, but huge sums of money were available for climate resilience initiatives that could be mobilized by presenting projects to investors.

Sharif said that under the new initiative, they are targeting funding of $2-3 billion over the next two to three years out of the potential investment of $96 billion that Pakistan could tap into.

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

Initially, the government and UNDP identified three projects worth $112 million to be funded under the SDG Investment and Climate Finance Facility.