Photo for illustrative purposes only. National flags and souvenirs sold in connection with Pakistan's 68th Independence Day celebrations ahead of Aug 13, 2015 in Quetta. Shutterstock

Islamic Finance

Coping with COVID-19 in Pakistan

This article is a chapter out of the e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" that is available as a pdf download from HERE. Read the article in the e-book for the complete set of tables, charts and references. 


The outbreak of COVID-19 amidst an already precarious economic situation has amplified challenges for Pakistan, a developing country with a per capita GDP of around $5,872 in 2019 (PPP Adjusted). The gross national income per capita remains at $1,590 as per World Bank data for 2018. Absolute poverty level has gone down in Pakistan during the first decade of the 21st century. Nonetheless, multi-dimensional poverty taking into account income as well as non-income indicators remains high at 38%, according to the United Nations Development Program (2016). With a meagre tax to GDP ratio at 12% and high current expenditures in defence and debt servicing, the government finds itself short of resources to fund development and welfare projects. The size of the financial sector is also small. Insurance penetration is less than 1% of GDP while only 23% of people are formally served with banking services through commercial banks and other institutions.

Pakistan’s external debt accounted for 37.5% of the country’s nominal GDP in 2019. External debt servicing and negative balance of trade put pressure on the country’s foreign reserves and exchange rate from time to time. In moving towards the recent IMF program to source $6 billion in 2019, the country had to face stringent guidelines to increase tax collection, reduce subsidies, keep tight monetary policy and let the exchange rate float freely in the market. High interest rates together with the drive for increasing tax net has put pressure on domestic businesses that were already finding it hard to deal with more than 30% depreciation in local currency and rise in cost of utilities since 2018. The balance of payment crisis was managed through increasing import duties and depreciating the local currency since 2018. However, with possible decline in exports, remittances and investment, the country faces another impending balance of payment crisis if external debt servicing and the import bill do not decline significantly.

Coronavirus cases in Pakistan

The first case of COVID-19 in Pakistan was reported on February 26, 2020. It took some time to mobilize resources and increase testing capacity. Table 1 summarizes the incidence of COVID-19 cases by May 5, 2020, in different regions along with the details of deaths and recovery. COVID-19 has reached almost 90% of Pakistan as on May 5, 2020.

Economic policy response to fight COVID-19

Following the outbreak of COVID-19, the government cut interest rates by 4.25% in three phases, introduced a relief package of 1.2 trillion rupees including the Ehsaas Cash Relief Program of 144 billion rupees, and announced investment incentives for the construction sector.

Export refunds are expedited to help businesses manage working capital shortfall and meet wage bills without layoffs during the second quarter of 2020. The construction sector was specifically targeted since it has a significant potential to provide employment to masons, electricians, plumbers, painters, welders, carpenters and retail and wholesale businesses that sell tools and accessories related to construction. A lot of other industries are connected with the construction sector including, steel, cement, paint and varnishing, brick, cables, pipes, aluminium, marble, tiles, ceramics, electric lighting, fan, electronics, furniture, curtain, carpet and rugs, plastic, spare parts, transport, electricity, gas, banking and insurance.

Going forward, on the macroeconomic front, the government faces the challenge of a decrease in economic growth, rise in fiscal deficit, decrease in tax revenues and worsening balance of payment situation.

Dealing with food prices

Inflation, for now, is not a potent problem. Consumer spending is now centred on essentials and the government has assured that there is enough stock for essential food items such as wheat, rice, sugar and pulses.

A drop in international oil prices has allowed the government some room to slash the domestic price of petroleum products. Since global oil prices are not expected to rebound anytime soon, the cost of transportation is not going to be higher than before.

The government has warned against hoarding and artificial price increases. On a limited scale in urban areas, efforts are made to actively monitor the prices of essential items. Right now, the prices of milk, vegetables and fruits have actually dropped from the previous months. If food supplies and distribution is adequately handled together with a limited ban on export and strong check on smuggling, food prices are under control at least for the time being.

Dealing with fiscal deficit

The real challenge lies in arresting the expected rise in the fiscal deficit. This can be achieved by further lowering the interest rate. The key policy interest rate in India and Bangladesh was slashed to 5.15% and 5.75%, respectively. Total domestic debt of Pakistan is around 20 trillion rupees. Every 1% reduction in the policy rate can save the government a significant amount of money.

The government’s domestic borrowing is in different forms, including Treasury-bills of different maturities, Pakistan Investment Bonds, National Savings Scheme instruments and sukuk to name a few. To get a rough estimate, let us assume that domestic borrowing is carried out at the current policy rate of 9%. In such a scenario, every 1% reduction in policy rate can save the government up to 200 billion rupees a year going forward. If the policy rate is brought down to 6% from 9%, then it will save the government roughly up to 600 billion rupees. Thus, a decrease in interest rates can help revive production, employment and ease the state’s budgetary position. So far, the government has taken the route of financing its budget deficit together with slashing the policy rate from 13.25% to 9%. Sukuk instruments of 700 billion rupees are being issued to meet the budgetary needs.

Dealing with decline in economic growth

Another big challenge is the inevitable decline in economic growth. The size of Pakistan’s GDP is around $300 billion. If the informal economy size is about 30%, then the total economy size would be around $390 billion.

A month-long lockdown will take out $32.5 billion if there is zero economic activity. But during the period of lockdown, not all economic activities are halted. Productive sectors, albeit at a reduced rate include telecoms, utilities, banking, e-commerce, the freelance sector, work from home by content writers, advertisers, programmers, teachers and graphic designers, the wholesale and retail trade of fast moving consumer goods and activities in rural farms. As such, we can expect the loss to be about 60% to 75% of when there is zero economic activity.

So, by rough estimates, a month-long lockdown would have trimmed GDP growth by 1% at least. A prolonged lockdown or slowdown in economy for another two months may very well push overall economic growth into negative territory as feared by the International Monetary Fund (IMF) in its latest economic assessment for the country as released on April 15, 2020. A further decrease in interest rates amidst lower expected inflation and lower international oil prices can help in meeting the challenge of worsening fiscal deficit and decline in economic growth.

Dealing with balance of payment difficulties

Going forward, the balance of payment situation is also going to present a big threat to our policymakers. A drop in oil prices will result in a loss of jobs to overseas workers in the Middle East. Most of our workforce in the Middle East are employed in blue collar jobs in construction and energy sectors. Since these sectors are going to be hit badly, the overseas workers will face layoffs and it will decrease remittances back to Pakistan.

In addition, Pakistan also has many of its overseas workers engaged in blue collar jobs in countries like Italy, Spain, UK, Germany and France. Many of them have activity-based work and earn their livelihood on a daily basis. Even if they are engaged in small businesses like in East Asia, their businesses are in retail which is badly hit during the lockdown period.

On the other hand, attracting foreign investment in a short period is difficult even with policy incentives. Foreign portfolio investment could potentially come to the stock market at the current attractive valuations, but very few people are convinced that markets have bottomed out and hence investorswait unless they have lucrative incentives like significant decrease in capital gains tax.

Exports could have had a cushion in a scenario where the pandemic had remained in China. But the epicentre is now Europe and America where most of Pakistan’s exports end up.

In such a scenario, it is important to seek reprieve from foreign lenders to provide debt relief in the form of deferment, if not waivers.

Secondly, it is important to look inward and mobilize local resources to produce goods previously imported. Pakistan has a workforce hungry for work even at lower wages and businesses that are anxiously looking to survive. Falling oil prices have provided an opportunity to become competitive. A further decrease in tax cuts and interest rates can help revive local industries to meet at least the domestic demand of goods which we can produce locally and which we were not producing previously only because of a lack of competitiveness due to high cost of production.

Common people in urban areas are responding to the crisis through generous donations. They can also play a role by spending on local goods.

The lockdown has affected approximately 50 million poor people in Pakistan as well as the daily earners who were non-poor before. The non-poor daily earners bring in no incomes during lockdown. Hence, they are effectively in as much a vulnerable position as the poor themselves. For the safety of these poor people and others, we asked these poor people to sacrifice their right to earn to feed themselves. But, we need to also think about ourselves who or for whom $1,187 million or 8.6 billion rupees worth of the following goods were imported last year. These are reported and documented figures for FY19 retrieved from the Pakistan Bureau of Statistics. Actual figures including the undocumented imports might be many times over.

  • Coffee, Tea, Mate and Spices $635 million
  • Dairy, Eggs, Honey and Edible Products $133 million
  • Furniture; Bedding, Mattresses, Lamps and lighting $129 million
  • Cereals $89 million
  • Cutlery, Spoons & Forks of Base $67 million
  • Toys, Games and Sports Requisites $45 million
  • Sugars and Sugar confectionery $39 million
  • Articles of Leather, Travel Goods and Handbags $31 million
  • Tobacco $19 million

Thus, tighter import controls on non-essential goods, further decrease in interest rates, decrease in capital gains tax on shares trading, tax cuts for labour intensive manufacturing industries other than construction, lobbying for external debt deferment, appeal for foreign aid, mobilizing donations from overseas Pakistanis and incentivizing flow of remittances through formal banking channels are some of the steps that can help in mitigating the impending balance of payment challenge.

Monetary policy response

On the monetary side, the usual policy options include interest rate cuts and easing credit availability by relaxing the credit controls and stability checks. The policy rate has been slashed by 425 basis points in three phases to 9% from 13.25%. Keeping in view the interest rate cuts globally, some economists feel there is more room for decreasing the policy rate further. India has cut its base rate to 5.15% and Bangladesh has slashed its repo rate to 5.75%.

It has been found in many intertemporal consumption studies that savings are significantly related to income, but not with interest rate in developing countries. The sensitivity of savings to interest rates measured through intertemporal elasticity of substitution is either found to be insignificant or not positive in many studies1. Thus, savings would not be affected by much with the cut in policy rate. In recession, a bigger concern for most people is income, especially for those who face liquidity constraints. In Pakistan, about 30% of people are poor, fewer than 10% have access to bank credit and not more than 30% have formal employment contracts. On the other hand, the government also has low tax revenues. In this scenario, a further decrease in interest rates would support both the private sector and government.

The State Bank of Pakistan, the central bank, has taken other steps to support the economy. These include i) relaxing the Debt Burden Ratio (DBR) requirement from 50% to 60%, ii) reducing the Capital Conservation Buffer (CCB) from its existing level of 2.50% to 1.50%, iii) deferring the payment of principal on loans and advances by one year and iv) introducing refinance scheme for financing wage bill. Islamic banks are also beneficiaries of these steps.

These measures are beneficial. However, few suggestions are given to further improve their effects. First, it is better to apply Debt Burden Ratio (DBR) relaxation on smaller loans first. Those eligible for smaller loans are going to be in a more vulnerable position. A person borrowing 1 million rupees for five years having a monthly income of 100,000 rupees and a person borrowing 200,000 rupees for five years having a monthly income of 35,000 rupees differ in their capacity to withstand a decrease in income or increase in medical and other expenses.

To achieve economies of scale, banks prefer to lend big and hence are less inclined to lend to small borrowers, SMEs and microfinance clients. Hence, a policy guideline from the central bank could achieve prioritized access of loanable funds to small borrowers.

It is good to relax the capital conservation buffer. Furthermore, relaxation in reserves can also enhance the capacity to lend directly and swiftly since capital conservation buffer primarily looks at stability.

Deferment of principal payment by one year is a good step. But, people having to pay interest payment would still find themselves in a troublesome position. Banks usually revise the instalment schedule on a yearly basis. The effect of policy rate cut may not reflect in upcoming monthly payments for those who had just taken loans or whose instalments had been revised few months prior. The central bank is well advised to ask commercial banks to revise instalment schedules immediately on the basis of the current lower interest rates.

Finally, the central bank’s refinance scheme for financing the wage bill is very generous and perhaps a little broad. As per SMEDA, a company having up to 250 employees, paid-up capital of up to 25 million rupees and sales of up to 250 million rupees is classified as an SME. As per the scheme, for up to 200 million rupees wage bill for 3 months, the company can avail finance up to 100% of the wage bill. For total wage bill between 200 million rupees to 500 million rupees for 3 months, the company can avail finance up to 75% of the wage bill. For example, a company with a monthly wage bill of 160 million rupees can still borrow 360 million rupees at 5%.

Some tweaks can make this scheme robust and allocate loanable funds among the most deserving candidates first. Adding a filter for number of employees would be good. Priority shall be given to those firms employing the greater number of unskilled or low skilled workers.

A cascaded interest rate structure at the end user level is going to ease the burden on smaller firms. Currently, it is 5% for all scale of businesses, small, medium or big. Addressing the issue of activity- based workers is tricky. What if they are genuinely underemployed or not given work? What if the firms genuinely do not have enough work for them and hence under employ them? What if firms over report the wage bill to finance other expenses as well at subsidised rate?

The central bank would refinance banks at 0%, but why are there no burdens to be taken up by senior management of private sector corporations? At least, executive salaries should be excluded from the wage bill to determine financing limit. It will ensure access to subsidised loans to a maximum number of companies. Furthermore, since there is a 2% lower rate on financing for active taxpayers at the end-user level, banks are going to have a lower spread when financing to taxpayers at 3% as compared to non-taxpayers at 5%. Lastly, in providing relief to borrowers, it would have been better to also include microfinance borrowers.

Role of private sector businesses

Realignment in product mix can help the textile, pharmaceutical, surgical goods, cement, processed food and hygiene industry. The textile industry can produce goods that are used in hospitals and medical care, such as towels, bed sheets, face masks, handkerchiefs, and suits worn by medical practitioners and patients, for instance. Pharmaceutical companies can meet the demand of antibiotics, anti-viral and other medicines not only for the local market, but also for neighbouring countries. The surgical goods industry can also join the global value chain and supply the surgical instruments used in intensive medical care.

Just like Pakistan, other countries will also have to deal with massive unemployment by supporting labour intensive sectors like construction. Pakistani cement companies have an opportunity to benefit from the construction package announced for Pakistan and also tap global markets when post-development construction activities surge.

In Ramadan and after, the market for dates, mangoes and citrus fruits can also be tapped. Finally, the demand for anti-bacterial and anti-malaria sprays, sanitizers and anti-bacterial soaps can also be tapped locally and internationally as consciousness for pre-emptive hygiene care is being taken seriously.

As social distancing increases, people may increasingly use e-commerce which can increase the demand for motorcycles as well as create employment in the delivery segment, but it will take time.

Tapping these segments is vital to stay afloat and avoid massive unemployment that can be contained if private sector business owners also play their part. Formal sector businesses can initiate work from home if the lockdown persists further. In Ramadan, work hours are usually curtailed in the country. Work in multiple shifts and a rotation policy among employees and industries can also be used to have balance between work and social distancing. The government can give a daily schedule as to which industries and types of businesses can be opened on which days.

Since most utility companies are owned and operated by the government, authorities can use scheduling of utilities access like electricity and gas to ensure smart lockdown with smart work. Instead of layoffs, avoidable expenses need to be curtailed like advertising, organizing corporate events and deferring bonuses of senior executives.

Industries that cannot operate for the time being can give employees leave if they have in balance or give leave on account. When the lockdown ends and work resumes, the employees can be asked to provide work in lieu of leave on account.

Finally, companies can also avail refinance schemes to manage their wage bills. The government can also introduce a similar scheme to finance overhead expenses at subsidized rates or by providing deferment of utility bills. A strong message and commitment from the government to support local industries in the post lockdown period will encourage industrialists to hold onto their businesses.

Implications of COVID-19 for the Islamic finance industry

Islamic finance is a growing industry in Pakistan. Islamic banks have 15% market share in the overall banking industry at the end of December 2019.

There are 5 full-fledged Islamic banks and 17 conventional banks with Islamic banking windows. The total branch network in Islamic banking reached 3,226 in 2019.

Islamic banks face the issue of a small number of liquid instruments for short-term investments in the money market. The recent sukuk issue of 700 billion rupees by the government would enable Islamic banks to place their liquidity in sukuk. Islamic banks are relatively less risky with smaller value of gross non-performing financing to total financing ratio (4.3%) as compared to the overall industry (8.6%) as at the end of December 2019.

However, since the lockdown which started from mid-March is extended to at least May 9, 2020 and given the expected slowdown in economic activity in the remaining months of 2020, Islamic banks are going to face challenges in maintaining a quality portfolio of financing assets. Additionally, Islamic banks cannot rollover loans nor charge penalties on late payment as their income. Finally, the exchange rate and mark-up rate fluctuation will pressurise their margins in short-term sale based financing contracts, such as in murabahah.

On the other hand, takaful companies have a minuscule presence. Given the lower levels of per capita income and lower private savings rate, insurance penetration in the country is 0.85% of GDP. Takaful companies rely on banks for their business, such as general insurance for underlying assets in financing contracts. Falling equity market returns, mutual fund returns and lack of activity in the real estate sector will also put pressure on their portfolio returns in long-term savings plans which they offer to individual clients.

The Islamic capital market comprising Shariah-compliant stocks, sukuk and Islamic mutual funds will also not be immune to systemic risks. Most of the Shariah-compliant stocks are in the manufacturing sector which is going to face challenges. Just before the outbreak of COVID-19, the halal stock index, i.e. Karachi Al-Meezan 30 Index started to recover from a prolonged slump over the last two years. However, the outbreak of COVID-19 has resulted in a steep decline in the index. In the first quarter of 2020, the Halal index KMI-30 lost one-third of its value.

Nonetheless, some steps, such as the announcement of the construction package, release of sales tax refunds, tax cuts, interest rate cuts and an ease in the banking sector’s lending capacity has been taken positively by market participants in the recent trading days. It remains to be seen whether this will be short-lived or not.

Islamic mutual funds also rely on Shariah-compliant stocks and sukuk in their portfolio. Income funds like cash funds, sovereign funds and money market funds as well as balanced funds, commodity funds and asset allocation funds will not face steep decline as they can cling on to sukuk. However, they will have increased appetite to invest in new sukuk if they are issued. On the other hand, equity funds will face a hard time coping with systematic risk. They would still look towards cement, fertilizer and pharmaceutical stocks which can still manage to keep their sales safe from decline and benefit from different investment incentives that are offered in these sectors.

Role of Islamic social finance in resource redistribution during lockdown

There are approximately 50 million poor people in Pakistan. If the poverty line is defined at $1.30 a day, 10 billion rupees is needed to feed them daily. The total federal Public Sector Development Program (PSDP) size is 675 billion rupees for the whole year and it is allocated for all development spending for the country. If total PSDP is allocated to feed the poor only, it would be enough for roughly 2 months.

After the lockdown, which started in the third week of March 2020, millions of poor people fell out of work. If the government or the third sector does not intervene, then these people do not have the purchasing power to afford essential items.

In poor countries like Pakistan, people with surplus resources engage in charity, donations, and volunteering.

Within a few days, 800,000 people voluntarily registered themselves for the volunteer work in the ‘tiger force’ constituted for relief efforts. Empirical evidence in Pakistan in multiple research studies has found that faith is the biggest motivation behind charitable donations and it encapsulates and is associated with other humane motives.


In most countries where data is retrieved, the wealth to income ratio ranges from 4 to 7 as per the data from the World Inequality Database (2019). Let us assume this ratio to be 5 for Pakistan. Pakistan’s GDP is around $300 billion. Conservative estimates put the size of the informal economy at one-third of total GDP3. Adding both the value of production in the formal and informal economy, we get $400 billion. Five times the sum of aggregate GDP in documented economy plus the value of production in the informal sector will be around $2,000 billion. If one-fifth of that national wealth comprises assets that are eligible for zakat, then 2.5% rate of zakat on that portion of wealth will be $10 billion. It roughly equals 2.5% of aggregate value of production in the formal and undocumented economy. Estimates using disaggregated data of income and wealth subject to zakat in a study published in Pakistan Development Review in 2015 also confirm such estimates.

It is important to put this money mobilized through philanthropy to effective use. Islamic scholars have come forward and explained that people can pay zakat in advance to people suffering from lock- down. Lockdown has not affected only the poor, but the daily wagers and earners who are non-poor in normal circumstances if they get daily work. The Pakistan Institute of Development Economics estimates that a prolonged lockdown can bring short-term unemployment to as many as 20 million people. Many of them would be looking after 2 or 3 dependents on average in their families.

In response, the government launched the Ehsaas Emergency Cash programme to extend one-time cash support of 12,000 rupees to 12 million families benefitting 78 million individuals. 17,000 payment points are being established across the country with special protective measures to facilitate payment of cash assistance.

Philanthropic sources

The role of non-market philanthropic activity can also not be undermined. An important goal is to reach the right targets efficiently. If the food ration packs or cash support does not reach rural areas, then it may create panic and bring a lot of people to urban areas in the hope of help and work. Private welfare institutions like Al-Khidmat, Alamgir Welfare Trust, Saylani, JDC, Edhi and others can collect most of their donations in the urban areas. It is important that the  funds are also allocated widely across the country. That is where planning and coordination is vital.

Private NGOs also need to cooperate with government. They have the trust capital, but lack infrastructure to reach masses across the length and breadth of the country. The government has a trust deficit, but it has profiled data and government machinery to mobilize activities and human resource. It is hoped that a close and collaborative effort between non-market institutions and government will leverage the philanthropic impulse and provide a social safety net to affected people.

The full e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" is available as a pdf download from HERE. The e-book is published by Indonesia's Islamic Finance and Economy Committee (KNEKS) in partnership with DinarStandard and Salaam Gateway. It was launched on May 27, 2020. The 12 countries covered are: Bahrain, Bangladesh, Brunei, Indonesia, Iran, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Turkey, and UAE. 


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Salman Ahmed Shaikh