Pakistan has become the land of financial technology startups. For the longest time, we here at Profit have been explaining ad nauseum how Pakistan is ripe for the digital payments revolution. How we have a largely unbanked population, a growing number of software side workers, entrepreneurs with bright ideas, and most importantly consistently growing internet coverage with cheap 3G and 4G available in different corners. With all of these factors, it was only a matter of time before the people of a country tired of bureaucratic red-taping and slow inefficient paperwork would shun the same and turn towards the accessibility, utility and convenience that comes with money going online.
And it has happened. Banks are improving digital payments, fintech startups in Pakistan are popping up. There are microfinance banks, agro finance applications, and multiple super apps. All of them have gotten competition and there is a vibrant and very competitive field of capable people running the show. It seems to be working. Pakistan has become a go to area for investors and eyeballs are on how this revolution pans out. You could still say that these investors might be betting on the wrong horse, but at least they are not just willing to but actively wanting to bet on us.
But there is only so far that the digital payments providers can get us. There has been a growing demand that if digital payments are to be pushed, there’s only so much that fintech companies and banks can do. This revolution actively needs the participation and backing of the government and financial institutions to succeed. They have been interested in it for a while, but haven’t quite been enthusiastically participating. Now that might be changing, and the saviors of the revolution could be Shaukat Tarin and the Federal Board of Revenue (FBR).
In a recent measure, which our sources say has been pushed by Finance Minister Shaukat Tarin and the team at FBR, the payments push has come which is likely going to give a big impetus to digital payments, and consequently help FBR prop up revenues. The fintech companies have been longing to see some reforms that push the demand up so that these companies can push the supply up. For some context about the problems, consider the case of POS acquiring (acquiring is the business under which a bank or a fintech company imports the point of sale machines and deploys them at a merchant which accepts the payments through debit or credit cards).
Understanding the problem
Citibank has had an interesting history in Pakistan. The bank is by no means even close to being the largest bank in Pakistan, or for that matter even the largest foreign bank in the country. What it has had is a history of innovation, and producing the financial leaders of Pakistan. Multiple finance ministers and one prime minister have all at some point been Citibankers. In fact, even the incumbent finance minister, Shaukat Tarin, began his career in finance at Citibank in 1975.
It is with Citibank that this story begins in some ways. In both Corporate Pakistan – as well as the government – it means something special to be able to call oneself an “ex-Citibanker”, more so than any other financial institution. A majority of innovation in Pakistani banking has come from Citi. In the early 1990s, it was a team of Citibank executives who decided to re-invent the very notion of consumer banking in Pakistan, introducing products like credit cards, auto loans, and significantly expanding the scope of the country’s mortgage market. At the time, the bank was led by Shaukat Tarin.
Ever since Citibank entered the market with its debit and credit cards, POS acquisition has predominantly remained the headache of a few players. They would be hurting their own P&Ls to get these machines installed at the merchants. Bank Alfalah for instance, in its early days in the POS acquiring business, waived off the price of these machines to merchants just so that the uptake of these machines could be improved. These machines are costly, running in hundreds of dollars to be paid for a single machine, and when these machines are deployed, transactions on these machines would be small because such transactions were not incentivised against cash transactions.
There is only so much that the individual banks or fintech companies, pushing these POS machines in the market, could do on their own. A merchant keeping the POS machine at his shop has to pay an MDR, a fixed percentage charged on the transaction amount, which is a cost for the merchant. While on the other hand, cash transactions do not cost anything extra upfront. Though cash transactions have hidden costs for the overall economy, upfront, the merchant is not paying anything extra at that very moment for that transaction.
So in very simple words, if you are a merchant who has kept a POS machine at his retail outlet, does not see the benefit for him to push the uptake of digital payments, if he is not able to collect such payments at such volumes that it makes sense for him to keep those POS machines. So if you go to Servaid today to buy medicine, you can pay a Rs5,000 bill using your debit card – you are most likely not going to keep Rs5,000 in cash with you all the time. A Servaid pharmacy manager told Profit that around 40% of their transactions are through debit or credit cards and because that is a significant volume of transactions, it makes sense for them to pay an MDR for POS service – the money goes directly to the bank account of the merchant and the security of money automatically increases.
In contrast, a small shop which has mostly small bills to collect, prefers cash and has a small turnover. His sales are already small and he is not likely to be willing to pay and MDR for debit or credit card transactions.
Such merchants have all the incentive not to accept digital payments because obviously, they are not paying anything extra, which would have been the case if they accepted digital payments. Cash transactions also help suppress sales volume and help evade taxes. This is why cash is a bane for the FBR that it has long been trying to fight, and, consequently, had all the reasons to push digital payments. That is what is also behind policies such as there being less tax if you pay through a card, or discounts and rebates on taxes if you pay online.
The earlier business model had more costs than incentives for POS acquirers, and it did not make sense for banks or fintech companies to deploy more POS machines in the market when they knew that the uptake would not be there. To keep it brief, POS acquirers used to get a small cut from the MDR charged to merchants which disincentivized the business from an acquirer’s perspective because the cost of deploying these machines was high and the requisite transaction volume was not there for these players to make money. The State Bank of Pakistan realised the problems and incentivised the acquiring business by rationalising the MDR.
In February last year, the central bank made the POS acquiring business a lucrative undertaking for players that are in this space by rationalising the cut for acquirers from the MDR.
There are at present five major POS acquirers which include big banks such as HBL, Bank Alfalah, MCB Bank, United Bank, and a fintech company called Keenu. While the MDR was rationalised in which the acquirers did not get a bigger cut, the end consumer was not incentivised to make digital payments.
So even if POS acquirers pushed more machines into the market, it would be of no use if end users like you or me do not make payments through debit or credit cards on these machines. While POS acquiring is one example that highlights problems that affect one particular type of business, it underscores the one problem in the entire economy which keeps digital payments from picking up; that if the government does not incentivise digital payments, cash will always remain incentivised and everyone, including the government, businesses that transact in cash, businesses that help digitisation of payments, consumers and the economy overall, loses.
What has the government done?
So what has the government done? In the recently announced budget this year, the government, spearheaded by Finance Minister Shaukat Tarin, decided to integrate Tier-1 retailers with the FBR’s systems whereby the FBR would have live access to transactions carried out at that retailer. This was coupled with exemption of duties on the import of POS machines.
While the digitisation was helped, as the FBR told us, a recently passed ordinance, gives further impetus to digital transactions, which will not only help FBR with its tax collection, it incentivises fintech businesses, and opens further opportunities for IT companies to come in and provide services, thereby creating new businesses altogether.
It is perhaps because of Shaukat Tarin’s experience as a banker that he realises how important digital payments are and the good they can bring to the economy. As I have learned, Tarin has been instrumental in getting some measures passed which will push digital payments. The push could have come earlier after all these measures, which are discussed below, require political ownership.
But past finance ministers including names such as Hafeez Sheikh, Asad Umar or ministers in previous governments could not push these measures. While Tarin was able to do it in only a few months after being appointed as the finance minister. Shaukat Tarin was appointed as the finance minister in April this year, and four months later, the government introduced Tax Laws (Third Amendment) Ordinance 2021, passed a little over a week ago, in what is being called a substantial push likely to change the entire digital payments landscape.
Here’s a list of measures passed:
i) Companies are now allowed to make payment for their expenses of Rs 250,000 or above (under a single account head) only through digital means.
Predictably, the problem with the Federal Board of Revenue (FBR) has been that if businesses are dealing in cash, the Board would not be able to assess their sales. And if their sales are not assessed, how would their income tax be?
Essentially, the government has disallowed paper-based cheques, which would be non-admissible for tax purposes. As FBR explained to us, paper-based cheques would be paid in other peoples’ names which would hide the transaction.
Now, digital is the only way acceptable. Since businesses run in tens of thousands in numbers, banks can not reach every single one of them, let alone with speed. The fintech companies have opportunities to move in and reach where banks would not be willing to go to and digitise payments for small businesses.
However, the FBR and the State Bank would have to ensure that service quality for the end consumers with regards to such digital payments would have to be good. If these businesses are pushed to digital payments and the service quality is not good, it would deter them from digital transactions. Simultaneously, the regulators would have to review the digital payments limits allowed to banks and fintech companies which would have to be revised.
ii) For businesses making payments through digital means, the sales tax has been reduced to 16.9% from 17%
It may not really look like a big percentage at first but if you do some calculations, things will add up. Businesses transact in billions so even a percentage as small as 0.1% would yield numbers in millions, which can substantially add on to a business’ bottomline. Banks actually charge 0.1% on transactions for businesses made through digital means. This measure has been introduced, as the FBR told us, to compensate for the charge paid to banks for these transactions. To be clear, this incentive is for the businesses collecting sales tax and not the ones that are paying.
iii) To enforce the digitisation of payments, the FBR will resort to punitive measures which will make compliance more likely.
FBR Director General of Retail Sajidullah Siddiqui, who has also been instrumental in getting these measures through and is at the helm of the digitisation drive at FBR, told Profit that the FBR is liaising with electricity distribution companies (DISCOs) and other utility companies to get access to companies not enforcing digitisation measures. The FBR will actively discontinue utility connections of delinquent businesses not registering or integrating their systems with FBR for sales tax purposes, besides enhancing penalties for such persons. Initially, those resisting will be served notices, and their failure to integrate with FBR even after these notices will result in FBR resorting to punitive measures for compliance.
iv) For all payments made by customers at retailers through digital means, the sales tax has been reduced from 17% to 16%.
So if you purchase anything using your debit or credit card or even through a QR code, the sales tax retailer will charge you on this transaction would be 16% instead of 17%. Individual consumers would be paying 1% less in sales tax while the retailer where you are making the transaction, would be saving 1% because he pays 17% sales tax when he makes the purchase of the same product from a distributor, while he is only liable to collect 16% now.
v) FBR has been authorised to extend the integration with FBR to all retailers. So if you are a karyana store, the FBR can ask you to create digital invoices on your cash register and integrate your digital system with FBR. The karyana store transactions would populate live in the FBR’s system, helping the FBR keep record of your transactions.
Earlier, FBR only mandated tier-1 retailers to integrate with FBR. Now the problem was that the retailer also bought products from unregistered sellers, which suppresses actual sales. Now the FBR after the recent law will not only integrate tier-1 retailers but also any other retailer it deems necessary for invoicing.
vi) For retailers to go digital, the expenditure incurred on obtaining hardware and software, if it goes above Rs150,000, the retailers would be able to claim tax credit when they file their returns. And there is also sales tax exemption on import of debit/credit card terminals and cash registers.
The government realises that asking businesses to go digital is going to come at a cost, which would be a burden for small businesses such as karyana stores. In that respect, tax credit has been allowed. Moreover, big corporations, because they are not digital ready yet, have been allowed to ramp up their digital readiness by the month of November, instead of asking them to do it instantly.
vii) Currently, any salary payment exceeding Rs25,000 per month is required to be made through a crossed cheque or direct transfer of funds to the employee’s bank account so as to qualify as admissible business expenditure. Henceforth, all salary payments through digital modes will qualify as admissible expense.
Salary disbursements are allowed through funds transfers into your bank accounts. The scope has been widened to include all modes of digital payments rather than direct bank transfers only.
The promised land
What does all of this mean? For starters, banks would be the biggest winners because they dominate digital payments. All acquiring business is going to pick up and four out of five acquirers are banks. Then the fintech companies like Keenu will see growth.
The definition of digital payments is not just restricted to debit or credit cards. It goes on to include QR codes. It’s just that debit and credit card transactions are most in numbers after cash transactions.
To digitise the retailer, the FBR connected with cash registers of retailers through APIs. As FBR told us that around 1,400 retailers have been activated through this measure and they have 25 billion transactions recorded. These transactions are auto-populated and the FBR takes it up as soon as the revenue is recognised.
“Right now we have around 1,400 retailers which are integrated. The impact would be substantial when this number goes to 50,000 retailers which are integrated,” says Sajidullah Siddiqui, director general of retail at the Federal Board of Revenue. The FBR has further mandated that tier-1 retailers would have to accept digital payments without exception, and they will also have to keep banking POS which accepts debit or credit card payments.
Since all retailers are going to have to keep the POS terminals, POS acquiring is going to see a boom. In fact, all acquiring is going to see a boom. POS machines for debit and credit cards are all imported and the decision to import is based on the demand that vendors that import these machines foresee. Already, duties have been exempted and the demand side push in terms of less sales tax on digital payments is going to help see more machines in the market.
Already there are 5 major acquirers and four more are entering the market to provide POS machines for debit and credit card transactions. Akhtar Fuou Technologies is one such fintech company and reportedly, Bank of Punjab and Meezan Bank are also entering the POS acquiring business to digitise retail transactions.
“These measures are substantial which will help move Pakistan from a cash-dominated economy to a modern one, which will help disburse credit to the lowest strata of society, help businesses, job opportunities will be created and SMEs would flourish,” says Saad Niazi, chief operating officer at Keenu, the only fintech company in the POS acquiring business.
Simultaneously, demand for more debit and credit cards in the market would push issuing for payment schemes such as Visa or Mastercard through respective issuing banks which have subscribed to these payment schemes. The users of debit cards have less sales tax to pay (16% instead of 17%) if they pay using digital methods instead of cash.
Is the 1% difference going to help? Well Mexico introduced a 2% reduction in sales tax on digital payments and witnessed digital transactions volumes going up. The enforcement measures in terms of disconnecting utilities for delinquent business helps IT companies such as fintech companies, which see this measure as a boost on the demand side which will help the supply side, the companies that provide softwares and hardwares for such integration, to provide these services to businesses.
Paysys Labs CEO and founding member of Pakistan Fintech Association (PFA) Karim Jindani tells Profit that the FBR has created a platform for IT companies to come in and provide such integration services. According to Karim, the era of the salaried classes having to pull everyone’s weight through indirect taxation might be ending soon. “In the past 50-60 years, the tax collection has had indirect taxation which has resulted in indirect taxation for the salaried class. So if businesses are asked to pay the right amount of taxes, taxes for the economy overall will be rationalised and that would be achieved simultaneously with IT companies getting more business opportunities.”
As the volume of digital payments increases, there will be data points to collect and help assess the creditworthiness of small businesses. Right now, small businesses do not have access to credit because they deal in cash which is not documented, and the lack of financial history means their creditworthiness can not be determined.
Fintech companies in particular can move in and provide lending services to small retailers. So as digital transactions start getting recorded, more fintech companies would be able to provide microloans, sometimes in partnerships with banks like in the case of Finja, to small businesses based on the credit assessment achieved through the digital transactions data.
Other avenues will open up for IT companies to start completely new tech services. For instance, SupTech (supervisory technology) will come into play which would use innovative technologies for supervisory support. Concomitantly, InsurTech (insurance technology) will help build technological insurance models, and WealthTech (wealth management technology) will further help build the digital financial ecosystem.