Source tax a fresh blow to bond market: bankers

The country’s feeble bond market is going to face a major blow as the government plans to impose a 5 per cent source tax on profits of investments in treasury bills and bonds.

The government may face an impediment to managing its bulging budget deficit during the ongoing economic fallout if it implements the proposed source tax, bankers say.

As per the Finance Bill 2020, the government will impose the source tax from the upcoming fiscal year, in a development that will discourage both individuals and corporate entities to invest in government securities.

Against the backdrop, the central bank requested the finance ministry on June 18 to withdraw the tax proposal, saying banks would be forced to lend more to the government due to lower investment by individuals and corporate entities.

Bangladesh Bank also sent the same letter to the National Board of Revenue, urging it to take required measures.

The outstanding investment in government securities stood at around Tk 280,000 crore, of which 30 per cent came from individuals and corporate organisations, according to data from the central bank.

The government earlier took a set of initiatives to encourage insurance companies, mutual funds and provident funds of private organisations to invest in government securities.

This had subsequently increased the demand for government securities bringing down the interest rate, according to the central bank letter.

For instance, the interest rate on 20-year T-bond stands at around 9 per cent, down from 15.50 per cent six years ago.

In the past, banks largely participated in the auction of securities but now many other organisations invest funds.

The private sector will be deprived of adequate loans if banks are forced to invest in the instruments in order to help the government manage the deficit financing, the central bank warned.

“This will create a crowding-out effect in the financial sector.”

The crowding out effect is an economic theory arguing that rising public sector spending drives down or even eliminates private sector spending.

The proposed plan will raise the interest rate on government securities as individuals and corporate entities will shy away from the instruments.

In addition, individuals will feel the pinch in buying and selling securities in the secondary bond market as they will have to bargain over who would foot the source tax.

The BB letter explained that an individual is allowed to enjoy profit from the tools every six months and they would face trouble in selling the instruments before they mature to provide interest.

If the bond-holder sells the securities halfway to maturity, this will create an ambiguity. There will be a dispute about who will provide the tax or how the amount will be divided.

The Primary Dealers Bangladesh, a forum of 21 banks dedicated to lending to the government by taking the securities, also requested the central bank to take measure to this end.

The government withdrew the 5 per cent source tax in 2012 in order to make the secondary bond market vibrant, the association said in a letter on June 16.

So, the latest decision is quite contradictory to the previous decision, said a central bank official, wishing not to be named.

The secondary bond market faced troubles for a long time due to the higher interest rate of the national savings tools.

The government is paying interest rates ranging from 11.04 per cent to 11.76 per cent to the investors of savings instruments at a time when clients get a maximum of 9.20 per cent by investing funds in government securities.

However, many clients have recently opted for T-bills and bonds as the government capped the investment in the savings tools.

“Corporate organisations will get a respite if they continue to enjoy the ongoing facility,” said Mirza Elias Uddin Ahmed, managing director of Jamuna Bank.

The source tax will have to be paid every six months but income tax is paid once a year.

The entities can invest in other sectors for the time being if they do not pay the source tax, Ahmed said, adding that a good number of non-taxpayers now invest in government securities instead of banks’ deposit products.

They have to pay a 15 per cent tax on investment in fixed deposits at banks. “But now they will be discouraged to invest in the government securities as well,” Ahmed said.

The government plans to borrow Tk 84,980 crore from banking sources in FY 2020-21.

The record bank borrowing by the government will put an adverse impact on banks as some of them have been facing a liquidity crunch in recent months due to the ongoing financial meltdown brought on by the coronavirus pandemic.

The liquidity crunch will widen further if individuals and corporate companies avoid investing in government securities.

If banks fail to supply the targeted amount, the central bank will have to lend to the government. If the central bank injects money, it will create an inflationary pressure in the market.