Pakistan’s central bank urges tax policy refinement to curb rising cash circulation

The State Bank of Pakistan (SBP) has advised the federal government to refine tax policies to combat the rise in currency in circulation (CiC), which previously surged due to the imposition of a withholding tax (WHT) on cash withdrawals.

In its semi-annual State of the Economy report, the SBP noted that the 2015 imposition of a WHT on non-filers’ banking transactions led to a sharp increase in cash circulation. According to the SBP (2017), the tax contributed to a 379-basis-point rise in CiC growth between July 2015 and April 2017.

Cash in circulation declined significantly after the WHT was removed, prompting the central bank to call for more refined tax policies to avoid unintended consequences that fuel cash-based transactions.

Pakistan’s large informal economy, where transactions often occur outside the banking system, makes cash the preferred medium due to its convenience and privacy. The report emphasized the need for policies that encourage economic documentation to reduce reliance on cash.

Gender Disparity in Financial Inclusion

Only 47% of women in Pakistan have formal bank accounts, compared to 81% of men. Addressing this gap presents a key opportunity to expand financial inclusion through enhanced mobility, digital access, and targeted financial programs for women.

CiC tends to rise during periods of high inflation, as increased prices necessitate larger cash withdrawals for transactions. Additionally, economic and political instability often leads people to hold more cash as a precaution.

Contrary to conventional economic theory, high interest rates have had little effect in reducing currency demand in Pakistan. The prevalence of cash transactions in the informal economy—where low documentation and weak regulatory oversight persist—may explain this trend.

During the 1990s, CiC declined as financial inclusion improved alongside banking reforms, expanding access to formal financial services. Innovations like credit/debit cards and online banking further reduced cash reliance. However, the 2015 WHT on non-filers’ transactions reversed this trend, increasing the CiC-to-M2 ratio.

To promote inclusion, the SBP introduced National Financial Inclusion Strategies (NFIS) for 2015-2018 and 2019-2023, focusing on regulatory improvements, digital financial services, and public-private partnerships. As a result, the percentage of adults with bank accounts rose to 64% in 2023, up from 13% in 2014.

Building on this progress, the SBP recently launched its third NFIS (2024-2028), aiming to further expand financial access and reduce cash dependency in the economy.