MONTREAL - Pakistan's economic outlook, already darkened by internal violence,
strife on its border with Afghanistan, soaring inflation and a plunging stock
market, took a turn from bad to worse this week with the decision by Standard
& Poor's to downgrade its foreign-currency rating.
Along with other emerging stock markets, Pakistan's has taken a battering as
global confidence has eroded. The Karachi All Share Index is down 40.5% from
its high on April 18 this year, the Karachi 100 a similar amount, and the
narrower Karachi 30 is down 47.4%.
Yet ironically, the banking sector, which has benefited from financial reforms
that began several years ago under finance minister Shaukat Aziz, has been a
bright spot and has proved
relatively immune from direct fallout from the US financial crisis. Its capital
adequacy ratio is about 12.1%, which is above international standards.
Pakistani banks are legally prohibited from investing in low-quality assets and
are therefore not exposed to the subprime crisis.
The broader market declines have followed a fairly steady descending-tops trend
line from April, although the averages have been extremely stable since the end
of August, when the government took measures to stabilize the market.
In June, the government imposed a 5% trading collar, in August it put a
short-term floor under stock prices, and last month it banned short selling and
set up a stock market stabilization fund. The finance and energy sectors of the
stock market have attractive valuations, but both foreign direct investment and
the participation of foreign institutional investors have declined
precipitously since last year.
Foreign funds fled Pakistani equities especially during the uncertain economic
and political conditions in the run-up to decide a successor as president to
Pervez Musharraf, with a net exit of US$400 million in the three months
preceding the elections. According to one report, foreign institutional
investment was down from a high of $1.8 billion in 2007 to $20 million just 10
days ago.
This complicates management not only of the external debt but also of the
current account deficit and fiscal deficit. It was little surprise that four
days ago, the Asian Development Bank (ADB) gave Pakistan a $500 million loan as
part of a larger ($1.5 billion) package to try to guarantee economic stability
specifically by providing foreign currency reserves as well as promoting
general economic development through job creation.
Last month, the ADB revised its growth forecast for the country downwards.
Whereas the average rate of growth has in recent years been as high as 7.5%,
but falling to 5.8% last year, the ADB lowered its projection to 4.5% for the
current year. This was due largely to political instability, which impedes
inflation-fighting - to decreased demand as a result of tighter monetary
policy, and to a slowdown in the rate of production of commodities as well as
an increase in their prices. Consumer price inflation rose past 25% in August,
compared with 6.5% a year earlier.
On the other hand, foreign exchange reserves are declining, as a result of
which the rupee continues to weaken - the currency is down 21% since the
beginning of the year. Countervailing options include selling off more public
sector enterprises to foreign investors and new incentives for expatriate
Pakistanis to increase their foreign remittances.
Standard & Poor's, fearing that Pakistan would fail to meet interest
obligations of $3 billion on its external debt, this week cut the country's
long-term foreign-currency rating to CCC+ from B. The US-based rating company
also noted that rising political risk from increased violence is threatening
the business environment.
Two weeks before, Moody's maintained a B2 rating on the government bond but cut
the outlook from stable to negative. "The likelihood of further domestic
political tumult amidst a growing tide of religious extremism and high
inflation could slow structural reform and fundamentally weaken much-needed
capacity to generate higher savings, tax revenue and foreign exchange," Aninda
Mitra, Moody's sovereign analyst for Pakistan, commented.
Pakistan is the world's riskiest government borrower, according to
credit-default swap prices from CMA Datavision, with investors concerned by a
deterioration in security that saw 53 people killed in a bomb attack on the
Islamabad Marriott hotel last month, according to a Bloomberg report.
More than 2,000 people were killed in Pakistan in 2007 in terrorist attacks
that the government blames on militants opposed to its support of the US-led
campaign against terrorism, Bloomberg reported.
Credit-default swaps are contracts based on bonds and loans and are used to
speculate on a company's ability to repay debt. Pakistan's five-year credit
default swap indicates that its sovereign debt trades as high as 2,050 basis
points. An investor would thus need to pay $2.05 million annually to insure
against $10 million of Pakistan's sovereign debt, according to S&P's.
The government is trying to borrow $100 billion from the US, the UK, and the
International Monetary Fund to help service the external debt (which amounted
to more than one-quarter of domestic gross product at the end of 2007). It is
in negotiations with the United Arab Emirates on economic aid, to which
security and political conditionalities would probably be attached, and it is
putting off paying its oil bill to Saudi Arabia. (The country's oil imports
cost over $1.1 billion per month.)
In sum, while it was thought president Musharraf's resignation might accelerate
economic reforms, thus giving foreign investors hope that the country's fiscal
problems were not beyond resolution, the political class now finds itself
caught between the Scylla of the political risk that those necessary reforms
will create, accelerating already vertiginous security problems, and the
Charybdis of the reforms themselves.
Big European banks believe that more fiscal and monetary tightening is
necessary, because in their view interest and inflation rates have not reached
their peak.
R M Cutler (http://www.robertcutler.org) is a Canadian
international affairs specialist.
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