Worsening economic fundamentals, a weakened stock market, a troubled financial sector and a lack of clear direction made for a difficult twelve months

Naween A. Mangi
Dec 28 - Jan 03, 1996

In a country already politically ravaged and economically weakened, 1996 brought little good news. Internal political troubles grew as ethnic violence continued, corruption took deeper roots and the stark lack of leadership became more and more apparent. Growing levels of unrest culminated in the sacking of the Bhutto administration in early November and the setting up of a caretaker government headed by Malik Meraj Khalid as Prime Minister. Investor confidence, already shaky from the post-bull market of 1993-94, wavered and then plummeted as basic macroeconomic indicators worsened during the year and clearly formulated long term effective policy did not appear forthcoming. The State Bank of Pakistan repeatedly devalued the rupee through the year in an effort to make exports more competitive, more and more taxes were imposed, first in the federal and later in the mini-budget, and sharply higher utility rates as well as an increased cost of living made for an even tougher business environment. A precarious reserve of foreign exchange, falling low enough to cause default to look a distinctive possibility and a continued tussle with the International Monetary Fund over the stand-by loan facility added to the troubles. And the downgrading by Moody’s Investors Service of Pakistan’s sovereign rating as well as the ratings of the large commercial banks rocked the country further. Bad debts mounted in the banking sector and industrial growth slowed. The trade and budget deficits both ballooned during the year. 1996 was characterized by uncertainty and instability.

Stock Market

he woes of the economy and the country at large were reflected in the growing weakness of the stock markets. The early part of the year was perhaps the only good period for the market as the KSE-100 index surged by 20% touching its year high of 1855.22 in the middle of February. But this unsustainable high did not last long as the market closed the first quarter at 1548.01 points. There was some recovery in the second quarter as the index recovered about 10% and rose to 1703.28 points. But the middle of the year and the announcement of the federal budget were the turning points. The KSE-100 index lost almost 15% during July and August as investor reeled under the new taxes including the 18-20% sales tax. And the devaluation of the rupee was not a comforting factor either. Investors saw more attractive returns on a simple dollar deposit account and bought dollars heavily in the stock market. With falling exports and concerns over the next cotton crop size, the share prices of textile stocks remained depressed as well. The index touched its low of 1332.14 on September 10. The mini-budget of October 22 which brought additional taxes worth Rs 40 billion, brought more troubles and the KSE Annual Report for 1996 says that " in order to avert a crash, an appeal was made to the government to consider urgent remedial measures." Some token measures assured the market and the index rose. But the fundamental problem remained: not only had the foreign investor and the local institutional investor been driven away from the market, but the small household investor, who brings his savings to the market had been burned and was not about to return to the market yet either.

After the severe volatility following the President's dissolution order after the initial one-session euphoria a stronger bear market set in, and the stock market package announced by the caretakers early this month, while addressing all the demand of the bourse chiefs, did not reverse this trend.

As a part of the package, the repurchase of treasury stock was allowed, insurance companies were made exempt from the capital gains tax and bonus shares were exempted from withholding tax. In addition, the income of mutual funds and NIT units were exempt from capital gains tax on shares, the Central Depository Company was ordered to be streamlined and made ready for operation, and provinces were to rationalized stamp duty on share transactions. While both the President of the Karachi Stock Exchange and the broker community expressed their satisfaction with these measures, analysts predicted that the package was just not substantial enough to jump start the market at the low levels it was at, and that the long term outlook was still gloomy.

The Economy

And this is primarily because, in the long-term, nothing drives markets quite like strong economic fundamentals. And so these analysts argue that until our economics is set right, the stock market will continue to waver and investors will continue to stay away from the market.

The challenges facing not only the caretakers but the elected government which will follow, are not easy to handle. According to the State Bank of Pakistan Annual Report 1995-96, the rate of GDP growth over the year was 6.1%, the rate of inflation was 10.8%, the budget deficit was up to 5.8% of GDP, bank borrowing was twice as high as the target at Rs 54 billion and monetary growth was 14.9%. Furthermore, exports increased only 7%, import growth was 16.2% and the current account deficit was as high as 6.6% of GDP.

Thus ensuring GDP growth, cutting inflation, and tackling the budget and trade deficits are all important priorities. Cutting the budget deficit to 4% of GDP is of prime importance. And the experience of other countries has shown that this is more successfully done by cutting current spending rather than raising taxes and cutting development expenditure. This approach will not only help cut the fiscal deficit but will not hamper growth either as the Rs 27 bn cut in development expenditure in the mini-budget is bound to do. Effective and efficient tax collection and an equitable tax system whereby the agriculture sector is also brought into the tax net will also help to resolve this issue. All, however, are politically difficult to implement.

As far as the agriculture tax is concerned, an ordinance was recently promulgated in Sindh to raise Rs 500 million through the imposition of an agriculture land tax. Other provinces are to follow and while the imposition itself is to be welcomed, effective implementation is still a pressing concern.

An effective, long term strategic tax and trade policy will also help improve the balance of payments situation. Early this year as the trade deficit touched the $ 3 billion mark, large scale concerns surfaced over the growing import bill for furnace oil to meet the needs of a growing power sector. The government continued to devalue the currency to "make exports more competitive" but it remained an ineffective and artificial policy. As one economist said, while talking to PAGE, " the country’s real competitiveness cannot be improved merely through nominal devaluation but through an improvement in the real terms of trade which will only come about when we are able to reduce the price differential of our goods versus those of our trading partners and competitors." Therefore, the solution would seem to be cutting inflation which has been independently estimated to be as high as 21%, and increasing our value added production, especially in the agricultural sector.

The IMF just last week, agreed to resume the stand by loan arrangement to Pakistan after a prolonged tussle and repeated negotiation. What remains troublesome however, is that we seem caught in a trap where we borrow to meet debt repayments and successively add to our growing debt burden. With a debt to GDP ratio near the 50% level and no clear policy to tackle the rising levels of domestic and external debt, the need for something more credible long term policy rather than tide-over deals with the IMF is becoming more and more necessary. The interim government has aimed to boost the country’s foreign exchange reserves to $ 1.6 billion, but Pakistan's proximity to default has remained close and threatening through the year.

Policy so far, has been characterized by short term relief measures and the mini-budget of October 22 is testimony to this fact. Analysts said at the time that the economy would be left with a general "feel good factor" and the IMF would be appeased enough to release the next tranche of money. It was abundantly clear at the time, however, that the cut in development spending will cause growth to slow and the increases in petroleum prices coupled with the devaluation will cut consumer spending power and cause a recession to set in. And at the end of the year, this still looks like a very real possibility.


The growing debt burden has left the country with little choice but to use the potential proceeds from the sale of state assets to retire debt. During the Bhutto government, while privatization remained a key goal, it appeared difficult to achieve.

During 1996, the fiasco with the attempted sale of the United Bank Limited took its toll on the privatization process. It was in March that the Cabinet Committee on Privatization approved the sale of the Bank at Rs 15.19 per share to the Saudi Basharahill Group. It was also determined that $ 500 million were needed to be injected into the bank to improve capital adequacy. After a long tussle and repeated hitches, however, the State Bank took over the management of the Bank and the deal with the Saudi group, which, it was alleged did not have the money to put into the Bank, was cancelled. It has been estimated that UBL has bad debts in excess of Rs 27 billion as well as over 10000 excess employees.

In the financial sector, the financial institution Bankers Equity Limited (BEL) was successfully sold to the LTV group at Rs 18.50 per share. Although the new management of BEL is still in the process of working out a concrete strategy to revitalize the institution, recent months have seen the launch of a range of new well-marketed deposit products and a new company image as well.

The Kot Addu Power Plant Company was also successfully privatized and went to the UK utility National Power, also the prime sponsors of the Hub Power Company which gave them increased control over Pakistan’s power sector.

Pakistan Telecom (PTC) , however, remained a problem area. While the markets waited anxiously for the sale of PTC to boost confidence, and the depleting forex reserves of the country, the privatization seemed harder and harder to achieve. The performance of the share price remained weak over the last few months and foreign investors seemed to turn bearish on the earnings prospects of PTC. Needless to say, the successful sale of PTC is critical to the overall, economic well being of the country and the projections for the future as well. It is critical at this juncture that caretakers' emphasis on privatization prioritizes PTC; -its marketability needs to be increased and the sale needs to go through quickly at an acceptable price.

And fortunately there is a case for some guarded optimism in this regard. The caretakers task force on accelerated privatization and the new chairman of the Privatization Commission, Dr. Salman Shah seem to have their priorities in the right place. In an interview with PAGE last month Dr. Shah emphasized the need for an adequate regulatory framework saying that "unless regulatory bodies are seen to be effective and independent by potential buyers, it is not possible to privatize major investments."

As regards PTC, Dr. Shah emphasized that "the privatization of PTC is the highest priority of the Privatization Commission." He said that they were in the process of addressing some of the concerns of strategic investors, most of which relate to regulatory issues, and that they expected to be done with their homework by end January so that the next government can invite bids whenever it feels ready.

His plans for accelerated privatization also extend to the gas companies, area electricity boards, strategic alliances for airports and the financial sector. The Faisalabad Area Electricity Board is to be ready for bidding by April / May and Sui Northern Gas Pipeline Limited is to be ready for privatization by June next year.

Although it is difficult to say how much the government can achieve in this area by the end of January, Dr. Shah has emphasized that his aim is not to sell off as many state units as possible but to put a strong Privatization Commission in place which fully staffed with professional, technical people.

One important area of emphasis is the banking and financial sector. The target of the PC is to sell both Habib Bank and UBL as well as some of the DFIs by end 1997. And in order to do so, the government is to set up a Resolution Trust Corporation (RTC) . This Corporation would have the task of cleaning up the balance sheets of banks and financial institutions and taking on the bad debts of the banking system. Practically speaking, once a financial advisor has determined which loans are to be sent to the RTC, the equivalent amount of money in the shape of a bond will be placed on the bank’s balance sheet making the bank a healthy one without bad debts. And the buyer will then be able to focus on the strong points of the bank.

Financial Sector

If this works, and if the legal structure is well formulated, this could be just what the financial sector needs. Burdened with over Rs 130 billion worth on non-performing loans, the financial sector has had a troubled year. Close to nothing was achieved by way of recovering bad loans and in addition, Moody’s Investor Services assigned abysmal ratings to the four largest commercial banks in the country. On the long term rating, MCB, UBL, and NBP were assigned a B2 ranking making them "speculative", and HBL was rated B1. And all four banks were rated "non-prime" for short term borrowings which is a high risk category. And in terms of overall financial rating, UBL and HBL have been assigned a rating of E and NBP and MCB are rated E+. An E rating implies that a bank is likely to require financial assistance from a third party in order for it to survive.

On the deposits side, competition for depositors money intensified as private banks competed with the big four and the foreign banks as well as amongst each other in vying for customers money. Several new savings products were offered and almost all banks developed high yielding rupee transactions accounts. Nonetheless, rupee deposits remained lower as the effects of inflation and devaluation continued to eat into the value of the rupee, leaving depositors with little to hope for in the way of positive returns on their money. Most savers preferred a dollar savings account, and rightly so, to any other investment vehicle.

As the banking crisis reached a crescendo with the total size of bad loans on a distinct upward path, the sacking of the Bhutto government and the appointment of the caretakers brought with it the announcement of a banking and financial sector reforms package.

The Prime Minister's Advisor on Finance and Economic Affairs and the defacto Finance Minister Shahid Javed Burki announced a package in Islamabad at the end of last month. This package included the setting up of an oversight board as a temporary entity to acquire the infected portfolio of nationalized commercial banks and DFIs and to aggressively pursue the recovery of dues. The bad assets of the banks were also to be cleansed by introducing a government marketable security. Furthermore, the government is also to prepare comprehensive laws on foreclosure to facilitate the recovery of bad loans — a measure much appreciated by top level bankers. The Pakistan Banking Council was announced to be abolished and the government was to update different laws in order to ensure that the regulatory authority of the SBP is enhanced for improved banking. The prudential regulations were also to be strengthened with special mention to capital adequacy and DFIs were to be consolidated before privatization as well. The Youth Investment Promotion Society and the Small Business Finance Corporation are to be merged, the Regional Development Finance Corporation is to be merged with National Development Finance Corporation, and the Equity Participation Fund is to be merged with the Industrial Development Bank of Pakistan. The Finance Advisor said at the time that the mergers were to make the sector more attractive to foreign buyers and restructuring would follow to make them more competitive. Effective implementation of these measures remained a pressing concern and observers also said at the time that it was difficult to say whether the elected government would follow through on these reforms or not.

In the rest of the financial sector, early September saw the voluntary winding up of two modarabas after the Corporate Law Authority put 17 modarabas on observation for poor performance. First DG Modaraba and First Paramount Modaraba, both with paid up capital of Rs 50 million were allowed to be voluntarily wound up although the CLA said they were both required to meet their financial obligations fully before doing so.

The investment banking sector suffered large losses this year after counting on equities. Most banks had relied heavily on investment in the stock market since most were established during the bull market of 1993-94. After the persistent bear market of the last two years, however, and with little or no income from the more traditional investment banking activities, many banks posted large losses, after providing for the reduced value of their portfolios.

The leasing sector was perhaps the only one in the financial sector with some good news. After a long period of abysmally low share prices, and poor performance, this year companies declared some good dividends and many analysts pronounced the sector as undervalued. Of course the issue of a lack of low cost long term credit lines remained a problem, resulting in exceptionally high markups on leases, but some upturn in the sector appeared forthcoming.


A case which affected almost the entire financial sector was the default by Mohib Textiles, a member of the Saigol Group of Companies in August. With several banks, both local and foreign as well as several leasing companies largely exposed to Mohib, the default caused waves in the financial community and American Express Bank instituted legal proceedings against the company as well.

But Mohib Textile Mills was not the only company in trouble. The textile sector has been through a prolonged bearish spell this year with the pressure from the All Pakistan Textile Mills Association persisting.

The federal budget this year brought more troubles as a 15% sales tax was levied on ginned cotton, yarn and cloth, and corporate tax was increased from 33% to 36%. Central Excise Duty , however, on cotton and blended yarn was proposed to be withdrawn. The devaluation in the mini-budget was said to make exports more competitive but analysts forecast that exporters will only gain the short term as sector fundamentals remained weak.

The availability of raw material and the high cost of inputs remained pressing problems. The interim government announced a relief package for the industry at the end of last month but analysts did not agree that the measures would attack the key problems of the sector in the long run. The package did offer some relief in the short term though. The withdrawal of duties on the import of raw cotton and polyester staple fibre would reduce the input costs to some extent but observers said this would be wiped out when overseas buyers start demanding reduction in export prices and exporters voluntarily reduce the prices in a bid to negotiate more orders to achieve higher capacity utilization. Furthermore, the industry classified the package as one of relief measures for the spinning sector only, although the value added sectors like weaving, finishing and ready made garment manufacturers were said to be next in line for a relief package.

The package aimed to solve the problems of availability of raw materials and high cost of inputs. The withdrawal of duties on imported raw cotton was said to not only help spinners to source cheaper cotton from outside Pakistan but also bring down cotton prices in Pakistan. Furthermore, this would reduce the pressure on the spinners to buy cotton for the whole year which would improve their liquidity. The profit margins of spinners would also be improved as PSF would be easily available at lower prices and spinners will be able to produce blended yarn which fetches higher prices.

Cotton prices in the domestic market are higher than international prices and exporters were able to export only 2500 bales against registered export contracts of nearly 12000 bales

Despite statements through the year that more area was brought under cotton cultivation and the quality of the cotton seed was much improved, cotton production is expected to touch 9.5 million bales this season. Analysts recommend that the government examine the reasons for this failure and institute efficient methods of crop estimation.

In addition, since the textile sector is of crucial importance to Pakistan's economic well being especially with regards to the balance of payments situation, attention needs to focused in 1997 on the value added sector. Increasing production and hence exports in this area will prove more beneficial in the long run.

As regards the Polyester Staple Fibre industry, however, analysts did not generally think the package would improve profitability all that much, Because spinners have a limited consumption of PSF, any reduction in its prices would not boost the offtake substantially. So some analysts thought that sales and profitability would marginally improve for this sector. Others argued that the removal of the 10% regulatory duty would lower the price of imported PSF; but the negative impact of this on local manufacturers would be offset by the reduction in duties on PTA and MEG and the removal of the 5% CED on local PSF sales and therefore the net impact on the sector would be positive.

The sugar industry also had problems as over expansion continued with associated repercussions. Sugar production in 1995-96 was close to 3 million tonnes 20% lower than the previous year and about 500,000 tonnes were required to be imported. Domestic consumption was estimated at 2.7 million tonnes and crushing capacity utilization dropped to 55% in the year. Therefore profitability remains a problem.

The shortfall in sugarcane availability was the reason for under utilization of capacity and this coupled with the increases in the support price fixed by the government were responsible for the increase in the cost of production of sugar. Profit was squeezed and accumulated losses rose.

Growers also demanded higher prices than those fixed by the government and curtailed supply to the mills. And mills, which were already under financial pressure, were forced to succumb to the pressure and pay a higher price for the sugar cane. Independent analysts have suggested that until such a time when existing mills achieve a 90% capacity utilization the establishment of new units and the expansion of existing ones be banned. Observers also suggested that the country is capable of producing twice the quantity consumed domestically and export of the surplus can help improve the balance of payments situation.

Possibly the most lucrative sector from the investors point of view, the power sector remained the most attractive during 1996. Hubco commissioned their first generator and Southern Electric Power company and Japan Power were also listed at the Karachi Stock Exchange. The Bhutto government's generous power policy, however, came under criticism as analysts began to realize that the cost of private power would be prohibitively expensive. The federal budget imposed a 5% sales tax on the import of power generation and transmission machinery and a rise in corporate tax from 33% to 36%. The sales tax however only affected captive power units as the policy for independent power projects remained unchanged. The continuous increase in petroleum prices during the year, however, including a 10% rise in the mini-budget, resulted in an increase in utility rates. Independent power projects gained as the increase in the cost of furnace oil was a pass-along item and not a cost to be borne by them. The devaluation during the year also improved their US dollar linked returns.

The other attractive sector from the investors perspective, the fertilizer industry maintained its strong fundamentals, growth in demand and solid performance. However the supply of natural gas, the main input in the production of urea remained a problem. The federal budget of 1996 imposed a 5 % sales tax on raw material for fertilizers but the sales tax exemption on natural gas remained. Analysts pronounced the budget as neutral for this sector and did not think the strong growth would be deterred. Urea manufacturers, Fauji Fertilizer and Engro Chemical were said to remain unaffected as the exemption on natural gas, the main input remained in place. However, phosphoric acid which is the main raw material for the manufacture of DAP was to be taxed at 5% and those was said to affect the earnings of Fauji Jordan Fertilizer since the total project cost would be higher and depreciation expenses would rise. This project is expected to come on line in 1998 and with this and other factors causing an increase in gas prices, there might be some pressure to increase DAP prices as well. The mini-budget of October 22 was said to have a positive effect on fertilizer companies because local companies will be able to increase prices as imported urea and DAP will be more expensive due to the devaluation.

The shipping sector on the other hand seemed to have more troubles, as the long standing decline continued and the sector's total vessels, only 20 in number carried only about 7% of the national cargo while the remaining was handled by foreign companies costing $ 1.5 billion every year. These problems were compounded by the fact that the country's ports, Karachi Port Trust and Port Qasim, remained poorly equipped. Port Qasim remained a day time port and without a dredging fleet and mechanical workshops, costs also escalated during the year.

The operations of Pre Shipment Inspection Companies came under fire repeatedly this year, culminating in a announcement just this month by the Central Board of Revenue that the services of SGS and Cotecna would be terminated. Importers criticized the companies for incompetence and the CBR accused them of costing the exchequer Rs 5 billion every year without increasing revenue from customs duty. It also said that companies committed omissions, violations, breaches and irregularities in the issuing of clean reports of findings. The absence of an alternate system, however, leaves importers to grapple with the customs and CBR authorities who will conduct valuations.

And in the pharmaceutical sector, the absence of coherent, consistent, long term policies left the sector with all its troubes unresolved. The measures of the federal budget — a 5% sales tax on medicines and medicine raw materials (later withdrawn) , a 5% CED on raw material imports and an increase in the corporate tax rate from 33% to 36%- had a large negative effect on profitability. This was somewhat offset later as the 8.5% devaluation of October 22 set in. The effect on consumers was heavy however, as the prices of medicines escalated during the years.


Whether we look at industry, the financial sector, the privatization programme, the stock market or the overall state of the economy, the caretakers have a phenomenal challenge before them. President Farooq Leghari announced a relief package this past Wedensday and the government has already set up fourteen task forces to recommend measures to revitalize the economy. But three major concerns remain; what will the interim government achieve, will their measures be implemented effectively and will the elected government follow through on the reforms instituted by the caretakers.

What they can achieve is clear. Even if a period of three months is too short to actually put changes in place, it is the process of instituting change that is important. To some extent this has happened. The task forces have made recommendations and reform packages have been announced. But the pressures of 1996 persist; the problems of the stock market have not gone away, the textile sector's long term prospects have not brightened, and the banking sector remains a major problem. The cost of living is continually rising and the fiscal deficit and the balance of payments remain pressing concerns.

Independent observers are still concerned about effective implementation and at least until February 3, uncertainty will continue to prevail. And add to this uncertainty, the lack of clear concrete policy changes which we still see, and the outlook is not all that optimistic.

Until the caretakers are able to instill some measure of confidence not only in the investing community but in the public at large that their policies are long term, sustainable measures which will lead to economic stability and revival, the outlook will remain on the pessimistic side. Pakistan is wary of elected, political governments. And even though a caretaker government has no political mandate to institute solid economic change, their potential to do so is extensive. And the economic picture of 1997 depends largely on their ability to utilize this potential and set in an irreversible process of change.