While the short run outlook may appear positive, the longer term view continues to depend on the state of economic fundamentals.

Naween A. Mangi
Oct 26 - Nov 01, 1996

The sacking of the government of Benazir Bhutto and the dissolution of the National Assembly in the late hours of Monday night by President Farooq Leghari was greeted on Tuesday morning by the business community with a general feeling of relief. While many expressed concerns at the repeated demolition of the process of democracy by the ousting of every government before the completion of term, and that too by the signature of one man, the optimism and positive sentiment within the financial community was hard to miss. With investor confidence having reached an all time low and the impact of the recent mini-budget still fresh in the minds of people, this change-- as probably any manner of change would have been-- was more than welcome.

After the initial skyrocketing of mithai sales and the celebrations by rival political groups, especially in Karachi, some concerns surfaced about the recently concluded IMF agreement. The Fund had agreed, after the new economic package, to release $ 160 million of the $ 600 million stand-by arrangement. However, IMF sources said that they would continue talks with the interim government for reviving the loan arrangement, despite the removal of the Bhutto government. In latest reports on Thursday, IMF representatives were quoted as saying that they would seek assurances from the caretaker government that it will implement the agreement reached with the ousted government. The Fund is now expected to call for a formal signing of an agreement with the interim government.

"Of course, the new package will have to remain in place since the IMF agreement is otherwise at stake. But the legality of the recent tax measures will continue to be questionable until a bill is ratified by parliament," one economist said.

In his speech on Tuesday night, though, President Leghari did say that "the stabilization and structural reforms programme that had recently been agreed with the IMF will have to be fully implemented and further strengthened. Adoption of a long term strategy for sustained economic growth and financial stability is a national requirement that the present and future governments will have to observe. The present government will launch an economy drive and cut expenditure by reducing the size of the federal government functionaries."

Under the new leadership of the well-regarded, modest Malik Meraj Khalid, this might just be possible. For what is worth, the new team has already ordered a cut in current government expenditure by reducing cabinet costs. These austerity measures, substituting cuts in current rather than development expenditure if implemented, will be a much needed and welcome change from the economic standpoint.

Stock Market

The euphoria of the announcement, however, was best reflected in the pole-vaulting of values seen at the Karachi Stock Exchange. Even though the Tuesday after the dissolution of the assembly, the KSE was closed on account of a religious holiday, in kerb trading in the crowded parking lot of the exchange building, the index rose an estimated 40-60 points, amidst heavy buying to close just below the 1500 levels. Analysts, however, though upbeat in general, warned of speculative trading and said that these gains would not be sustainable. It was expected that the rise would continue up to the 1600 levels and then the index would come down. "It has gone up too fast too soon. Fundamentals are still weak, the index will have to come down. Too much is still riding on what happens now, and what the plans of the new government are," one analyst said. The more optimistic traders, however, expected 300-400 point increases to be followed by a stabilization at those high levels.

The following day, on Wednesday, the market opened on an aggressively positive note, with even otherwise "uninteresting" stocks opening at high prices. A real bull market was seen in action as the index rose a record 78.41 points to close at 1577.25. Before mid-session the market was as high as 108 points up, stabilizing slightly in later trade. Volume was also high at 84.295 million shares. By now, even optimistic analysts were growing pessimistic of the sustainability of the market at these levels. Most predicted that the surge might continue for a day or so more but was likely to come down.

And when the market opened on Thursday, stock prices were already lower, and as the news of Moody's Investors Service's decision to downgrade Pakistan's sovereign rating hit the market, a sharp fall began, with the index sliding 60 points in early trade. " We were expecting the index to come down today, but not by this much," said Sohaib Umar, analyst at AKD Securities. "Today was expected to be negative, and people were expected to come, book profits and leave," another analyst said.

If the news of the Moody's downgrading had not come at this time, the drop, it is speculated would not have been so steep. " Moody's downgrading was necessary even inspite of the IMF agreement because if Pakistan had defaulted on its external loans in the next six or nine months, of which there is still a good chance, Moody's would have been held responsible for not warning investors. Of course coming at this time, their decision is also based on political events to some extent," one analyst said.

The index closed down 69.4 points at 1507.85 in the last session before the weekend close.

In the currency market, meantime, although the pound sterling was exceptionally strong, trading about the Rs 70 levels, interest was minimal with most capital flowing to the stock market, leading currency dealer Owais Kalia of Khanani and Kalia International said. Following the 8.5% devaluation of the rupee at the end of last month, no further devaluation is expected till after the first quarter next year.

Returning to the stock market, however, analysts expected the selling pressure to continue for the next three to four sessions next week, especially in the GDRs of PTC and Hubco which would, in turn trigger further selling. The short term outlook, therefore, is that the slide will continue for the next few sessions, but that the market would stabilize at the minimum level of 1400 points.

"Otherwise, in the medium term, the market is likely to stay in the range of 1400-1550 points" analysts said. Until it is clear when elections will be held in the country, and until the interim government's economic policy is clearly spelt out, things will continue to hang in balance.

The sentiment after mid-morning trading was still marginally positive, on the condition that the interim government doesn't hold elections within the next three months. The reason for this of course, is that a technocrat government is an elevating factor from the market's point of view.

In the medium term, the market is not likely to fall, analysts said, but it will not go up dramatically either.

Economic Fundamentals

Of course, in the long term, nothing drives markets like strong economic fundamentals. And needless to say, nothing has changed in that department, and is not likely to change in the immediate future; at least until the interim government announces their new economic plan.

What does seem to be somewhat encouraging in this respect though is the appointment of World Bank Vice President Shahid Javed Burki to the post of Advisor to the Finance Ministry. Aside from anything else, it is expected that he will personally restore or ensure, high levels of credibility with both the World Bank and the IMF. And with some uncertainty still surrounding the IMF agreement, this is viewed by many as a positive move.

Although the agenda of the new government is far from clear, and of course, a lot is now riding on what those policies will be, in an article published some months ago, Burki discusses what he perceives as the problems of the Pakistan economy.

In doing so, he describes his primary concern as that of the budget deficit. "Fiscal imbalances have been around for a while but the point has been reached where they cannot be sustained at their present level for much longer," Burki says. He says that there are two ways of handling budget deficits; to borrow from markets, which will result in a crowding out effect, or to print money which will further fuel inflation. Seeing as the budget deficit which is now at 5.3% of GDP, against the target level of 4%, is indeed a pressing concern, there is at least the hope that with Burki in the picture, something will be done about this. "Being a World Bank man, it is likely that he will focus on the deficit rather than on growth," one observer said.

In his analysis of the "faultlines" in the economy, Burki identifies the following in addition to the budget deficit: "a monetary system that does not operate independently of the political system, a poorly developed financial system and a banking sector which is now under considerable strain, low rates of domestic savings, a high and growing burden of external and internal debt, low rates of investment and and equally low rates of return on them, rapidly deteriorating physical infrastructure, poorly developed human capital, rapid population growth, reemergence of poverty, the inability of the government to provide basic services to the poorer segments of the population and a legal system in which the people do not have a great deal of confidence."

"The economy is left with a debt burden that is hard to shoulder and difficult to reduce," Burki says. And the problems of debt servicing and defaulted loans worth over Rs 113 billion need urgently to be addressed. The recognition of these problems iappears to be an excellent starting point.

There may be a case for marginal optimism on the macroeconomic front therefore, keeping in view that Burki is known for his competence, even though many political analysts speculated that he might not achieve much since historical experience has shown that interim government's are not able to take any action that yields longer term sustainable positive results.

One observer said, "the short term is certainly brighter, there is a sure sigh of relief as the repressive feeling has been lifted."

But the optimism is not completely well founded. One economist said, "It is all just a circus. These are all simply cosmetic changes to amuse the people. Governance is the fundamental problem and for good governance, we need resources- but all our resources are going to the maintenance of the armed forces. " He went on to say that, "these short term stabilization measure may cause businessmen to feel optimistic, but, businesses look for short term rent-seeking activities. There is absolutely no difference in long term investment for long term growth. If the interim government has a long term in office, some stabilization may set in but fundamental problems remain. My economic outlook is no different than it was last week before the ousting of the Bhutto government."

Another economist said, "We are in for a rough ride. We would have been in for a worse ride if this move had not been made, because investor sentiment was severely negative-- now at least there is the chance that it will turn positive. But as far as the man on the street in concerned, the price spiral of the last few years, his primary economic consideration will not stop now. Quite to the contrary, prices will continue upwards, and fact we are in for a bad short term inflationary period. It is just the setting up of a process of change which may bring in structural fundamental reforms that is positive."

In such a backdrop, perhaps the widespread distribution of sweets on Tuesday was a little premature.