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Jul 17 - 23, 2000

United States is the strongest economy of the world, which, in 2000, enters the 10th year of economic expansion. This is the longest spell of continuous economic expansion in US history. Economic development in US usually affects other economies of the world. PAGE conducted a Q&A session with Riaz Andy and Akbar Hussain of Harvest Group's research department about their views towards the US economy with some hints of its effects on the Pakistan economy. Following are some key excerpts of the session.

Q. What is the outlook of the US economy?

A. Well, we have witnessed 110 months' spell of economic growth in the region. The economy grew 4.1% ($9.1 trillion) after gaining 4.3% in 1998 and 4.5% in 1997 but lately things are changing as some slow down in expansion is taking place due to the recent increases in interest rates, a situation which is good for the country as the 10 years of expansion took them far ahead from other G7 countries so they have time to wait for other G7 countries to join them. Over all the economy is doing fine.

Q. Why Fed has been raising interest rate step by step?

A. Obviously, this tool is used by a central bank for kerbing inflation. The Fed has been doing exactly the same except that these rate hikes were more of precautionary or what we may call pre-emptive measures to avoid a sudden stall in the economic growth of the country.

Q. Why these pre-emptive measure when apparently there was no inflation as such?

A. Pre-emptive moves in interest rates are not aimed at facing present inflationary situation rather they are aimed at avoiding the threats of underlying inflation. Yes! Apparently there is no inflation if look at the consumer prices but if notice the US equities' market we will realize that stocks were generally overvalued by 30-40%, as was also indicated by the Fed chairman, Allan Greenspan in his latest Humphrey Hawkins testimony. This speculative over valuation of stocks lead to extra income for the investment public, translating into more spending power, which finally leads us to inflation as demand starts to outpace the supply. This underlying inflation is also quite evident in the ballooning trade deficit of US, which this year topped the $30 billion mark.

Q. What is the state of the economy right now?

A. The rate hikes are taking effect now and the economy has started to show signs of slowing down. Consumer spending is down and the new home sales, which was the main cause of concern of the Fed is also steaming out.

Q. Is this the reason why the European currencies have been undergoing a very weak spell against the dollar?

A. Precisely, though there is growth in E11 countries but it has been over shadowed by growth in US. The flight of funds from Europe to US pressured Euro but lately the single currency is recouping.

Q. What effect these fluctuations have on Pakistani rupee?

A. I would rather look at it from the viewpoint that what effect would that have on our trade balance. More than 40% of our exports are to Europe; therefore, currently the amount we are receiving for our exports is lesser than what we may have earlier anticipated. For example when the Euro was trading around $0.88 to a Euro, L/Cs which were opened at parity stood 12 cents away which in rupee term is almost Rs 6.50 on each dollar or Rs. 650,000 on a $100,000 L/C, which is obviously very high. In easy terms, exporters who were expecting a dollar worth of revenue will receive only 88 cents instead. At the same time we have benefits on the import side as the government has successfully maintained the dollar/rupee rate, which translates into cheaper imports. Lets not forget that the later shall remain only if we are able to maintain the current stability.

Q. What do you believe is the future outlook of interest rates among the major economies?

A. We have witnessed a period where all the major economies used their interest rate to control their money supply but lately this old method of using the discount rate is somehow not in practice instead countries are using their short term rates. US and UK are almost at the peak in this race, there might be another 25-50 basis point hike from US towards the election season and that's it but the Euro zone needs more in order to maintain its 2% inflation target. Japan is also in line to end its zero rate policy and that suggests that one should prepare for what is ahead.

Q. Does this mean that the strong dollar phase is over?

A. Not really, this is a race of a hare and tortoise. The hare (US) is far ahead and taking some rest whereas the tortoise (E11) is working hard to catch up with hare. The only different thing is that this time the hare only take some rest and get on with the race. Actually economic fundamentals are still very good and that suggests that the growth will again pick up in recession struck regions with worldwide demand when the spending in other parts of the world improves. Every single country including Pakistan will receive some share out of it. It just the matter of time and effective planning for the future.

Q. How does Harvest Smartrend Securities (Pvt.) Limited (HSS) review the year 2000?

A. Stock market started its steady upward journey banking on the fact that the initial move by the new government was in right direction. Crackdown on wilful defaulters, privatization of state owned entities with emphasis on phasing the process through listing at local stock exchanges were all seen as positive economic measures. Government was able to renegotiate power tariff with 13 IPPs, however, the issue between Hub Power and WAPDA still stands unresolved. Government also started hectic negotiations with the fund to replace it with new PRGF (Poverty Reduction & Growth Fund) facility.

With the turn of new millennium, we saw that market made series of new records that was mainly attributed to expectation of political stability in the foreseeable future. With rising domestic liquidity, both within and outside the banking system, institutions were left with no other choice but to pump their capital into the equity market. Besides that, financial institutions were barred from investing in National Saving Schemes (NSS) that also provided the market with additional liquidity. SECP put emphasis on good governance and came up with some new proposals for the revival of various sectors including Mutual Funds, and Modarabas. In finance bill 1999-2000, government announced measures to safeguard the right of small investors and that resulted in one of the highest dividend yield for the year as compared with other regional markets.

The bearish run was mainly fueled by the row between government and traders over the issue of National Tax Survey and imposition of GST at retail level. Despite long deliberations, the issue still remains unresolved and government has still not been able to win traders' confidence. Moreover, the sharp decline in equity prices was said to be a war between two groups who tried to corner each other and as a result, market took a nosedive by losing all of its year's gains. KSE100 made a year high of 2073.13 points then tumbled to reach the lowest level of 1373.61 points towards the end of May.

Q. How does HSS assess the market situation after the recent fiasco at local bourses?

A. Well it can be termed as a feature of emerging markets but at the same time it is to be handled with sheer professionalism. Emerging stock markets offer very lucrative return on investments and this very characteristic often stimulates local as well as foreign investment into the stock market. It was going along very steadily till the time liquidity crunch hit the market. It is true that the bubble finally burst and the bull-run eventually came to a rather drastic end. There is one lesson for us that to handle such a volatile market, regulators have to improve the risk management procedures and inculcate modified exposure laws. There is always a system of 'Checks & Balance' and nothing should be left unnoticed. Leveraged trading is a part of the game but there are certain so called 'Circuit Breakers' that protect the market from a free fall. So recent crisis revealed certain loopholes in the system and there is an urgent need for improvement. Most hurt are the local retail investors who were again caught wrong footed. One can well imagine what would be going through the minds of foreign investors, still sitting at the brink and waiting for the right opportunity to enter.

Q. Would you like to point out some measures for market stability?

A. SECP is now really expediting the process of implementing the prudential regulations and we believe emphasis should be on the corporate culture in brokerage industry as government has extended the tax exemption for another year for new corporate brokerage houses. The idea should help inculcate the good governance and professionalism. Management of stock exchanges should adopt consistent yet innovative management techniques so that smooth running of operation may be assured. An effective risk management policy should be devised & implemented, for which regulators may take hints from other regional markets to improve on this part. Recently Securities & Exchange Commission of Pakistan (SECP) has introduced Capital Adequacy requirements for stockbrokers that will improve the stability in the market and check the over-trading done by speculators. Trade and Settlement system is being converted to T+3 and cash margins are required from brokers for the exposure. Recently ADB has sanctioned the second tranche of $125 million under Equity Market Development Programme, which would help speed up the incorporation of National Clearing and Settlement System. Once implemented, an immediate consequence of these measures would be a sudden drop in volumes. Eventually, activity would gradually pick up as only genuine investors would be there to trade. Movements would be steadier and based on fundamental developments.

Q. How do you see Federal Budget 2000-01 and its impact of the market?

A. The federal budget year 2000-01 is not an ordinary one in the sense that it is an integral part of a 'Three-year economic roadmap' envisaged for the revival of economy. So this document becomes more critical with reference to medium-term economic planning. This document emphasizes upon broadening the tax net, rationalizing tax regime and reducing number of taxes in order to increase tax revenue. Abolition of wealth tax is a welcome step that would restore the confidence and would help build a conducive investment environment. NSS rate of return reduction by 1.5% and extension in tax exemption on bonus shares and capital gains for another year should help bring in some more investment. On the other hand, imposition of 5% surcharge on corporate sector may harm their profitability. The entire theme of the budget is based on the assumption of documentation of economy and levying of GST. However, the resistance shown by the business community against the tax survey and documentation portrays it as ambitious budget. External sources largely depend upon facility from IMF. Currently Pakistan is engaged in negotiations for $2.5 bn worth PRGF facility as a replacement of stalled ESAF. Again IMF Executive Board is very closely monitoring the implementation of economic reforms and enforcing its guidelines. A detailed budget review is given in our 'Monthly Outlook' report for July 2000.

Q. Would you like to highlight HSS performance during the year?

A. HSS believes in giving quality services to its clients. The company is just in its fifth month of operation but surely has emerged as a matured brokerage house. We have been able to cater a large clientele through our specialized services namely customer services, research and efficient operations. HSS has the distinction of being the first brokerage house of Lahore to have 'REUTERS' On-line services for its clients at Harvest Group Building in Lahore. The Customer Services Department assures the timely execution of orders with accuracy and maximum dependability. HSS operations ensure highest level for transparency and swift execution of Buy/Sell orders according to the will of clients. We think it is the responsibility on the part of a brokerage house to fully inform clients regarding prevailing situation and advise them on their investments and portfolios. Equipped with all modern tools and having a team of experienced analysts, HSS research department is indulged in producing a wide range of reports for trading as well as investment point of view. Harvest group organised a seminar "Investment Opportunities in Pakistan" in April to feature FOREX and Stocks investment. We would like to continue this exercise and have interaction with more people. Another seminar is being held towards the end of July in order to create awareness of various investment avenues.

Q. Where do you see HSS after 3 years?

A. HSS belongs to a multi-national group that strongly believe in penetration through diversification. The Harvest group came to Lahore with an aim to set higher standards in the business and provide maximum benefits to the investors. Lahore is an emerging market and possesses great potential for business growth. HSS is optimistic about the future and foresee more favourable times ahead. Undoubtedly, a huge untapped market is out there and Harvest Smartrend is all geared to fully explore it by virtue of innovation and improvement. The mission does not stop here, advance level work has already been done to offer trading facilities with other exchanges especially developed markets including New York Stock Exchange (NYSE), NASDAQ, and Hong Kong Stock Exchange. HSS believes in steady growth and shall remain very optimistic about the future.