Updated November  20, 2003



The index, during this event filled week, grew marginally. The week started off very badly as investors were badly shaken by the attempt to assassinate President Musharraf on Saturday. This was further compounded by the new COT rules that went into effect, which restricted COT trade to 30 stocks, and increased bond yields.




Tuesday saw some growth, however volumes remained low, whilst rumors regarding exposure problems being faced by a broker forced the index downwards. Later on during the session however, PSO's privatization related rumors surfaced along with news regarding KESC's privatization, which pushed the index into positive territory. Wednesday brought the index down as MMA's deadline on the LFO issue approached and investors looked to book profits. This carried on into Thursday as investors remained jittery with regards to MMA's protest action, which however was offset by institutional buying. Friday's session received strong positive support from rumors of an agreement between the MMA and the government regarding LFO and the President's uniform and from the President's statement regarding Kashmir.


Any further news on the MMA-govt and Pak-India front will probably have an immediate impact on market sentiment as we have seen over the past week. Furthermore, as we approach the end of the year we may see volumes remaining low as institutions prepare their period-end financial statements. Lastly, any news regarding the privatization of SSGC and HBL should also provide the market with some excitement.


The major developments this week were:

•Pakistan's current account surplus during July-October dropped 11% YoY to $1.4bn due to the decline in workers remittances to $1.2bn as compared to $1.4bn that were received during the same period last year and the jump in overseas travelers requirements to $244mn from $18mn that was spent last year. Additionally, Pakistan's capital account witnessed a worsening deficit to $682mn from the $163mn recorded during July-October last year. This was due to a fall in foreign investment to $88mn (2002: $242mn), a fall in direct foreign investment to $170mn (2002: $402mmn) and a fall in foreign loan disbursements to $374mn (2002: $641mn).

•The government is expected to introduce 15 and 20-year bonds next month to serve as a benchmark for house financing and construction loans. This led to a sharp rise of 30 to 40 basis points in the yields of existing PIBs during the last week.

•The government has decided to issue bonds worth PkR14bn to cover HBL's non-performing loans in an attempt to speed up the privatization process. It has also announced that the second pre-bid meeting will be held in two weeks time.

•The management of PTCL is considering offering a Voluntary Separation Scheme to about 25% of its staff.

•Reportedly, the Privatization Commission has received 5 Expressions of Interest for KESC in response to its recently advertised invitation. However, four of these five parties have actually submitted statement of Qualifications. These parties include: i) A consortium led by Hassan Associates; ii) Independent Power Corporation PLC and Eskom of South Africa; iii) Corner Stone Partners; and, iv) Kanooz Al Watan & Siemens.

•According to OCAC press release, petrol prices for the next fortnight will be about 28-30 paisas higher. However, there was a marginal downward adjustment in the HSD prices.

•WAPDA has announced that it will work on improving its payment schedule to the IPPs who have been struggling for timely payment of their dues even after the resolution of their issues with the state run utility.

•The visiting IMF review mission concluded its weeklong visit with a final meeting with Finance Minister, Shaukat Aziz, during which it was agreed that Pakistan could beat the 5.3% GDP growth target for FY04.

•Remittances sent by overseas Pakistanis during the first five months of the current fiscal year (Jul-Nov) declined by 16.6% YoY to $1.49bn. During the same period last year, $1.79bn was received, which resulted in a year-end total of $4.2bn. The target for FY04 was set at $3.6bn (14% YoY lower).

•Money Supply (M2) grew 8.06% during July-Nov 03 against a target of 11.06% for the year as a result of the growth in Net Domestic Assets by PkR108bn versus a year-end target of PkR100bn. The main reason for this growth was the PkR124bn in credit extending by banks to the private sector against a full year target of PkR85bn as a result of the low interest rates. This growth has resulted in a 2.6% rise in consumer inflation during the first five months of the fiscal year against a target of 4% for the year.

•Unilever Pakistan on Thursday announced its intentions to sell Dalda, its edible oils business, as part of the parent company's global strategy. As per reports, the company is considering either an outright sale or a joint venture. Rumors suggest that parties interested in acquiring Dalda include the Lakson group and Habib Oil.

•Minister of Industries, Liaqat Jatoi while speaking to the press commented on the difficulty of taking action against cartels in the large scale manufacturing sector because of their huge contributions in terms of tax revenues and jobs. He also said that he had received a formally signed copy of the auto Task Force's report on December 15.

•The Private Power Infrastructure Board has given its approval to setting up of four power projects in the country. The proposed power projects are likely to add around 770MW to the installed electricity generation capacity of the country at a cost of approximately US$838mn. Out of the four power plants, three are thermal plants based on gas, while one is based on hydropower.

•Foreign Direct Investment in Pakistan during the July-November registered a fall of 53% YoY to $217mn. Total FDI received last year was $798mn, which was primarily high on the back of proceeds received against the privatization of United Bank Limited.

•The Corporate and Industrial Restructuring Corporation (CIRC) managed to settle non-performing loans worth PkR3.5bn for Habib Bank Ltd. during the last three months. Since potential bidders for HBL have expressed concern over the bank's large portfolio of non-performing loans, the CIRC has been awarded the responsibility of settling PkR8.0bn worth of these loans.

•Pakistan's total liquid foreign reserves fell by $8mn during the week ended December 13, to $11.861bn from $11.875bn. The primary reason for the fall in reserves was the $176mn payment on the outstanding Eurobond that is to mature in 2005.




A justification for immediate change in interest rates?

Advocates for an immediate increase in interest rates have repeatedly pointed towards inflation as a justification for their arguments. This article attempts to evaluate this argument by comparing the current year's inflation rate with last year's inflation rate, as well as the government's full year target of 4.0%. The analysis shows that while inflation has shown a rising trend during the past few months, the inflation rate for the first five months of the current fiscal year is at a lower level than that for the corresponding period last year. Thus, it appears that the target inflation level can be achieved without any drastic move by the State Bank. Moreover, the need for maintaining a balance between promoting further economic growth and curtailing inflation is likely to keep the SBP from raising interest rates within the next one or two months.

The yields on 3, 5 and 10-year Pakistan Investment Bonds witnessed a sharp rise during the previous week, fueling speculation about a possible hike in the interest rates in the near future. Furthermore, local newspapers have cited various experts who claim that, given rising inflation, the current interest rate structure is not sustainable and that the State Bank will be forced to revise its policy as early as January next year. This article attempts to analyze some of these arguments to evaluate whether or not the State Bank can continue with its current policy, at least in the short run.


The local economy has rarely, if ever, seen a combination of as many positive influences as it is currently witnessing — capital inflow reached unprecedented level during the past few years, the Government paid off more loans than it borrowed, leading to net debt retirement last fiscal year and even the IMF recently expressed the opinion that current year's GDP growth target of 5.3% could be surpassed. All these factors, combined with a number of other developments, has led the State Bank to reduce interest rates to their lowest level ever. Given that capital inflow, which is widely regarded as the key catalyst for the economic upswing, is reverting to a slower, more normalized level, there is a general consensus that the SBP will raise interest rates during the second half of the current fiscal year. However, there is a stark difference of opinion among the experts over how soon this change is likely to occur.


Experts advocating an immediate change in interest rates often refer to the level of inflation as strongest justification for their argument. Inflation in November-03 over the corresponding month of the previous year was 4.22% as opposed to 3.11% last year. Moreover, this number stood at 3.51% in October '03, as compared to 3.49% in October '02. These figures indicate a rising trend in inflation, pointing to a need to tighten the monetary policy, especially considering the Government's target inflation of 4% for this year.

Most consumer finance products were introduced in the current calendar year and have been identified as a key cause for rising inflation. Given that these financing options are likely to gain more popularity and acceptance in the coming months, the upward pressure on inflation is likely to increase. Moreover, the general view holds that the rise in disbursement of private credit by banks has been directed towards such products rather than manufacturing. This implies that prices are likely to rise without a corresponding rise in production unless the interest rate structure is adjusted.


As mentioned above, rising inflation is the most important argument presented for demanding an immediate rise in interest rates. While it is true that inflation is currently at a higher level YoY as compared to the Government's full year target, Table 2 shows that inflation during July-November over the corresponding period year stood at 2.62% compared to 3.59% last year. Given that this period includes data for Ramazan, it is likely that the Government will be able to reach its inflation target without a drastic change in its policy. The argument for controlling rapid spread of consumer financing that does not add to the production capacity of the country is justifiable. However, the SBP needs to ensure that any such move does not curtail any development that is already taking place in the manufacturing sector. Moreover, despite an improvement in most macro variables, the current economic growth has not yet translated into greater employment opportunities. If the SBP moves too fast in raising the interest rates, its actions might curtail the trickle down effect of this growth.




While we agree that the analysis above is by no means comprehensive, it demonstrates that the threat of inflation alone does not justify a sudden change in the interest rate levels. Some people have argued that low interest rates have forced banks to look towards alternative avenues, such as the stock market, to maintain profitability and rising interest rates would prompt them to focus more on their normal operations. Again, while this argument holds some truth, the introduction of consumer finance and the current cotton crisis has presented banks with an opportunity to make money through lending activities rather than investments. This mitigates the need for any sudden change in interest rates by the SBP. Consequently, we feel that while the State Bank is likely to raise interest rates in the second half of the current fiscal year, we expect this change is likely to occur in the latter half of the next quarter, or even in the fourth quarter, rather than as early as January.






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