AROOJ ASGHAR (Arooj.asghar@crosby.com)
Nov 26 - Dec 02, 2007

Pakistan's stock market has all the ingredients of making a financial fable with unexpected heights and falls, record-breaking numbers, and unfettered greed. It grabbed headlines because of  its race to new highs on the back of a powerful economic recovery with stunning corporate profit growth. It captured the limelight in March 2005 & 2006 and July 2007 and then again in November 2007 when investors got heavy losses when the market crashed miserably. Pakistan's stock market started rising in early 2002, in the aftermath of 9/11. Economic performance improved, liquidity in the market rose, and investor confidence increased. Over the last few years from Dec. 31, 2001 to November 2007, the benchmark Karachi Stock Exchange 100-share index rose from 1,273 to 13,700 after touching 15,000 whereas during the same period, market capitalization raised many fold.

As everyone knows, political turbulence affects economic performance. Economic players don't like uncertainty; it makes it difficult for them to reach informed judgments about the future. They are likely to wait out the turbulence. The government believes that the 7% rate of growth per annum since 2002 is the result of the way it managed the economy. Islamabad suggests that its policies have brought about a profound structural change in the economy which will take it towards a high growth path similar to the one being followed by other Asian countries. One determinant of growth that has received little attention is the promise of political stability. As was the case in the 1960s, Pakistan has experienced considerable political certainty over the last few years. This contributed to the expectation that there would not be any major changes in the nature of public policies affecting the economy. There was a widespread belief in the country that the political system presided over by President Pervez Musharraf would continue. The continuation in the system would ensure no surprises for the various players performing on the economic stage. The sudden rise of political Islam, the gathering storms in the tribal areas and the executive's confrontation with the judiciary have resulted in creating an enormous amount of political uncertainty.

Pakistani stocks, the best performers in Asia since the country's president, General Pervez Musharraf, seized power in a coup eight years ago, may be set for a sell-off as his bid for a new five-year term meets widespread public opposition. The KSE index has leapt 858% in dollar terms since he ousted Prime Minister Nawaz Sharif in a bloodless coup on Oct. 12, 1999. Musharraf's support of the U.S. led war on terrorism has attracted foreign aid and investment. Market analyst believe that market was due for a correction of 1,000 to 1,500 points whereas it was difficult for investors to ignore the political situation because nobody knows who will win the elections and how much control Musharraf will have going forward. It's a big question mark hanging over the economy.

On November 3, 2007, Pakistani President General Pervez Musharraf issued a Proclamation of Emergency suspending the country's Constitution. The proclamation justified the suspension as necessary due to the country's rapidly deteriorating security circumstances. The imposition of an emergency came after months of political instability and worsening Islamist-related violence in Pakistan in 2007. Lawyers have demonstrated against his decision in March to remove the chief justice and now on November 3rd and supporters of opposition parties have joined the demonstrations since then. They are demanding him to take all the steps taken on November 3rd. Security forces are battling against militants in NWFP and FATA. The fighting is claiming lives of not only dozens of militants but also of security personnels and innocent people.

If political stability was one of the determinants of good economic performance in the past, then the reverse effect must also be true. The turbulence that has hit the political field in the last few months will have a significant consequence for the health of the economy. This is where we should turn to history in order to derive a lesson for the future. The market is booming like never before, with the KSE-100 index touching new all-time highs every few days. This steadfast bullish trend has little to do with the fundamentals of the economy, the state of the nation or the strength of listed companies. Clearly, the confidence of the market is not based on macroeconomic performance, which has been well below par in the last 11 months, or the security situation in a country ranked in a recent study as the seventh most dangerous in the world. Nor is it's associated with the profits announced or dividends paid out by any particular company. There is an element of the speculative in bourse activity across the world. However, it is only in a few emerging markets that decision-making tends to be completely isolated from the ground realities. Pakistan's is once such case where speculation not only rules the market, it appears to be its sole occupation.

Trade experts say that everyone was expecting that the market will react bearish after the weekend political developments (November 3rd). The market moved between a generally acceptably narrow band of 230 to 300 points decline until midday when panic button was finally pressed on 5TH November. The rumors of house arrest of General Musharaff spread like wildfire and nervous investors started selling their shares on throw away prices. By the time dust settled, an estimated sum of above US $3 billion had been washed away from the market capitalization. The KSE-100 plummeted by 635 points or 5% by 2 p.m. the biggest ever one-day fall on what will always be remembered as black day in the history of the Pakistan's capital markets. Industry experts were not expecting that the KSE would react so violently after the proclamation of emergency and the issuance of the Provisional Constitution Order by the Chief of the Army Staff. One of the reasons for this optimism was simple that the market had been discounting the emergency during October and already adjusted itself by shedding 800 points in that period. The bullish sentiment that had propelled the KSE-100 index to the all-time highest level of 15000 points in October was already diminished on speculation of the impending imposition of emergency. The market braced itself for some further erosion in the value of the stocks at the beginning of the week because along with the proclamation of emergency on Saturday came the PCO. For the market players, it was "emergency plus". Therefore, a little bit of further adjustment to the new reality was inevitable. But nobody was prepared for such a massive fall on a single day, which eroded market capitalization by Rs186bn.

It is quite evident that what happened on the black day was not the result from the manipulation of the big stock brokers or any inadequacy of regulations. It was a consequence of the government's own doing. With the shutdown of the television news channels investors had no means to verify or refute the fast traveling rumors of a "counter" coup. That led to panic selling by big and small investors. Along with local jobbers and speculators, foreign portfolio funds are also believed to have taken out US$25m (though very little what they are holding) from the market during the day. It is expected that this trend will persist over the next few weeks, unless state-owned and private institutional investors are forced by the government to intervene. In the absence of credible source of news because of a TV news channel blackout, the market was totally in the hands of speculators. By the time the denial from Islamabad reached the KSE, the damage had been done. So, should the KSE Board or the frontline regulator or the KSE management has moved in to calm the investors' fears. "We cannot be expected to comment on rumors," says Shaukat Tarin, the chairman of the Board of Directors of KSE, adding: "If we were to do that, we would be doing just that and nothing else". Adnan Afridi, the KSE managing director who took office only last month, affirmed that risk management measures were in place; that exposures had been collected in time and that there had been no defaults.

Since November 3rd, there are (so called) some positive developments on the political front, including formation of caretaker cabinet and perception of continuity in financial policies. Although the future market outlook is still unclear, but if emergency is lifted during the next couple of weeks the market will bounce back to its pre-reaction levels just in no time. Since proclamation of emergency, one finds various terrible moments in KSE as the political uncertainty continued to intensify by each passing day. Since then, there is a partial exit of some of the leading foreign investors but the satisfying feature is that they did not opt for panic selling and held the fort anticipating some positive corrective steps by the government to defuse the tense situation. The net outflow by them over the last week was said to be around US$135 million out of their total stake of about US$900 million, reflecting that they were not scared and hoped an improvement in the prevailing situation as long as President Musharraf is at the helm of affairs. But local selling both general and institutional was massive as it eroded at one stage about Rs250 billion from the market capital, took away 800 points or 6% from the KSE 100-share index earlier during the week. The dissolution of assemblies, perception of caretaker set up on the economic and financial issues and the law and order situation in the wake of agitation by the opposition against the imposition of state of emergency, world pressure to lift it continue to take their toll, intensifying the tense political situation and suspension of Pakistan from the Common Wealth. But leading analysts predict that the market is in for a extended recession as investors will think twice before resuming covering operations at the attractively lower in the developing scenario, mainly law and order situation and agitation against the emergency by political parties.

Earlier, the announcement of election schedule by the president seems to have ended the one phase on political uncertainty where investors' welcomed it by resuming covering purchases at the attractively lower level. Investors' perception that sanity will return to stock trading after the January 8th national elections as the future government will be well in place ending the current agitation. Re-election of the president for the second term is appeared to be pretty certain where Supreme Court has already dismissed all the legal obstacles which mean the continuity of the current financial and economic policies. This sends a wave of optimism in the market leading to snap recovery. Unable to bear the heat, punters and day-traders did make a dash for the exit, but analysts thought that long-term, deep-pocket investors had decided to "wait and watch". However, return of foreign investors may be further delayed until the emergency is lifted as they will await fresh development on the post-election schedule trading sessions. The current lower levels attained by most of the leading shares, however, provide attractive bait for any prospective investor having strong holding capacity to make fresh investment but low volume figures show leading among them are still in two minds about the future share market outlook.