INFLATION, INTEREST RATE, AND EQUITY MARKET

TARIQUE KHAN JAVED
(President, Overseas Pakistani Investors Forum)

Feb 09 - 15, 2009

No matter how much the demand pressure or supply shortages are, there can be no inflation without accompanying expansion of money supply. When petrol and food prices went up people all over the world were forced to pay more for these and consumed less of others. So there was no change in aggregate demand. In the case of Pakistan inflation was building up since 2004 and it became nasty during the last one year due to subsidy given by the Government to keep the price of fuel and essential food lower. The subsidy amount increased the already higher than income expenditure making the budget deficit worst.

Last years budget projected revenue of Rs 1 trillion and expenditure of 1.5 trillion and yet to expect that there will be no consequence of this over spending is na‘ve, to say the least. Inflation was planned to deprive the people and enrich the government servants, contractors and businessman. If oil and food prices had not gone up as much as they did we would have seen inflation of say 15% instead of current 25%.

INTEREST RATE:

With 25% inflation what should be the interest rate for deposits? Current offer of up to 15% implies negative income of 10%. Interest rates always move up or down on the basis of expected inflation rate. Depositors now expect at least 27% to have a positive return of 2%. Banks and Government saving schemes are expected to increase rates in coming months to come close to this expectation.

SBP rate increase to 15% is therefore justified no matter what its consequences are for the industry or stock market. We have to pay a price for the original sin of conspiracy to rob the common man of his hard earned meager income. ALLAH will punish those responsible for this heinous crime, even if they escape accountability in this world.

FX RATE

While increasing the cost of production locally by allowing inflation to happen the previous Government following a very short sighted policy endeavored to keep the FX rate fixed at Rs 62 = 1 USD. This was detrimental for export and invitation for imported goods to come in and wipe out local industries. Exports could no longer supply at the old negotiated rates as the corresponding decline in FX rate was not happening when there cost of production was going up as a result of increasing wage, energy bill and local inputs. Thus we saw a flood of imported AC, TV, Motorcycles, Cars, Tiles, Chandeliers, Electrical items, Canned food and drink, Cosmetics, Crockery and other luxury sweeping through the country, pushing the local industry of these items towards closure. This was simply because it was an unfair competition. While we were subsidizing imports by the cumulative inflation rate we were strangulating the local producer by not letting the FX rate go down.

The increasing import bill and almost stagnant exports proceeds made the trade deficit increase with the passage of time.

Then came the huge increase in oil and food prices and that blew the trade imbalance out of the roof leading to rapid decline in FX reserve and prospects of default.

If we all accept that cumulative inflation from 2004 when FX rate was fixed at 62 to date is 70% then, whether we like it or not, value of Rupee in the FX market must also decline by 70% to match its decline in local market. This will happen no matter what we do. Holding few Kalias will not help.

EQUITY MARKET:

KSE was used to hover around 1,500 points, it dropped to 1000 level following 9/11 and resumed to 15,700 in April 2008. Did the productivity, profitability and divided payout of 100 Cos in KSE 100 index increase 10 times between August 2001 and April 2008? The answer is no. It was a manipulated jump similar to increase in the NASDAQ index from 1998 to 2001. It jumped from 1,300 to 5,400 without rational. So called investment Gurus used the media to spread the lie that the market would keep going up and the current level were well justified on the price earning ratio basis.

So people all over the world glued to Bloomberg, CNBC, CNN and Fox news and kept buying shares and investing their life savings in Cos like Yahoo whose share rose from 13 USD to 450 USD to drop again to 13 USD after 9/11 in the process sweeping away billion of dollars of hard earned saving meant for retirement.

Same has happened in Pakistan. Stock brokers and media are responsible for the misery which the common investor is passing through now. Many do not have any liquidity in the wake of closure of the market, while brokers trade out of the market.

Given the increasing interest rate on deposits the prospects of Stock market is getting worst. It is expected that soon we will see Government saving schemes offer up to 20% return. And thus, investor will seek 22 to 25% return on stock market implying PE of 4.