June 20 - 26, 2011

Pakistani stocks showed a mixed reaction to the country's budget for the fiscal year 2011/12 (July-June) announced on June 3, as some fiscal measures dampened the sentiment in the market, while some measures had a positive impact. The stocks tumbled in the post-budget session, as the government did not announce the removal of capital gains tax (CGT) in the national budget. The benchmark Karachi Stock Exchange 100-share index lost 0.20 percent, or 25.01 points, closing at 12,211.65 on the first trading day of the week after the budget. Stocks however recovered after initial bearish reaction under the lead of cement and oil shares, one of the chief beneficiaries of the fiscal measures announced by the finance minister Dr. Abdul Hafeez Shaikh. The KSE 100-share index gained 0.85 percent and 0.42 percent on the second and third trading days of the week after budget, respectively.

In his budget speech, the finance minister announced removal of special excise duty and reduction in federal excise duty on cement that kept the cement manufacturers amongst the most active companies in the market. Analysts believe that future perceptions about the negative and positive impact of the budget played its role in shaping the investor behavior in the post budget week.

The KSE 100-share index continued to witness a bullish trading in post budget week after the budget was termed positive for cement and corporate sectors scrips. Renewed foreign interest in blue chips and higher local commodity prices played a catalyst role in the positive activity at KSE despite concerns over rising inflation and fiscal deficit in the country.

The market was expecting the removal of the CGT, which did not happen, so that had a negative impact, while the government reduced the excise duty on cement and it did not increase the rate of corporate tax on bank, which was positive for the market. The cement stocks remained the volume leader after removal of special excise duty and reduction in federal excise duty. The government has reduced regulatory duty to 5 to 10 percent which will cause a loss of Rs800 million. It has also abolished federal excise duty on 392 items but retained on five items - betel nuts, luxury cars above 1800 cc, arms and ammunition and bathroom ceramics. The business community has welcomed the reduction in GST and Special Excise Duty and termed it a good sign for the revival of the economy.

The analysts believe that investors are disappointed as the budget was silent on the issue of CGT as some of the investors had built long positions on the hope it may be removed.

Some analysts however argue that Finance Minister did not make specific announcement regarding CGT, but it was agreed with KSE that individual and small investors would continue to pay 0.02 percent withholding tax as a final tax liability. They expect that specific announcement regarding CGT will come in the Finance Bill 2011-12.

What also led the market to the bullish reaction have also been the expectations of early release of next tranche of $ 11.3 billion loan from International Monetary Fund (IMF) for Pakistan, which played a catalyst role in the bullish sentiment at KSE despite concerns over rising government borrowing, inflation and lower economic growth indicated in Economic Survey 2010-11 unveiled on June 2.

The IMF stressed upon the government for sales tax reform and linked it with its disbursement of loan program. Therefore, the government initiated implementing its components in the budget through eliminating exemption given to five zero-rated sectors by levying five percent sales tax on local supplies. The Federal Board of Revenue (FBR) will have to collect 1.952 trillion rupees in the next fiscal year, compared with the targeted 1.588 trillion rupees for the outgoing fiscal. The government hopes to achieve this target on the back of expanding the tax-net and a crucial step in this regard remains bringing several sectors, which so far have enjoyed exemptions, under the umbrella of general sales tax. Analysts believe that the government's move to bring new potential 700,000 taxpayers in the tax-net in a country where only 1.5 million people file returns could help boost revenues if FBR manages to follow this task till the end.

In a post-budget press conference, the finance minister Dr Abdul Hafeez Shaikh said the government had given incentives to companies to get them enlisted on stock exchanges. The government would reduce tax rates and number of taxes to ease burden on the existing taxpayers. He said the government had promised last year to reduce the rate of general sales tax its reforms process completed and powerful people were brought to the GST net.

The IMF last year halted a $11.3 billion loan package agreed in 2008 over a lack of progress on reforms, principally on tax. Analysts believe that meaningful tax reform should lift exemptions on powerful interests, such as the country's enormous agriculture sector. The government has long defied Western pressure to end giant tax-dodging in a country where barely one per cent of the population pays at all, as a corrupt bureaucracy starves energy, health and education of desperately needed funds.

'The United States should delay much of its multibillion-dollar package to Pakistan pending economic reforms as the aid has led to official inaction and public resentment,' said a report by the Center for Global Development, a private Washington think-tank. The report has come as more US lawmakers question aid to Pakistan after US forces discovered and killed Osama bin Laden in Abbotabad town, near Islamabad.

"With Pakistani leaders now assuming a steady flow of cash from Washington, it makes sense for them to push for that money rather than to work with their political rivals to move on key reforms," the study said. "For these reasons, we recommend that much of the $7.5 billion Kerry-Lugar- Berman aid package not be disbursed immediately," it said.

The country, heavily dependent on foreign aid and an IMF rescue package, is desperate for foreign investment to improve its battered economy. Foreign direct investment fell 28.6 per cent in the first ten months of the 2010/11 fiscal year to $1.2 billion from $1.7 billion in the same period last year.