Let Equity and FX markets find equilibrium.
By: Tarique Khan Javed
President, Overseas Pakistani Investors Forum.
                           Dated 26 Nov 2008

Last month (Oct) I was of the opinion that KSE 100 index’s drop to level of 7,628 (or PE of 6) would be enough to stabilize the market. However with passage of time the situation is getting worse. Now the discount rate has gone up and inflation rate for last one year is confirmed at 25%. With measures like stoppage of borrowing by Government from SBP starting Ist Nov, the inflation is gradually expected to ease. Still it can not reduce very sharply during next 12 months at best it can come down to 16-18% level.

With the inflationary expectation investors would demand interest of 18-to 20% on deposit or Price Earning ratio of 5 to 5.55%.  Allied Bank is already paying 16.27% on a 15 months deposit; while National Saving Scheme rates are also improving, in line with inflation rate and would soon reach 18%.

From the Stock market Investors would demand at least 20%. That would translate to PE of 5. Therefore KSE 100 index needs to come down to 6,357 to become attractive. Implying further drop of 2,822 (30.74%), from current pegged level of 9,180.

Additional drop of 31% will bankrupt a large number of Stock Brokers. Bagasra ticket was sold for Rs 55 million, as it could not make interest payment. What will happen when additional capital losses are recorded following opening of the market? Tens of ticket will be up for sale and price is likely to drop to Rs 20-30 million.

NASDAQ fall from 5,400 to 1,300 after 9/11:
When this massive drop happened, within weeks, I was Credit Manager of a large Brokerage House of my Bank. By selling shares on time we escaped any loss as a Bank, although investors suffered heavily. The lesson learned was that the House should sell the share as soon as the margin call is not fulfilled by the client. This should happen the same day, as no one knows what will happen the next day.

In the case of Pakistan the Stock brokers by putting 1% fall floor and later fixing a floor at 9,180 effectively closed the market and made selling impossible. That is the reason they have lost so heavily besides the investors. If sanity had prevailed these measures would not be taken and market allowed to find its own level. The Brokers have sealed their fate and brought unlimited hardship for their customers. Thousands of jobs are being lost everyday, as one by one Branches and Head Office of Brokerage houses are closing down. Massive lay offs will happen in Dec, if market is not opened soon. 

Government or institutional support can only be limited:
Now it clear that Government will not be able to use IMF for supporting the Equity market. The Funds are for supporting balance of payment only. In the past institutions like NIT, EOBI have defied direct order of Government to fund Rs 20 billion Support fund.  Now it is reported that funds are being borrowed from Banks and that will be later paid off by selling PIB Units to Overseas Pakistanis. The Fund of Rs 20 billion is reportedly ready. The Support fund plus Rs 30 billion Put option, out of which Rs 25 billion is reserved for foreigners, is the best we can muster at this point of time.

On top Mr. Tareen has indicated that Government would try and buy its own shares from the market. But that will depend on the liquidity position of the respective Co. On the other hand the move to ask Banks and other Co to buy back their own share from the market as Treasury Operation has also not materialized. Out right buying back would imply a reduction in the Equity base and it would have adverse ratio implication and may clash with respective Cos expansion plans.

The IMF fund, however will help government pay off USD 2.2 billion foreign investment after the opening of the Stock market.

Investors demand opening of the market immediately:
Enough is enough; it is time to open the market. Common investor is suffering a lot due to lack of liquidity. A long time has passed and people can not wait more. Many people kept all their liquid assets in the form of shares as it en-cashable at one or two days notice. It was more like a current account. Now people are facing running their kitchen expenses and hospital bills.

Government should intervene with a firm hand and open the market by next Monday, come what may. They have an obligation towards local and foreign investors to return to them their depleted investment. Government’s lack of action and firm decision is having a very negative impact on their image and people will not trust Pakistan as an investment destination in future.

Many markets have seen massive sell off and decline upto 70% but barring for few days they were not closed and new equilibrium level was allowed to be attained.

Role of Advisor Finance:
1. Stock issue:
Mr. Tareen’s announcement that market will open on 27th Oct and its defiance by mafia like Group of Karachi Brokers is indeed quit insulting. It seems he finds himself helpless. Now he must firmly act and order the opening of the Market latest by Monday,  8th Dec 2008.

2. FX issue:
He should also assert his opening message on flexible exchange rate. He should  let the parity rate come to the actual market level of around Rs 93= 1 USD, to account for at least 50% inflation since 2004, when the rate was artificially pegged  at Rs 62. This was possible because lot of investment was flowing in the Country, including USD 4.5 billion in Stock market. Now that the hot funds are going back keeping currency at artificial high level will not be possible.  Out of the Stock market alone USD 2.3 billion has already gone out and remaining 2.2 is expected to flow out with days of market opening.

Adjustment of FX rate to its correct equilibrium level is central to correcting the current trade deficit and run on our FX Reverse. If this not done the USD 7.5 billion IMF fund will used up paying for high Import bills, while our Export remain uncompetitive owning to artificially high FX rate, in the wake of substantial increase in local cost since 2004.

FX rate which would seem to be stable, supported by economic fundamentals, is also key to attracting foreign investment in our share market. Until and unless foreign investor is not assured that they would incur heavy losses in exchange while taking back their investment, no return will attract them to our market.