The dichotomy of market and economic performance

The Karachi Stock Exchange's index was surging, belying underlying fundamentals, but with policy roots, until it re-linked with certain realities and came crashing to the ground amid acrimony.

"I picked up the Wall Street Journal one day and there was a front-page article on 'terrorism in Pakistan', while on the business page there was a story on the Karachi Stock Exchange being the most successful stock exchanges in the world. So I wanted to visit this stock exchange which is the symbol of Pakistan's growth and of hopefulness in the economy," said Anne W Patterson, US Ambassador to Pakistan, recently in the Asian country.

Unfortunately, those remarks have been superseded by a sharp downturn in the market amid frantic scenes, but there remains an underlying story to tell.

Patterson's comment alone makes one ponder on how a country torn apart by relentless acts of terrorism and violence could have had such a flourishing financial market. It's certainly a striking contrast.

The performance of Pakistan's stock market, defying the popular wisdom that it was headed for doom in the wake of the never-ending political turmoil and killings might have been some kind of testimony to the common man's hardened resilience, or it could be policy-based.

Not so long ago, Pakistan's prominence in the international political arena centred on its hostility towards India, with two full-fledged wars. Military skirmishes are still quite regular along the 'mutually-agreed' boundary between the two unfriendly neighbours. In recent times, however, the scenario has changed and aggression with India has almost headed backstage.

The country is now fighting the enemy within, in the form of Islamist fundamentalists, Al Qaida and the Taliban. Recent media reports on Pakistan have been dominated by its political crisis after the ousting of former President Pervez Musharraf and the relentless suicide attacks, including the one leading to the assassination of prominent opposition leader and twice prime minister Benazir Bhutto.

Adverse economic and political events in any country are always carefully watched and closely followed by international investors because they can have a very negative effect on the performance of a country's stock market.

For example, the 1982 international currency and debt crisis depressed stock markets, and caused hardship in the affected countries for over a decade. The Asian crisis, which started in July 1997 and ended in February the following year caused havoc across the continent. Korean stocks plunged by 63 per cent, Indonesia shares crashed by 82 per cent, Thai stocks fell by 48 per cent, Malaysian by 58 per cent and stocks in the Philippines by 49 per cent.

But those were economic episodes by source. In Pakistan's case, political events instead have had their negative effect on the financial health of the country.

The fundamental economic indicators currently portray a sorry state of affairs, if not near-chaos. Latest data indicate that the fiscal deficit has shot up to 8.3 per cent of GDP, and the current account deficit to 8.4 per cent of GDP. On July 29 the central bank took matters in hand, raising the key policy rate by 1 per cent to 13 per cent, to soak up excess cash from the monetary system.

According to a recent Standard Chartered report, that move had been very much on the cards, as the macroeconomic imbalances had continued to deteriorate beyond initial estimates, and headline inflation had touched record-high levels since the last meeting of the central bank in May.

Inflationary pressures have surely and continually growing in the economy, owing, the report suggests, to the large build-up of monetary assets, primarily on account of heavy government borrowing from the central bank to finance the fiscal deficit.

The economy was already out of kilter. In 2007 inflation plateaued at 7.8 per cent, while the current account deficit reached 4.9 per cent, according to IMF data. Both figures were estimated to rise in 2008.

Yet the Karachi Stock Exchange (KSE) index grew by an impressive 40 per cent last year. Moreover, the average dividend yield of its stocks rose to six per cent.

Notwithstanding the market meltdown of recent weeks, there has to be a rationale for this thought-provoking dichotomy, with investor confidence not only domestically but internationally too pepping up the bourses.

The fact is that Pakistan, despite its turmoil, successfully marketed to the global investor that its potential remains severely untapped. The government also took some rapid steps in opening up its financial and telecommunication services sectors to foreign funds, with support from experienced regulators adopting global practices.

That helped KSE emerge as one of the top performers in the emerging stock markets of the world. Until its recent demise, KSE's rate of growth was over 35 per cent per annum for the past 10 years, with its market capitalisation touching $75 billion (about Dh275.47 billion).

A World Bank report released in February this year said the country's infrastructure, including water, power and transport, is seriously inadequate. The report said Pakistan has to invest around $1 billion (Dh3.67 billion) per year in building reservoirs and irrigation-related infrastructure over the next five years. The country is predicted to face serious power shortages of around 6,000 megawatts by 2010. Inefficiencies in the transport sector would cost the economy between 4-5 per cent of its GDP per year.

To fill these lacunae, Pakistan has tripled its annual infrastructure investment from an average of $2.5 billion (about Dh9.18 billion) to $7.3 billion (about Dh26.81 billion). But what is most noteworthy is that the government has increased the involvement of the private sector to meet the gaps, which is predicted to rise more and more as private-public partnerships increasingly percolate in.

Now the economy is said to be one of the world's most open investment regimes, allowing 100 per cent repatriation of profits, a major attraction for global companies.

International companies have been flocking into the country to make the most of the current growth momentum. Companies from the Middle East, Korea and China are investing heavily in sectors such as telecom, farming, information technology, etc.

The longevity and continuity of such investor-friendly economic and industrial policies is the key to Pakistan's prosperity. The potential dovetailing of economy and market (for the medium term) ironically becomes apparent.

Implosion

That, at least, was how it looked, till the market imploded. And it was essentially political uncertainty which was responsible, both concern that the ruling coalition would collapse because of disputes, and over a warning of US military threat. Technical factors related to the capacity of the market for downside trading played a part too.

Ultimately, however, the economic dimension has sustained the woe, as the indicators have succumbed to the international phenomena of food and fuel price escalation, bringing a general collapse of confidence, epitomised by the plunge of the rupee. Inflation has taken off, to the vicinity of 20 per cent, making the IMF's semi-annual data outdated. Socially, the rampant cost-of-living, power and wheat shortages, as well now as stock losses, have torn the previous market euphoria to shreds.

It's a cautionary tale. Market dislocation from the economy is perfectly possible, and for some time. Eventually, there has to be some dovetailing in performance, otherwise only volatility persists. Few would recommend more volatility for Pakistan.