Politics hold Pakistan economy hostage
By Syed Fazl-e-Haider
QUETTA, Pakistan - The breakup of Pakistan's five-month-old ruling coalition,
just a week after the resignation of former president Pervez Musharraf, has
further aggravated investors' concerns about the country's political
uncertainty and weak economic outlook, dragging stocks and the local currency
to record lows.
The benchmark Karachi Stock Exchange (KSE) 100 share index fell on Tuesday
(August 26) by 383 points, or 3.5%, closing at 9,475.76 points. Though the
breakup of the coalition government eliminated one aspect of the recent
uncertainty, investors remain concerned about settlement of outstanding
political issues, including the reinstatement of judges deposed by Musharraf
and
election of his successor.
Politics at present are holding the Pakistan economy hostage. After Musharraf's
exit, the gap in views between the two major political parties that were in the
ruling coalition ultimately widened to an open fight. The Pakistan Muslim
League-N on Monday finally quit the coalition because of differences with the
Pakistan People's Party (PPP)on the issues of the reinstatement of deposed
judges and the unilateral nomination of PPP co-chairman Asif Zardari as a
presidential candidate.
Both the partners have nominated their own candidates for the election to the
post and PML-N chief Nawaz Sharif has accused the PPP leadership of repeatedly
reneging on promises to reinstate the judges.
The PML-N's departure has further diverted the government's attention from
pressing economic problems. Some analysts believe that victory in a
presidential election by Zardari will bring stability and ease political
tensions. Even so, the formation of new political groupings is already underway
in parliament before the election for early next month gets underway.
Even before the split, the ruling coalition partners had been at loggerheads
over political issues, so much so they paid little or no heed to the appalling
fiscal position. Rating agencies have already warned of a potential downgrade,
which would raise the costs of meeting Pakistan's debt obligations. The country
is heading towards the risk of default due to its rapidly depleting foreign
exchange reserves, burgeoning current account deficit, outflow of portfolio
investment and continuously falling rupee, according to analysts.
A recovery by stocks and the rupee after Musharraf's resignation on August 18
certainly proved temporary. On August 21, the rupee fell by 2.1% against the US
dollar to 76.50 and the KSE-100 index had fallen by 9% during the three trading
days to August 22. Sentiment was further hit by suicide attacks at the gates of
the Pakistan Ordnance Factories in Wah, Punjab on August 21, which killed at
least 70 people and injured over 100 injured.
The economy is virtually in a shambles. In July, the first month of the current
fiscal year, the current account deficit rose to $1 billion, compared with $816
million 12 months earlier. Low inflows have made it difficult for the country
to arrange more dollars for external payments, while the central bank's
reserves, which are used to pay foreign bills, fell to $6.97 billion as of
August 1, 2008.
The country has reportedly paid only $3.03 billion in debt servicing for
2007-08, or just half of the central bank's foreign exchange reserves. Local
analysts fear that if the country has to pay $3 billion as debt servicing this
year, then it will have no reserves to pay back for its oil bills, or meet
trade and other obligations.
According to the central bank, the cash outflow to pay debts, depriving the
country of $350 million to $400 million each week from its reserves, is pushing
the country fast towards the old days of 1998-99 when it was about to default.
Since the beginning of this year, the local currency has lost value against all
major international currencies, declining as much as one-fifth against the US
dollar. Its present value in the open markets of about 77 to the dollar
compares with its stability at around 61 to the dollar under the government of
former prime minister Shaukat Aziz.
The then size of the foreign exchange reserves, at more than $16 billion, were
a key factor in the currency's stability. The reserves have now fallen to $9.6
billion. Officials say that is enough to pay for three months imports. On the
other hand, the country a year ago had reserves enough for seven months of
imports.
Local bankers and currency dealers say exchange rate stability depends on
rebuilding foreign exchange reserves, yet despite pursuing a tight monetary
policy, the central bank is see them quickly erode.
International finance institutions and rating agencies present a bleak economic
outlook for Pakistan. Last week, Moody's Investors Service said the country
risked a further downgrade of its "B2" sovereign credit rating due to the
decline in foreign exchange reserves.
"If the government remains unable to govern effectively, then discordant
policies and their weak implementation could further set back investor
confidence," the US-based ratings company said. "This would damage Pakistan's
balance of payments stability as well as the government's fiscal financing
prospects."
The country also has to grapple with a host of other issues that could have
credit rating implications, according to David Beers, a London-based executive
of ratings company Standard & Poor's. Beers believes that Musharraf's
resignation solves one dimension of the political crisis but it doesn't
necessarily signal a dramatic change for the better in terms of the broader
risks weighing on the credit rating.
S&P in May cut the country's credit rating to "B" with a negative outlook,
based on the escalating budget deficit and large current account deficit in the
balance of payments. Moody's rates Pakistan at B2, one notch above Argentina,
which earned earlier this decade earned the opprobrium of foreign financiers by
defaulting on $100 billion of debt.
Merrill Lynch has called Pakistan the epitome of what has gone wrong in Asia
this year. It has recently reduced its outlook on the country to "mild
underweight" from an overweight position of 0.4% . That reverses its stance of
last year, when the country was among the US investment bank's favorite
markets.
This year, the KSE 100-index has lost about a third of its value due to the
perpetual political instability and law and order problems. Under former prime
minister Aziz, who held office from August 2004 until November 15, 2007, the
KSE-100 index was one of the best performers among Asia's emerging economies.
Last year, the country's stock market attracted about $1 billion in overseas
funds.
Even so, its previous strong showing had its blemishes. The KSE 100 crashed in
March 2005 and again in June the following year on reported speculative
manipulation by some big players, which wiped out between $13 billion and $15
billion on both occasions. Investigations failed to name who was behind the
crashes, with key data allegedly wiped from computers.
The grim position on the external account could ultimately force the country to
go to the International Monetary Fund with a begging bowl for help and accept
harsh conditions for further funds. Even then, political stability is the key
for Pakistan's credit rating.
The most serious credit challenge would probably arise from further political
infighting, high inflation and fiscal fundamentals that could further worsen
macroeconomic stability. Analysts believe the country has yet to convincingly
show it will deal with its host of economic problems, but if the politicians
settle their differences, Pakistan could continue to raise money in global
capital markets.
Syed
Fazl-e-Haider , sfazlehaider05@yahoo.com, is a Quetta-based
development analyst in Pakistan. He is the author of six books, including
The Economic Development of Balochistan.
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