The world has witnessed one of the most difficult year (2008) that has passed, but what is more worrisome is that 2009 could be worse. We fear bigger decline and more problems, as the crisis is unlikely to end this calendar year due to global recessionary trend. As 2009 looms, everyone is calling for a possible doom, though it is yet to be seen if the year is going to witness gloom, doom or boom.
The global currencies would continue to wobble on back of poor economic numbers. But US Dollar will take the ultimate beating. Against Euro and Yen, USD is likely to loose 17 pct. Sterling Pound will recover by 10 pct and Indian Rupee will loose 14 pct of its value and likely to hit INR 55 per USD
Currency Market Associates (CMKA) is of view that though Pakistan's economy may receive minimal impact of the global financial crisis, as its economy is less prone to outside influence, but it has bigger home grown economic and administrative issues, which need to be sorted out quickly.
The country cannot afford to be complacent, quick fix solutions is required that would not only help in easing tough economic conditions, but would also help in its future negotiation with the IMF team. After IMF's rescue package, Pakistan's economy did get a breathing space. Sharp fall of oil and commodity price in the international market will surely help. This offers good opportunity to make some recovery if prudent decision is taken.
If we compare last year's average oil price of Light Arabian Oil of USD 95 per barrel, which is commonly used in Pakistan, with possible average price for 2009, we are cautiously bearish on oil and expect prices to remain under pressure due to global slowdown and may see average somewhere around USD 55 per barrel. It will help in reducing current account deficit and pressure on balance of payments.
In the current fiscal year, we are expecting a fall in oil bill by 20 pct to around USD 9 Billion against last fiscals USD 11.30 Billion. Real impact of falling oil prices will be seen in the last two-quarters of this calendar year.
Overall, though inflation is peaking, a higher inflationary pressure would persist for longer period of time than anticipated, which may not allow easing of discount rates in this fiscal year, unless there is a sharp fall in inflation number. Indication of more rate hike is visible after State Bank of Pakistan's recent announcement of Treasury Bills target of Rs 565 Billion for January-March 2009 (6-Auctions).
SBP's purchase of T/Bills in previous quarter was higher than the announced target and the trend would continue in this quarter. Furthermore, banks are not actively participating in T/bill auction in tenor beyond 3-month anticipating Discount Rate hike that would add pressure on yields. Since the options are tough and fiscal target is not very easy to attain, we believe that the SBP's T/Bills and PIB target could stretch over 26 pct from current 22.5 pct, which is roughly Rs 160 billion.
We believe that administrative measures are required to ensure that the benefit of lowering of commodity and oil prices is passed on to the consumer. Our real problem is that the wholesaler and the retailer are not committed to pass on the benefit of decelerating prices to the end consumer without proper justification.
Asset price inflation, higher rental and real estate value (Actual amount not documented), which has a nuisance value in economic sense is disadvantageous to the economy and causing alarmingly high level of money in circulation. Exchange rate behaviour would largely depend on narrowing of current account deficit, balance of payment and foreign exchange reserves position, all based on capital inflow and remittances.
Oil slide is putting immense pressure on oil producing Middle- Eastern countries. Construction related business will surely suffer, resulting job losses. This could affect our inward remittances. Slowdown would further discourage overseas Pakistanis to send excess money. Therefore, Rupee could come under pressure and slide down by 6-8 pct by the end of current fiscal year. Rupee will remain volatile and both way move will be witnessed frequently. Our Rupee is 85.40 per one USD.
We are projecting GDP growth rate of around 3.75 pct for the current fiscal year and 3.25 pct for the 1st two-quarter of next fiscal year. Imports figure will decelerate to USD 32 Billion due to lower oil bill, falling commodity prices, weakening of Rupee and measures taken to discourage non essential items, while impact of global slowdown will hurt exports, which could be short of target by 15 pct. Current deficit is also likely to drop around USD 10 billion.
DOMESTIC MARKET To attain IMF's fiscal deficit target of 4.3 pct, a slow growth rate is unavoidable and to achieve this number the country should be prepared to take tough measures such as rate hike, cut in development expenditure to a sustainable level, slash all unnecessary imports (20 pct, minus oil and defence), increase in NSS rates, bring down borrowing from SBP to zero level and most importantly reduce banks lending portfolio (credit given to private sector), which will start reflecting the desired result by the end of the current calendar year.
Instead of chasing inflation from behind, inflation should be attacked from front and the first step to hit inflation is by taking measures that compel commercial banks to reduce their lending to private sector, this could only be possible by further tightening of liquidity. We believe that without foreign inflows and narrowing of deficit, liquidity crunch will remain a matter of concern. Crisis of Confidence is another big factor that helps liquidity to disappear, as lenders are choosy when lending.
It is unfortunate that our export figures always lag behind the imports causing a wide trade gap that also creates more demand for money, which is another cause of liquidity squeeze. Therefore, it is necessary to reduce banks Advance/Deposit Ratio (ADR) from current 73 (Minus OMC's) pct to around 65 pct (based on old calculation), which would also help in solving the liquidity crisis to a larger extent.
There are few options available to reduce the government borrowing from the Central Bank. It can be achieved through investments in T/Bills, PIB's (Govt Securities), by increasing investments in NSS or by increase in revenue through higher taxes. Present economic condition is not suitable to impose new taxes to generate Government revenue. Neither there is a willingness to raise taxes from agriculture sector, real estate and capital market.
Hence, it is unlikely to make substantial contribution in helping to reduce the fiscal deficit. Therefore attaining 11 pct level of Tax-to GDP ratio could be tough, hence, increase in tax base should be the top priority. National Savings Schemes (NSS) needs to be more operation friendlier and simpler to deal.
In our view, to make it more attractive for lower category investors, it is suggested that withholding tax should be reduced and applied on amount of Rs 500.000/- and above, instead of Rs 150.000/-. To increase national savings ratio, NSS Rates should be adjusted timely and regular public announcement is necessary to attract investors.
CMKA is firm in its view that the State Bank of Pakistan should raise its floor on PLS rates from current rate of 5 pct to around 8 pct to 10 pct, which will attract depositors, as the benefit of previous two discount rate hike has not been passed on to the savers. Such measures would also help in raising the National Savings Ratio, which is hovering around 13 pct. It is important to raise our national savings ratio close to 20 pct.
We are not in favour of further reduction of domestic oil prices. Slash in petrol prices by 33 pct from its peak of Rs 87 has been witnessed. Current petrol and diesel prices are already at a sustainable level. In comparison, current price of petrol in India is INR 45 or equivalent to PKR 75 as against Pakistan's Rs 57 per litre. Government has to ensure that the benefit of price cut is passed on to general public.
Furthermore, current oil prices is not sustainable for the oil producing economies, so oil prices in the international market will gradually inch up. We cannot adjust domestic oil prices on daily basis. We disagree with the idea of sharp reduction of Government spending and focus should be on construction of roads bridges, dams and industries, which will help in creating new jobs and help in stimulation of economic growth.
China fearing slowdown of its economy announced domestic spending of USD 586 billion for next two years, which will help in growth stability. Similarly, India was quick to follow China's footstep by announcing first part of stimulus package, with second package in pipeline. US President elect Barack Obama has already pledged to revive the US economy with the biggest public works programme in a half century.
Pakistan needs to opt for the same stimulation method of public spending and slow down the pace of consumer culture, which is dependent on borrowed money, as the country is already suffering due to high deficit. The other key factors to kick start our economy and to avoid recession trend is by increasing exports, which in real terms has never helped in maintaining a trade balance.
Textiles, which contribute 50 pct towards our export earnings have a difficult times ahead, due to rising domestic cost and global slowdown. Textile and agriculture could be the major contributing factors in raising our export earnings. Until 1950, Pakistan's agriculture sector was contributing over 50 pct towards the GDP.
As of now the agriculture sector contributes only 22 pct towards the GDP growth due to sharp decline in agriculture output, whereas, 70 pct of its population is directly or indirectly involved with the agriculture business. Despite being an agriculture based economy, Pakistan is suffering from acute food shortages.
Since last four years Pakistan has been constantly importing various essential food items such as wheat, sugar, meat, lentils, vegetables etc. Hence, Pakistan could not benefit from global commodity price hike, as the country is net importer of various essential food items. Agriculture sector reforms should be the top priority in practical terms, as it has the potential to start delivering results in a short span of time.
Policy formulation is required to convey to the producers and farmers that export of food items will not be allowed unless the country is self sufficient. Growth plan is required when planting seeds to meet future demand and incentives should be given accordingly. Modernisation is the key to success in agriculture industry.
Irrigation system needs to be improved. Drip irrigation, though expensive can be offered at subsidised price. Sprinkler, a long awaited demand could help in saving 40 pct of fertiliser. Elimination of water logging and salinity could save 25 pct of the cultivated land. Focus should be on increasing the crop yield. If 5 pct of the wheat farmers have the ability to produce 45 maund per hectare, then why 95 pct of the remaining farmers are producing 22-23 maund of wheat.
We believe that with more effort and better crop management, crop production can be increased to above 40 million tons, which would help in raising agriculture base export to USD 5 billion. Presently Pakistan's cereal production is close to 35 million tons and the population roughly consumes 30 million tons. Similarly, cotton production is too low and has a declining trend, as textile industry plays major role in GDP growth.
Livestock is another major contributor towards agriculture sector. Pakistan is the 4th largest milk producing country in the world and annually produces 34 million tons of milk. Estimates are that 8 million families are engaged in milk business. The growth does not match the demand and the country has to import milk in form of powder.
To obtain higher quantity of milk, chillers should be installed to avoid milk going bad. Food given to cattle is not enough and by increase of 30 pct food to cattle, milk production can rise by 20 pct. Pakistan's per head milk production is roughly 5 liter, whereas, in India it is 10 liter per head as compared to 25 liter per head in developed countries.
There is huge demand for dairy products in the international market and self sufficiency in dairy products would help Pakistan to increase its export share, as the country is already exporting a small quantity to Iran and Afghanistan. Potential market for Pakistan is Islamic countries, which is the largest Halal market for dairy products.
From investors perspective farming remains a very attractive business and lot can still be done in Honey Bee farming, Fish Farming, cattle farming. Government needs to relax its policy, keeping in view that domestic farmer's interest. Ultimate target should be export of agriculture products. Subsidy culture is the most damaging factor for the economy.
Business failures should not be compensated with subsidies at the cost of tax payer's money. Subsidy should not be allowed without the approval of legislative body. Parliament should pass a law for subsidy approval. Subsidy should only be considered for those living in poverty.
INTERNATIONAL MARKET As the world financial market opted for a casino culture, it has been awful year for them. Historically unprecedented mess has been witnessed in 2008. From Australia to Iceland and from USA to Russia, banks, equity market, currencies, commodity, hedge funds and economies tumbled like nine pins. Now, the world will have to combat worse recession since the great depression of 1929. Consumer spending is sharply down, as consumers can hardly afford.
Unemployment is up, as jobs are not easy to get and the banks are not lending, credit is hard to find. Estimates are that the world markets have so far lost about $30 Trillion in stocks value. A rough estimate suggests that the size of outstanding Ponzi Scheme Derivatives spread all over the globe by shadow money lenders is far above USD 500 Trillion mark.
Out of which, interest rate derivatives are about USD 375 Trillion. Unallocated derivatives are estimated to be around USD 70 Trillion. Credit default Swaps (CDS) that was invented to protect the investors surpassed USD 60 Trillion in 2008, though it is down to USD 33 Trillion. Commodity derivatives are close to USD 9 Trillion Foreign exchange derivative is above USD 55 Trillion. Equity linked derivative at about USD 8 Trillion.
Despite Fed and US Treasury injection of USD 8.5 Trillion in to the economy through purchase of shares, bank stocks, liquidity infusion and bailouts, half of 8.500 banks and financial institutions are facing a risk of shutdown. Though announced losses are a little over one Trillion marks, in our view, it could easily hit over USD 3 Trillion mark.
Similarly, European economies have tougher challenges ahead, despite oil prices having eased off quite sharply, credit crunch caused by US housing market slump and strong Euro does not bode well for European growth, which will slip under 2%. Europe too, like USA will be facing bigger challenge to create jobs and instead unemployment rate will spike sharply in 2009.
In our view, there are numerous factors that have caused global financial meltdown, but greed and disinformation about the financial market is real cause of crisis of confidence, which could ultimately lead towards financial collapse of the world market.
GLOBAL OIL TREND-WTI $43.24 Depleting supplies from ageing oil fields, Oil cartel, American threat of air strike on Iran, fighting in Iraq, attacks on Nigerian facilities, pressure mounting by hedge fund demanding oil in futures and demand for oil from world's fastest growing economies China and India was enough to believe that future oil shortage is imminent. On July 11 2008, oil touched all time high of $147.27.
In real term, there were three factors that were driving the oil prices higher, speculation by hedge fund, buying of oil on margin and the falling Dollar, as Fed was keeping interest rate low below the inflation rate. Recent fall witnessed in the oil prices was in correlation with strength of Dollar, since oil is priced in US Dollars.
Fall in the value of USD puts pressure on oil exporting countries, as they import inflation for their Non Dollar imports. We believe that since hedge fund was the major oil player in futures market and it is estimated 80 pct of the future contracts were rolled over without maturing the contacts, and since they lost huge amount of money, so they may not remain active player for sometime.
However, the correlation between USD and Oil will remain strong. In our view the strength of the US Dollar may not last long due to deteriorating US economic condition and creeping recession in developing economies, which will give small boost to oil prices. But, sluggish economic growth will certainly affect consumption.
We may also see downward revision of global oil consumption to around 86 million barrels per day. Therefore, in our 2009 annual average target for Western Texas Intermediate (WTI) would range between USD 55 to USD 60 per barrel. Technically, on the downside oil has a good support at $32.40, which should hold.
If seen long is preferred and only break of this level could ring the alarm bell for $28, a less likely scenario. Requires a break of $45.80 for $51, once this level is surrendered, oil will find a new trading range of $50-58. A break of this range would see spike in oil price towards $64-68 levels.
GOLD - $880 The current gold rally is a bit overdone due to geo political factor. The run may not be sustainable beyond $950 and looking for a drop to $720, which is the key area to watch, a break would encourage bears for $640. If seen, we suggest trying long, because from here onwards Gold will gather momentum for its next Bull Run. Once $1050 clears, gold will be set to test all time new high of USD 1180.
USD & US ECONOMY The previous two recession of 1990-91 and 2001 were short lived mostly linked to consumer spending, which was manageable. But the current asset bubble has spread all over the globe like a plague hitting banks, corporations, and insurances companies. There is lot of talk of measures being taken by Global Central Banks to stimulate the economy? New estimates for the calendar year 2009 are that the Global growth projection is pushed down to below 3 pct.
If we do not add Asian growth number, then the overall global GDP number could worsen to negative. In CMKA's view, USD 3 to 4 Trillion Cash Injection is immediately required to calm the market, which is not there. Most of the injection is against borrowed money, which is not easy to get. The cost of fund is also gradually going to rise and printing of money would see sharp surge of inflation, which could lead towards hyperinflation scenario.
It is very tough for capital market, as balance sheets are required to have healthy assets.Banks & Financial institutions are concentrating on quality lending. Globally lending standard has been tightened and lenders are unsure about the health of the borrower's balance sheet and therefore, may not be willing to offer liquidity which would continue to cause credit crunch.
Though the US Economy is in doldrums, there are numerous factors that have shifted market sentiment towards USD. This time the crisis is not only restricted to USA, but the disease is spreading all over the world.
The global economy that includes USA, Europe other developed countries is badly deteriorating. So far only Asia's growth projection seems to be satisfactory. Amongst the Asian currencies, except for Japanese Yen, the rest of the Asian currencies were unable to maintain currency stability as they are not convertible, which means buying and selling cannot be done feely.
The other weakening factor for the Asian currencies was that the Asian economies are largely dependent on exports to USA and the emerging economies are finding hard to get easy access to USD due to liquidity crunch. It means that emerging markets were facing severe Dollar crunch, since the currencies of emerging market is not convertible and most of their trades are US Dollar based.
Oil, Gold, Silver and many other major and minor commodities are also traded in USD. Secondly currencies of emerging market economies were under sever pressure due to Dollar demand. Hence, we have witnessed FED and European Central Bank offering Dollar Swap facility against their Domestic currencies to ease off the pressure.
This is why we have witnessed surging demand for US Dollars. Furthermore, in an uncertain environment investments shift in Government security, this is why US Govt Bond yields are pushing higher and for a Non-US investor to invest in US Securities, Dollar purchase is a prerequisite to invest in US Govt Bonds.
But, the next big bubble in the making is US Bonds. Global Central Banks have invested heavily in US Treasuries and are enjoying profit on revaluation due to bond yield gains. On reversal of US interest rate that will be caused due to unrestricted printing of Dollar, US Treasury Bond yields will ease and then the global Central Banks will have to book losses. This is likely to happen anytime, sooner or later. Hence, US Dollar will come under renewed pressure.
EURO - 1.3940 ECB President Trichet, a hard-liner when it comes to inflation or softening of Euro interest rates surrendered his tough monetary stance by slashing Euro interest rate sharply, he fears that Euro zone economy may contract this calendar year and hence, forecasting negative growth rate.
We believe that the Euro zone economy is feeling the pinch, economies of Germany, Spain, France, Italy and Greece are already in recession, more job losses will be seen and ECB will have to go for another rate cut soon. So Euro may weaken and requires a break of 1.3710 for a drop to 1.3330. All this could happen in January. But 1.2680 is the key, which should remain intact for a move to 1.4770. Once 1.4980 surrender Dollar will rush towards 1.5550. Our target for the year is 1.6260.
GBP 1.4540 For the past two quarters the UK's growth outlook has been very poor. On the economic front it all started with slump in the housing sector, which is badly hit. UK's manufacturing sector too has suffered badly falling to a 16 year low and the employment sector is unable to create new jobs.
UK's banking sector is facing a severe liquidity crunch situation, like most of the global economies. Latest numbers suggest that banks lending in UK fell by almost 18% & deposit has dropped by more than 4 pct, as quality lending remains a big issue. Sensing urgency and to make cheap funds available BOE had to slash its benchmark rates quite a few times, which is now 2 pct.
This means that the UK Central Bank is left with very little option to further lower its rate and the risk is that economy can enter deflationary period. The lowering of interest rate also discourages carry trade business. But despite difficulties BOE is likely to go for another slash probably in this quarter. In our view, the ongoing recession is likely to extend this quarter as uncertainty would prevail, which further strengthens BOE's case of more slashing of its benchmark rates.
For the moment Pound will remain under sever pressure, a break of 1.4320 would pave way for more losses and the next crucial resistance level to watch for Cable is 1.3520, which is unlikely to surrender for bounce back. We believe that Pound will start making a come back in the 2nd quarter of 2009. On the upside, a break and New York close of 1.5580 is required, which would confirm Cables up move for my 2009 target of 1.6305.
JPY - 90.85 Dollar dropped most against Japanese Yen (by 19 pct). It's the biggest decline since 1987. Despite reoccurrence of recession in Japan, fall in industrial growth and low interest rate return, investors are showing confidence in the currency. Japan has numerous problems its electronic industry is badly suffering as sales have fallen sharply.
Its car industry has already announced losses due to turmoil in international market. Global slowdown and Yen's strength is not helping the cause. Yen is also gaining on back of unwinding of high yield currencies, caused by sharp global interest rate cut.
We continue to favour Yen as a currency of choice. Technically, only a break of 93.90 would pave way for 101.40 and beyond. We do not support Dollars strength against Yen. We favour a fall towards 82.80, with next target 75.20. The writer is a former bank treasurer.
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