Upgradation of Pakistan's stock market to MSCI emerging markets index, as opposed to MSCI Frontier Markets Index, on 1st June 2017 was expected to be marked by a significant rise in the inflow of foreign capital and instead data reveals that foreign investors have withdrawn 92.265 million dollars to-date. Additionally, Pakistan may no longer be eligible for assistance under International Bank for Reconstruction and Development if our foreign exchange reserves (held by the State Bank of Pakistan minus those held by the private sector in commercial banks) decline to less than 3 months of imports. These are extremely disturbing trends and one would hope that Shahid Khaqan Abbasi-led administration would focus on these two major issues that would have serious negative implications on the economy on an emergent basis though recent statements of the Prime Minister and several of his cabinet members indicate that the focus remains on politics.
Pakistan was a member of the MSCI emerging markets till 2008 but lost membership when our stock market placed an arbitrary floor on share prices making it impossible for foreign investors to exit the market. On the first day of Pakistan's re-entry into the MSCI emerging markets index (June 1, 2017), amidst build-up of high expectations by Finance Minister Ishaq Dar, the Karachi Stock Exchange (KSE) index suffered a record fall of 1810.76 points (this record was broken by a 1900-point decline on July 3), on massive foreign selling and little will to purchase shares.
So what was responsible for this decline in the KSE? Arif Habib Ltd CEO Shahid Habib maintained that "the budget was pretty hard for the stock market. Capital gains tax was changed to a flat 15 percent, tax rate on dividend was increased and the recommendation to charge tax on the face value of bonus shares was ignored." He, however, acknowledged at the time that "with the ongoing probe of the joint investigation team, the political scenario is uncertain as well." Today the budgetary decisions as identified by Habib remain relevant and the political uncertainty has intensified after former Prime Minister Nawaz Sharif's rally from Islamabad to Lahore during which he criticised the Supreme Court verdict in the Panama Papers case as violating the people's mandate and, more disturbingly, got his audience to commit to any line of action he may deem appropriate at a future date raising the prospect of confrontational politics that would send a warning to all foreign investors to exit our market.
Equally unfortunate is the fact that during the past four years, the Sharif administration relied on heavy borrowing from donor agencies/bilaterals as well as foreign capital markets (defined as debt equity) to shore up foreign exchange reserves; and at the same time ignored, and continues to ignore, the steady decline in exports through appropriate mitigating measures (notably timely payment of refunds) and the rise in imports (made attractive due to an overvalued rupee) leading to a steady rise in current account deficit. Remittances, the other major source of desirable foreign exchange earnings are on the decline due to an ongoing recession in Arab countries. The International Monetary Fund (IMF) mission leader under the 2013-16 Extended Fund facility acknowledged our rising foreign exchange reserves were debt enhancing. Pakistan's capacity to borrow at concessional rates from abroad is shrinking (due to failure to continue with the reform agenda agreed with the IMF after the end of the programme) compelling the government to rely heavily on borrowing from foreign commercial banks - to the tune of 4 billion dollars last fiscal year - which is at higher rate of interest and a small amortization period.
One would urge Prime Minister Abbasi to focus on these disturbing elements of the economy on an emergent basis to the exclusion of all other considerations as failure to do so may push us towards unsustainable borrowing with implications on our ability to undertake mega infrastructure projects under the China Pakistan Economic Corridor as well as under Public Sector Development Programme.
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