Pakistan's A Wild Card For The Future

While the media has been focusing on the political and economic upheavals of Pakistan in recent months, one should not be oblivious to the growing danger of Pakistan as a time bomb of sorts. Unless we engage Pakistan in a pragmatic manner, unless we have a 'democratically inclined and transparent' governance in the near future, Pakistan could prove to be "hot and trouble spot" of the future. Just to cite one factor - it has an unwieldy population now of 176m, which is slated to grow to 336m by 2030 and 446m by 2050. For such a large populous nation that is highly fragmented, it sure is a potent mix if Pakistan continues the way it has.

From Nomura strategy piece on Pakistan: In the past few weeks (and most notably in his 4 June major policy speech in Cairo), President Obama has gradually been unveiling a strategy which appears to be aimed at enhancing prospects for peace and stability throughout the Middle East and which seems to involve parallel diplomatic tracks from Bombay to Beirut. That process now looks to be accelerating as we enter a period which some commentators see as pivotal in determining the future of the region as a whole and where we judge stabilising Pakistan to be one of a handful of key objectives. While the Pakistan army’s recent push against the Taliban in the Swat valley has been broadly welcomed, concerns remain about its tactics and the related civilian casualties and refugee problem which may serve to make the authorities in Islamabad even less popular than previously. Much may now depend on the ability of the civil authorities to deliver immediate aid (including significant contributions from international donors) to the civilian population and to follow this up with the sort of long-term economic development which economic experts believe is essential to counter Islamic militancy.

Some recent claims by some experts (including US Secretary of State Hillary Clinton) that the threat posed by the Taliban to the Pakistan state is “existential” (or that it is likely to result in nuclear weapons falling into the hands of Islamic extremists) could be misguided, the army’s efforts in Swat have certainly not neutralised the Taliban’s ability to carry out terrorist attacks throughout Pakistan, which now appears to be its preferred modus operandi. Nevertheless, the Pakistan military has been encouraged by its success in Swat and, in a marked change of approach by the government, is now looking to expand its operations into Taliban-controlled frontier areas of the country, with advanced strikes being launched in mid-June in Waziristan (the main stronghold of the militant group Tehrik-i-Taliban). However, military experts judge that the army is likely to face significantly greater challenges than it did in Swat as militants disperse to other parts of the country (and, possibly, abroad) and as further humanitarian problems come into play as a result of the new offensive.

For all that, Pakistan’s political and economic fragility seems to have been eased – at least temporarily – by renewed US support (and sensitivity over drone missile strikes against suspected Taliban/al Qa’ida targets in the Pakistan/Afghanistan border region) under the overall guidance of Special Envoy Richard Holbrooke who has publicly noted that stabilising Pakistan is essential to the achievement of US/Nato objectives in Afghanistan. Additionally, the US seems to be reconciled to the prospect of former prime minister Nawaz Sharif returning to public office (following a recent high court decision to lift the ban on him) and possibly even driving through constitutional changes which would allow him to run for a third term as prime minister. However, any such move looks likely to deepen the rift between Mr Sharif and President Asif Ali Zardari (who is already widely seen as weakened by recent events in Pakistan) and could lead to renewed political turbulence and weak governance.

One more factor which we believe is likely to come into play with a new Indian government in its renewed efforts to broker a long-term settlement over Kashmir between India and Pakistan. However, it remains to be seen whether a weak Pakistan government could deliver on its side of any agreement, especially if the widely held view is correct that influential elements in Pakistan would prefer the current impasse to continue. There is, therefore, a significant risk in our view that any real progress in negotiations could precipitate further terrorist attacks in India originating from within Pakistan’s borders, with consequent serious implications for
regional security.

• Stock market has gained 20.23% ytd from January to mid-June 2009. Yet it has been one of the worst performers in Asia. But it was fell by 58% in 2008.
• Weak domestic economy, security and political instability and military action in the Swat valley have led to a sell-off by investors. Capital flight has raised the need for additional external assistance to finance defense and reconstruction spending and external debt payments
• Valuations: With stock market rally in early 2009, P/E ratio has improved from the lowest level at 6.31 on January 2, 2009 to 10.89 on April 24 as improving current account balance based on strong remittances and aid from IMF and other countries enhanced market sentiment. However, with several risks to the stock market such as war in the Swat valley, widening trade deficit, portfolio outflows and deteriorating domestic consumption, the P/E ratio has slightly decreased to 9.54, the lowest level in Asia, in mid-June 2009
  
• Outflow of portfolio and other foreign investment: Domestic and foreign investors turned net sellers in FY 2009 and sold US$ 1.1billion during July 2008 to May 2009. They were net buyers in FY 2008 at US$ 87.2billion. Foreign investors have sold shares worth US$ 290million until mid-June in FY 2009
• Outlook for 2009: Easing monetary policy trend and low P/E ratio level relative to other Asian countries might be attractive. But ongoing risks such as political uncertainty, security risk, slowing GDP growth, weak manufacturing sector and tight budget conditions can hurt investor sentiment and lead further outflows of FIIs
• Too much reliance on foreign funds and lack of strong positive stimulus will limit gains in the stock market
• Terrorist attacks and outflows of foreign investment have made the stock market the cheapest in the region
• Progression of ongoing military action and political stability will be key factors for the stock market ahead
  
  Currency:
  
  
• In 2009, Pakistan rupee has been deprecated 2.9% from January to mid-June
  
• In 2008, Pakistan rupee depreciated 13.7% against U.S. dollar. It started to depreciate from March 2008 and sharply declined until October 2008 when IMF announced an assistance package. It was reflecting foreign investor’s concerns about political instability, weak economic conditions and high inflation
• Outlook for currency: Pakistan rupee is expected to remain weak. Sustainability of BOP is challenging amid declining FDI, risk of portfolio outflows and scarce forex reserves. Security risks due to ongoing war against Taliban,impact of contracting exports and slowing remittances on the current account, and weak economic growth will also have a negative impact on Pakistan rupee
  
  Bonds:
  
  
• Pakistan 10-year government bond price in 2009 increased by 26.6% from January 2009 to mid-June and yields decreased by 26.9% until mid-June
• Moderating Inflation has provided central bank room to cut interest rate by 1% in April 2009. Analysts expect central bank to cut interest rate further which will put pressure on bond yields ahead
• Narrowing balance of payments (BOP) deficit due to surplus of current account improved market sentiment. Successful payment of government debt in February 2009 (US$ 500 million Eurobond and US$ 17million on account of interest payment) reduced fears of Pakistan debt repayment capacity
• Ratings: S&P downgraded Pakistan’s credit rating to ‘CCC’, the lowest level in 10 years, from ‘CCC+’ in November 2008 due to deteriorating BOP and delay in securing external assistance. Moody’s rated Pakistan’s debt at ‘B3’ in 2008 due to political risks and falling forex reserves. “Ratings can downgrade further if government does not show secured external assistance”

p/s photos: Zhang Xin Yu