With brakes on growth, and the economy drifting towards stagflation amid rising interest rates, the equity market is the last thing a government wants sliding even if it is dizzy.
After weeks of deliberations, the new economic managers have persuaded the decision-makers for the establishment of a market support fund to salvage the stock market. Before we discuss what this fund is all about and how it will rescue the fall we should have a cursory look back at the track we trod over to reach here.
After merging three stock markets, the Pakistan government created the Pakistan Stock Exchange (PSX) in 2016 which was followed by the Morgan Stanley Capital International’s (MSCI) announcement of the possibility to promote the PSX from a frontier market to an emerging market. In contrast to emerging markets, frontier markets are small, less developed and have modest capitalization which limits their investibility and liquidity. The news of the PSX being considered by the MSCI for upgradation to emerging markets created a frenzy among investors who started dreaming of huge inflows. Consequently, a buying spree ensued. For the following year, the bourse index kept breaking its own record every other day. On May 31, 2017, a day before the PSX was formally enlisted among the emerging markets list, its index closed at 53467 points.
But to utter surprise, since the very first day of its enlistment among emerging markets, it has been bleeding. It lost 14000 points by the end of 2017 and earned the title of the worst performing market in the world. The fall continued. The new year, a new government and another new year – nothing could stop it. A total market cap of $26 billion was lost in dollar terms.
Many believe the market was continuously growing for the last seven years before it started sinking. In the wake of the MSCI’s indication to classify the PSX as an emerging market, a wave of hype and over enthusiasm pushed it to an unrealistic altitude. The fall was destined. This is what happens to frontier markets when they jump into the ocean of global markets. There are others who think that assigning the drop of 20,000 points to mere hype is also shying away from the underlying causes.
The market abhors uncertainty far more than bad news. The bearish marathon was expedited by a spell of political uncertainty following former premier Nawaz Sharif’s removal through a court order and then trial which was extravagantly covered by the media. There were expectations and also calls from a few quarters for the dissolution of assemblies and announcement of fresh elections well before schedule. This lurking precariousness increased the market risk, compelling retail investors into panic selling. With all this, the pace of economic stabilization slowed and economic fundamentals started to look feeble. Current account deficit expanded, forex reserves started shrinking and the pressure on the PKR started mounting; the country was steadily moving towards chaos. By each passing day it was becoming more evident that sooner or later Islamabad would need a bailout. How could a capital market not have responded to an evolving crisis and accompanying uncertainty?
There were high hopes that Election 2018 would arrest the decline – both of economy and trust. However, surprisingly the trends of uncertainly evolved and remained persistent after the elections. Some believe the indecisiveness of the economic managers to opt for a recovery course and self-inflicting claims of economic conditions made things worse. Although things have been sorted out now, the bailout deal is awaiting final approval of IMF executives, the government has outlined its strategy, and future economic course is also evident by the selection of economic guards, the market still remains irresponsive.
Perhaps we have not given due consideration to the devaluation and increasing interest rates. The stock market is highly reactive to both of these. Obviously, who would want to lose the value of money? Continuous selling is suggestive of the fact that people are moving out and parking their liquidity somewhere else. If the dollar can give one 10 percent return in three months what else does one need? Particularly, when one knows that inflation is touching double digits. The government has no option but to target it through monetary tools; and the decision to be or not to be becomes easy. Increasing interest rates drive liquidity away from equity markets to fixed-income investments or alternative investment opportunities.
There may well be other factors at play. However, the government’s plan to intervene in the market has been hailed by brokers. In fact, an earlier intervention in 2009 was quite successful in stabilizing the market. As revealed by the finance division, this initiative will cost Rs20 billion and the National Investment Trust (NIT) will do the task. The government has been authorized by the Economic Coordination Committee (ECC) to issue sovereign guarantees regarding transfer of funds.
The argument is that once the market picks up, the government entities – National Bank of Pakistan (NBP), Employee’s Old Age Benefit Institution (EOBI) and State Life Insurance Corporation – will be able to recover the money and its cost. However, many in the opposition believe the move is tantamount to charity at the cost of pensioners and petty savers. They also think doling money in push-starts will prove to be a government failure. They contend that the government should infuse confidence in the market by appropriate policy measures and support the market through the regulatory regime – which itself is a flawed argument given the size of the market.
The size of the market is very modest. Almost 80 percent of market cap is mainly represented by a handful of government-owned companies. Hence the regulators do not have much space to manoeuvre the situation for creating favourable market conditions. Interestingly, the main regulator, the SECP, is already a mere spectator in the whole scheme. Even declassification as frontier market, as being suggested by some financial commentators, may not be much helpful in the immediate run.
While we wish all the best to government endeavours to rescue the market, we must not overwhelm ourselves with euphoria. The market support fund is a gamble. If the government is able to contain inflation, bring down the repo rate and keep the rupee where it is, there are good chances that activity will gain traction. Otherwise, we will creep back to the earlier position with another leaf in our thick lesson book.
The writer is public policy scholar at the Lee Kuan Yew School of Public Policy Singapore.