GOP PROPOSED KARACHI STOCK EXCHANGE SUPPORT SCHEME

C O N F I D E N T I A L SECTION 01 OF 02 ISLAMABAD 003545 SIPDIS E.O. 12958: N/A TAGS: ECON EFIN EAID ETRD EAGR PREL PGOV PK SUBJECT: GOP PROPOSED KARACHI STOCK EXCHANGE SUPPORT SCHEME ¶1. (SBU) Summary. The Board of the Karachi Stock Exchange (KSE) placed a trading "floor" on August 28 to halt the market plunge and block the withdrawal of approximately USD 2 billion foreign investors have invested in the KSE. Market participants say the floor will remain until positive news, such as a commitment to an IMF program, buoys investor sentiment enough to prevent a market crash. While trading is functionally suspended, the State Bank of Pakistan (SBP) changed regulations to limit forced-sales during a declining market. Local Citibank officials predict that 500 million to one billion dollars in foreign investment may be withdrawn when the floor is removed. The Government of Pakistan also proposes two new measures to support stock prices but the IMF wants them abandoned as a precondition of a program. End Summary. ¶2. (SBU) On August 28, the KSE announced a trading restriction that prohibits listed shares from being traded below the closing price on August 27. The KSE-100 stock index trades slightly above the floor of 9,144, which is a 42 percent reduction from its high on March 21. The Board of the KSE planned to remove the "floor" on October 27, but decided to maintain the floor indefinitely. Market participants speculate that the floor remains in place in the hope that positive news, such as a commitment to an IMF program, will buoy investor sentiment enough to prevent a market crash. ¶3. (SBU) While no exact data on the specific amount of foreign investment is available, Reza Rahim, Senior Country Officer for Pakistan at JP Morgan estimates that foreign institutional investors have USD 1.8 to 2.2 billion invested in the KSE. Furthermore, Yousaf Ahmad, Vice President and Corporate Bank Head at Citibank estimates that USD 500 million to one billion of foreign capital will be divested from KSE listed companies after the floor is removed. -------------- ACTIONS ALREADY TAKEN -------------- ¶4. (SBU) On October 20, 2008, the State Bank of Pakistan (SBP) announced measures to help stabilize the market decline after the floor is removed. The SBP specifically focused on accounts brokers have with banks to trade on credit. All existing facilities of "financing against shares to members to stock exchange" (margin accounts) outstanding as of August 31, have been converted into a one-year term facility. Borrowers can repay but no fresh disbursements are allowed under this facility. The SBP also announced that in addition to shares, banks may accept other types of collateral such as real estate. The SBP reduced the margin requirements from 30 percent to 25 percent, though the minimum margin requirement at inception of an account remains 30 percent. Banks continue to be limited on the amount they can investment in futures contracts of 10 percent of shareholder equity, but may now apply any unused portion of that limit toward the pre-existing cap on equity purchases, thereby increasing banks' ability to invest in stocks. -------------- STOCK MARKET SUPPORT MEASURES -------------- ¶5. (SBU) Junaid Mirza, Deputy Manager of the KSE, reports the GOP plans to implement two new measures to support stock market prices and retain foreign portfolio investment. The first is a fund managed by the National Investment Trust that will invest in seven listed, public-sector enterprises. This will cost approximately 20 billion rupees (USD 247 million at 80.9 rupees per dollar) and is a 3-year plan. The second program will offer foreign stock holders the right to sell stocks listed on the KSE to the GOP one year from removal of the floor at the floor price (a put option). This measure will cost approximately 30 billion rupees (USD 371 million). Whether the GOP should implement these measures is one of the last unresolved issues in GOP/IMF program negotiations. ¶6. (SBU) These programs are well targeted at capital that is actually foreign-owned. Both Ahmad and Rahim estimated that only a small portion of foreign registered members' capital is actually Pakistani. Rahim offered a tentative estimate of USD 300 to 400 million. Prior to the imposition of the floor, there were few incentives for domestic holders to move money abroad and repatriate as foreign-owned. However, Pakistan has been an attractive destination ISLAMABAD 00003545 002 OF 002 for foreign investors as there are no capital gains taxes, withholding requirements, or capital movement restrictions. ¶7. (SBU) The KSE has 200 members, though some are inactive. Originally, they were all individuals but are all are now incorporated entities and probably engage in a great deal of cross selling on margin. The floor may have given some time to unwind transactions, but not the ability to settle since there is no clear market price or the ability to register transactions. ¶8. (SBU) Comment. The market support programs will have very little effect on medium-term stock prices. Stock prices are determined by market expectations of earnings and since these support measures are relatively small they will provide little motivation for shareholders to hold unattractive assets. Critics of the programs, such as IMF staff, believe the programs are ineffective transfers to investors at the expense of the cash-strapped Pakistani tax-payers. End Comment. PATTERSON