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dollars in foreign investment may be withdrawn when the floor is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.

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ACTIONS ALREADY TAKEN
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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.

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STOCK MARKET SUPPORT MEASURES
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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

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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