Shamshad Akhtar, Pakistan: the most challenging environment ever

Asiamoney, July 2008

“Let me tell you,” says Shamshad Akhtar, the governor of the State Bank of Pakistan. “From where I sit, this is the most challenging task I have ever undertaken in my career.”

She is referring to a tension that afflicts most Asian central bank governors today: striking a balance between two goals which, on the face of it, are mutually exclusive. In one corner: the need to foster and stimulate growth in a market hit by US slowdown and the global credit crunch. In the other: the dangers of inflation, a situation made worse by the day by rising oil and food prices. One requires a loose monetary policy, the other, a tight one. You can’t win.

In Akhtar’s case, it’s even worse: she’s doing so against a backdrop of unprecedented political instability in Pakistan. The last six months have seen an assassination that resonated around the world; a change of government, to a shaky coalition that has already seen a founding member drop out; and growing animosity between the president and the judiciary. It’s hard to think of worse circumstances in which to be a central banker.

It’s hard to know which challenge to ask her about first, but Asiamoney opts for the political climate. Because the truth is, Pakistan had been travelling remarkably well under the team of President Musharraf and the ex-Citibanker prime minister, Shaukat Aziz. Foreign direct investment hit US$8.42 billion in the 2006-7 financial year, an 88% increase on the previous year, and a 15-fold increase in four years. Pakistan’s economic growth topped 7% for four years in a row up to mid-2007. But that was achieved against a background of political stability, however uneasy the methods of its achievement (Musharraf came to power through a coup, and had consistently failed to follow through on a promise to relinquish his uniform as head of the army).

Recent months have been anything but stable: Benazir Bhutto, having survived a bomb that killed 140 in October, was assassinated in December; an election brought opposition to power, but in an uneasy coalition between two parties; and the day before Akhtar met Asiamoney, Nawaz Sharif, the former prime minister and a key coalition leader, withdrew his ministers from the government.

So how does Pakistan fare in such an environment? “I think it is important to recognise that Pakistan has actually weathered a number of shocks, both domestic and external,” she says. “The net result today, of still having positive economic growth of a fairly decent kind, should give a sense of the resilience of the economy.” She notes the challenges, but adds: “One has to keep track of the baselines relative to the noise. I think that, touch wood, the baseline is intact: the fundamentals are there, and this year’s disruption to macroeconomic stability will have to be accepted and moved on.”

And the politics, while distracting, do reveal an important point. “At least we have achieved a democratic transition. Of course the coalition is going through its challenges right now, but hopefully, I have confidence that the political set-up will come out of it.”

It does appear, though, that the country is beginning to suffer, whether because of political noise or global malaise. FDI for the first three quarters of the 2007-8 year stood at $3.6 billion, suggesting that the full year total is likely to be half of last year’s. Portfolio investment in particular has fallen away, reaching barely 4% of the 2006-7 figure so far. The stock market, which has always shown remarkable resilience to political disruption, is actually one of the better performers in the region, but these numbers suggest that it’s not foreign participation that’s keeping it buoyant.

One particularly alarming element of the new administration has been its vigorous criticism of the fiscal data reported by its predecessor government. “There was a lot of inaction and mismanagement, under-budgeting, and as a consequence of that we have had a huge budget blow up,” finance minister Ishaq Dar told Asiamoney at the Asian Development Bank meeting in Madrid in May. Dar says the budget deficit was heading for 9.5% when he took over, but believes it can now be brought below 7%. But isn’t an attack on previous fiscal reporting an attack on the central bank too?

“Well, we are not involved in the fiscal preparation per se,” Akhtar says. “We do comment and give feedback to the government based on a regular review of what’s going on in the budgetary projections; we recommended the government curtail its borrowing from the central bank, and we maintain that.”She notes that several things factored into previous budget scenarios ended up being far worse than expected, notably oil prices, but also the passing through of food price hikes to consumers.

And this brings us to the second great challenge: the macro story. Akhtar’s approach, faced with this tension between growth and inflation, has opted for monetary tightening, which suggests she sees inflation as a bigger threat than slowing growth. It is not an approach that has made her particularly popular. “From 2005 the central bank, despite facing the displeasure of the industry and various other stakeholders, has been taking measures which are not popular but which are very important to maintain the demand pressure being contained,” she says. Doing so is a challenge anywhere; in a big country with a lot of people below the poverty line, it’s worse. “In the most informed developed economies it is a challenge to do this public communication,” she says. “In a developing country context it is an added challenge. Often I have to face this unfortunate task of announcing the measures and dealing with the public as we go along.”

Akhtar has been among the most vocal of Asian bank governors in saying that commodity price rises are not a spike, they’re here to stay, and people had better get used to dealing with them. “We have to position ourselves at a new level,” she says. “Prices are moving upwards, not back and forth, and it is hard to predict where it will land.” And she is visibly angry about the causes of the oil price rises in particular. “There are clearly corrective actions being taken for food prices on all fronts, some good and some bad, but on oil prices regrettably there is no global concerted effort. I wish there were more questions being asked about why it is the world is not collectively sitting at a table and hammering the suppliers for more production.”

Consequently, when Asiamoney asks what she thinks about a proposal from Thailand to form an OPEC-style cartel for rice production to help stabilise prices, she gives it short shrift. “OPEC has failed us as an institution and as a body to stabilise international prices. It is because of OPEC’s behaviour the world is facing this crisis. If the world was hit by this crisis uniformly, you would have had a different perspective. But now, with the oil producing economies enjoying the benefits at the expense of poorer economies, there is virtually no international noise.”

In the international community, analysts are cautious. “Political uncertainty, tighter monetary conditions, adverse weather and poor agricultural policies are likely to take their toll on GDP growth in fiscal year 2008,” said Citi in April. The cotton crop could be 20% lower this year than last, denting the agricultural sector, while the manufacturing sector has been hit by high lending rates and power shortages, says Citi, expecting the slowdown to spill into services.

“Pakistan’s current account deficit in the first eight month of fiscal year 2008 was 44% higher than the corresponding period a year earlier,” says Citi, noting that the situation is much more serious than last year, when a 4.9% gap (measured as a proportion of GDP) was easily financed by incoming FDI. “The immediate challenge facing the external sector is to secure external funding… we believe the new government will need to step up its efforts to attract petro-dollar surpluses into real estate investment and refining,” says Citi, noting it is optimistic Pakistan can secure the funds it needs.

Other analysts find spots of value in individual companies. Merrill Lynch, for example, likes Pakistan Petroleum.

For her part, Akhtar has been a regular fixture at world summits lately spreading a message with some common themes: that there is no decoupling between Asia and the US, inflation is a vast threat that must be addressed, high commodity prices are here for the long term, and Asian central banks need to tighten monetary policy. It’s not a popular message. “Often people have very unpleasant things to say, she says. “But you have to go on with your work and build your courage to move on with life.”

BOX: THE BANKS

It’s remarkable how the challenges in Akhtar’s day to day existence have changed in recent years. In a previous interview with Asiamoney, one problem was to keep the extraordinary strong performance of the country’s banking sector in check. The gap between what banks were paying on deposits and charging on loans was the highest in the region by a distance, creating one of the most vibrant financial services sectors in Asia. In the midst of this, alongside what she called a process of “moral suasion” to try to make the banks a little fairer to their customers, she required more up front provisioning, “which made a lot of owners unhappy.” That’s starting to look a smart move. “Profits have been lower but in an economic sense the banks will benefit from this provisioning.”

The health of the sector had prompted a number of foreign banks to buy in to Pakistan. Standard Chartered’s US$413 million purchase of 80.86% of Union Bank in August 2006 was the landmark deal, but others have included ABN Amro purchasing Prime Bank, and institutions like Merrill Lynch and JP Morgan staffing up on the ground. Citi, Deutsche and HSBC are already here in their own names.

This seems to be one area that has maintained interest despite the shocks. Barclays has approval from the State Bank to open 10 branches this year, and is expected to start operations in June. There has also been interest from the Gulf (such as an ownership transfer in Saudi-Pak Commercial Bank, and an investment by Bank Muscat) and Japan. In fact, interest has reached a point where Akhtar is already wondering when to say enough is enough. “There is continued interest, but we have to see at what level we say: enough foreign bank stakes, because it creates some resentment in the domestic community.”

The biggest area of growth in Pakistan financial services is in Islamic finance. Pakistan was a late arrival here, taking longer than many Muslim peers to develop an enabling regulatory environment, but since doing so it hasn’t looked back. “It’s been growing at 40% plus and is positioned to grow at that level,” she says. And it’s driven from the grass roots. “Pakistan’s biggest trend of Islamic finance will come from the masses themselves. There is a huge need to enhance the penetration ratio of the banking system, and I see Islamic banking playing a key role in trying to enhance financial penetration.” Pakistan has 160 million people, mostly Muslim. “We are already at 3% of the banking sector [in terms of deposits] in the last two years, and we think that in the next five years we should get to 12 to 15% of the market.”

BOX: THE MARKET VERDICT

One gets a keen sense of what the world thinks of a country’s political climate and outlook when that country’s companies and agencies approach the global capital markets. The vote, so far, seems to be reasonably optimistic.

In May, Lucky Cement priced a GDR issue in London to raise $110 million. It covered its books two and a half times over, attracting 40 institutions following a global roadshow; 20% apiece of demand came from the US and Europe, with the bulk from Asia and the Middle East. The deal priced at a 9% discount to its underlying share price, which isn’t especially high for a GDR given the country’s national circumstances. Merrill Lynch led the deal, with its local partner KASB Securities as financial advisor.

Locally, fund managers believe investors are prepared to separate the political noise from the fundamentals of investments. “The last seven months have seen markets worldwide being more subdued,” says Nasim Beg, chief executive of Arif Habib Investments in Karachi. “In that context, the Pakistan market has continued to do well despite a year of political turmoil around the election. Clearly, most institutions who look at emerging and frontier markets would look at Pakistan as a market that tends to hold its value. There is a high investment return rate here.”

Earnings growth is still good, he says, “and a company like Lucky Cement is poised to do well, both in terms of domestic demand and regional demand for cement.” Another observer says: “There is a very strong reception towards this transaction, because it’s really a play on Middle East construction growth. There is a strong shortage, Pakistan is well positioned to provide it, and cement prices are at all time highs.” He adds: “No matter what governments do, they still have to build roads.”

Beg expects the new government to continue with a policy of using GDRs to privatise state assets, and “my expectation is there will be demand for such stock internationally.”

So should investors be worried about the political climate? “Clearly this will be of concern to international investors, but then whoever has taken exposure to Pakistan in the last 12 months – including the assassination of Benazir Bhutto – has seen that throughout the market has shown remarkable resilience.” He’s right: in the 12 months to June 9, the KSE 100, Pakistan’s benchmark, was down just 1.1%. Over the same period Australia is down 10.3%, China 9.4%, Japan 18.5% and the Philippines 22.3%.

MA Samad, chief investment officer of Atlas Asset Management in Karachi, says that five years of GDP growth, strong remittances from overseas Pakistanis and rising FDI have given Pakistan “a shock absorber. If something goes wrong in the short term for the local economy, it can cope with it.”

Still, we haven’t yet had the chance to see how the state itself fares with an international deal. A planned exchangeable bond of between US$750 million and US$1 billion was axed earlier this year following the change of government. The deal, expected to be exchangeable into shares of Oil & Gas Development, was well advanced: ABN Amro, Barclays and JP Morgan had been appointed as bookrunners in April. However in May finance minister Dar confirmed that Pakistan would be visiting the debt markets in the near future.

Also closely watched will be an international equity issue by Habib Bank, in order for the government to reduce its stake in the bank from 45 to 25%. Habib had originally planned a GDR, but will now undertake a cross-border placement of local shares. At some point the long-planned issue of GDRs by National Bank of Pakistan, which had been mandated to Deutsche Bank and Morgan Stanley, will return to the markets too.