Outlook 2008: currencies and gold
KARACHI (January 03 2008): Currency Market Associates (CMKA) has a cautious outlook for Pakistan for the calendar year 2008. Risk of spillover effect of global credit crunch led by US housing slump and now political developments in the country could destabilise the economic growth, unless the situation reverses quickly.
We remain cautious in our stance, projecting a small dip in growth to 6.5 percent to 6.7 percent by the end of current fiscal year. While next fiscal year we could witness the impact of spillover effect of global slowdown to hit our economy too, which could pull down our growth to 6 percent or less.
In our view, the next elected governments should focus on education, health, human resource development, water, power and agriculture. It is also suggested that discovery of sufficient oil should be on top of the list of national security priority, though country's oil production would soon touch 75,000 barrels per day, which will roughly meet 21 percent or 22 percent of our daily need.
Working on Thar coal reserve should not be delayed any further, because an average GDP growth of 6 percent will require an extras 5,000 megawatts of electricity by 2010. In 2007, coal prices surged by 55 percent in the international market. Neighbours India and China are the two largest buyers of coal from South Africa and Australia.
Inflationary pressure would continue to persist as oil, food and liquidity pose bigger threat. In the calendar year 2008, we are looking for 50 to 100 basis point hike in discount rate with further tightening through Cash Reserve Requirement (CRR).
While we do not favour weak Rupee, but higher oil prices in the international market and import of essential food items to meet domestic demand would weigh on Rupee, that would further widen Current account and Trade deficit gap by a couple of billion of Dollars. Global credit crunch and country's rating could hinder launching of Euro and Sukuk Bonds due to unfavourable pricing, as Pakistan is under scrutiny of the Global Rating Agencies.
Hence, Rupee could slightly weaken. Next level to watch would be 62.80 per US Dollar. Only break of this important psychological barrier could push Rupee to 63.50 zones. Resistance is at 61.20 with major support at 60.80.
The global slowdown would impact regional economies, which could ultimately put pressure on Pakistan's economy too, though economies of Asia and oil producing Middle-Eastern countries may sustain growth.
Theoretically, Pakistan's Trade deficit that is hovering around USD 17 billion may not be a worrisome factor, but USA is a good example where the trade number is on constant rise since last three decades and they are yet unable to get out of the web.
Similarly, our Current Account deficit has been creeping up constantly, which is managed through receivables, but for how long is this going to be sustainable, remains a big question. Unless we are able to raise our exports or curtail imports, pressure from surging oil price is likely to stay for a while. Hence, the C/A number would continue to inflate.
DOMESTIC MARKET: The Macro Economic indicator of Pakistan ie, GDP, Inflation and Employment could pose bigger challenge for the next elected government and to maintain strong growth of over 6.5 percent in the later half of fiscal year, now seems a tough task. For poverty alleviation, stronger growth is required. Education budget should be raised to a minimum of 4 percent of the GDP and fiscal discipline is necessary. Broadening of tax base remains a big challenge, since over 50 percent of the employment is confined to the agriculture sector.
The rise in country's overall trade volume (Import & Export) helped in increasing tax revenue collection. However, in percentage terms, tax to GDP is still hovering around 11 percent, which is too low. Percentage of Tax to GDP cannot rise unless agriculture tax is raised to a required level, or tax percentage is increased in the private sector.
CMKA's view on the Micro Economic front is that the Central bank has to be more vigilant on certain issues. Banking spread, which is one of the highest in the world, needs downward revision or else country's savings ratio will not pick up. It is presently around 16 percent. It is vital for the economy to have a savings ratio of above 20 percent.
Higher savings ratio also helps in containing inflation. Asset Price inflation is another big factor causing inflation, which is being neglected. SBP should take strong note and recommend measures to reduce the level. In our view, it is one of the distorting factors.
Most importantly, we do believe that the State Bank of Pakistan will have to use its monetary tool more effectively and raise Cash Reserve Requirement (CRR) to minimize the inflationary impact. Had SBP used its credit tightening tool earlier, there would have been lesser inflationary impact on the economy. We support immediate hike of CRR by 3 percent that is approximately Rs 100 billion, with more hike recommended, if and when necessary. This will also help in neuteralising the excess liquidity in the banking system.
Secondary Bond market is another neglected area that needs quick attention. Until now, Central bank did not play active role for the development of secondary market. Government borrowing relies heavily on Pakistan Investment Bonds (PIBs). In the current FY, MOF have been consistently offering PIB's through auction However, the main bidder of government paper has been country's largest insurance company that has purchased over 70 percent of securities in period beyond 10 years and the remaining amount of shorter maturities was either picked up by banks and financial institutions, or small buying was done by corporate sector. In Pakistan bond trading beyond 10 years is almost nil due to illiquid market condition. Therefore, bonds up to 10-year bond can be more helpful for the development of secondary market.
SBP should formulate a policy for the development of secondary bond market. Primary dealers should be asked to play active role. Unless there is an inter-bank bond market activity, secondary market will remain dull, corporate interest will remain thin and purchase of PIB for trading purpose could remain meaningless for the investors.
Privatization was a success and Pakistan succeeded in attracting FDI worth $8.4 billion, which helped in improving the financial position of the country. Service industry, which benefited most, is now at a saturated point. It needs a breathing space to avoid increasing NPL's. Hence, more emphasis should be given on industrial and manufacturing sector, which helps in transfer of technology to the country, passing of skills to the local market participants and helps in job creation.
In our view, modernization of agriculture sector through reforms would certainly help to reduce poverty to a great extent. Since it contributes 22 percent towards the GDP and over 50 percent of population is directly or indirectly engaged in the agriculture sector, modernization should also be on a national priority list.
Shortage of essential food item has become a regular feature. It is required to ensure that unless there is surplus stock of grain available, exports should not be allowed. Pre-emptive measure of taxing on export of grains would help in arresting the volatility and discourage hoarding.
Estimate is that water-logging and salinity has destroyed 20 percent to 30 percent of the cultivated land , and needs quick attention. Irrigation system should be improved. Sprinkler Irrigation saves 40 percent to 50 percent fertilizers and water Drip irrigation is an expensive affair, but it can be provided at subsidized rates.
SME's and Micro Finance Banks can play major role by providing soft and easy loans to the agricultural sector and help farmers to equip them with better Agri-seeds and pesticides, and creating farming awareness with modern techniques by help in hiring farm experts. With ample liquidity flowing in the country, we support raising agricultural financing target to Rs 400 billion from Rs 200 billion.
Global warming is an important development, which should be taken seriously, as our economy is largely agriculture based. Industrial revolution is producing Greenhouse gases. The temperature is on the up, sea level rising and polar ice melting. This is causing a shift in the global weather pattern resulting in flooding and frequent storms. It may also cause disruption of drinking water and there is a fear of spreading of tropical diseases. Hence, we should prepare ourselves in advance before we are hit by any such calamity.
Textile sector has little to cheer about, as slowdown of global economy and competition by polyester in the major markets could pull down cotton growth, which is expected to fall slightly, There is a risk for an increase in price in the international market. Except for India, world cotton production forecast is not very encouraging as targets could be missed in China (Mainland), Turkey, USA and Pakistan. US economy is heading for recession and therefore, its economy will slow down. China's growth is export led, 40 percent of its trade surplus is from USA, and so China's growth will surely get hurt. Pressure is mounting from American legislatures on China to revalue Yuan. Relations between USA and China will remain a burning issue on US demand for sharp revaluation. China has to take action to cool US reaction. In the past, China has made several reforms, but recently, has slowed down on the issue of currency. Ultimately it has to revalue its currency which would further dent its economy.
Furthermore, we expect China's GDP to slide, which is led by exports. Its domestic consumption will start feeling the heat. Its equity market will start melting, as individuals own 70% of the shares. So, we do not hesitate to say that China is a Bubble on the edge of American Bubble. This is when we expect Dollar to start making its recovery.
Oil-WTI $96.2:
Various factors are driving the oil prices in the international market. There are fears that higher oil prices could slowdown the growth. Many are of view that the world economies can easily sustain the current levels and it is the liquidity crunch that has spoiled the growth momentum.
Apart from demand arising from the Asian economies, it is the calculated move by OPEC and helped by America's stance on Iran, which is pushing oil prices higher.
If we look at the Geo-Political condition, North Korean front is quiet. Presently, Iran issue does not look too serious. Recession in USA and forecast of slowdown in China means less consumption of oil. Iraq has started to produce to its maximum capacity of 2.5 million barrels per day. All this means that if the tension in the Gulf eases, oil prices could slide.
In our view, weak Dollar is playing a vital role in keeping oil prices higher. Currencies of oil producing Gulf countries are pegged to the Dollar and as they are unwilling to detach their currencies from the peg, due to expensive imports, oil supplies are kept tight.
Hence, any easing of tension in the region could see oil sliding toward $ 60-70 range. Meanwhile, getting so close to century, Oil will certainly try to test and breach the level, even slight tension in Gulf region would give enough reason for a spike towards $ 120. We still favour a dip in oil prices to $ 70-75 zones in 2008, though we are not expecting a test of $ 50 per barrel.
Commodities:
With the rising demand for commodities around the globe, the crop market may have an interesting challenge ahead. The crop producers' interest could shift from one crop to another as the shift can be motivated from ethanol based crop, which gives higher return due to continued higher oil prices.
It is also a matter of grave concern for grain importers that Australia, one of the largest grain exporters, continues to suffer drop of its annual grain harvest, which has fallen to 25 million metric tons from 37 million metric tons. Severe draught and migration from farm sector to urban areas are some of the known causes of drop in Australia's annual grain harvest.
Global projection for wheat is better acreage, but market fears that forecast of bad weather in USA, India, Argentina and Pakistan could threaten the recovery in 2008. Meanwhile, significant shift has also been noted, as Canadian wheat exporters are producing canola instead of wheat.
Pakistan has recently witnessed wheat shortage and the recovery would depend on good winter sowing and wheat output. Only massive year-on-year increase with good weather condition may meet the domestic demand, but normally two good years are required for the market to settle down. Our estimate is that with the annual population rise of 3 million, the domestic demand for wheat could surge beyond 24 million tons. Once again, blessings of Mother Nature would be the key to good growth.
Good sugarcane crop around the world was responsible for drop in sugar prices in the international market. Brazil, India, Pakistan, China and Thailand witnessed surplus sugar production.
We are expecting surge in global prices despite reports of higher production, as sugar is the cheapest major agriculture commodity. In February sugar will become part of commodity index, therefore, sugar will get bigger share in the weightage of index, which means increase in investment by institutional funds. So buying of sugar could be more due to speculative reasons rather than increase in consumption demand.
Gold $ 834:
While, the market witnessed Bull Run in the commodity market, demand for gold was seen for the second successive year as investors showed confidence in the yellow metal. Gold gained almost 25 percent during the year to close at $ 834.
We believe that with US economy heading toward recession, precious metal will remain in area of focus for the investors. Since oil, gold and currencies are taken as a hedge against decline, demand for gold will persist. On the downside, Gold has minor support at $ 785 with major support at $ 760. Our target on break of $ 880 is $ 925.
Currencies:
Euro 1.4650
We remain bearish for Dollar and do not expect ECB to cut rates aggressively, as inflation remains their major concern. Slowdown of European economy could force a 25 basis point cut, but overall Euro will be a net gainer. Needs to clear 1.4940 convincingly for the next big rally, as our target is 1.5480. Historically Dollar has the tendency to bounce back in January or February, so those who missed out the rally earlier can join the bandwagon. Euro has resistance at 1.4420, which should hold. A break here encourages for 1.4020, which we are expecting in the later half of the year.
GBP 1.9840:
Since sign of slump in the UK housing market became evident, BOE was quick to act by slashing its rates. We are expecting couple more rate cuts, but Cable has already lost 1300 pips, so it has strong support at 1.9550 which should hold and follow other major currencies. Needs to clear a close above 2.0180 for another feeble attempt towards 2.0620. Should struggle to clear convincingly for a fall to 1.9050.
JPY 111.55:
Yen gain was seen in the last quarter of 2007, which was best in 2 years, breaching 110 briefly before bouncing back, as speculators rushed to avail carry trade opportunity. Yen's strength was more due to Dollar's weakness rather than strong economic recovery in Japan. However, with FED cutting its rates aggressively, carry trade opportunities are thinning down. Yen has strong support at 114.80, should hold for a rally towards 106.40, a correction could occur before another attack towards 102-103 zones.
Business Recorder [Pakistan's First Financial Daily]
