VZCZCXRO0790
RR RUEHLH RUEHPW
DE RUEHIL #3888/01 3541116
ZNR UUUUU ZZH
R 191116Z DEC 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 0778
INFO RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEHRC/USDA FAS WASHDC 4297
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUEKJCS/SECDEF WASHINGTON DC
RUEAIIA/CIA WASHDC
RUEHKP/AMCONSUL KARACHI 0804
RUEHLH/AMCONSUL LAHORE 6536
RUEHPW/AMCONSUL PESHAWAR 5394
RUEHNE/AMEMBASSY NEW DELHI 4222
RUEHBUL/AMEMBASSY KABUL 9595
RUEHKT/AMEMBASSY KATHMANDU 9343

UNCLAS SECTION 01 OF 02 ISLAMABAD 003888 
 
 
SENSITIVE 
SIPDIS 
 
 
E.O. 12958:  N/A 
TAGS: ECON ETRD EAID EFIN ENGY EINV PGOV PK
SUBJECT: KARACHI STOCK EXCHANGE DROPPING WITHOUT FLOOR 
 
¶1. (U) SUMMARY:  Beginning Monday, December 15 the Government of 
Pakistan (GOP) required the country's three exchanges  to remove a 
restriction ("floor") on trading below closing prices of August 27, 
¶2008.  The Karachi Stock Exchange (KSE) dropped approximately 4 
percent during each of the first four days of trading, passing its 
lowest point since September 1, 2005.  Analysts estimated the market 
has been overvalued by 40 percent.  An exchange regulation that 
strictly limits the amount share prices can move each day has slowed 
the market decline but has also made finding fair market prices very 
difficult.  Meanwhile, the GOP and the International Monetary Fund 
(IMF) finally reached consensus on a limited stock market support 
scheme of USD 250 million.  END SUMMARY. 
 
¶2. (SBU) On August 28, the KSE announced a trading restriction that 
prohibited listed shares from being traded below the closing price 
on August 27, following a plunge of 42 percent from the market's 
high on March 21.  The "floor" on market prices effectively halted 
trading on the KSE although off-market, unregistered trading 
continued.  Initially labeled a short "breathing space", after more 
than 100 days the floor is now described by the Pakistani press as 
the longest closing of a stock market in history.  The Securities 
and Exchange Commission of Pakistan required the three exchanges of 
Pakistan to remove the trading floor as of Monday, December 15.  The 
KSE dropped approximately 4 percent during each of the first four 
days of trading.  After the tumble on December 18 the KSE hit its 
lowest point since September 1, 2005. 
 
-------------------------------------------- 
MARKETS WILL LIKELY CONTINUE TO RATCHET DOWN 
-------------------------------------------- 
 
¶3. (U) Despite these drops, the market still has not reached 
equilibrium.  On the day the floor was removed the Karachi 100 Index 
traded at 9.9 times earnings, compared to the Morgan Stanley Core 
Index (MSCI) Emerging Markets Index's average of 8.3 times, making 
Pakistan Asia's fourth-most expensive market.  Citibank analysts 
estimated the market was 40 percent overvalued at the time the floor 
was removed, and would decline to be closer to parity with other 
Asian markets.  The MSCI AC Asia Pacific Index has fallen 31 percent 
since the floor was first imposed.  On December 10, MSCI announced 
that Pakistan will be removed from the MSCI, effective December 31, 
which will force many index funds to sell Pakistani shares and 
further hurt Pakistan's equity market. 
 
¶4. (SBU) KSE's Managing Director, Adnan Afridi, confirmed to EconOff 
that the KSE has not experienced a huge wave of panic selling 
because a "circuit breaker" mechanism is choking trade.  He said 
that, following September 11, 2001, the KSE enacted a rule 
prohibiting the trading of stocks beyond a band of five percent 
above or below the opening day's share price.  (Note: Bloomberg 
reports, and evidence suggests, that the rule actually permits 
stocks to decline 5 percent or 1 rupee, whichever is higher.  End 
Note.)  Afridi explained that the activity during the first days 
without the market floor were small trades (as little as 100 shares) 
to daily move the price down by the full amount permitted by the 
circuit breaker rule, and that trading will rapidly increase as 
shares approach competitive market valuations. 
 
------------- 
BAIL-OUT FUND 
------------- 
 
¶5. (U) Following the establishment of the market floor, many 
investors had hoped for a government bailout package designed to 
support stock prices.  The GOP proposed two measures, the first 
would cost PKR 30 billion (USD 373 at 80.5 Pakistan rupees per USD) 
and entail offering foreign investors "put options", or the right to 
sell shares at a predetermined price.  The second was a PKR 20 
billion fund (USD 248 million), financed by private banks with a 
public guarantee, which would purchase shares of eight state-owned 
enterprises (SOE).  As part of a USD 7.6 billion IMF program 
beginning November 24, Pakistan agreed to consult with the IMF 
before implementing any stock market support scheme. 
 
ISLAMABAD 00003888  002 OF 002 
 
 
 
¶6. (SBU) On December 16, Pakistan announced it will establish the 
USD 250 million fund to buy listed SOE's shares after the market 
falls to its new equilibrium.  IMF representatives had said they 
were opposed to the use of public funds to assist wealthy, private 
investors.  However, the GOP revised the original proposal to 
eliminate the put-options fund and modified the SOE share-purchase 
fund so that it would not buy shares at above market prices 
selectively from some investors.  IMF management remains reluctant, 
but the potential fiscal cost involved (a total of 0.2 percent of 
GDP distributed over a few years) is not large enough to be critical 
to macroeconomic stability. 
 
------------------------------------- 
FOREIGN PORTFOLIO INVESMENT WILL DROP 
------------------------------------- 
 
¶7. (U) Financial analysts estimate that foreign portfolio investors 
have approximately USD 1.8 to 2.2 billion invested in Pakistani 
equity markets but that USD 500 million to 1 billion will be 
divested and expatriated now that the floor has been removed, 
draining scarce foreign exchange.  Pakistan's two-year program 
agreement with the IMF loan agreement included an initial tranche of 
USD 3.1 billion.  This infusion lifted foreign exchange reserves 
held by the SBP from USD 3.5 billion (less than one month's imports) 
to USD 6.01 billion as of December 15, but requires that the GOP 
maintains net foreign assets above predetermined levels to remain 
eligible for the remaining loan tranches.  Huge outflows of 
foreign-owned assets will make it harder for the GOP to meet the IMF 
program performance criteria. 
 
¶8.  (U) COMMENT: As constructed, the circuit breaker causes 
stagnation in  Pakistan's equity market.  If such a safety mechanism 
is necessary, it should apply to an index rather than each 
individual company share price, and thereby protect the market from 
either euphoria or panic.  The current formulation simply inhibits 
accurate pricing. 
 
¶9.  (U) COMMENT CONTINUED:  The fund to purchase shares of SOEs is 
also poorly conceived.  By interceding only after the market has 
reached its new equilibrium, the publicly guaranteed funds will have 
a negligible effect on market sentiment.  Implementation of the 
support scheme looks increasingly like fulfillment of a promise by 
the ruling Pakistan People's Party to save political face.  END 
COMMENT. 
 
PATTERSON