South Asia’s Dichotomy Drifts

Pakistani and Sri Lankan bonds and stocks moved in opposite directions as the former was up double-digits on the MSCI index amid a sovereign ratings downgrade, while the latter frontier component stumbled as debt was well supported on likely reapplication for IMF assistance. In Colombo GDP growth was off the previous post-war 8 percent pace in the first half as the central bank hiked interest rates and imposed credit curbs, although inflation brushed the 10 percent mark on drought-related food prices and 20 percent currency depreciation after adoption of a free-float. Tourism and infrastructure remain key economic drivers, and international reserves have stabilized around $3 billion to cover 3 months’ imports. Restrictions are in place on banks’ open foreign exchange position as a slight balance of payments surplus is now expected, according to the Fund’s last review of its existing arrangement. The budget deficit is steep at 6 percent of GDP, and the state-run electricity and petroleum utilities have brought in new management and subsidy procedures to staunch losses and stakes may eventually be offloaded on the exchange. Public debt is 80 percent of national income, about half external and one-quarter of that category commercial. Rollover risk is “manageable” Fund staff believe, but short-term exposure exceeds recommended boundaries. The financial sector may be compromised by large government securities portfolios although headline capital adequacy is above the required 10 percent of assets, and a multilateral lender assessment will be conducted by year-end to determine possible priorities for a successor program. In Pakistan that prospect continues to be moot pending tax collection breakthroughs and an end to official upheaval with top figures under corruption investigations and coalition infighting and intrigues. US military aid has been suspended and the future development piece is under interagency study. The low “B” sovereign grade was further punished as CDS is already among the most-distressed spreads. Elections are scheduled for 2013 as the budget gap mirrors Sri Lanka’s but is financed by central bank borrowing in violation of both international standards and domestic statute. A chronic energy shortage and near 15 percent inflation erode private investment and another flooding bout may keep GDP growth at 3 percent.

Falling oil costs may bring current account respite, but law and order and terrorism woes impose additional burdens. The first proposed opening in India of Pakistani bank in decades has been complicated by cross-border security scrutiny despite a bilateral trade thaw. With the Indian finance minister assuming the presidency and Prime Minister Singh grabbing the dual post investors await long-signaled subsidy, foreign access, and land purchase changes as GDP growth dropped to the 5 percent range in the latest quarter. Modest liberalization in the aviation, insurance and retail industries may result even as corporate earnings expectations turn more crustily conservative.