The Asia Subcontinent’s Subpar Sweep

Pakistan on the main Morgan Stanley Capital International Index with a 15% loss and Bangladesh and Sri Lanka, down 5% on the frontier rung, were at the bottom of regional ranks through the third quarter.  Foreign investors shunned bonds as well on uncertain standing with the International Monetary Fund, and political and geopolitical complications. Subcontinent giant India struggling with financial sector crisis reinforced negative neighbor views likely to persist into year-end in the absence of economic policy breakthroughs.

The IMF’s September Article IV report on Bangladesh captured “downside risks” despite strong 7.5% gross domestic product growth predicted again this fiscal year. Private consumption, garment exports, worker remittances and infrastructure projects will be drivers, against the background of rising trade protectionism and natural and humanitarian disasters. Monsoon flooding and climate change erosion could lift food prices beyond the 5.5% inflation target, and the 700,000 Rohingya refugees from next door Myanmar remain in place with a $1 billion donor appeal subject to “fatigue” and fiscal fallout. Reserve money growth as of mid-year was double the 8% central bank goal, and it recently shifted course on lowering banks’ mandatory loan/deposit ratio to 83.5%. Higher electricity charges and value added tax could be inflationary, but disciplined monetary and fiscal policies, with the deficit to be kept under 5% of GDP, are official commitments. Tax collection at 10% of GDP lags behind peers, and without a broader base and exemption elimination revenue mobilization will also stymie progress toward the anti-poverty Sustainable Development Goals, the Fund warned.

Banking system cleanup is pressing with the stated bad loan ratio above 10%, and 30% for state-owned lenders. Under a wider definition stressed assets exceed one-fifth the total, despite a “growing trend” of rescheduling and restructuring. Due diligence and risk management are poor and “comprehensive reforms” are overdue to reverse regulatory leniency. Loan classification and corporate governance criteria should be stricter, and fraud and defaults require court action. The overall historical role of government-run intermediaries must meet a commercial test, especially as national savings certificates sold through them crowd out private capital markets.. As investors in this paper they also come under pressure to breach allocation limits to help relieve short-term budget squeezes, the Article IV commented.

Securities market weakness is in turn an obstacle to economic diversification beyond ready-made garments, as new businesses seek venture funding. South Asian stock exchanges trade at a discount to the region with single digit price-earnings ratios, but the Dhaka heavyweight Grameenphone is in a fight with the telecoms regulator over outstanding fees. Until a settlement and further bad loan purges at banks otherwise prominent among listings, possibly through a central disposal agency as in Vietnam, lethargy is the presumed near-term sentiment.

Sri Lanka’s second quarter GDP growth halved to 1.5% with the Easter terror bombings, but the PMI manufacturing gauge was again over 50 in August signaling recovery. The central bank cut the benchmark rate 50 basis points then on 3.5% inflation, and in October imposed loan cost caps on banks to ensure relief was transferred to borrowers. Investors have taken positions on private sector retail-oriented competitors most likely to benefit, and they could further rally after the November presidential election with the two party contenders are in a close race. The winner may offer additional fiscal and monetary stimulus after the IMF program allowed such temporary moves in the wake of the bloody attacks still denting tourism and consumer confidence. A silver lining in the latter is lower import demand set to narrow the current account gap to 2.5% of GDP.

Pakistan is a contrarian play as the Fund’s mid-September review called for “decisive implementation” of far reaching reforms never achieved under previous arrangements. The central bank is on hold, and fiscal retrenchment is to shrink the coming year’s deficit to 7% of GDP.  Growth is estimated in the 2-3% range, and inflation should fall to single digits. The 5%-plus current account hole has started to improve with the 30% real exchange rate depreciation the past two years, although foreign direct and portfolio investment have yet to rouse. The Kashmir confrontation with India has again raised the nuclear alarm, at a time when prospective share buyers prefer to monitor that reaction within the economic sphere.

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