KARACHI, Jan 18: Is excessive supply and low demand of money in commodity producing sectors creating an irrational exuberance in soaring asset markets and a bubble economy?

Watching closely market trends, some monetary and currency experts are showing concern over the direction in which the economy is moving.

As the US stock prices have plummeted and investment is flowing out because of over-priced equities in a face of uncertain recovery, Pakistani stock markets are pursuing western models to attract foreign and local portfolio investment.

Though the fundamentals of the economy have not changed significantly over the past one year, excess liquidity, as a result of capital inflows from abroad, is moving into stock market, real estate and is being used for purchase of consumer durable.

And the risks and challenges that the trend offers can be gauged from the performance of the global capital market, more aptly, described in the words of Malaysian prime minister Dr Mahathir Bin Mohamad.

He says “Today, business is not about making real profit or accumulating assets but about creation of market perception of the value of companies. Share price is all important. It need not reflect the profitability or real worth of the company. If there are buyers for the shares then the demand will push the price up and vice versa. If the money invested will not yield any worthwhile profit, it does not matter, as long as the shares can be disposed of at a higher price and capital gains made.”

Currently, in the booming Karachi Stock Exchange, it is not the creation and accumulation of new assets but trading in existing scrips. The market lacks depth, the number of listed scrips has fallen sharply and the new companies listed annually is a mere 3 or 4. The number of firms which have announced annual results by early December 2002 is much less, 234 as compared to 422, in the comparative period ending early November last year. It means less availability of core-income stocks. Very few scrips are actively traded. Yet, the KSE 100-share index is at all time high of 2,950 points.

A leading industrialist says he is puzzled by the soaring interest rates on Badla transactions and is concerned that their worth has now touched a record Rs15 billion.

Barring excessive liquidity, the fundamentals of the economy have not changed for the past one year. The stock markets are no longer the barometer of the economy.

Portfolio investment is like a migratory bird, always on the move in search of greener pastures, its exit often causing serious crises. Pakistan has also gone through its own experience in the 1990s when foreign investment withdrew.

Owing to declining return on government securities and low demand for credit, specially for long term investment, financial institutions have also built up substantial equity portfolios, specially, says Taurus Securities (TS), in dividend yielding stocks. A further reduction in interest rates would reinforce the current trend, driving additional liquidity towards the equity market.

A pertinent question raised by the security house report (when the KSE index had touched 2,700) is: “Is it safe to invest at these levels or should one take his profits and run”. Using the sample of 82 companies from the KSE 100-share index, the financial analysts concluded that the market has still room for growth. Now, the index is at 2,950.

The meteoric rise of the stock market, says TS, has driven the dividend yield (on the basis of sample of 36 companies) down to 10-11 per cent. Given the favourable tax treatment of dividends versus interest income, on after tax basis, the net yield spread over the risk free rate, is still attractive and for commercial banks, it is more attractive. The low loan demand will mean greater inflow into the stock market. The pressure may increase by March as the peak lending season (November-February) ends.

A similar situation prevails in the real estate market. No doubt, there is some genuine demand of overseas compatriots for real estate but speculative investors have stepped in property markets in posh localities like Defence and Clifton, driving the genuine local buyers out of the market. Six months back, an individual says, he bought a plot for Rs2.3 million. Now, its market rate is around Rs3.5 million.

Remittances that include “reverse flight” of capital has reduced the demand for credit in the real economy. As the rupee gets stronger, the exporters are encouraged to bring 100 per cent of their earnings, (a small proportion of which was allegedly kept abroad) and that too promptly. When the rupee was depreciating importers hedged their risks. Now, it is turn of the exports, says currency expert.

Conscious of the problem of excess liquidity, the State Bank has opted for a sterilization policy. The central bank buys dollars in excess of the market demand and also mops up the rupee proceeds through sale of government securities.

The State Bank has opted for the sterilization option because, its quarterly report points out, it provides breathing room to assess whether the inflows are transitory or permanent.

If the foreign exchange flows are permanent in nature, it would be preferable to allow domestic currency to gradually adjust to improvement, say central bank officials.

Market perception differs. “We believe that remittances will keep flowing as the crackdown on illegal channels of money transfers continues, says Taurus Securities. Many currency experts share this view. And to add to what they have to say the Bush administration believes that war on terror is a long term strategic goal.

Economists say that central banks are conservative in their outlook and prefer to err on the side of caution. The advocates of a free float of the national currency want a quick end to sterilization and SBP intervention in the exchange market. Their expectation is that the rupee would further gain strength and the short-term rate would stabilize at Rs55 per dollar. Views, however, differ on how fast should the rupee appreciate.

The State Bank has been losing money in the purchase of dollars as the rupee continues to appreciate. And some currency experts believe that subsidy on exchange rate for exporters should end and imports should be encouraged. The subsidy deprives the government of the revenue that could have gone into development spending and in launching big infrastructure projects to kick start the real economy.

Similarly, says another currency expert, that the treasury bills worth Rs617 billion with the State Bank in June 2001 has come down to Rs154 billion and the interest rate has been cut from 6.5 per cent to 4.3 per cent. The government is retiring treasury bills that is being passed on to the commercial banks.

The challenge before policy makers is to use the excessive liquidity for improving the real economy, beyond the capacity of an emerging market. Money should be not be employed in sale and purchase of existing assets but in modernization of agriculture and industry to boost national production and reduce poverty.

In the current environment, the two areas holding immediate promise are consumer banking and house financing. Pakistan needs marked improvements in the real economy.