October 1, 2007	Monday	Ramazan 18, 1428

The US sub-prime mortgage fiasco is snowballing in global credit markets. But top bankers say it would not directly affect Pakistan, at least immediately.

“The US crisis should not have a direct impact on interest rates or exchange rates. But the interest rate cut in the US to contain the ramifications of the sub-prime mortgage crisis is contributing to weakening of the dollar. This directly affects countries like Pakistan that keep the bulk of foreign exchange reserves in dollars. Also, a weaker dollar means costlier imports in terms of rupees that can fuel inflation further “This is how the head of a foreign bank summed up his views on the situation.

Focusing on the US economy, a senior investment banker cautioned: “ If the dollar continues to fall against key currencies and if the US economy slows down, exports to America, inflow of foreign investment and home remittances from there, all might come under pressure.” America is the largest trading partner of Pakistan and the bulk of FDI and workers remittances also come from the US.

Viewing possible developments in Asia economist Dr Asad Sayeed observed: “In case American economy slows down, and in the process its imports decline, then that would also have a depressing impact on the Chinese economy. That should be a matter of concern for us because a slowdown in the Chinese economy would hit Pakistan in more ways than we can think of.” In recent years, the economic and trade ties between the two countries have been much strengthened.
Six to seven years of high growth, low interest rates and easy credit saw an easing of lending standards and a large build-up of debt as loan portfolios were leveraged with other financial institutions including hedge funds.

This has seriously affected several funds managed by major international institutions and is leading to a tightening of credit standards.

“For emerging markets, this could mean higher priced international borrowing and tighter terms,” says Mr Zubyr Soomro, president of Overseas Investors Chamber of Commerce & Industry.

“In the case of Pakistan, we need to ensure effective regulation of the banking system (to avoid negative repercussions of what is happening in the global financial system),” he added.

Mr Soomro was worried that “ there is a move under way to take banking supervision away from the State Bank. This would be a mistake as some other countries are now learning.”

Bankers and stockbrokers say that sub-prime mortgage crisis may have a minimal impact on Pakistan’s global bonds.
Except for the first Sukuk bond of $600 million launched in early 2005 other euro bonds offer fixed rates and would see no negative impact.

The Sukuk that offer a yield based on six-month floating interest rates would be subject to price volatility.
Some securities analysts fear that as the US credit crunch spreads across global financial markets, some increased risk may be witnessed in local equity market as well. They say that about one -fourth or one- fifth portfolio investment falls into the category of hot money which could flow out once the overseas investors based in the US or UK need extra funds to overcome their debt problems.

But a former chairman of Karachi Stock Exchange Mr Arif Habib bulldozed this idea. “I think what happens to the global financial market would have no direct impact on Pakistan’s portfolio investment,” he remarked.
“On the contrary, as the recent Fed rate cut has resulted in more funds flowing towards emerging markets. We may see our portfolio investment rising in future.”

He made it clear that overall inflow of portfolio investment has remained negative so far this fiscal year “mainly due to political uncertainties and has nothing to do with the sub-prime debacle.”

Portfolio investment into Pakistan witnessed a net outflow of $40 million in a-little-less than three months of this fiscal year.
Mr Habib held the view that the US credit crisis would rather facilitate portfolio investment and that the crisis has made it evident to the US investors that the return on their investment at home is much lower than what they are getting in Pakistan.
For some analysts, however, there is an area of concern.. “What if overseas Pakistanis and US-based foreign investors need more financial resources to avoid debt defaults at home and they start offloading their investment in Pakistan’s stocks and real estate?”

Economist Dr Asad Sayeed plays down this possibility yet does not entirely overrule it. Leading bankers and brokers say it would be too early to speculate on it.

Analysts say the first thing which comes to one’s mind and looks common between Pakistan and America is skyrocketing of property prices during the last couple of years. However, in case of Pakistan, there is a silver lining; the increase in domestic real estate prices was backed by “cash buyer” demand and not by any significant level of “mortgage financing” or other leveraged means of funding from the banking industry. “Therefore, we rule out any risk of a crash in domestic property prices or any negative fall out on the banking industry for the time being,” said a senior analyst.

Another analyst said that Pakistan’s external sector looks less vulnerable to the global credit squeeze due to lower FDI outflow exposure risk, stable exchange rate and comfortable foreign exchange reserves of $16 billion. “So, the capital inflows might not decline in the first place and even if they do that would be quite manageable.”

Some bankers and analysts believe that the worsening of sub-prime scenario could lead to reassessment of risk by investors across markets and products. This could also lead to withdrawal of capital from the emerging market economies. In the event of any severe fallout of sub-prime crisis, reverse flow of global excess liquidity can bring negative impact on Pakistan’s economy. While the US credit crisis does not pose an immediate challenge, many say that it does offer some lessons to learn. “One of the lessons is that whenever mortgage lenders innovate to generate multiple loans they need to know that it can have major repercussions,” said a senior executive of a foreign bank.

At the root of the US credit crisis is this very art of creating multiple loans. Sub-prime mortgages are low credit quality loans repackaged in the US and sold around the world where these are used as collateral for a host of further financing.
The head of consumer credit of a local bank pointed out that there is another more critical lesson to learn. “No compromise or short cut for booking new mortgaged backed assets to generate fee based income. Since the banking spread has risen too high and the banks are under immense pressure from the SBP and their clients to reduce it, they might be tempted to increase the volumes of fee- based income. “And that is where they may make mistakes.”