Treasury Focus

A Weekly Publication of InvestCap Research

Pakistan Research Week 1, May 2010

Greased economies getting rusty

Greece's debt problem came to forefront when the newly elected government revised the estimates of fiscal
deficit for 2009 to 12.7% of GDP, roughly twice that of 6.7% estimated earlier. The said figure was more than four
times the limit allowed under the European Union rule i.e. 3% of GDP. In today's Treasury Focus, we discuss the
Greece Debt Crisis and the fallout effects in EU, on Euro, international capital and commodity markets and more
specifically, its possible implications on Pakistan.
The Greece problem
Eurostate - EU statistics agency - estimates Greece's fiscal deficit to be even higher at 13.6% of GDP for 2009. In
addition, Greece’s total debt was estimated to be USD400bn (120% of GDP) and current account deficit of
nearly 14%. The figure together revealed the compromised Greece’s ability to meet its debt obligations (esti-
mated to be Euro54bn or USD72.1bn) in 2010, forcing the country to i) an ambitious austerity plan aimed at
reducing fiscal deficit to 8.7% of GDP this year, and below 3% by 2012, and ii) seek assistance from other European
countries and International Monetary Fund (IMF) to meet its debt obligations.
Euro-zone entangled in a web of debt
The current Greece Crisis is a deemed to be the tip of the iceberg, which has a potential to expose other
vulnerable Euro-zone economies like Portugal, Ireland, Italy and Spain (together called PIIGS). As per the data
released by Banks of International Settlements on Apr-10, a picture of European Web of Debt has emerged
(shown in the diagram below).
Germany USD45bn

France USD75bn
Britain USD15bn

Greece
Total D ebt US
D0
e s 5 bn USD 236bn .7 b
OwD 8 . n
e S
ec d U
re n
G la n es 8 b
w 0. US
Ir e O SD D6
USD

nd U
.9 b
n

la c e n
0.4b

I re ree
0.1b

G Ita ly
USD

G erm any USD 184bn Irela nd G erm any USD 190bn

n

Total D ebt
Britain USD 188bn Total Debt US D 46bn USD 31bn Britain USD 77bn
US D 1.4tn
Franc e US D 60bn US D867bn Fran ce US D511bn
US
D5
.4 b bn I taly owes F ra nc e
n 31 US D 511b n, n early
USD

D
US 20% of Fren ch GD P
.7bn
.2b n
30 b

n
1. 3b

US D 6
US D9
n

USD 5
n

USD
16b

bn
.7

47
US D

SD
bn

W ith un employmen t of U
20%, Sp ain has a n US
D2
econom y am ong the 2b
w eakes t in EU Spain n Portugal
US D86b n
Total D ebt Total D ebt
USD 1.1tn US D286bn
G
e
n

Br r ma
D 14 8b

USD 28bn
F r it a n y
U S D 1 23

0b n

a
22 b

nc in U U S
n
c e US US D

N early 1/3 rd of
Portu gal’s debt is held e S D
U S D 2 47
Fr ita ny

b y Sp ain and c redit D4 4b bn

B r r ma

5b n
an i n

ratings of both ha s
e

n
G

been droppin g

Source: Bank of International Sattlement, NY Times, InvestCap Research

InvestCap is the brokerage arm of:

Invest Capital Investment Bank Ltd. Page 1 of 5
www.investcapital.com
 Treasury Focus
A Weekly Publication of InvestCap Research
Pakistan Research Week 1, May 2010

The figure clearly reveals that net debt amount pay- EU TRADE BALANCE -JAN-10
able within the PIIGS states stands at USD158bn as of
31 Dec-09. Therefore, contagion effect is quite a (Euro mn) Import Export Trade Balance
valid point as the Greece crisis could potentially trig-
Euro-zone 106774 97850 -8924
ger a chain reaction, initially engulfing PIIGS state,
Netherland 13643 7519 -6124
which could subsequent spread across the Euro-zone
causing a drag on more advanced economies like UK 14245 10746 -3499
Germany and France with relatively stable macro Spain 7077 4423 -2654
indicators. PIIGS’s payables to these major European Italy 11916 10294 -1622
nations stand at USD1.1tr, 29% of total USD3.9tr Poland 2953 1845 -1108
amount outstanding. These numbers are even more Greece 1055 365 -690
alarming when placed in the contest of trade rela- Czech 1505 1068 -437
tionship within the Euro-zone. The emergence of the Portugal 1079 659 -420
common currency (EURO) and liberated regional Hungary 1582 1169 -413
trade environment also paved the way for the Slovakia 917 573 -344
above-mentioned advanced economies to run huge Lithuania 559 358 -201
Current Account (CA) surpluses on the expense of Slovak 535 423 -112
structurally weak economies. Cyprus 135 27 -108
The common currency and free trade regime helped Luxemburg 224 169 -55
these countries, particularly Germany, to take ad- Malta 99 97 -2
vantage of export potential residing in the relatively Latvi a 140 163 23
weak economies and unleashing cheaper resources, Estonia 138 221 83
while keeping their products prices competitive. A Finland 1189 1370 181
look into trading partners i.e. Germany and France Austria 1910 2265 355
reveals that 50% trade partners comprise the Euro- Denmark 1291 1712 421
zone partners, while trade balance of the discussed Belgium 5754 6176 422
countries is given in the table on the right. Sw eden 2497 3406 909
It is evident from the above-right table that France 9902 10902 1000
Germany’s trade surplus for the month of Jan-10 Ireland 1307 2574 1267
stood at EUR7.4bn, which is cushioned by the trade Germany 19377 26805 7428
deficit of EUR5.4bn from the PIGS (excluding Ireland) Source: Bloomberg, InvestCap Research
where Irland stands in surplus and owes USD184bn to
Germany. Moreover, in the contest of overall CA balance, Germany stands with a CA surplus of EUR12.6bn for
Jan-10, roughly equal to combine CA deficit of EUR13.0bn (excluding Ireland) ran by the PIIGS economies during
the same period.
Therefore, spillover effect of the slowdown in the structurally weak economies has the potential to rope-in the
economic recovery of more developed economies (Germany and France) in the Euro-zone and in turn, dampens
the optimism regarding the global recovery in 2010.
EUR losing charm
This above highlighted inherent economic imbalance in the Euro-zone would also have major implications on
the 16-nation common currency, the EUR. The currency is normally considered as a safe heaven/alternate
investment avenue when the world gets in an economic turmoil i.e. the on-going worst recession period since
the Great Depression. The investors flocked towards the EUR because of its perceived underlined strength of
the Euro-zone and USD was being battered on account of US problems. However, the recent Greece episode
has exposed Euro-zone as well as EUR’s inherit weakness caused by the drag of structurally weak economies.
Since the start of Greece problem, Euro has depreciated against the major world currencies. The EUR touched
USD1.2521 depreciating by 4.5% against USD on 06 May-10, which is lowest since 01 Jan-09. Going forward, we
expect the Euro-zone problems to keep EUR under-pressure with investment flows getting away from EUR.

InvestCap is the brokerage arm of:

Invest Capital Investment Bank Ltd. Page 2 of 5
www.investcapital.com
 Treasury Focus
A Weekly Publication of InvestCap Research
Pakistan Research Week 1, May 2010

EURO vs USD Index MSCI Index Relative Graph

180% EU NORTH AMERICA
130% DOLLOR INDEX Euro / USD
125% 160% EM ASIA THE WORLD INDEX
120%
140%
115%
110% 120%
105%
100%
100%
95% 80%
90%
60%
85%
80% 40%
Jun-06

Dec-06
Mar-07
Jun-07

Dec-07
Mar-08
Jun-08

Dec-08
Mar-09
Jun-09

Dec-09
Mar-10
Sep-06

Sep-07

Sep-08

Sep-09

Aug-09
Oct-06

Jul-07

Dec-07

Oct-08

Jan-10
May-06

Mar-07

May-08

Mar-09
Source: Bloomberg, InvestCap Research

Spilling onto global capital markets

After going through recent recessionary periods, global equity indices initiated the recovery process from Mar-
09, in which emerging markets were the chief beneficiaries where the MSCI EM Asia Index posted a massive
growth of 98% YTD owing to a phenomenal economic growth expectation from the two giants, China and India.
During the same period, Frontier markets were not as focused however, registered the growth of 51% during the
same period. At this time, expectation of slow recovery of the world economies led by expected EU recession
has once again given a severe amount of battering to the global stock markets (MSCI EU Index down 10% since
Apr-10, MSCI US Index down 7% followed by MSCI EM declining by 6%). We believe margin calls in the US and EU
equity markets are and will be exerting pressure on emerging
markets further. Com m odities Relative Perform ance
Gold shines while crude getting darker Crude USD/bbl Gold USD/oz
200%
With signs of weakening underling global monetary system of 180%
the world, we expect fund flows towards safer commodities
160%
like Gold. As it was evident from the fact that with US going in
140%
to recession, Gold rallied to record high of USD1,226/oz, be-
120%
fore easing to average 1,1500/oz with emerging signs of eco-
100%
nomic recovery. However, as EU's economy is exhibiting the
recessionary phase, the gold has already started its climb and 80%
touched USD1,210/oz lately. We believe this precious metal 60%
could potentially climb to USD1,300/bbl in near future. 40%
On the flipside, we expect the opposite in the crude oil prices. 20%
May-06

Nov-06
Feb-07
May-07

Nov-07
Feb-08
May-08

Nov-08
Feb-09
May-09

Nov-09
Feb-10
Aug-06

Aug-07

Aug-08

Aug-09

Our argument stems from the reasoning that USD will gain
strength against the EUR. This in turn would enhance the op-
portunity cost of holding extra barrel of oil while the funds flow Source: Bloomberg, InvestCap Research
would be away from the crude oil and thus, would reflect in weakening of the crude oil prices. We expect crude
oil (WTI) to come down to USD70/bbl by Jun-10.
What's in it for Pakistan?
So far, Pakistan appears to have been favored by the global meltdown in terms of its trade, remittances as well
as portfolio investments. While portfolio investments could be short lived, volatile or an economically less-
reliant phenomenon, a more relevant assessment to gauge long-term sustainability of foreign exchange re-
serves should be to analyze the impact of present EU economic crises on Pakistan's trade imbalances. During
9MFY10, Pakistan's current account and trade account deficits were both down by 68% and 22% YoY respec-
tively, boding well for country's overall Balance of Payments (BoP).

InvestCap is the brokerage arm of:

Page 3 of 5
Invest Capital Investment Bank Ltd.
www.investcapital.com
 Treasury Focus
A Weekly Publication of InvestCap Research
Pakistan Research Week 1, May 2010

On the export front, textile continued to remain the key contributor with 52% share in overall country’s exports
during 9MFY10. The group witnessed a very nominal decline of 0.3% YoY, which could be partly attributed to
slowdown in global markets but evidently more to structural issues prevailing in the country (in the form of
energy crises). Even within the textile group, raw cotton and yarn exports remained robust while recent initia-
tives to cap exports of textile inputs could bode well for exports by the value-added sector.
With Pakistan's export-mix showing underlying strength, breakup of exports in terms of destination further re-
veals interesting facts. As such, Pakistan appears to be at high risk in context of present EU crises as 27% of our
exports are destined towards Europe, making this region the single largest consumer of Pakistani goods, fol-
lowed by USA (18% share) and Middle East (14% share). Interestingly, Pakistani exports' exposure to PIGS stands
at 6% during 9MFY10 while including Ireland and Great Britain in the mix (PIIGGS) it doubles the exposure to 12%!
Even then, our exports have so far remained least affected as such, as export to Europe only depicted a very
nominal decline of 0.3% YoY during 9MFY10, against a decline of 5% visible in exports to USA. While our exports
to the original PIGS were down by 9% YoY during 9MFY10, owing to much better exports to UK(+15%YoY) and
Ireland (+23% YoY), exports to PIIGGS actually grew by 2%YoY. Still, with the troubles in western hemisphere,
growth in our exports were very encouraging during 9MFY10 as far as China (enormously up by 83% YoY), Far
Eastern region (+16%YoY), Africa (+14%YoY) and Central Asia (+8% YoY) are concerned. China alone now
contributes 6% in our total exports (double from 3% last year). The shift in our export-mix through diversification
as well as switching towards new customers anyhow places our export at lesser risk going forward.
Still, we ran a brief sensitivity as far as our country’s outlook is concerned to assess the magnitude of exports lost
from Euro-zone and how fall commodity prices (typically oil) could offset such a decline. Assuming trend in
exports remain the same as far as other regions are concerned, a 5% decline in our exports to Europe could lead
to a loss of USD254mn. On the other hand, fall in crude oil prices to the extent of average USD70/bbl for FY11 will
result in savings of USD302mn, thereby having a favorable impact on overall trade balance of the country.
Sensitivity is provided in table below to broadly assess the impact:

PAKISTAN'S TRADE BALANCE SENSITIVITY AGAINST EUROPEAN CRISIS

Decline in exports to Europe % 0 5 10 15

Loss in exports USDmn - (254) (508) (761)
Crude oil price USD/bbl 75 70 65 60
Savings in imports USDmn (196) 303 866 1,430
Net Savings / (Loss) USDmn (196) 49 358 669
Source: InvestCap Research

With this sensitivity, it is clear that Pakistan is not only least exposed to prevailing crises, it will also be a net
beneficiary via dynamics of international trade and commodity markets. Although short term portfolio invest-
ment might face trouble resulting in capital markets volatility in the country, the situation appears favorable on
a broader spectrum as far as trade and current account balances, flow of remittances or even prospects of
foreign direct investment in the country are concerned.
InvestCap Research
research@investcapital.com
+92 21 111 111 097 (ext. 8725)

InvestCap is the brokerage arm of:

Invest Capital Investment Bank Ltd. Page 4 of 5
www.investcapital.com
 Treasury Focus
A Weekly Publication of InvestCap Research
Pakistan Research Week 1, May 2010

MONETARY DATA
MoM YoY
30-Apr-10 27-Mar-10 25-Apr-09
Increase Increase
Notes in Circulation (Rs. mn) 1,346,384 1,362,147 -1.16% 1,183,141 13.80%
YTD YoY
23-Apr-10 30-Jun-09 25-Apr-09
Increase Increase
M2 (Broad Money) (Rs. mn) 5,421,809 5,138,196 5.52% 5,205,991 4.15%
Source: SBP

MoM YoY
24-Apr-10 27-Mar-10 24-Apr-09
Increase Increase
Scheduled Banks' Deposits (Rs mn) 4,430,176 4,424,190 0.14% 3,874,318 14.3%
Scheduled Banks' Advances (Rs mn) 2,969,831 2,954,542 0.52% 2,814,947 5.5%
Banking ADR 67.04% 66.78% 25 bps 72.66% -562 bps
Source: SBP

MoM YoY
7-May-10 7-Apr-10 7-May-09
Increase Increase
KIBOR 6-month (Bid-Offer) 11.99% - 12.24% 12.12% - 12.37% -13 bps 13.10% - 13.35% -111 bps
T-bill rates -Secondary Market (Bid-Offer)
90 days 11.90% - 11.70% 12.15% - 11.95% -25 bps 13.10% - 12.90% -120 bps
180 days 12.15% - 11.95% 12.25% - 12.05% -10 bps 13.15% - 12.95% -100 bps
365 days 12.26% - 12.06% 12.40% - 12.20% -14 bps 13.20% - 13.00% -94 bps
IRS rates - Secondary Market (Bid-Offer)
1-year 12.11% - 12.01% 12.17% - 12.07% -6 bps 10.05% - 9.95% 206 bps
2-years 12.21% - 12.11% 12.26% - 12.16% -5 bps 10.25% - 10.15% 196 bps
5-years 11.05% - 10.85% 10.70% - 10.50% 35 bps 10.70% - 10.50% 35 bps
Source: Invest Cap Research, Bloomberg

Secondary Auction Original

Remaining
Market Rate: Cutoff: Difference Maturity -when
Maturity
07-May-10 03-Feb-10 auctioned
PIB rates - Secondary Market (Bid-Offer)
Maturity: 03-Feb-13 12.38% - 12.23% 12.30% 8 bps 3.00 Yrs 2.74 Yrs
Maturity: 03-Feb-15 12.31% - 12.53% 12.41% -10 bps 5.00 Yrs 4.74 Yrs
Maturity: 03-Feb-20 12.51% - 12.46% 12.54% -3 bps 10.00 Yrs 9.74 Yrs

Y i el d C ur ve ( as o f 3 0 - A p r i l- 10 )
15.60%
14.70%
13.80%
12.90%
12.00%
11.10%
10.20%
9.30%
8.40%
7.50%

1W 2W 3W 3M 6M 9M 1Y 3Y 5Y 7Y 10Y 15Y 20Y

Source: Invest Cap Research & Bloomberg

ECONOMIC DATA
MoM FY10 Target -
YoY Mar-10 YoY Feb-10 YoY Jul-Mar-10
Increase Govt.
Inflation
CPI 12.91% 13.04% -13 bps 11.29% 10.00%
SPI 18.17% 18.01% 16 bps 12.54% Not Available

WPI 21.80% 19.29% 251 bps 10.08% Not Available

Source: FBS/ SBP

YoY FY10 Target -

(In USD bn) FY09 FY08 YTD Figures
Increase Govt.
Trade Balance -12.63 -14.97 -16% -8.02 (9M FY10) -8.8
Imports 31.74 35.39 -10.3% 22.41 (9M FY10) 28.7
Exports 19.12 20.42 -6.4% 14.39 (9M FY10) 19.9
Tax Revenue (Rs bn) 1,150 1,022 13% 1,028 (10M FY10) 1,513
Forex Reserves 11.84 11.40 3.8% 15.04 (YTDFY10) Not Available

Foreign Direct Investment (USD bn) 3.70 5.41 -31.6% 1.37 (9M FY10) Not Available

Remittances 7.81 6.45 21.1% 6.55 (9M FY10) 7.00

Current Account Balance -9.34 -13.87 -33% -2.70 (9M FY10) -9.4
Fiscal Deficit (% of GDP) 5.2 7.4 -310bps 2.70 (1HFY10) 5.2
Source: FBS, CBR, SBP & M oF

InvestCap is the brokerage arm of:

Invest Capital Investment Bank Ltd.
Page 5 of 5
www.investcapital.com