Rupee Rally Can't Convince Mobius of Pakistan Rebound

By Shanthy Nambiar and Lilian Karunungan

Aug. 25 (Bloomberg) -- The ouster of Pakistan President Pervez Musharraf was hailed by the government as a chance to turn around a crumbling economy that has left half the 168 million population short on food. Investors aren't convinced, and that means more declines for the rupee.

A rally in the Pakistani rupee from its Aug. 15 record low of 76.50 per dollar last week faltered after two days, leaving the currency down 19 percent this year. The rupee is the world's fourth-worst performer, behind the Zimbabwean dollar, Turkmenistan manat and Icelandic krona.

Templeton Asset Management Ltd. and Aberdeen Asset Management Plc said they doubt Pakistan's new leaders have the resolve to slash outlays or raise borrowing costs to help curb the fastest inflation in 30 years at a time when the economy is slowing. The risk of failure has prompted investors, stung by a global slump in stocks and debt markets, to shun developing economies from India to Chile that face similar dilemmas.

``Inflation can only be beat by a cut in government spending, which means turning off the currency printing press,'' Mark Mobius, executive chairman of Templeton in Singapore, who has about $200 million invested in Pakistan, said in an interview. ``Stop spending. Stop wasting through corruption.''

The cost to protect the nation's sovereign bonds from default has almost tripled since October to the highest for government debt after Argentina. Foreign-exchange reserves have declined by more than half to $6.6 billion, enough to cover just three months of imports, according to Standard & Poor's. The United Nations World Food Programme said on June 11 that half the population was at risk of running short of food.

General's Exit

Musharraf, 65, quit Aug. 18 to avoid impeachment charges that he illegally toppled former Prime Minister Nawaz Sharif, 58, in a 1999 coup and violated the constitution when he fired 60 judges in November. The former general's exit spurred the rupee to appreciate to 74.35 per dollar within two days, before ending last week at 76.35.

While the rupee is ``undervalued,'' Mobius said that high inflation and rising unemployment threaten to spoil the environment for investing. Mobius oversees about $40 billion in emerging-market stocks for Templeton, a unit of San Mateo, California-based Franklin Resources Inc.

Pakistan's rupee may weaken to 80 ``anytime,'' said Tim Condon, chief Asia economist at ING Groep NV in Singapore. Win Thin, a senior currency strategist at Brown Brothers Harriman & Co. in New York, said it may drop beyond 80 as Musharraf's resignation ``leaves a power vacuum.''

`Avoiding Pakistan

``We have been avoiding Pakistan for a while because of the political uncertainty and we will probably continue to do so,'' said Goh How Phuang, a Singapore-based portfolio manager at Schroder Investment Management Ltd., which manages about $250 billion in funds globally.

The Pakistan People's Party, the ruling coalition's biggest member, wants their leader, 52-year-old Asif Ali Zardari, to be president. The Muslim League's Sharif has withheld support and will meet other party leaders today to decide whether to quit the ruling coalition. Sharif and Zardari's wife, former Prime Minister Benazir Bhutto, who was assassinated at an election rally in December, were rivals in the 1990s before their parties jointly defeated pro-Musharraf groups in February.

The coalition last week failed to agree on how to reshuffle the judiciary, an issue that prompted Sharif to withdraw his ministers from the cabinet in May. The dispute has left Pakistan without a permanent finance minister, as inflation accelerated to 24.3 percent in July.

Subsidies and Deficits

Subsidies to cap food and fuel prices have widened the budget deficit to a 10-year high of 7 percent of gross domestic product. The government has turned to the central bank to finance the deficit, increasing reserve money, a measure including cash in circulation and bank deposits, by 22 percent to 1.47 trillion rupees ($19.3 billion) as of June 30 from a year earlier.

``Musharraf's exit is unlikely to improve the political outlook in the near term, which in turn could exacerbate the deteriorating fiscal position,'' said Kevin Daly, a money manager in London at Aberdeen, Scotland's largest independent money manager, with $5 billion in emerging-market bonds. ``We've been negative on Pakistan post-elections.''

Pakistan's dilemma is a reminder of the risks to investing in emerging markets. Central banks of Chile and India were forced to raise rates even as their economies slowed to curb price increases. The Chilean peso fell 4 percent this year, while the Indian rupee slumped 9 percent.

Current Account

As inflation accelerates, S&P says fund inflows are no longer enough to cover the current-account deficit. The shortfall in the broadest measure of trade expanded to a record $14 billion in the year ended June 30 from $6.9 billion a year earlier.

S&P and Moody's Investors Service cut their Pakistan foreign-currency debt ratings in May for the first time in almost a decade, to B and B2, five levels below investment grade. After the central bank told fuel importers in July that it will give them dollars to ensure supplies, Moody's said reserve depletion was the ``most imminent risk.''

Loans of as much as $4 billion from the Asian Development Bank and the World Bank may support the currency, causing it to appreciate to 73 by mid-2009, said Sayem Ali, a Karachi-based economist at Standard Chartered Plc.

``If oil prices stabilize at around $110 a barrel, which I think they will, that will actually be good for the Pakistan current account,'' said Arjuna Mahendran, the Singapore-based head of Asia investment strategy at HSBC Private Bank, which manages $494 billion in assets. He expects the rupee to settle at 76.50 and recommends buying the nation's debt next year.

Suicide Bombings

Rupee bears point to rising violence as another reason to avoid the currency.

A strategy of negotiating with Taliban leaders has failed to halt bombings by extremists in Pakistan, Afghanistan and India, straining ties with its neighbors and the U.S. and Europe. Twin suicide bomb explosions at a weapons factory near the capital, Islamabad, on Aug. 21 killed at least 70 people.

Credit-default swaps on Pakistan's $2.7 billion of dollar- denominated bonds outstanding rose to 788.8 basis points on Aug. 22, meaning it costs $788,800 annually to protect $10 million of the nation's debt from default for five years, according to data compiled by Bloomberg.

Credit-default swaps, financial instruments based on bonds or loans, were conceived to protect bondholders by paying the buyer face value in exchange for the underlying securities should the borrower default.

``Much depends on what they do with monetary policy and the current-account deficit,'' said Anton Hauser, a fund manager who helps oversee $2.4 billion of emerging-market debt at Vienna- based Erste Sparinvest KAG. His fund owns about $6 million of Pakistan's dollar-denominated debt. ``I am more on the sell side.''

To contact the reporters for this story: Shanthy Nambiar in Bangkok at snambiar1@bloomberg.net; Lilian Karunungan in Singapore at lkarunungan@bloomberg.net.