Pakistan's Market Policy: Removal of Market Floor

Pakistan´s main index, the Karachi Stock Market (KSE) has witnessed a dramatic fall in market capitalization during the year 2008; falling from ahigh of approx 16,000 points in April in a steep fall to 9,000 points in a span of a few months. Resultantly, the Karachi Stock Market (KSE) put a floor of 9000 points on the index to arrest the unrelenting flight of capital. The market capitalization of the KSE has decreased by about $36 billion dollars during the last year. Around the same time the total liquid foreign exchange reserves have fallen from an all time high of $16.5 billion to $8.4 billion. This dollar flight has resulted in gradual erosion in the value of rupee, which has fallen from 60.74 to a dollar in October 2007 to around 80 to a dollar in October 2008 within a span of one year.

Statistically speaking, it was found after calculation that capital movement away from the stock market had a strong correlation with the depreciation of the rupee and it was found to be around 0.6057, while capital flight from the total liquid foreign exchange reserves was found to have a very weak positive correlation of 0.0525 with the depreciation of the rupee.

Foreign investors have repeatedly asked for the KSE index to be traded free from the floor imposed at 9000 points. If such a demand is met anytime soon and the market capitalization goes down by $15 billion, it would result in the further devaluation of the rupee from its current parity of 80 to a dollar to 90 to a dollar or beyond according to our extrapolation of data.

Many advocates of the free markets are asking the government to remove the floor as soon as possible. I also am an ardent fan of free markets to restore consumer confidence. However, at a time when the stock markets of the entire world are feeling the pinch, it might not hurt Pakistan too much in terms of investor confidence to keep the floor for a few months till the markets of the world stabilize to a low cusp. However, if Pakistan does remove the floor, it would cause tremendous pressure on the rupee which would not recover even with the injection of meager $100 million or $200 million or even a $1 billion in the market, even if the State Bank of Pakistan decides to follow such a course.

One solution however, to the rupee devaluation and stock market freedom problem is to remove the floor gradually by imposing new floors like at the 8500, 8000 and 7500 levels, if the need be. It would allow some time for the rupee to recover and the effects of floor removal to rupee devaluation can be easily observed and controlled to a degree. Gradual floor removal might also help with the restoration of investor confidence in the market.

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http://www.economistan.com/articles/10057.html