Assignment of Economics

ALLAMA IQBAL OPEN UNIVERSITY, ISLAMABAD (Commonwealth MBA/MPA Programme) Course: Economic Environment of Business (5571) Level: Executive MBA/MPA ASSIGNMENT No. 1 Q.1 The demand for a good or service is determined by household income, the prices of other goods and services, tastes and preferences, and expectations. Justify this statement! Semester: Autumn, 2010

Market demand for goods and services Demand is defined as the quantity of a good or service consumers are willing and able to buy at a given price in a given time period Determinants of demand and consumption Levels of income Population End market indicators Availability and price of substitute goods Tastes and preferences Economic analysis has recognized the role of key variables in determining demand and consumption. In practice, the distinction between demand (as a schedule of quantities as a function of price, other factors held constant) and consumption as an equilibrium quantity at a given price is frequently ignored. Demand, as the relationship between price and quantity, is subject to change over time due to changes in the underlying factors held constant by the static notion of demand. Changes in demand "shifters" are often included in economic estimation of demand representing anticipated dynamics in these determinants. Levels of income A key determinant of demand is the level of income evident in the appropriate country or region under analysis. As a generality, the higher the level of aggregate and/or personal income the higher the demand for a typical commodity, including forest products. More of a good or service will be chosen at a given price where income is higher. Thus determinants of demand normally utilize some form of income measure, including Gross Domestic Product (GDP).

Population Population is of course a key determinant of demand. Although all forest products do not necessarily enter final consumer markets, the actual markets are largely presumed to be functionally related to population. Growing populations are positively correlated to timber demands in the aggregate, as well as specifically to individual forest products. Frequently, population and income estimators are combined, as in the case of the use of Gross Domestic Product per capita. End market indicators The use of end market indicators as determinants of demand is frequently incorporated into demand analysis. For example, much of the final use of forest products is linked to construction (residential and total). Indicators and trends related to construction activities, or which are determinants of construction, provide indirect estimates of the influence of these activities as the source of derived demand for wood. Housing starts, public investments, interest rates, etc. can be highly correlated to timber demand. Availability and price of substitute goods Consumption choices related to timber are also influenced by the alternative options facing users in the relevant marketplace. The availability of potential substitute products, and their prices, weighs heavily in determining the elasticity of demand, both in the short run (static) sense and over time (long run). Fuel wood, as a dominant use of timber in the Asia Pacific Region, reflects conditions of very limited options for energy sources at 'reasonable' prices. Rural low income or subsistence populations simply do not have 'options' regarding energy - they use wood or go without. Demand, at this basic level, in almost perfectly inelastic. The cost (if only implicit in terms of gathering time) does not materially affect consumption quantity. Suitability of alternative goods and services is, in part, a question of knowledge as well as availability. Market information regarding alternative products, quality, convenience, and dependability all influence choices. Under conditions of increased scarcity and rising prices for tropical hardwood panels, for example, users have a positive incentive to search for and investigate the suitability of alternatives that were previously overlooked or ignored. Tastes and preferences All markets are shaped by collective and individual tastes and preferences. These patterns are partly shaped by culture and partly implanted by information and knowledge of products and services (including the influence of advertising). Different societies use forest products differently because of these differences in taste and preferences. For example, markets for wood products in Japan are commonly2

recognized as requiring very high product quality standards, the importance of visual attributes of wood, and other preferences not commonly found in many other markets. . EFFECTIVE DEMAND Only when the consumers' desire to buy something is backed up by willingness and an ability to pay for it do we speak of demand. To emphasize this point economists use the term effective demand. There are an unlimited number of human wants and needs - but in the market-place these can only be bought / purchased if there is sufficient purchasing power. LATENT DEMAND Latent demand exists when there is willingness to purchase a good or service, but where the consumer lacks the real purchasing power to be able to afford the product. Latent demand is affected by persuasive advertising - where the producer is seeking to influence consumer tastes and preferences. THE RATIONAL CONSUMER Economists assume that in deciding what to buy, consumers will tend to act rationally in their own selfinterest. This means that they will choose between different goods and services so as to maximize total satisfaction. Clearly they will take into consideration How much satisfaction they get from buying and consuming an extra

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Q.2 (a)

c)

What is unemployment statistics? Explain the problems associated with unemployment statistics? (b) Use the information provided below to answer the following questions: Civilian population 30 million Employed 15 million Unemployed 1.5 million a) What is the size of the labour force? b) How many individuals are out of the labour force? Calculate the unemployment rate.

Who is "unemployed"? According to the International Conference of Labour Statisticians Resolution, 1982, a person of working age is classified as unemployed if, during a specified reference period (either a day or a week), he or she was: (a) without work", not even for one hour in paid employment or self-employment of the type covered by the international definition of employment; (b) "currently available for work", whether for paid employment or self-employment; and (c) "Seeking work", by taking active steps in a specified recent period to seek paid employment or self-employment. These three criteria for measuring unemployment, with certain exceptions and amplifications, are almost universally applied, particularly where unemployment is measured through population censuses and household surveys. Statisticians see unemployment within what is called the labour force framework. According to this, the working-age population is divided into categories: the employed, the unemployed and the not economically active. The classification of an individual into one of these three categories is based on the type of activities performed during a specified short reference period, and according to a priority scheme, where employment activities take precedence over job-seeking activities, and job-seeking activities take precedence over unpaid activities.

Unemployed or registered job-seeker: Two types of statistics In certain countries unemployment statistics are also obtained from special household surveys called labour force surveys. The inquiry consists of selecting a representative sample of households and asking individual members of working age about their employment activities during the reference period, their availability for work and their recent job search experiences. The data are then processed and each4

individual is classified as employed, unemployed or economically inactive. The sample counts are then weighted to obtain estimates of the number of people employed or unemployed in the population. Because the target population and the timing and processing procedures are different, the statistics resulting from the two types of sources are generally not identical. In fact, it would be more or less accidental if any statistics from both sources agreed exactly for any particular period. To avoid confusion, a distinction is usually made between unemployment statistics, based on information from labour force surveys, and "statistics on registered job-seekers" or "statistics on insurance claimants" obtained from employment exchanges or unemployment insurance systems.

Numerical differences The direction of the difference between the number of registered jobseekers and the number of unemployed measured in a survey will not be the same for all countries. In developing and transition countries, the registration data are generally much lower than the corresponding unemployment survey data. These differences can be explained by the limited coverage of employment exchanges and unemployment insurance systems in these countries. Differences observed in the different statistics concern not only levels but also trends of unemployment, where registration data might decline while survey data could show almost no change in the number of unemployed during a same period. Which statistics can be trusted? It is generally considered that the unemployment statistics obtained from household surveys are most in line with international standards. Based as they are on interviews, the survey questionnaire and instructions can be designed to suit the desired statistical definition and, in particular, to measure all three categories of the labour force framework simultaneously. This is an essential requirement for the application of the framework on which the international standards are based. As with any sampling method, however, errors creep into the results, especially in estimates concerning population groups for which the corresponding sample size is small. Another limitation of household surveys is that they require an important statistical infrastructure, with substantial material resources and a network of experienced interviewers and supervisors. Registration data derived from administrative records are not affected by sampling errors - they are based on complete counts. As by-products of administrative operations, they are relatively inexpensive to obtain and can be released frequently, on a monthly, weekly or even daily basis if required. However, they suffer from two major limitations. First, by their nature such data are subject to administrative rules and regulations, the underlying concept and definition of which may change and not necessarily be in line with the desired statistical principles.5

Since regulations differ from one country to another, the resulting statistics tend to invalidate international comparisons and even comparisons in time for the same country if administrative rules have changed during the comparison period. Second, they cover only that part of the population which uses employment exchanges or is eligible for unemployment insurance benefits. This often leaves out a substantial segment of the unemployed, particularly in developing countries.

For example, the number of insured unemployed in Vermont, U.S.A., was 10,600 in 1991, while the reported total number of unemployed persons obtained after adjustment was 20,000, that is about twice as many. The difference is essentially accounted for by those who were unemployed in the statistical sense, but not included in the count of the insured unemployed either because they were last working in an industry not covered by the State Unemployment Insurance Law, or because they had just entered the labour force for the first time, or re-entered after a period of separation.

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Q.3 (a) (b)

What is the relationship among a firms total revenue, profit, and total cost? How are they related? Define economies and diseconomies of scale and explain why they might arise.

Costs, revenue and profit are basic but crucial parts of the financial analysis of a business and it is on the comparison of these three things that success is judged. Costs: Costs are described as fixed or variable. Fixed costs:

Fixed costs are incurred and have to be paid regardless of the volume produced and sold. They are the costs of running a business such as heating, lighting, rent, insurance, marketing and so on. Variable costs:

In contrast, variable costs are directly related to the job and so change with the level of output. The best example of a direct cost is the raw materials that go into making a product. Fixed costs plus variable costs are known as total costs:

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Figure 1: Illustration of Fixed and Variable Costs. Revenue: This is the total amount of money coming in to a business from sales of goods or services. It is a topline figure that excludes deductions of tax, interest and dividend payments. It also usually excludes discounts for early payments and customer returns. Profit: This is often referred to as the bottom-line and is the result of subtracting costs from total revenue. It can be expressed as gross profit which is revenue minus the variable cost of goods. It can also be expressed as net profit which also takes off the relevant amount for fixed costs, tax and so on. Profit is perhaps the most important indicator of how well a business doing. Various calculations, or ratios, can be used to analyse the relationship between costs, revenue and profit. One would be the profit margin. This is found by dividing the profit figure into the revenue figure and allows you to see how well the company controls its costs to turn revenue into profit.

(b)

Define economies and diseconomies of scale and explain why they might arise.

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Economies and Diseconomies of ScaleDiseconomies of scale are the forces that cause larger firms and governments to produce goods and services at increased per-unit costs. They are less well known than what economists have long understood as "economies of scale", the forces which enable larger firms to produce goods and services at reduced per-unit costs]However the political philosophy of conservatism has long recognized the concept when applied to government.

economies of scale Economies of scale are the cost advantages that a business can exploit by expanding their scale of production in the long run. The effect is to reduce the long run average (unit) costs of production over a range of output. These lower costs are an improvement in productive efficiency and can feed through to consumers in the form of lower market prices. But they can also give a business a competitive advantage in the market. They lead to lower prices but also higher profits, consumers and producers will both benefit. There are many different types of economy of scale and depending on the particular characteristics of an industry, some are more important than others. They are the result of a complex series of factors which together form the benefits of operating on a bigger scale of production in the long run.

Why can you now buy high-performance personal computers for just a few hundred pounds when a similar computer might have cost you over Rs.20000 just a few years ago? Why is it that the average market price of digital cameras is falling all the time?

The answer is that scale economies have been exploited bringing down the unit costs of production and gradually feeding through to lower prices for consumers. Internal economies of scale Internal economies of scale arise from the growth of the firm itself. Examples include:

Technical economies of scale: a. Large-scale businesses can afford to invest in expensive and specialist capital machinery. For example, a national chain supermarket can invest in technology that improves stock control and helps to control costs. It would not, however, be viable or9

cost-efficient for a small corner shop to buy this technology. b. Specialization of the workforce: Within larger firms they split complex production processes into separate tasks to boost productivity. The division of labour in mass production of motor vehicles and in manufacturing electronic products is an example c. The law of increased dimensions. This is linked to the cubic law where doubling the height and width of a tanker or building leads to a more than proportionate increase in the cubic capacity an important scale economy in distribution and transport industries and also in travel and leisure sectors

Marketing economies of scale and monophony power: A large firm can spread its advertising and marketing budget over a large output and it can purchase its factor inputs in bulk at negotiated discounted prices if it has monophony (buying) power in the market. A good example would be the ability of the electricity generators to negotiate lower prices when negotiating coal and gas supply contracts. The major food retailers also have monopsony power when purchasing supplies from farmers and wine growers. Managerial economies of scale: This is a form of division of labour. Large-scale manufacturers employ specialists to supervise production systems. Better management; investment in human resources and the use of specialist equipment, such as networked computers that improve communication raise productivity and reduce unit costs. Financial economies of scale: Larger firms are usually rated by the financial markets to be more credit worthy and have access to credit facilities, with favourable rates of borrowing. In contrast, smaller firms often face higher rates of interest on their overdrafts and loans. Businesses quoted on the stock market can normally raise fresh money (i.e. extra financial capital) more cheaply through the issue of equities. They are also likely to pay a lower rate of interest on new company bonds issued through the capital markets. Network economies of scale: There is growing interest in the concept of a network economy of scale. Some networks and services have huge potential for economies of scale. That is, as they are more widely used (or adopted), they become more valuable to the business that provides them. The classic examples are the expansion of a common language and a common currency. We can identify networks economies in areas such as online auctions, air transport networks. Network economies are best explained by saying that the marginal cost of adding one more user to the network is close to zero, but the resulting benefits may be huge because each new user to the network can then interact, trade with all of the existing members or parts of the network. The rapid expansion of e-commerce is a great example of the exploitation of network economies of scale how many of you are devotees of the EBay web site?

Two good examples of economies of scale huge freight tankers and large-scale storage facilities Illustrating economies of scale the long run average cost curve The diagram below shows what might happen to the average costs of production as a business expands from one scale of production to another. Each short run average cost curve assumes a given quantity of capital inputs. As we move from SRAC1 to SRAC2 to SRAC3, so the scale of production is increasing. The long run average cost curve (drawn as the dotted line below) is derived from the path of these short10

run average cost curves.

Exploiting economies of scale TNT In January 2006, the market for postal services was opened up to competition thus ending the monopoly of the Royal Mail in the delivery of letters to households and businesses. Attention is now focusing on some of the likely rivals to the Royal Mail in the newly competitive market. One such business is TNT logistics. TNT Express Services was established in the UK in 1978, the company has developed its dominant position in the time-sensitive express delivery market through organic growth and, with an annual turnover in excess of 750 million. TNT employs 10,600 people in the UK & Ireland and operates more than 3,500 vehicles from over 70 locations. TNT Express Services delivers hundreds of thousands of consignments every week - in excess of 50 million items per year. Source: TNT investor relations web site

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Q.4 Explain law of supply with the help of hypothetical data and diagram. Discuss the factors that cause shifts in supply curve? The Law of Supply: The law of supply states that the quantity supplied for a good rises as the price rises. In other words, the quantity demanded and price is positively related. Supply curves are drawn as 'upward sloping' due to this positive relationship between price and quantity supplied. Note: There are theoretical instances where the law of supply might not hold, though these are rarely, if ever, seen in the real world. Law Of Supply

A microeconomic law stating that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services offered by suppliers increases and vice versa.

Law Of Supply As the price of a good increases, suppliers will attempt to maximize profits by increasing the quantity of the product sold. What Does Change In Supply Mean? A term used in economics to describe when the suppliers of a given good or service have altered their production or output. A change in supply can be brought on by new technologies, making production more efficient and less expensive, or by a change in the number of competitors in the market. Change In Supply A change in supply will lead to a shift in the supply curve, which will cause an imbalance in the market12

that is corrected by changing prices and demand. If the change in supply increases supply, you will see the supply curve shift to the right, while a decrease in supply from a change in supply will shift the supply curve left. For example, if there is a new technology that makes the production of DVD players a lot cheaper, according to the law of supply, there will be an increase in the output of DVD players. With more outputs in the market, the price of DVD players will likely fall, creating greater demand in the marketplace and more overall sales of DVD players

The Supply Curve The relationship between the quantity sellers want to sell during some time period (quantity supplied) and price is what economists call the supply curve. Though usually the relationship is positive, so that when price increases so does quantity supplied, there are exceptions. Hence there is no law of supply that parallels the law of demand. The supply curve can be expressed mathematically in functional form as Qs = f(price, other factors held constant). It can also be illustrated in the form of a table or a graph. A Supply Curve Price Widgets $1.00 $2.00 $3.00 $4.00 of Number of Widgets Sellers Want to Sell 10 40 70 140

The graph shown below has a positive slope, which is the slope one normally expects from a supply curve.

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If one of the factors that is held constant changes, the relationship between price and quantity, (supply) will change. If the price of an input falls, for example, the supply relationship may change, as in the following table. A Supply Curve Can Shift Price Widgets $1.00 $2.00 $3.00 $4.00 of Number of Widgets Sellers Want to Sell [10] becomes 20 [40] becomes 60 [70] becomes 100 [140] becomes 180

The same changes can be shown with a graph that shows the supply curve shifting to the right. Notice each price has a larger quantity associated with it.

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Supply Terminology As with demand, economists separate changes in the amount that sellers will sell into two categories. A change in supply refers to a change in behavior of sellers caused because a factor held constant has changed. As a result of a change in supply, there is a new relationship between price and quantity. At each price there will be a new quantity and at each quantity there will be a new price. A change in quantity supplied refers to a change in behavior of sellers caused because price has changed. In this case, the relationship between price and quantity remains unchanged, but a new pair in the list of all possible pairs of price and quantity has been realized. Supply curves as well as demand curves appear much more concrete on an economist's graph than they appear in real markets. A supply curve is mostly potential--what will happen if certain prices are charged, most of which will never be charged. From the buyer's perspective, the supply curve has more meaning as a boundary than as a relationship. The supply curve says that only certain price-quantity pairs will be available to buyers--those lying to the left of the supply curve. Price Elasticity of Supply: The price elasticity of supply represents how sensitive quantity supplied is to changes in price. Further information is given in the article Price Elasticity of Supply. In economics, the law of supply is the tendency of suppliers to offer more of a good at a higher price. Behavioral economics and its related area of study, behavioral finance, use social, cognitive and emotional factors in understanding the economic decisions of individuals and institutions performing economic functions, including consumers, borrowers and investors, and their effects on market prices, returns and the resource allocation. The fields are primarily concerned with the bounds of rationality (selfishness, self-control) of economic agents. Behavioral models typically integrate insights from psychology with neo-classical economic theory.15

Behavioral analysts are not only concerned with the effects of market decisions but also with public choice, which describes another source of economic decisions with related biases towards promoting selfinterest

The direct relationship between supply price and the quantity supplied, assuming ceteris paribus factors are held constant. This economic principle indicates that an increase in the price of a commodity results in an increase in the quantity of the commodity that sellers are willing and able to sell in a given period of time, if other factors are held constant. The law of supply is an important principle in the study of economics. The law of supply is the scientific relation between supply price and quantity supply that captures the supply side of the market. When combined with the law of demand the result is the market model. The market provides a powerful tool for analyzing exchanges, resource allocation, and efficiency.

Shifts in Supply Changes in supply or shifts in supply occur when one of the determinants of supply changes. (Remember, price is not considered one of the determinants of supply. A change in price leads to a movement along a supply curve, not a shift of the supply curve.)A contraction, or shift to the left can be caused by a negative change in:

The The The The The

price level. level of technology in an economy. size of a labour force and its skills. amount and state of capital equipment. skill of management to combine resources and use them effectively.

Read more: http://wiki.answers.com/Q/What_factors_cause_a_shift_to_the_left_in_the_aggregate _supply_curve#ixzz1Ekpuu4GB

Examples: 1. The price of an input (corn or ovens) rises. Producers will have to pay more to make tortilla chips and therefore will no longer be able to offer the same quantity of tortilla chips at each possible price. This would cause a leftward shift of the supply curve. (A decrease in the price of an input would cause a rightward shift of supply.)

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2. There is an improvement in technology (such as the development of a tortilla pressing machine that requires less labor to produce chips). This reduces producers labor costs and leads to a rightward shift of supply. 3. The number of tortilla chip producers increases. The entry of new firms into the industry will increase the quantity supplied at each price. This would cause a rightward shift of supply. (A decrease in the number of tortilla chip producers would cause a leftward shift of supply.)

Q.5 Critically write about the present economic situation of Pakistan and its consequences. Economy - overview: Pakistan, an impoverished and underdeveloped country, has suffered from decades of internal political disputes and low levels of foreign investment. Between 2001-07, however, poverty levels decreased by 10%, as Islamabad steadily raised development spending. Between 2004-07, GDP growth in the 5-8% range was spurred by gains in the industrial and service sectors - despite severe electricity shortfalls - but growth slowed in 2008-09 and unemployment rose. Inflation remains the top concern among the public, climbing from 7.7% in 2007 to more than 13% in 2010. In addition, the Pakistani rupee has depreciated since 2007 as a result of political and economic instability. The government agreed to an International Monetary Fund Standby Arrangement in November 2008 in response to a balance of payments crisis, but during 2009-10 its current account strengthened and foreign exchange reserves stabilized - largely because of lower oil prices and record remittances from workers abroad. Record floods in July-August 2010 lowered agricultural output and contributed to a jump in inflation, and reconstruction costs will strain the limited resources of the government. Textiles account for most of Pakistan's export earnings, but Pakistan's failure to expand a viable export base for other manufactures has left the country vulnerable to shifts in world demand. Other long term challenges include expanding investment in education, healthcare, and electricity production, and reducing dependence on foreign donors. CONTEXTUAL OVERVIEW OF PAKISTAN The economic blues continue to encircle Pakistans fragile economy, which is faced with many challenges such as high commodity prices, wheat/sugar crisis, declining17

exports, current account deficits, and severe power shortage, and low literacy rate, paramount political and geo-strategic issues. Stagnating health facilities, poverty, unemployment, regional and provincial disparity are the hallmark.

According to World Bank, the Public Sector Capacity Building Project in Pakistan was framed to improve the Government's capacity to implement its on-going economic reform programme. Focusing on strategic areas, the project had three distinct capacity building objectives: 1) broad-based professional development of the public sector officers; 2) Capacity enhancement in key ministries and agencies at the forefront of design, implementation and monitoring of policy reforms; and 3) Strengthening of regulatory agencies. However, the target could not have been achieved to its fullest due to the bleak security conditions.

Pakistan is facing one of the severest downturns of its economy now-adays. 1. National currency is constantly devaluing 2. The electricity crisis is harming most of its industries, as a result of which exports have been declined drastically 3. The original capacity of producing electricity is greater but effective capacity is much lesser 4. Pakistan is facing lack of resources even in those categories in which it should be self sufficient like Gas crisis 5. Due to instable political conditions of the country a lot of foreign investments have been swayed away of the country and now suffering from lack of proper investments to keep the businesses inflow 6. The current situation is that the Government has to pay money to the many of the local industries which are due and the Government is not in a position of. Like it has to pay around 20(m) rupees to some Oil producer.18

Difficulties in Pakistan and Economic Problems. Pakistan economic environment is affected by intensification of war on terror and deepening of the global financial crisis which penetrated into domestic economy through the route of substantial decline in Pakistans exports and a visible slowdown in foreign direct inflows. Pakistan economy continues to remain exposed to the vagaries of international developments as well as internal security environment. The intensity of the global financial crisis has further added to Pakistan predicament. Despite support from the IMF and other bilateral and multilateral donors, Pakistan external account remains exposed to a host of uncertainties.

Growth and investment In growth and in investment we lost investor because of global economic situation, through financial markets which collapse the external demand for its exports and decline in availability of external capital to finance or invest in growth process of the country. According to global financial crisis was felt on market and investor confidence in many developing countries, including Pakistan, as banking systems and asset markets came under stress.

Economic Indicators of Pakistan Economy Economic Review 2004-2005 Pakistans economy extended its impressive expansion for the third year in a row in 2004-05. Economic growth at 8.4 percent reached its highest level in two decades, the fifth time in the countrys history that it exceeded 8 percent growth mark. Real GDP grew by 8.4 percent in 2004-05 as against 6.4 percent last year and surpassed the target of 6.6% for the year by a wide margin. The sharp pick up in growth is ably supported by large-scale manufacturing, impressive recovery in agriculture and a strong growth in services sector. Large scale manufacturing grew by 15.4 percent against the target of 12.2 percent. Agriculture posted a growth of 7.5 percent against the target of 4.0 percent on the back of unprecedented rise in the production of cotton and high growth in wheat production. The services sector registered an equally strong growth of 7.9 percent aided by remarkable growth in finance and banking sector (21.8%), wholesale and retail trade (12%) and a modest growth in transport and communication (5.6%).19

Investment is a key determinant of growth. During the fiscal year 2004-05 gross fixed capital formation or domestic fixed investment grew by 15.6 percent as against a sharp rise of 17.4 percent last year. Although the growth in domestic investment was marginally slower than last year, private sector investment grew by 19.3 percent this year as against a growth of 9.6 percent last year. Public sector investment on the other hand registered marginal decline of 4 percent as against a hefty 36.8 percent increase last year. Inflation, as measured by changes in the Consumer Price Index (CPI), averaged 9.3 percent during fiscal year 2004-05 as against 4.6 percent in the last year. External sector is being affected both by structural and cyclical factors. Exports and imports both grew by 17 percent and 32.3 percent respectively during 2004-05.

Economy Is Pakistan heading into another debt trap? The recent projections given by the IMF of Pakistans external debt burden shooting up to US$72.6bn by FY16 from current level of US$55bn has raised concerns regarding debt sustainability going forward.. In my view, as Pakistan retires the US$11.3bn debt under the stand-by facility, the countrys external debt will start stabilizing. We are cognizant that the increase in external debt burden will make the country more vulnerable to both endogenous & exogenous shocks. However, if Pakistans debt servicing capacity, as measured by growth in GDP and increase in export earnings, improves then the debt burden should remain manageable despite the nominal hike in debt. Considering that Pakistans debt to GDP ratio is comparable to its international competitors and significantly lower than the economies in Eastern Europe, we think that the possibility of Pakistan falling into a debt trap has an outside chance in our view!

2009 a year of redemption KSE-100 rounds off 2009 with 60% YoY gain KSE rounded off the decade with ~2% MoM return in Dec, bringing CY09 gains to 60% which were short of regional peers and left KSE trading at ~45% discount to peers. 2009 saw KSE driven in spurts by diverse variables - 'distressed valuation' rally (4 x forward PE) and reinstatement of judges in 1Q, Swat operation in 2Q and booming FPI (US$235mn) in 3Q. Dec-09 was politics' turn as Supreme Court declared NRO void. This20

combined with preference of institutions to preserve YTD gains saw 2nd & 3rd tier stocks dominate activity. KSE-30 share of market volume touched year low of 50% in Dec, resulting in 22% MoM decline in avg vols. Macro stabilization was one of the comforting factors Key highlight of 2009 was macro stabilization as most data points improved YoY (CPI down to 10% from 25% leading the way), providing SBP comfort to cut the discount rate 250bp during CY09 to 12.5% vs a 500bp hike in CY08. Progress was also appreciated internationally as IMF augmented its credit line by US$3.7bn to US$11.3bn, CDS receded to ~8% level from a high of 50% last year and credit rating was upgraded in 2009 to B- with stable outlook. Variables that should shape 2010 On the macro front, we believe two driving factors would shape key indicators (inflation, currency and interest rate outlook) i.e. 1) commodity prices, as Pakistan remains a net importer and 2) sovereign flows from US, IFIs and FoDP. On corporate profitability, while improvement in macro will have a positive impact on demand and hence pricing power + margins, sector wise, we eye 1) positive news on oil and gas production, 2) developments on power capacity/ tariffs/ interoperate debt, 3) slowdown in NPL provisions, 4) developments on cement pricing agreement and 5) judicial activism (courts' recent involvement in oil pricing and written off loans) as key swing factors. Performers 2009 vs 2010 Study of BofAML-KASB Pakistan universe reveals that gains in 2009 were broad based with 17/19 stocks outperforming KSE-100 where NML (+239%), FFC (+236%) and FFBL (+194%) led the way. Looking ahead, our sector picks in 2010 include PPL within E&Ps, PSO amongst OMCs, Hubco amongst IPPs, Engro within fertilizers, while PTCL remains the sole investable telco. While we await further clarity on banks and cement, we prefer Lucky and MCB to sector peers.

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