Outgoing calendar year has witnessed a clear tilt in New Delhi and Islamabad towards fostering larger and deeper CBMs (confidence building measures) and developing greater understanding towards resolving conflicts between the two countries. It has reduced the danger of armed conflict. Ironically, these developments have not been without visible paradoxes.

On the diplomatic front, Islamabad has successfully kept US interest alive by playing "frontline state" role in US-led war on terrorism. US has provided military hardware and financial support in lieu of logistic support provided by Islamabad and to crush pro-Taliban insurgency along Pak-Afghan border. It has also kept, IAEA at arms length with tacit US support, a measure of expediency on part of the US, from being openly hostile to Islamabad on Dr A Q Khan alleged role of proliferation of NWs to Iran and North Korea. Washington has also supported financially and materially Islamabad's efforts to build its arsenal of conventional weapons. The diplomatic gains have given Islamabad enough confidence to maintain a reliable nuclear as well conventional deterrence against any threat from India or from elsewhere.

During the period of composite dialogue, India and Pakistan have steadfastly tested their missiles. India tested Agni-1 tactical short range ballistic missile (range 700kms), Dhanush (range: 250kms), sea version of Prithvi-III and the supersonic BrashMos Missile. Pakistan tested Ghauri Missile (range 1500kms), Shaheen missile (range 2500km) and cruise missile, Baber (range 500km). Pakistan also succeeded, in principle to buy 75 F16s at an enormous cost of around $4bn. These aircraft as and when inducted in the PAF will enhance its capability not only to defend Pakistan's airspace to target sensitive targets within the Indian air space and on ground. But, now right their purchase has been delayed because of huge post-earthquake rehabilitation and reconstruction task. It has changed government priorities. But, it might not be too long to get back to purchasing F-16s because Washington agreed to sell the aircraft after 15 years and that too after Islamabad fully aligned itself in war on terrorism. The government may not like to miss the opportunity by prolonging the delay. Washington has also agreed to sell 115 115mm self-propelled howitzer artillery pieces at an estimated cost of $56 million. Pakistan is also to get financial assistance of $3.0bn over next five years starting from US FY2005, $600 million each year. Half of it for military use and half for socio-economic development. Diplomatic support, financial assistance and sale of military hardware have helped Pakistan to be more confident in augmenting its defence capability. But ironically, there is much more beyond the US support that is fuelling arms race in South Asia and changing the entire regional defence and security spectrum which would affect our national defence and security in quite subtle ways in future. Let us have a look at the new emerging scenario.

China is emerging a great economic and military power. China is already a nuclear power and member of P-5. Its missiles of DF Series (DF-5, DF-31 and DF-41) have a range of 8000 to 13000kms and during any armed conflict with the US can reach it. It threatens global hegemony. To keep China pinned down, the US is continuously working on multi-dimension strategy involving engaging China in trade relations, siding with Taiwan, propping up India as a regional power and counter-weight to China. India has potential for such a role. Its economy is booming at around 7% GDP growth, it is piling up huge forex. It has one of the largest standing defence establishment in the world and huge human resource comparable to China. All it needed was a push by the US. It has come through during the year 2005 through the signing of 10-year defence pact in June, 2005 between the US and India. It "goes beyond security, proliferation or regional issues", was stated by the US secretary of state. The pact stipulates the joint production of weapons, Co-operation in missile defence, increase in military ties, joint production and procurement and technology collaboration. US is also providing PAC-3 system --- an anti-missile system capable of eliminating short and medium range missiles carrying nuclear, biological or chemical warheads. Its range is 150km. Transfer of PAC-3 system is likely to trigger anti-missile race between India and Pakistan. US has shown its readiness to sell 126 F/A-18E/F Super Hornet with possibility or co-production. US has sold sophisticated Fire-finder radar system to the Indian army and has already given green signal to Israel to sell sophisticated arms to New Delhi, including Phalcon airborne warning and control system (AWACS). India will thus further enhance its edge over Pakistan's somewhat fragile balance of power with India.

The other significant development is Indo-US nuclear alliance signed on 18 July, 2005. It overcomes many restrictions that had isolated India, like Pakistan, from becoming a NWS (nuclear weapon state) recognised by P-5 (US, China, Britain, France, and Russia) and purchasing nuclear fuel from the NSG (Nuclear suppliers Group). It will also provide access to India to international civil nuclear technology. Nevertheless, India will have to separate its civil and military nuclear facilities which will be subject to IAEA rules and inspections. India wants to build six nuclear reactors to meet its burgeoning energy needs. Washingto is keen to help India in nuclear field for strategic reasons.

Pakistan has asked the US administration to treat it at par with India for access to nuclear technology and for very obvious reasons, being accepted a NWS in the some sense as India has tacitly been recognized by Washington. It has shown its unwillingness to do so. The emergence strategic defence relations and tacit acceptance of India as a nuclear power, have huge potential to tilt military balance in India's favour during next a few years.

Pakistan presently has limited options. The option of entering into one to one arms race is simply not there as has been the case in the past. The other option, the option of maintaining minimum deterrence for self-defence has to worked out prudently. This, too, is unlikely to work satisfactorily without pro-active support of Washington which is available at present but might wither away with the passage of time because of change of US interest in Islamabad. Pakistan, therefore, needs to work out on regional diplomacy that should aim at reducing risk of armed conflict between India and Pakistan.

General Pervez Musharraf has once again raised the ante over the Kalabagh Dam issue. The argument that is repeatedly made for the Dam is that, unless the Dam is built, the country will run short of water for irrigation, with serious implications for the agricultural sector. The opposition to the Dam is based on more varied grounds: unavailability of enough water for another Dam on the Indus, apprehensions regarding inundation of large urban settlements and loss of fertile lands in NWFP, desertification and coastal degradation in Sindh, and - above all - political factors. Most of those opposed to the Kalabagh Dam, however, appear amenable to the building of spillover dams anywhere along the Indus. They also appear agreeable to building dams upstream of Tarbela, given that it will reduce silt flow into the Tarbela reservoir and prolong its life.

Water availability is being cited by both sides to justify their respective cases. Proponents of the Dam argue that water is wasted into the sea and needs to be harnessed, for which new storage capacity is needed. Environmentalists dispute defining water flowing into the sea as a waste and claim that it is necessary to protect the mangroves and to prevent sea intrusion into productive land in the coastal areas. However, opponents of the Dam largely base their arguments on the fact that super floods occur on average once every seven years and cannot be used to estimate water availability. They maintain that the international practice is to use average annual flow in 3 or 4 out of 5 years. On this basis, simple arithmetic rules out the case for another dam on the Indus. After all, dams do not produce water; they merely store the available water. It appears, however, that the argument over Kalabagh Dam is entirely misplaced and the ends and means have been confused. The ends is the availability of water and the means can be many, a dam at Kalabagh being one of them. The supporters of the dam base their case on the need for making water available. As such, the real debate needs to be conducted over alternative means for making water available for irrigation instead of turning the issue of building a dam at Kalabagh into an end in itself. Not surprisingly, a technical issue has been politicised and both sides in the highly partisan debate are responsible for the situation.

A dam at Kalabagh is just one of the means for ensuring water availability, but options are available for building dams at other sites as well. Regrettably, the proponents of the Kalabagh Dam, treating it as an end in itself, have blocked progress on consideration of dams at alternative sites or other alternatives for that matter. Spillover dams can also be an option. Such dams store water when there is a flood in the river and empty out by itself when the water level in the river falls. Spillover dams cost less, are less hazardous to the environment, and would address Sindhís political concerns as well.

Conservation is another option. After all, it is widely acknowledged that about 40 percent of irrigation water is lost before reaching the plant root. Such a large quantum of water loss in the distribution system raises questions of economic feasibility of building new water storage facilities; since 40 percent of the additional water made available is also likely to be wasted. The implication is that for every one billion rupees that will be spent on constructing new water storage facilities, 0.4 billion rupees is likely to be wasted. Certainly, a resource constrained economy like Pakistan cannot afford to squander scarce development funds to finance waste.

In fact, General Musharraf appears to have turned the Kalabagh Dam issue into a political football in trying to shore up his regime and is using Punjab to this end. After all, this is not the first time in the last six years that he has raised the Kalabagh Dam issue out of nowhere and pitched the nation into opposing sides. There is now a pattern as to how he raises the issue and lets it simmer for a while. The timing of the current effort to raise the Kalabagh Dam issue is particularly unfortunate. With the entire country united in attempting to grapple with the aftermath of the devastating earthquake, raising such a divisive subject is certainly uncalled for.

An analysis of the timing of the General's periodic outbursts regarding the Kalabagh Dam reveals a definitive configuration. Clearly, the Punjab is the power base of the military regime and the necessary equation to remain in power is to keep Punjab on board in order to keep the other three smaller provinces in line. It appears, herewith, that the General considers it expedient to raise the Kalabagh Dam issue whenever he feels his support base in Punjab eroding. The tactic is designed to unite Punjab behind a regime who is prepared to accede to one of Punjabís longstanding demands. The current campaign appears to be motivated by the serious rift in the Punjab PML(Q), which threatens to upset the fragile US-sponsored applecart that the General presides over. General Musharraf's exhortation to the feuding Muslim Leaguers to campaign for the Kalabagh Dam is designed to shift the focus of their agitation to a more uniting Punjab-centred issue.

An additional advantage of the tactic is that it divides national political parties along provincial lines and serves to weaken their challenge to the military regime. That the divide and rule ploy also tends to undermine national unity and integrity is not what military dictatorships tend to worry about. However, playing football with Kalabagh does not serve Punjab's interests either. It is not long before political parties begin to educate public opinion in the Punjab as to how the General is using Punjab to serve the narrow purposes of his regime and the destructive potential of his policies.

General Musharraf has offered constitutional guarantees to Sindh in order to ensure protection to its interests. The offer is laughable. For a man who has committed treason by subverting the Constitution and making a mockery of every principle of the rule of law to proffer constitutional guarantees is indeed ironic. On a lower level, even agreements on water have been violated. The Thal Canal, being built by General Musharraf's regime, and the operation of the Chashma Link Canal are prime reminders to smaller provinces not to place trust in Islamabad. Proponents of the Dam claim that design changes have been made to accommodate the concerns of NWFP and Sindh. The height of the Dam has been lowered to address concerns about inundation of Nowshera and the provision of canals leading out of the Dam have been deleted. Fears persist, however, as there is no guarantee that the height of the Dam will not be raised a la Mangla or canals built a la Thal some years after the Dam is completed.

ECONOMY IN AN UPTREND

Following a steady recovery in 2003 (5.1%) & 2004 (6.4%), Pakistanís economy witnessed a sharp above trend GDP growth (8.35%) in 2005. Resultantly, productivity growth slowed down as capacity constraints come to the fore, pushing up inflation (9.28% YoY). The State Bank of Pakistan (SBP) made an effort to bring the economy back down to its sustainable growth path by raising interest rates (400bps); however GDP growth remained stubbornly above trend owing to high domestic demand. Stock returns were strong on the back of high returns. Jan 01 (KSE-100: 6232.50 - 9371.52) to Dec 26, Karachi Stock Exchange (KSE), has risen by 50.37% purely driven by strong growth in corporate earnings.

IMF and Inflation in Pakistan

The government has assured the International Monetary Fund (IMF) to bring down inflation from 8.4 per cent to 8 per cent by the end of the current financial year as it is still hurting the common man in the country. The average inflation rate for 2005-06 was likely to be less than 8 per cent by June 30, 2006. Since IMF's assessment on Pakistan's economy is taken seriously by international lending agencies including banks, the government wanted to further reduce inflation, particularly the Consumer Price Index (CPI).

WTO, EU and Agricultural Subsidies

The European Union (EU) agreed to end agriculture subsidies by 2013, which was the main hurdle to develop consensus among the 150 member countries of World Trade Organisation (WTO). The progress on different thorny issues, was achieved and an agreement was reached to ensure the parallel elimination of all forms of export subsidies and disciplines on all export measures with equivalent effect to be completed by the end of 2013.

ADB and Pakistan Investment Climate

The ADB urged Pakistan to improve investment climate and promote better business practices with a view to attracting sizable local and foreign investment in the country. According to ADB's latest Working Paper, the international evidence on infrastructure privatization suggests that Pakistan's current structure of power supply will produce only limited efficiency gains in the absence of strong regulator to look after the public interest and active competition at the generation and distribution levels.

Monetary Policy 2 HFY06

It appears that the aggressive Monetary Stance by State Bank of Pakistan (SBP) is to be slowly removed in 2HFY06 monetary policy, as balance of risk still favors long-term inflationary expectations. Concerns of high utilization rates, oil prices and budget deficits are still lingering on. In addition, expected shortfall in wheat and sugarcane output in current fiscal year might push inflation higher. Given the stabilizing macroeconomic trend SBP can probably afford to loosen its monetary policy to stimulate economic growth, which is expected to be in range of 6-6.5% in ongoing fiscal year (compared to 8.35% last year).

Forex reserves $11.321 billion

Our Foreign exchange reserves increased by $6.9 million to $11.321 b in the week ending December 10, 2005. During the week, reserves held by the SBP went down by $3.1 million to $8.867 billion this week compared to $8.870 billion a week ago. During the same period, net foreign reserves held by the banks (other than SBP) increased by $9.8 million to $2.454 billion from $2.444 billion.

7% GDP growth may not be achieved

The govt was depending more on better than the expected rice production, good minor crops and Wapda's less dependence on Independent Power Producers (IPPs) for generating enhanced hydel electricity to meet, what is being termed a somewhat difficult 7 per cent GDP growth target.

Decline in Overall Debt

The country's total external debt has declined by 0.35 percent or $119 million in the first three months of the current fiscal and the total external liabilities have dropped by 0.44 percent or $159 million. According to the State Bank data, Pakistan's total external liabilities during the first quarter of 2005-06 stood at $35.675 billion down from $35.834 billion, whereas the total external debt stood at $33.918 billion down from $34.037 b.

The Privatization Process

The National Investment Trust (NIT) - Pakistan's largest mutual fund that holds Rs75 billion under management - would be split into six parts, three would be distributed to three banks - Faysal Bank, Bank of Punjab and National Bank of Pakistan - that hold the letter of comfort (LoC) and the remaining would be put on public auction. January 15, 2006, as deadline for Pakistan Steel Mills (PSM) sell-off.

Eitesalat gets connected

The Pakistan government and Eitesalat reached an agreement on Tuesday for the privatization of the Pakistan Telecommunication Company Limited (PTCL). A team from Etisalat will arrive in Pakistan to finalize the transaction, which is to be completed in January 2006.

KESC: An Electrifying Experience

Pakistan handed over the ownership of its second largest energy company to a private Saudi-Pakistani consortium under a deal signed earlier. KESC was officially sold for $340 million. The disinvestment deal of 73 per cent shares of KESC at Rs1.65 a share, involves a total payment of Rs20.24 billion.

THE STOCK MARKET IS A BULL MARKET

What a year it has been for the Stock market. The journey that started at 6232.50 on 1st January and continues at 9371.52 on 26th December 2005, up by 3139.02 points. That is a robust 50.37% gain. Where else can you get this return on your money in a calendar year. My analysis of the stock market was that, it is a "Bull Market". So, if the market finds a bottom at the current level of 8500 points or 300 points lower, is of very little significance, as the upside in this Bull Run is at least several hundred points, to begin with.

THE TREND

KSE100 closed down at 9,491.47.83. Volume was 79% below average and Bollinger Bands were 39% wider than normal. Short-term traders should pay closer attention to intraday levels while intermediate/long-term traders should place greater emphasis on the Bullish or Bearish trend. KSE100 is currently 97.8% above its 200-period moving average and is in an upward trend. Volatility is extremely low when compared to the average volatility over the last 10 periods. There is a good possibility that there will be an increase in volatility along with sharp price fluctuations in the near future. Our volume indicators reflect very strong flows of volume into KSE100 INDEX. Our trend forecasting oscillators are currently bullish on KSE100 INDEX and have had this outlook for the last 11 periods. Our momentum oscillator is currently indicating that KSE100 is currently in an over bought condition.

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