Pakistan markets look to coalition for decisions

KARACHI (Reuters) - Pakistan's coalition government needs to prove its mettle on political issues to investors in immediate weeks ahead now that it is finally rid of President Pervez Musharraf, financial analysts said.

Analysts said the next 30 days is a key period to test the resolve of the government to tackle difficult issues including the restoration of the judges deposed by Musharraf last year, the appointment of the next president, and Musharraf's future.

Whether the coalition government -- the two main parties in which have historically been rivals -- can effectively deal with the issues will show investors the parties can cooperate.

More importantly it will demonstrate that they likely have the will to quickly deal with Pakistan's ailing economy, and help restore investor confidence shattered by the country's political tension and shaky economy, analysts said.

"If they cannot agree on the restoration of the judges in a matter of days, then clearly something is not right with the coalition," said Farid Khan, an analyst at Credit Suisse.

"We cannot afford to lose months, or even weeks on these political issues. They need to get to the economy, and only a strong government can take the tough decisions needed for the economy," Khan said.

As of late Tuesday the parties were deadlocked on the judges issue and had announced no decisions on the next president or Musharraf's future

Pakistan's financial markets, which have skidded this year,

rebounded somewhat after Musharraf resigned. Investors said his resignation sparked hope political tension was easing.

Pakistani stocks jumped to their highest level in 3- weeks on Tuesday, while the Pakistan rupee was lifted off record lows.

But the initial jubilation over the move was waning on Tuesday afternoon as markets turned skeptical about whether the coalition government can manage to turn the economy around, or even stay intact.

"The next one month will be a key period for the government," said Salman Ali, an analyst from Citi. "They need to restore confidence before the rally in markets can be sustained."

If the outstanding political issues are not resolved before the start of Ramadan in early September, their resolution will probably be pushed back to October, Ali said.

Working hours are usually shortened during Ramadan in Pakistan, a Muslim country, as businesses wind down to mark the holy month of fasting.

Pakistan is struggling with widening trade and fiscal deficits and soaring inflation. This has pushed Pakistani stocks to near two-year lows, and caused the rupee to lose over a fifth of its value against the dollar this year.

RESPECTABLE EXIT FOR MUSHARRAF

Musharraf resigned on Monday to avoid being impeached by the government after taking power nearly nine years ago in a coup.

However, his future is unclear. There has been no announcement on whether he would get immunity from prosecution and be allowed to live freely in Pakistan.

A respectable exit for Musharraf will help the coalition government attract more financial aid from the United States in the form of "democracy dividend", as well as money from investors abroad, said Imtiaz Gadar, an analyst at JPMorgan.

Pakistan is in urgent need of foreign inflows to pay for the country's imports, and offset falling foreign exchange reserves that have been depleted by high oil prices.

The country now needs to borrow billions from abroad to stay afloat. Analysts and investors are even talking about Pakistan returning once again to the International Monetary Fund as a last resort.

"The international community would like to see a respectable exit for the president," said JPMorgan's Gadar. "Satisfaction (from the) international community will influence future foreign flows."

Pakistan's newspapers also called on Tuesday for the coalition to immediately address the restoration of the judges Musharraf purged last year, and the election of a new president.

Former prime minister Nawaz Sharif, one of the main coalition leaders, has been insisting the judges be restored, but the party leading the coalition, that of assassinated former prime minister Benazir Bhutto, has been more wavering.

Analysts said this is partly because the deposed chief justice might take up challenges to an amnesty from graft charges Musharraf granted party leaders last year.

(Editing by Jerry Norton)