PSX-1100

Once booming, Pakistan’s bourse now sees some bloody days

By Harvard Zhang

Karachi, Pakistan — The year 2016 promised much, but so far delivered little in return as the KSE-100 Index has shed 5.5 percent.

Pakistan’s equity market has been subject to a persistent drain of foreign investment amid a global selloff since the beginning of the year, despite the January merger of three stock exchanges that was intended to attract more foreign investment.

Even though foreign investors are encouraged by Pakistan’s growth potential rooted in its young demographics and opportunities created by the $46-billion China-Pakistan Economic Corridor projects, this frontier market still needs to address structural and regulatory issues and improve national security to engage foreign interest while weathering a tumultuous global financial environment.

“2016 will be a difficult year,” said Nadeem Naqvi, managing director of the Pakistan Stock Exchange Ltd. “We’ve seen some foreign portfolio investment outflows primarily in the oil and gas sector which has a major impact on the index.”

Since New Year’s Day, foreign investors have withdrawn $82.4 million net as of Feb. 19. Last week the benchmark KSE-100 Index slid for four consecutive days, shedding 2.9 percent. It’s down 6.7 percent year-to-date, defying the authorities’ effort to attract foreign capital by integrating the stock exchanges of Karachi, Lahore and Islamabad.

The outflow came on the back of large redemptions from mutual funds whose heavily-weighted stocks include Oil and Gas Development Company Ltd. and MCB Bank Ltd., according to Beidi Gu, a portfolio manager at New York City-based Caravel Management LLC, which has $600 million under management, 40 percent of which is in frontier markets including Pakistan.

The stock exchange had 554 companies listed in 2015, and the market capitalization was $66.5 billion. In comparison, the Bombay stock market in India was more than 20 times larger at $1.51 trillion.

KSE-100 Index annual percentage changes

The benchmark KSE-100 Index rose at an annual average of 18 percent in the past 10 years. (Harvard Zhang/MEDILL)

About one third of Pakistan’s free-float shares valued at $6 billion are held by foreign investors, mainly institutional players including Franklin Resources Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc.

U.S. investment accounts for more than 50 percent of the foreign portfolio, according to Mohammed Sohail, CEO of Topline Securities, which handles 20 percent of the market’s foreign portfolio investments.

Foreign investors withdrew $315.2 million in 2015 after two years of injecting more than $380 million. The stock index, comprising 100 common stocks picked on the basis of companies’ market capitalization and business sectors, rose at an annual average of 18 percent in the past 10 years.

Not expecting a continuation of the average annual index growth of 18 percent in the last ten years, Naqvi said he “will be happy to see a 12 to 15 percent annual return at the end of 2016.”

Others echo the view

“This is a tough and negative environment for frontier markets like Pakistan,” said Win Thin, senior vice president and global head of Emerging Market Strategy at Brown Brothers Harriman in New York. “Global growth has slowed, U.S. dollar is stronger and interest rates are up, commodity prices have crashed — a lot of factors that have contributed to the market boom in the last 10 years have faded away.”

Frontier markets in developing countries, with smaller market capitalization and less liquidity than emerging markets like China and India, attract investors with relatively high tolerance to volatility to pursue high returns.

But frontier-market funds have been grappling with negative returns this year. Templeton Frontier Markets Fund, with a $23-million stake in Pakistan’s market at the end of 2015, had a negative year-to-date return of 6.3 percent and a negative one-year return of 26.5 percent as of Feb. 18.

Despite headwinds confronting frontier markets generally, the PSX is looking to a June decision of New York City-based equity indices provider MSCI Inc., on whether it will be included in the MSCI Emerging Markets Index, according to Naqvi.

“We’ve seen historically that whenever a market gets included in the emerging market universe there would be a significant inflow of big funds and repositions of portfolio,” Naqvi said. “In a small market like Pakistan, even if 200 or $300 million comes in, the indices will go up substantially.”

Foreign investment changes in Pakistan’s listed equities

Foreign investors withdrew $315.2 million in 2015 after injecting more than $380 million in the previous two years. (Harvard Zhang/MEDILL)

Pakistan’s currency has been relatively stable over the past two years despite the U.S. dollar’s appreciation against other currencies. The Pakistani rupee stood at 104.8 to the dollar on Feb. 19, little changed from February 2014. Meanwhile the Bloomberg Dollar Spot Index, which measure’s the greenback’s performance among 10 peers, has risen nearly 20 percent.

Foreign investors look to the potential for consumption growth in the world’s sixth most populous country. More than 60 percent of 181.2 million Pakistanis in 2013 were under 25 years old, according to Pakistan Bureau of Statistics and the World Bank.

The China-Pakistan Economic Corridor, or CPEC, is expected to boost the capital-raising efforts of companies supporting a slew of infrastructure and energy upgrading projects. Naqvi said he foresees at least $2 billion to $3 billion raised in the power sector in fiscal 2017.

“In the next 24 months, people will see the reality, not just talk, as CPEC projects get implemented,” Naqvi said. “A lot of ancillary industries will be needed to support these projects. Almost all cement companies have announced doubling their capacity.”

Despite record-low oil prices hovering around $30 a barrel that is beneficial for a net oil importer, investors are concerned that Pakistan might neglect to undertake tax and business reforms necessary for long-term growth.

Tax reforms needed

“The cyclical factor of oil price is almost a perfect scenario for Pakistan right now,” Gu of Caravel Management said. “Yet we have concerns that the government is not taking this window to reform its tax collection and energy policy including privatization.”

Pakistan has one of the worst tax collection records in the world. The country’s tax-to-GDP ratio was only 9.5 percent in 2015, compared to the average of 34.4 percent in 2014 for 34 advanced and emerging countries in the Organization for Economic Cooperation and Development.

Terrorist attacks in the country still unnerve foreign investors despite the authorities’ continuous efforts to wipe out terrorism. Only faring better than Iraq, Afghanistan and Nigeria, Pakistan suffered the brunt of the fourth deadliest impact of terrorism out of more than 160 countries in 2015, according to a Global Terrorism Index report by the Institute for Economics and Peace.

“Security issues have been a major hurdle historically and remains one of the biggest concerns of foreign investors,” Sohail of Topline Securities said. “But the situation has been improving.”

The Karachi-based stock market’s small size and lack of liquidity renders it vulnerable to manipulation despite attractive price-earnings ratios. Less than two-fifths of all the shares of listed companies were actually available in the market in 2015.

“The main concern of foreign investors is about the market’s liquidity,” Naqvi said. “We are working on the implementation of requiring all companies listed to maintain a minimum 25 percent of free-float shares at all times.”

Fraudulent trading has also been a chronic malady for Pakistan’s equity market, which prompted the Securities and Exchange Commission of Pakistan to declare insider trading “an offence” and tighten securities regulations last year to regain the trust of investors.

A version of this story was originally published in The Express Tribune in Pakistan on Feb. 22, 2016, as part of a joint reporting project of the Medill News Service and the Center for Excellence in Journalism in Karachi.

Photo at top: Pakistan Stock Exchange. Foreign investors have withdrawn this year $82.4 million net as of Feb. 19, while the KSE-100 Index shed 5.5 percent. (Harvard Zhang of Medill for The Express Tribune)