Reasons why Pakistan is a frontier market fairy tale

Matein Khalid/Macro Ideas
Filed on November 2, 2015 | Last updated on November 2, 2015 at 08.39 am
Reasons why Pakistan is  a frontier market fairy tale
The Karachi stock index has generated a 25 per cent per annum return in US dollars for five years in a row.


Nation's assets are grossly undervalued, says Matein Khalid

Fairy tales rarely happen in frontier markets but Pakistan, since 2010, is an exception. The Karachi stock index generated a phenomenal 25 per cent per annum return in US dollars for five years in a row. It is a pity that so few investors in the UAE trade Pakistani equities but the cognoscenti have made a fortune in Pakistani banks, current companies and leasing firms.

Amid all the global hype of Modinomics, Zardarinomics proved far more profitable for international investors. The real catalyst for Pakistan's spectacular bull market were the economic stabilisation policies adopted by General Musharraf and ex-PM Shaukat Aziz a decade ago.

Pakistan's unique investment appeal to me lies in its "too big to fail" geopolitical significance for two superpowers (the US, China) and two Gulf oil exporters (Saudi Arabia, the UAE). The UAE's financial lifeline prevented a Pakistani sovereign debt default in the late 1990s after the US Congress imposed sanctions in the wake of the Baluchistan nuclear test. Saudi Arabia sold crude oil at below market rates to Pakistan since the reign of the late King Faisal, in whose memory a major city in Punjab was renamed. Washington was Pakistan's Cold War ally and financial/security patron since September 2001. China has just promised $46 billion FDI in a new Silk Road economic corridor that straddles Sinkiang. This is the reason I believe Pakistani assets are grossly undervalued by a sovereign credit risk premium that is draconian, even though it is underwritten by Washington, Beijing, Riyadh and Abu Dhabi. No other emerging market in the world can boast such stellar geopolitical patronage.

This is the reason the IMF approved a $6.7 billion structural adjustment loan for Islamabad. This is the reason the Pakistani government was able to raise $2 billion in eurobonds and $1 billion in sukuk in the international capital markets. The plunge in oil prices has been a windfall for Pakistan's current account deficit and inflation rate. Inflation has plummeted from 8.4 per cent in 2013 to only 3.8 per cent now. This enabled the State Bank of Pakistan to reduce its policy rate to a 42-year-low of six per cent. The Pakistan Army is winning the war against the Taleban. Nawaz Sharif's pro-business cabinet has imposed fiscal discipline and earned the respect of the local financial elite on a scale impossible under the populist Sindhi feudal-dominated PPP. Profit growth in Pakistani corporates has been as consistent as it has been spectacular, despite a chronic power crisis. Relations with India have improved under Modi, as has the domestic security milieu. Yet Pakistan still trades at only 7.8 times forward earnings, making it my favourite frontier market Cinderella in the world.

Wall Street folklore argues that "the big money is made when things go from Godawful to just plain awful". This is what happened in Pakistan since 2008. The Philippines was rerated by global markets after President Aquino widened the tax base, slashed the budget deficit, fought corruption and attracted global investors with a credible, consistent reform agenda. This macro valuation rerating has not yet happened in Pakistan. But it will, if the military high command finally defeats the Taleban and Nawaz Sharif accelerates his pro-market reform agenda. Manila's valuation soared from eight to 19 times earnings when President Aquino changed the macro sovereign zeitgeist. This can also happen in Pakistan.

Pakistan has finally evolved into a mature parliamentary democracy with stable military-civilian relations, a vibrant free media and independent supreme court. Pakistan's sovereign credit rating will rise and 200 million citizens finally hope for the social justice envisioned by its founder, the Lincoln's Inn constitutional lawyer (and my ancestral kinsman) Mohammed Ali Jinnah. This is a wonderful dream that transcends mere criteria of money making for me. A stable, prosperous, democratic, moderate Pakistan at peace with India is an asset to a subcontinent whose time on the global stage has finally come.

The privatisation of Habib Bank was a global success. Earnings growth will top 15 per cent in 2016. Mutual funds have spawned an embryonic "equity culture" a MSCI upgrade is inevitable. Karachi's first Reit was listed on the stock exchange. The oil crash is a financial bonanza. There is no shortage of potential triple bagger shares in Pakistan. I expect to travel to the city on the Arabian Sea where I was born but not visited since 1996 multiple times in the next 12 months.

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