| Shaukat Aziz | ||||||
When the army seized power almost two years ago, Pakistan’s financial situation was so dire it was unable to access even the short-term to medium-term commercial bank market.
In the past four months or so, according to finance minister Shaukat Aziz, investor sentiment has improved and Pakistan has started to tap these markets. “Banks are looking at Pakistan and offering us facilities, which is a change from two years ago,” he says. “Later on in this financial year we hope to go to the market to rebuild our links with investors, although we recognize that a lot more needs to be done. We have to be realistic, but the reform agenda must continue. Reform and change are painful, but if we don’t do that we’ll be back to the days of the past where there was a lot of ad hocism and expediency as a driver of decisions rather than doing what’s good for the economy in the long run.”
Sound fundamentals
International interest in Pakistan evaporated in 1998 when sanctions were imposed after the country tested an atomic bomb in a tit-for-tat show of force following a nuclear detonation by India. Investors were frightened off when Pakistan slapped a freeze on portfolio outflows, resulting in an eight-month queue to remit funds abroad. The Musharraf government reversed the ruling in March 2000 by lifting the requirement for prior approval on remittances. That triggered a period of volatility with capital outflows of at least $350 million. In this period Morgan Stanley Dean Witter wound up its only dedicated Pakistan Investment Fund. The bank had put $200 million into the fund in 1994. By last year this had shrunk to $37 million.
In fact, since 1998 there have been almost no foreign institutional investor inflows. “Nobody is willing to commit new funds and this is keeping stock prices depressed,” says a broker. “This situation is in stark contrast to the fundamentals. The corporate sector has enjoyed an upswing since 1998, foreign exchange reserves have trebled, the government is certain to conclude a medium-term facility with the IMF and dividend yields are averaging 15.5% with interest rates at 11.5%. Once the IMF loan is signed or we have a high-profile privatization, investor confidence may be rekindled.”
Zubyr Soomro, chief executive of Citibank in Pakistan, says the government has been effectively out of the market since the nuclear blast in 1998. “Commercial overseas borrowing stopped until December of last year when we did a $45 million syndication for oil imports,” he says. “We followed this up with another $100 million facility last April and in May we syndicated a $59 million loan for Pakistan International Airways. A positive sign was that the pricing improved with each transaction.”
Pakistan has never provided any incentives to develop a domestic capital market other than for government bonds. Companies are reluctant to issue paper, with government borrowing instruments offering yields up to 15% compared with 11% to 13% for securities. One of the state banks has a mandate to take about 20 debut corporate bond issues to market by year-end. Pension funds, which are not allowed to invest in national savings schemes, are being targeted as potential buyers of this paper. “But,” says a bank executive, “it will take at least another two years to create the right environment for marketing international paper in the Pakistani market.”
Last year the government banned institutions from investing in the national savings schemes with an estimated pool of PRs370 billion ($5,8 billion) to PRs400 billion, 65% of which was accounted for by pension and provident funds. “As pressure mounts for improving the yields of pension fund investments there are signs that fund trustees and managers are moving into the equity market,” says Nadeem Naqvi, head of research at Merrill Lynch in Karachi. “While this is still a trickle into the domestic stock market we expect the pension funds to become an increasingly important source of long-term liquidity.” Naqvi believes that comparative valuations with Asian markets warrant an out-of-the-index play on Pakistan. “We are looking for 41% EPS growth for this year with a P/E ratio of 6.5,” he says. “The Pakistan market is arguably one of the cheapest in the Asian region.”
The government has been a driving force in promoting stock market efficiency through its policies of accountability and transparency. The Securities&Exchange Commission of Pakistan (SECP) has issued several regulations aimed at creating an investor-friendly environment. Short sales without security margins have been banned. SECP representatives sit in on listed company AGMs. Brokers have to register with the SECP and have been subjected to more stringent capital adequacy requirements. In addition, the Karachi Stock Exchange recently introduced a T+3 settlement system.
As for attracting international interest in domestic paper, Pakistan has only two companies with a market capitalization above $300 million. “Foreign investors want to take positions of $15 million to $20 million at the very least,” says this Karachi stockbroker. “They are not interested at the moment, although this is part of the wider problems in emerging markets elsewhere.”
Governor of the State Bank Ishrat Husain says the first step is to develop a domestic corporate bond market. “It is important for this market to flourish and expand, then we’ll look at international paper,” he says. “For now we are trying to reduce our [$37 billion] foreign debt with soft loans from the Asian Development Bank, the World Bank and other bilateral creditors. Once we’ve stabilized our debt ratios we will go to the international capital markets.”
