CAPITAL MARKETS OF

PAKISTAN

Muhammad Ehtisham Akram

Research Assistant
Level III candidate in the CFA program

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 ECONOMY AT A GLANCE

Foreign investors are pushing funds back into Pakistan stocks, setting the market up for its second-
best year for inflows in a decade, drawn by cheap valuations and some economic and security
improvements. Such investments may be paying off as well because the main Karachi stock index is one of
the few markets in Asia showing a rise since the beginning of the year. While the benchmark MSCI Asia
ex-Japan index is down 11 percent this year, the KSE is up 3 percent.
"Pakistan remains one of the cheaper markets in Asia and emerging markets with an improving
domestic situation and a stabilizing economy," said Mark Mobius, executive chairman at Templeton Asset
Management Ltd.
Net foreign portfolio investment into the stock market reached more than $530 million in the first
11 months of 2009/10, compared with a year-earlier outflow of $408 million. If that holds to the end of the
year, it would mark the biggest net foreign investment in more than 10 years, apart from 2007. The
government has pulled back from the brink of a debt default thanks to International Monetary Fund
emergency funding and is seeing some success in military operations against Taliban militants behind
bomb attacks across the country.
A government led by the party of assassinated former Prime Minister Benazir Bhutto has proven
more resilient than critics predicted and recently introduced constitutional reforms to bolster parliamentary
rule, and stability. The powerful military, which has ruled for more than half of Pakistan's history, is seen
as largely satisfied with the civilian government and loathe to step back in to politics while it hands are full
battling militancy.
The economy is also pulling out of the global downturn and this year the government expects
growth above 4 percent compared with record low growth last year of 1.2 percent. The Karachi stock
market has more than doubled from lows hit last year during the worst of the global crisis, although many
stock markets have seen similar gains.
To be sure, Pakistan remains one of Asia's riskiest investment destinations, Reuter’s surveys show.
That's why most foreign money goes into energy stocks or fertilizer company Engro Chemicals. Apart from
having cheaper valuations compared with many regional peers, they offer the liquidity foreign investors
need should they decide to sell.
Al Qaeda-linked Taliban militants remain a serious threat despite the military's successes, and
chronic power cuts and rising prices are eroding the government's support. There remains criticism of a
lack of policy stability. In addition, the inflow figures have been flattered by the lifting of a KSE trading
floor, which had stopped investors selling below 9,144 points between August and December 2008.
(Reuters)

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 Financial market development in Pakistan has, and will remain, the primary driver of
economic activity. Normally the real sector leads financial market development but in Pakistan
financial market development has stimulated the real sector. Over FY03-10, Pakistan has attained an
average economic growth of over 5% that, among other factors has been helped by the growth in
overall credit in the range of 16.1% per annum. Private sector and Bank credit has grown rapidly.
Later is because of serviced diverse needs and ventured into new areas such as consumer financing,
which has stimulated the demand for durables. However, over half of the credit still flows towards the
large corporate sector and in terms of tenor, bulk of the credit is for less than 1-2 years. Furthermore,
private sector credit still does not meet the full requirements of the economy and in the agriculture
sector bank credit meets perhaps half of the real demand, although its share has grown phenomenally.
Across the board credit flows to the corporate sector, infrastructure, and agriculture sector, etc are
likely to rise as the investment environment improves further. So what do we need to do here? We
need to position our banking sector to deliver these diverse sector requirements.

GDP / Capita (US$ PPP Based) growing at ~ 6%PA for 10

yrs

Nominal per capita income currently stands at PKR 88,996 (US$ 1,047), yet Pakistan’s GDP per
capita, when adjusted for PPP stands at US$ 2,538 – according to World Bank (~0.3% of the world
economy). Pakistan’s nominal GDP grew by CAGR of 17% for last 10 years to reach PKR 15,203bn (US$
179bn), yet on a PPP basis, Pakistan will achieve the a GDP on a PPP basis of over US $700bn by 2015.
Despite international political disputes and internal structural issues, Pakistan has posted strong growth
over the recent decade. A high degree of economic resilience, foreign investment and focused pro-
investment policies during this period helped average over 5.0% GDP growth has enhanced.
To stimulate economic growth to achieve above average trends, there is need to introduce more
depth and breadth in financial markets. The M2/GDP ratio – an indicator of financial deepening – has
grown in Pakistan, but when Pakistan’s financial system structure is compared with the structures of
the East Asian Economies, we get an indication of where we stand:

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1. Bank assets as a proportion of GDP in Pakistan are low relative to China, Malaysia, Hong Kong,
Singapore and Philippines.

2. Equity Market capitalization as a percentage of GDP in Pakistan is also substantially low relative
to Malaysia, Thailand and Korea but has most potential to grow

Market Capitalization/GDP PPP

3. Likewise, the volume of bonds outstanding as a percent of GDP is merely 7-8% in Pakistan
compared to Malaysia (80-90%), Singapore (65-75%%) and China (20-30%), although in China the bulk
of these bonds are sovereign.

While Pakistan has definitely improved quite a bit, when we compare ourselves to the region,
we are still lagging far behind and for me this is where we should strive to make more inroads. In my
view, not only is there more room for banking assets to grow, but also more fundamentally, there is now
need to finally jolt the non-bank financial sector more strongly. It is indeed noteworthy that the growth
of KSE market capitalization has risen from under 2000 points to over 10,000 points in the last few
years, and went on to record highs of 15737.32 points on April 20, 2008. Average daily turnover is

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remarkable, which, at 525 million shares, makes KSE one of the most liquid markets. Volumes are
substantially low these days because of uncertainty due to BADLA or margin financing announcement
and imposition of capital gain tax hinder investors to show activity. Likewise the P/E ratio of 7-8 is
extremely attractive when compared with average price earning ratios of neighboring countries.
Likewise, KSE’s dividend yield ratio also offers good prospects relative to other emerging markets.

MARKETS Dividend Yield PE (X)

KSE100 6.57 7.74

India 1.27 17.57
China 1.95 15.63
US-DJIA 2.75 12.7
NASDAQ 0.87 17.12
Hong Kong 3.25 13.93
UAE 3.89 8.34

However, I still maintain that Pakistan’s capital market lacks sufficient depth, breath and
maturity. It is prone to structural vulnerabilities and manipulation. This is confirmed by the decline in
the number of listed companies from 762 in the year 2000 to 652 in 2010. Moreover, as I have already
mentioned, market capitalization as a percentage of GDP is still low and there are very few listed debt
securities. But there are promising prospects and with various stakeholders’ efforts, the stock market has
achieved many milestones. The Stock Exchanges have fully automated the trading system with a T+2
settlement cycle. The shares are traded in dematerialized form and settlement takes place in a paperless
environment through the Central Depository Company and National Clearing and Settlement System.
Unique Identification Number (UIN) will substantially strengthen the disclosure regime and will go a
long way in bringing more transparency in trading, work as an effective deterrence against market
manipulation, and will be very helpful in investigating and probing any wrongdoing.

Besides the need for broadening and deepening of reforms, we need to further enhance the
efficiency of financial markets and institutions to lower intermediation costs. By and large, Pakistan’s
financial sector has performed fairly well within the South Asian context as the system has benefited from
the (i) privatization of banks, (ii) consolidation of the banking sector, (iii) strengthening of the prudential
regulations for the banking industry; and (iv) introduction and enforcement of corporate governance.
According to World Bank’s ranking, Pakistan is marginally behind India in access to finance and
efficiency, whereas it ranks the highest in corporate governance in the South Asian region.

In the context of the equity market, I believe that the lack of depth and breadth and weaknesses in
the price discovery mechanism, with multiple exchange floors and gyrations in equity markets driven by
speculative tendencies, undermine the process of stock valuation. The end result is that it is costly for
companies to raise capital from stock markets, which keeps individual investors, with less appetite for risk,
totally out of these markets. Further enhancement of market depth and liquidity by way of listing of
more primary issues, promotion of the secondary market in debt securities and strengthening of
regulations and their enforcement would help mitigate perceptions and risks.

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WHY? PAKISTAN’S STOCK MARKET:

• Pakistan remains one of the best performing markets in the world over the last 10-12 years,
investing US$1 after Pakistan went nuclear power would have outperformed BRIC (Brazil,
Russia, India & China) economies as well as gold as demonstrated in the graph after the bullet
points

o KSE100 is among few markets that are positive in CY10.

o Many companies among various sectors showing fundamentally sustained growth like
Financial Sector, Energy, Cement, Fertilizer and Auto.
o As compared to the region stocks are trading at large discounts.

• Pakistan has very lesser correlation with rest of the world especially with the region as well as
with developed nations; single this factor makes Pakistan huge opportunity for the foreign investors to
invest. It not only provides opportunity for diversification (Low overall risk) but also potential for
enhanced returns.

• Pakistan as a business model has very low synchronization (linking) with rest of the globe, the
reasons I believe are agriculture based economy, lesser relative trade with globe, large domestic consumer
market. We have our own problems like energy & water crises, political instability, security situation but
these events are isolated from the returns our stocks are generating, so investors shouldn’t hesitate
investing herein.

• Domestic capital inflows continue to underpin market performance – Foreign funds now own
more than 30% of the free float.

• Future outlook for Pakistan’s Stock Market is bullish.

• Pakistan has the lowest Market Cap / GDP PPP out of a wide selection of countries, Pakistan has
the most potential to grow.

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Buying Pakistan in Times of Pessimism – Post Nuclear to
2010

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12 years later, a comparative price performance in US$ terms highlights that any investor who invested in
Pakistan at the time of maximum pessimism, would have gained by over 60% in US Dollar terms and done
better than any other asset class. Investing for the long term in times of pessimism is perhaps the best
strategy for Pakistan. Twelve Year Performance Comparison of Different Asset Classes put Pakistan at the
top. The table above shows a comparison of different asset classes from October 1998 to 30 June 2010.
Investing US$ 100 in Pakistan after the fallout from the nuclear blasts would have outperformed everything
else in your portfolio, including BRIC, MSCI India and Gold.

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