Pakistan's Economy Comes of Age: Hope is in the air

Pakistan's Stock Boom
Rally Rolls On Despite Political Woes
By ZAHID HUSSAIN
June 11, 2007: Wall Street Journal

Pakistani President Pervez Musharraf is caught in a political maelstrom as an election looms and popular criticism of the military-installed leader mounts. Yet Pakistan's stock market is soaring to record levels.

Investment managers and stock analysts say the main reason is that despite Gen. Musharraf's political woes, his government's economic policies -- a successful privatization program, financial deregulation and other changes -- have worked. The result: an unprecedented influx of fresh foreign and local investment and sharply reduced government debt are paving the way for longer-term expansion.

And some analysts believe that even if Gen. Musharaff should lose power, any new government would likely keep in place his main economic policies.

"Structurally, the economy now is on much firmer footing to sustain growth for next three to five years," says Mudassir Malik, director of Karachi-based BMA Capital Management, which runs the $30 million Pakistan Opportunity Fund, the country's first, offshore, dollar-based fund.

That view has been reflected in a surging stock market. The Karachi Stock Exchange's 100 index has jumped more than 32% this year, reaching a record 13274.87 on Friday. That compares with a gain of 7.7% for the Dow Jones Industrial Average and a rise of 6.3% in the Standard & Poor's 500-stock index.

The market could rise further this week, analysts say, in the wake of Saturday's announcement of the government budget for the fiscal year that begins July 1. The budget, designed to sustain robust growth and appeal to voters, greatly increases the amount of development spending but imposes no changes in taxes on capital-market activity.

The spurt on Pakistan's stock exchange has been powered by a record inflow of foreign funds, which is expected to exceed $800 million in the year ending June 30. The bulk of the equity investments has come from funds in the U.S. and U.K.

Total foreign direct investment has reached $6 billion this year, up from $4.5 billion in fiscal 2006. Most of the investment comes from Persian Gulf countries, whose investors have bought into many recently privatized state enterprises.

"It is very clear from the inflow of both direct foreign investment and portfolio investment to Pakistan is that the investors de-link economic growth from politics," Mr. Malik says.

Foreign funds now own 20% of the shares on the Karachi exchange, which has a total market value of $60 billion. Foreign investors have targeted the financial, energy, textile and cement sectors in particular. Popular stocks with foreign funds include Oil & Gas Development Corp., Pakistan State Oil, National Bank of Pakistan and Pakistan Telecommunication.

Market analysts predict that Pakistan's stocks will remain attractive because they are significantly cheaper than those in Asian markets such as India, China, Thailand and the Philippines. For the current year, the Pakistani market is trading at a price-to-earnings multiple of 10, "which is a 40% discount to average P/E multiples of other Asian countries," says Mohammed Sohail, director of equity broking at Karachi-based J.S. Global, one of Pakistan's largest securities firm.

With international money seeking higher returns, Mr. Sohail and other analysts think the bullish trend will continue, despite the political uncertainty. "More and more funds are interested in Pakistan and those who are already there are comfortable with the current situation," says Ryan Floyd, vice president for emerging markets at New York brokerage firm Auerbach Grayson.

"The Pakistani economy is very vibrant despite the politics and violence," adds Mark Mathews, a Singapore-based Asia strategist with Merrill Lynch.

The apparent disconnect between Pakistan's political problems and its buoyant economy has become a striking paradox in recent years. Pakistan is expected to register 7% growth this year. The government has targeted 7.2% for the coming year.

Under Gen. Musharraf and his economic czar, Prime Minister Shaukat Aziz, a former Citigroup Inc. banker, Pakistan has pursued an aggressive privatization program. In the past four years, the government has sold more than $5 billion in state assets, including banks, telecommunications and industrial companies. The program has particularly been successful in improving the financial sector, with privatized banks now accounting for almost 90% of the banking industry.

Analysts credit privatization with easing the burden on the government's finances, resulting in significant improvement the country's fiscal position. Debt as a percentage of gross domestic product fell to 51.1% in 2007, down from 100% in 1999, when Gen. Musharraf came to power in a bloodless coup. That has lowered the risk premium that investors assign to Pakistani financial assets.

Still, the market's immunity from political unrest could be tested soon, as the possibility of fresh crises loom. Gen. Musharraf, who has said he intends to seek a second five-year term as president after parliamentary elections scheduled for later this year, is under mounting attack.

"If it comes to a point where uncertainty increases about Gen. Musharraf's political future it could start impacting the investments," says Sakib Sherani, an economist with ABN Amro Bank. "There will be a potential reassessment and a wait and see attitude."
But some analysts expect basic continuity in economic policies even if Gen. Musharraf fails in his bid to retain power. They reason that almost all the country's mainstream political parties -- as well as the powerful military -- are committed to economic liberalization.