A country’s balance of payments crisis normally creates the kind of volatility, which burns investors foolish enough to buy into rising stock markets without studying their history books first. Yet in 2018, Pakistan appears to be the exception to the rule, at least where the equity markets are concerned.
The crisis in the country, founded by Muhammad Ali Jinnah in 1947, is real and symbolised by its fast-dwindling foreign exchange reserves. These stood at $11.16 billion in early April, representing just two-and-a-half months of import cover.
So why are the equity markets doing so well? Year-to-date, the Karachi All Share Index (KSE) ranks as Asia’s best performer, up 7.72%.
One reason is because of the currency, which has lost about 5% against the dollar so far this year. As it gets weaker, rupee-denominated returns become more enticing for international investors.
Then there is the valuation. Unlike every other Asian market, Pakistan still trades on a single digit, forward earnings multiple of 9.2 times and a solid dividend yield of 5.1%.
This is thanks to last year’s rout, which means the KSE Index has clawed back less than half the amount it lost after investors celebrated Pakistan’s upgrade to MSCI Emerging Market status by dumping equities.
Pakistan’s international bonds have been less stable, although their performance remains in line with other lower rated Asian sovereigns like Sri Lanka and Mongolia, which have been hit by a pull back from emerging market dollar debt. The sovereign’s recent $1.5 billion 6.875% December 2027 bond, for example, is now almost 10 points below its issue price.
Financiers say one reason why things are not a lot worse is because Pakistan’s G3 bonds tend to be tightly held by local banks at home and abroad. They also say investors have been comforted by Chinese banks’ willingness to keep the credit taps open.
There had been suggestions that support might be waning after China allowed Pakistan to be placed on the Financial Action Task Force’s (FATF) grey list in February for failing to do more to prevent terrorism financing. But country specialists say China cut a deal with the US in return for the FATF vice presidency role.
Investors may also feel re-assured by the comforting presence of the IMF. It is literally the lodger that successive governments love to hate. It rarely gets a welcome mat and is often thrown out long before any agreement is up.
But Pakistan has a revolving door at the supranational level and will almost certainly celebrate the 60th anniversary of its first bailout with its 22nd. Since 1958, the longest it has managed to evade it is seven years.
Its last $6.6 billion Extended Fund Facility (EFF), for example, only finished in 2016. The reason why it cannot escape is because of its inability to leverage its massive population’s earning power.
Pakistan is the world’s sixth most populous country with 208 million people. But only 0.33% of them paid tax in the last fiscal year.
According to Moody’s, Pakistan’s 12.5% ratio of tax-to-GDP places it 31st in the rankings of 32 single-B rated credits. Only Nigeria has a lower ratio.
One investment banker told FinanceAsia he recently asked one of the country’s leading tax advisors how he could submit a return after making some investments in the country. The advisor suggested he give the money to charity instead.
The government is attempting to get its house in order through a number of measures. These include: two currency depreciations (December and March), a tax amnesty (5% one-off penalty onshore and a 2% penalty for undeclared income and assets repatriated from offshore) and a prospective $1 billion bond with rupee interest payments targeting the country’s 7.6 million diaspora.
Will it be enough? History suggests otherwise unless the forthcoming general election replaces messy coalition politics with a government, which has a majority and the political will to institute meaningful reform.