Pakistan has featured in this column once before, but now looks unlikely to ever appear again. The country, long one of the best-regarded frontier markets in Asia Pacific, has joined the ranks of the emerging market countries, after an upgrade from index provider MSCI.
That was supposed to be a boon for a country that has been doing all the right things. Pakistan has managed to pull off impressive growth while getting inflation under control. Its more conservative approach to spending has helped trim the budget deficit. It has signed a landmark agreement with China – which today learned its A-shares would be included in MSCI's emerging markets index next year.
But although the MSCI agreement was the icing on the cake, apparently promising a deluge of demand from foreign investors tracking the MSCI Emerging Market index, instead the result was more than a little disappointing. In the week before the upgrade, after hitting a high, the benchmark KSE100 index fell by 4.4%. It has continued to fall since.
The performance of Pakistan’s stock market since the MSCI upgrade shows just how important active demand is for frontier and emerging markets. Although the upgrade meant Pakistan could rely on rigid demand from some passive index-trackers, it is still active investors who decide where prices should be.
The government has hardly extended an olive branch to those investors. In its budget at the end of May, Pakistan opted to hike taxes on capital gains and mutual fund investments, sucking the air out of an almost 40% rally over the last 12 months.
Nor has it helped the confidence of domestic or international investors that the country’s prime minister, Nawaz Sharif, has been embroiled in corruption allegations linked to the Panama Papers.
Pakistan’s government appears to be heeding both issues. Sharif’s mature approach to the allegations has softened the blow. He has willingly appeared before the investigation team probing Pakistan’s involvement in the Panama Papers scandal, winning praise from pundits for his respect for the rule of law.
As for the tax hikes? They were adjusted almost as soon as they were introduced. On July 13, the government passed an amended finance bill, back-pedalling on the tax rise for mutual fund investments and giving an exemption on its capital gains tax increase to long-term investors.
Perhaps just as importantly for growth investors, the government relaxed rules forcing companies to pay out more than 40% of their earnings as dividends, reducing the penalty on additional reserves from 10% to 7.5%. That is a crucial step to helping Pakistan boost its weak investment rate, which represents only around 15% of GDP.
The country’s upgrade to emerging market status was the reward for capable economic management, an improving market infrastructure, and a compelling story. But Pakistan’s experience gives a clear demonstration to other emerging market hopefuls that even improving countries cannot rest on their laurels.
Foreign money will certainly flock to frontier markets ready to make the leap. But there is no guarantee it will stay — and it may not be enough to drown out domestic fears.