Deals

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Size isn't everything. Pakistan may be a minnow in equity terms, with one of the smallest stock markets in Asia by capitalization, but it has plenty to offer the biggest.

The Shanghai Stock Exchange, the larger of China's two main equity markets, has submitted a letter of intent to buy up to 40 percent of the Pakistan Stock Exchange, according to The Nikkei Asian Review. The move makes plenty of sense, both for business reasons and for China's overarching strategic and political ambitions.

The contrast between the two exchanges could hardly be greater. Shanghai is home to more than 1,100 companies with a combined market value of about $4 trillion. Together with companies listed in Shenzhen, China's stock market is valued at about $6.4 trillion, the biggest in Asia and second only to the U.S.

Pakistan's stock market, meanwhile, has a capitalization of about $81 billion, which places the country outside the top 40 globally and only 13th in Asia, according to data compiled by Bloomberg. Average daily trading volume in Shanghai is about 50 times higher than in its South Asian neighbor.

Now for the plus side of the ledger. Pakistan has been on a tear. The benchmark Karachi 100 Index has climbed 25 percent this year in U.S. dollar terms, the second-best performer in Asia after the Jakarta Composite Index. The Shanghai Composite Index, by contrast, is carrying the region's wooden spoon with a loss of 18 percent.

Up and Away
Pakistan stocks have outperformed the Shanghai market and the MSCI Asia Pacific Index this year
Source: Bloomberg

Pakistan has fast been shedding its image as a basket-case economy beset by corruption, mismanagement and violence. The government has mended fences with the IMF, growth has rebounded and its credit rating was upgraded by Moody's last year for the first time since 2008.

The Pakistan Stock Exchange was formed in January from the consolidation of the Lahore, Islamabad and Karachi bourses, a move that modernized the country's markets by following the global trend of converting mutually owned private clubs into for-profit corporations.

A crowning achievement came when MSCI admitted Pakistan stocks to its Emerging Markets Index in June, elevating the country from frontier-market status, at the same time as the index compiler denied entry to mainland Chinese shares. The Pakistan Stock Exchange's 90-day-average daily trading volume has jumped 64 percent this year, while Shanghai's has fallen 45 percent.

Pakistan-Shanghai Disconnect
Shanghai trading volume is currently around 50 times that of Pakistan, yet one exchange is seeing continued growth and the other has almost halved this year
Source: Bloomberg
Note: Data show change in 90-day average of daily volume from base date on 31 Dec., 2015.

If the potential of a strategically placed South Asian nation with a population of 200 million is easy to see, then China is better placed to grab it than most. Pakistan is at the nexus of President Xi Jinping's One Belt, One Road initiative to develop a network of ports, highways, railways and pipelines between Europe and Asia. China is currently building a highway between Karachi and Lahore and has taken over a 923-hectare free-trade zone at the deep-sea port of Gwadar, part of its China-Pakistan Economic Corridor that aims to link western China to the Arabian Sea.

As ties deepen with the region's largest economy, there may be opportunities for China-financed enterprises to raise funds in Pakistan, and perhaps vice-versa. This is the prize that becoming a stakeholder in the Pakistan exchange offers.

There's no doubt that the Shanghai exchange needs a lift. At home, it's been bedeviled by the government's attempts to micro-manage markets, illustrated by last year's botched rescue attempt and its on-again-off-again approach to the IPO pipeline. Meanwhile, a trading link established with Hong Kong has seen more money flow out from than into Shanghai.

The cost for Shanghai is unlikely to be prohibitive. The total assets of the Karachi Stock Exchange, the surviving post-merger company, came to the equivalent of about $134 million at the end of 2015, according to The Nikkei Asian Review.

While Pakistan would be a long-term bet, it offers more promise than other avenues for international expansion. The cost benefits of consolidating Asian exchanges may look clear, but they are often considered national preserves. Australia rejected Singapore Exchange's bid to buy ASX.  Elsewhere, no entity is allowed to own more than 5 percent of Hong Kong Exchanges & Clearing or 10 percent of the Singapore exchange.

In a world of limited opportunities, this looks like a savvy step.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net