Pakistan vs Vietnam

Kings of the Wild Frontier

The winner of emerging-market status looks the riskier bet now.
Photographer: Asim Hafeez/Bloomberg

An escalating political crisis in Pakistan makes you wonder why MSCI reinstated the country as an emerging market last month while keeping Vietnam, Asia's new manufacturing hub, at frontier status.

The promised hundreds of millions of dollars of inflows haven't materialized since Pakistan entered the MSCI Emerging Markets Index in June. The benchmark KSE100 Index has plunged 13 percent in the period, while Vietnam's VN Index has added 5 percent to bring its advance this year to 17 percent.

Pakistan Sinks, Vietnam Emerges

The KSE100 Index has been tumbling since last month's MSCI upgrade

Source: Bloomberg

Investors taking profits may account for part of the slump. It's common for markets to rally in the 18 months ahead of an anticipated MSCI upgrade, and the KSE100 remains about 14 percent higher than when the index provider announced the change in June 2016. Pakistan had an 8.9 percent weighting in the MSCI Frontier Markets Index, but now accounts for just 0.1 percent of the emerging-markets gauge. As a result, passive frontier funds have been trimming their positions while emerging-markets funds have had little cause to buy. 

But Pakistan's problem runs much deeper than just portfolio flows.

Pakistan and Vietnam both peg their currencies to the U.S. dollar. However, Vietnam boasts a current-account surplus while Pakistan has a deficit. In its latest country assessments, the IMF estimates that the dong is 10.3 percent undervalued while Pakistan's rupee is 10 percent to 20 percent overvalued.

For international investors who look to MSCI for guidance, a country with palpable devaluation pressure is a dangerous place to invest. On July 5, the rupee tumbled 3.1 percent, the biggest one-day drop in nine years. The central bank was said to have devalued the currency amid signs of economic stress ahead of elections next year. A corruption probe into Prime Minister Nawaz Sharif has also rattled investors.

The next day, Sharif appointed Tariq Bajwa, a former finance secretary and the government's man, as the new governor of the State Bank of Pakistan. The central bank has no independence, notably issuing dollar bonds in the international markets to fatten the government's wallet. 

Alarmingly Calm

Pakistan's heavily managed rupee saw a sudden dip on July 5

Source: Bloomberg

When MSCI evaluates whether to deem a country emerging or frontier, it pays a lot of attention to liquidity. Vietnam still owns many publicly traded companies, whereas the Pakistani government has shown firmer resolve to divest its holdings, such as the 2015 sale of a  $1 billion stake in Habib Bank Ltd., the country's largest lender. In Vietnam, meanwhile, foreign-ownership limits mean overseas investors can trade only with each other once the quota is reached. 

But does MSCI's definition of liquidity make sense? In Pakistan, there are only 19 stocks that have daily turnover of at least $1 million; in Vietnam, 45 stocks meet that criterion. The Vietnamese government is also gradually lifting its onerous foreign-ownership restrictions. Vietnam Dairy Products JSC, a foreign-investor darling, lifted its cap a year ago. 

And don't forget the Pakistan market's troubled history. The South Asian country was in MSCI's emerging stable when it suspended stock trading entirely during the financial crisis in 2008, prompting a downgrade to frontier status. And in March 2015, the stock market fell 10 percent in five days because of one investor: Miami-based Everest Capital unloaded around $70 million to cover a bad bet on the Swiss franc. 

After the recent selloff, Pakistan stocks are among the cheapest in Asia, trading at only 9 times forward earnings. That's back to the level reserved for frontier markets. But a word of caution: Valuations are still well above the 8.1 times multiple reached during the sudden dip in March 2015. In other words, the possibility of another black swan event may not be priced in. 

Don't Buy the Dip

Pakistan's stocks have not priced in a black swan event

Source: Bloomberg

The Supreme Court is set to release its findings on Prime Minister Sharif's corruption case on Monday. At a time when the rupee is weak and foreign investors are skeptical, Vietnam's frontier may look a safer bet than Pakistan's uncharted territory.

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

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    Shuli Ren in Hong Kong at

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