Pakistan Turns an Unlikely Corner

The stock market is booming, the rupee firming, and foreign investors poised to return. Ironically, it all stems from September 11

When the U.S. government moved to oust the Taliban in Afghanistan after the September 11 massacres, neighboring Pakistan seemed to be highly vulnerable. Its long border with Afghanistan, along with the cultural ties and tight political links, seemed to put Pakistan politically and economically at risk.

Now, just seven months after the attacks, early signs of a fragile turnaround in Pakistan's investment climate are everywhere. "From the perspective of foreign investors, two things are very important: liquidity and stability," says Arshad Arif, head of research at AKD Securities, a Karachi brokerage house. "And for the first time," he adds, "we've got it right."

Indeed, the domestic Karachi Stock Exchange (KSE) benchmark index of 100 companies has shot up 855 points, that's a full 80%, rising from a 12-month low of 1075 in October, 2001, to 1930 in March, 2002, the highest it has been in a year. Moreover, if the analysts are calling it correctly, the market is on course to break its all-time high of 2664, which was set in 1994 when foreign investment was also at a peak.


  Meanwhile, the KSE, the country's major equities market, attracted more outside investment in February than in any month over the last two years. Net foreign portfolio investment in the exchange hit $36.5 million, reversing a net outflow of $29.7 million in the same month a year earlier, with the vast bulk of the money coming from Britain. True, Pakistan has still seen a net portfolio-investment outflow of $7.7 million since July -- but the good news is that the figure is but a small faction of a huge $117.6 million outflow in the same period a year earlier.

Salim Chamdia, the KSE's chairman, believes February could mark the start of a major turnaround in investor confidence. "Right now, investors are in a wait-and-see mode," Chamdia says. "So we'll have inflows of about $20 million per month for the next couple months. But in the next fiscal year, net foreign-portfolio investment should be $700 million to $800 million."

Why the flurry of activity? The economic stability Pakistan's government has achieved post-September 11 is the major factor. After Islamabad shunned the Taliban and aligned itself with the U.S. and its war in Afghanistan, General Pervez Musharraf's government was rewarded with a lifting of economic sanctions imposed in 1998 after Pakistan conducted nuclear tests. As a result, the country requalified for International Monetary Fund assistance and also succeeded in rescheduling a chunk of its external debt.


  Another big attraction for foreign investors has been the the Pakistani rupee's health. The currency has gained 11% against the greenback since September 11, largely because of a crackdown on the black market hawala system of money transfers, as part of the U.S. war on terror. With strict curbs on this informal and widely used system, expatriate Pakistanis have been routing their remittances through the banking system instead.

As a result, the country's foreign-exchange reserves have topped $5 billion for the first time, giving the currency unusual strength. In 2001, by contrast, the rupee fell 23% against the U.S. dollar. "In the '90s, foreign investors would lose an average of 8% to 10% on their investments every year on account of the depreciation of the rupee," says AKD Securities' Arif. "This year, for the first time, they won't -- and this is a very good trigger for them to look at Pakistan."

Musharraf has scheduled an Apr. 30 referendum, which is expected to confirm him as the nation's leader for five more years. Meanwhile, investors are confident that Pakistan's economic reform will continue. "If the referendum passes without agitation and the currency remains strong, the market should cross history's highest levels," says Nouman Zaheer, investment analyst at Arif Habib Securities, a local brokerage that recently launched two mutual funds. The KSE-100 index fund now offers a yield of around 12%.


  Pakistan also has begun sweeping away the currency-exchange regulations that have long made foreign investors wary of investing in the country. Meanwhile, the State Bank of Pakistan, the country's central bank, recently began providing hedging mechanisms in a bid to protect foreign investors from exchange risk should the rupee decline.

The major regulatory authority, the Securities & Exchange Commission of Pakistan (SECP) also has moved aggressively to beef up vigilance over companies and brokers. "The absolute figures of foreign investment are not significant," says Shahid Ghaffar, commissioner of the SECP. "But going from a very huge minus to [a small] plus is in itself a big thing."

Of course, doubts about Pakistan's stability linger. December's troop buildup along the border with India sparked a panic among both domestic and foreign investors. The recent spate of sectarian violence in Karachi, the country's commercial capital, including the murder of U.S. journalist Daniel Pearl, heightened investors' skittishness. Until Musharraf's grip on power is reconfirmed by the referendum and October's general elections pass without chaos, investors are likely to remain relatively cautious.


  Analysts say the country has much to look forward to as it forges ahead with its IMF-led program to privatize state assets. For instance, a major reason foreign investors have stayed away from Pakistan in the past is the market's lack of depth. Just 20 companies typically account for more than 95% of the trading volume at the Karachi stock market, and only four new companies have been listed in the last two years.

To increase the market's liquidity, the government plans by yearend to sell off United Bank, giant monopoly Pakistan Telecommunications, Pakistan State Oil, the mammoth oil-distribution company with a 75% market share, and Karachi Electric Supply, the country's second-biggest electricity monopoly.

"Once that happens, foreign portfolio [managers] like Morgan Stanley and Barings will increase Pakistan's allocation and take this market more seriously," contends AKD Securities' Arif. Unless some fresh crisis erupts, Pakistan appears to be in the early stages of what could be a sustained bull market.

Naween A. Mangi in Karachi, Pakistan

Edited by Thane Peterson

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