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Gloomy macroeconomics may affect stock market’s goals, milestones

Pakistan’s stock market can manage to survive the political upheaval in the country. This is evident from the recent disqualification of prime minister Nawaz Sharif over the Panama Papers case by the Supreme Court. Following the ouster on July 28 of Sharif, the country’s stock market tumbled but after an initial fall in the same trading day, the market began to recover gradually. Actually, there are concerns on economic front. Dwindling foreign exchange reserves, rising foreign debt obligations and a sliding Pakistani rupee against the US dollar are the key concerns adversely affecting the market sentiments. The country witnessed a decrease in forex reserves by $3.9 billion between October and July 21 period, according to the State Bank of Pakistan (SBP). Rising costs of debt servicing could bring the rupee under pressure. The debt servicing during the last quarter of the last fiscal year was around $2 billion which may increase the annual debt servicing to a record $7 billion.

What is of paramount importance is the deterioration of macroeconomic indicators, which could prove a disaster for the market. This deterioration reveals structural problems in the country’s economy. Present government borrowed $25 billion in foreign loans in the past three years. The total level of public debt and liabilities has swollen to 75.9 percent of GDP in FY 2016 up from 72.2 percent in FY 2015 and likely to worsen in the next few years, according to the central bank. With the rising debt burden, declining exports and remittances from overseas workers, the country could face a severe balance of payment crisis in the near future. Given the drying up foreign remittances in the Kerb market, lower inflows and higher demands; the exchange companies in Pakistan are facing tough times due to dearth of dollars. With a widening trade deficit and low foreign direct investments, the country largely depends on its remittances to improve the balance of payment position.

Some observers believe that the country’s remittances have been stable for the last few years despite lower exports and FDI. The remittances declined after a restructuring of property valuations on sale and purchase of land throughout the country. Overseas Pakistanis were sending their hard earned money back to Pakistan for the purchase of property and earning a profit.

A low debt-to-GDP ratio indicates an economy that produces and sells goods and services sufficient to pay back debts without incurring further debt. The country’s poor debt-to-GDP ratio amply debunks that country’s economic managers have not been successful in initiating timely fiscal and monetary reforms to raise revenues.

Last year, the IMF painted a bleak picture of the country’s economy when it estimated that the country’s external debt obligations would surge to $70.2 billion by end of the last fiscal year. The IMF had also predicted that Pakistan’s debt-to-GDP ratio was all set to touch the 65 percent mark. The long-term solution to the country’s debt problem is to bring improvement in the export performance. In short term, the government avoid to borrow from the international lenders and take impressive measures to reduce the ever widening fiscal deficit.

The government and the central bank have repeatedly rejected the depreciation of the rupee in the last fiscal year, as the officials claimed that the economy of the country is stable and they will not allow any devaluation of the currency. The State Bank of Pakistan (SBP) is making every possible effort to reduce the gap between the interbank and Kerb market rates. In its effort, the central bank even exempted the exchange companies from surrendering 10 percent of dollars to the banking system against its exports of other foreign currencies.

PERFORMANCE OF STOCK MARKET

Last year, Pakistan’s reclassification from MSCI Frontier Market to Emerging Market could trigger a significant re-rating of the Pakistan Stock Exchange (PSX). The market was trading at a price/earnings ratio of 8.5x for fiscal year 2017 which was a 40 percent discount to MSCI EM PE of 14.1x. This discount is likely to attract foreign investors to Pakistan. It is, however, only the improvement in macro-economic indicators that will improve the investors’ confidence and form a strong case of market re-rating.

Last December, the Sale and Purchase Agreement (SPA) of 40 percent strategic equity stake of PSX with a Chinese consortium was signed. A Chinese-led consortium consisting of China Financial Futures Exchange, Shanghai Stock Exchange, Shenzhen Stock Exchange and two other firms, took a 40 percent stake in the business. Last month, a delegation from the Chinese-led consortium formally signed documents for the takeover of PSX with Pakistani authorities. The consortium had won by placing the highest bid of Rs28 per share for 320 million shares at the total price consideration of Rs8.96 billion ($85m) when the stake was put on the table in December. With the purchase of stake in PSX, the Chinese bourses are expected to help develop the latest technology and trading systems in the PSX.

Local observers believe that the partnership with the Chinese consortium would be crucial in bringing the governance and regulatory structure of the PSX on a par with global standards. Chinese investment in PSX will help broadening economic and financial collaboration between China and Pakistan and bring experience, technological assistance and new products in the country’s market.

The external sector’s stability depends on strong position of foreign exchange reserves, which will boost through foreign exchange receipts. The central bank’s reserves have started depleting due to a sudden spike in imports of heavy machinery under the $57 billion China-Pakistan Economic Corridor (CPEC) and growing obligations of debt servicing. The analysts do not foresee any major adjustment in the Pak Rupee in 2017 on the back of expected CPEC inflows, while the exchange companies are not ready to bring the US dollar’s rates down in open currency markets. Last year it witnessed stability in interbank rate, a 3 percent devaluation may not be ruled out this year.

The interest of the Chinese government and investors to launch various development and infrastructure projects in Pakistan has been supporting the positive sentiments in the stock market. This year, the PSX plans to launch infrastructure bonds which would mainly be used for the CPEC. Listing of infrastructure bonds are part of efforts to boost liquidity in the market and lure foreign investors, according to managing director of PSX. Experts believe that after Chinese investment, the capital market would sustain its position as one of the top performing market in Asia, and also advocate for strengthening the monitoring and enforcement regime by introducing structural reforms. However, a vibrant economy needs incentives and tax relief for local and foreign investors. China’s plan to invest $57 billion has further buoyed the sentiment in the market.

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