FOREIGN INVESTMENT
MONEY FLOWING INTO LOCAL STOCK MARKETS

The market observed that FY05 was the first year of net capital inflows in local bourses when US$154million were invested in local equities

By HARIS ZAMIR
Nov 28 - Dec 04, 2005

After many years, we have witnessed interest by foreign fund mangers in local capital markets. The data released by SBP endorses this fact that money is flowing into the local stock markets from abroad. Though the foreign portfolio managers missed the bull run of last 3 years (2002-2004), in which the market gained 72 percent annually, it looks like that they are now serious in relatively cheaper Pakistan equities.

Foreigners that started looking to Pakistan in early nineties had a very bad experience in late 1990s when after the nuclear blast economic indicators deteriorated and restriction was imposed on capital outflow.

Foreign funds net inflow was US$2,530 million from FY92-00. Then local bourse saw net outflow of US$156 million between FY01-04. However, due to sharp economic recovery and stable political environment, the market observed that FY05 was the first year of net capital inflows in local bourses when US$154 million were invested in local equities.

Lately, the quantum of investment increased relatively sharp. In the last two quarters (Apr-Sep 2005) a net inflow of US$191 million is seen as per SBP numbers. In fact in little of over four months US$250 million investment was recorded while in September alone a record US$80 million net investment was made in equities by off shore investors.

Ali Hussain, research analyst from Investcapital Securities said that the sudden upsurge in foreign portfolio investment during the first four months of the fiscal year was strongly felt in the stock market as well.

The year-on-year rise in foreign portfolio investment (FPI) from $25 million to $216.3 million also made the KSE-100 index see the March 2005 levels once again.

However, foreign investment can prove to be risky in some circumstances. As has been witnessed in different developing economies, apart from increasing the volatility of local equity markets, the FPI itself can be quite volatile.

The reverse capital flight of the late 1990s from the Southeast Asian Markets is a recent memory. The KSE-100 itself traded gigantic PE multiples of above 20x in early 90s on the back of significant FPI. However, with the capital outflow in the following years, the market could not sustain such high levels. With the start of this fiscal year, the market is again inching up towards the PE multiple of 10x with sizeable foreign portfolio investment ushering in. The low savings rate in Pakistan (at 16 percent) as compared to the regional economies like India (at 24 percent) and China (at 46 percent) can also fail to provide funds' support should the foreign investment in equity markets fly back.

Faisal Shaji, research analyst at Capital One Equities said that Pakistan can be regarded as an emerging capital market, where returns for the shareholders have increased manifold. Some of the fundamental reasons behind the said aspect are the impending growth coming in some key sectors of the economy resulting in a sustainable growth target that can go in the vicinity of 6-7 % for FY06.

This aspect coupled with nearly 12 percent - 15 percent growth coming in the corporate earnings delineated an upsurge in the values of equities. In the coming period, these good returns from equities would also improve portfolio mix of the mutual funds in Pakistan.

This phenomenon can be gauged in the backdrop of lingering maturities coming in the form of NSS as well as provident funds of the corporates in the current financial year. From the viewpoint of the nascent mutual fund industry as well as the upcoming 23 to 24 funds expected to land in the market, one may easily sense the flow of the above-mentioned amount in these viable investment vehicles. In other words, 50% of that amount from pension funds would certainly be diverted to the stock market in the form of investment in mutual funds. As per our initial estimates this amount can be to the extent of US $ 2.5 billion (equivalent to Rs 150 billion), illustrating significant boost to the industry in the foreseeable period.

This phenomenon can also be seen in light of low rates offered by the commercial banks that range only up to 3% - 5% (weighted average deposit rates are less than 2%) whereas the present mutual funds can offer up to 15% return. Our hunch is that another foreign investment up to nearly US $400bn can come from the industrialized world in search of viable investment options in countries such as UAE, India & Pakistan. If let us say 10% to 15% comes to the Pakistani mutual fund industry then return can go beyond our estimated 15% albeit gradual rupee depreciation contributing another additional return to the foreign investors.

According to an analyst either it is portfolio investment or foreign direct investment it is always a concern for the government. It has been well described by a stock market player that "it took immense time to make a flock of birds nearby and one single shot could scare them for years". However, in the recent past the country's performance in attracting FDI has improved significantly, where the growth in last three years average around 48 percent per annum, which compares well with many countries in the region. This is a reflection of successful liberal regime to attract foreign investment, improved macroeconomic fundamentals, appropriate amendments in laws and regulations governing FDI, implementation of effective reforms to improve governance. This is reflected in the country's improved competitiveness ranking from 91 in 2004 to 83 in 2005, according to Global Competitiveness Report 2005-06, prepared by World Economic Forum. Nonetheless, it is worth noting that country's ranking in terms of attracting FDI is still quite low, and therefore Pakistan has still a lot to do, in order to improve the domestic business environment.

Similarly, the watchdog-Securities Exchange Commission of Pakistan and front liner-the Karachi Stock Exchange should speedily introduce such measures, which could help curb speculation in the stock market. Because in the past we have witnessed that several companies shares got haywire without any fundamentals trapping the small investors, resulting in devastation at the local bourses. Such incidents would deter foreign investment and despite having cheap profit to earning rations, overseas fund managers found stock market a dangerous living being and parked their funds in less lucrative markets where at least smaller returns are secure. "So we need conducive, transparent and confidence building environment to assure sustainability and long term commitment for overseas fund managers, a dealer said.

Shahab Farooq, research analyst at First Capital Equities, said that foreign investment inflow slowed down in November as compared to previous months because several companies belonging to gas, oil, cement and banking sectors where most of the investment attracted have now reached their value and the index has crossed the psychological barrier of 9000 points.

Going forward, we believe foreign investment to remain subdued in stock market until index takes a technical correction and the corporate earnings seasons comes, Farooq said.