Hailey College of Banking & Finance Lahore

Nov 03 - 09, 2008

The high economic growth of Pakistan that started in 2000, interrupted in 2007-08, helped Pakistan stay in the group of countries experiencing booming stock markets, and even becoming one of the leaders among them in terms of high return under still reasonable risk. Indeed, the index of the major stock exchange in Pakistan, representing a weighted average price change of major traded stocks in Pakistan, grew significantly during the period. This was truly one of the best results all over the world.

After the short-lived but worldwide-spread Chinese crises erupted at the end of February 2007, most markets in the world quickly recovered and continued the rally. So did Pakistan, where KSE index quickly regained its lost levels for a very short period, except for the sharp interruption due to the explosive local political crisis. Indeed, when President Musharaf ordered the emergency, the KSE index plunged on November 3rd and while the stock market bulls in most other countries continued to enjoy the increasing trends, the local bulls were mostly confused. On one hand, they saw Pakistan continuing its impressive economic performance, which was even better than in most other countries and, on the other hand, political risk appeared to have increased dramatically, awakening the market bears eager to pull the market down.

All in all, the Pakistani market bears have been slowly but surely winning over the bulls since February 2008 and through almost all this period, lost more than 20 percent. But will this trend continue for long? Will the rally, disrupted by the political crisis resume and will the KSE break the 15000 point record again? The macroeconomic data released last week is certainly not favoring such a trend. The economy continues to lose its growth trend: real GDP grew about 5 percent year-on-year in July-Oct 2008, while the industrial output real growth is eroded due to no electricity. The official PKR/USD exchange rate has come down to (PKR 81/USD 1) while the interbank and street market exchange rates consistently feel some appreciation pressure-and all of this is despite the high political instability. Pakistan's total public debt and the planned budget deficit for 2008 are quite low relative to peer countries. Finally, inflation over July-Oct 2008 has also been reduced by 2.2 percent. Moreover, the decrease of CRR should eventually lead to a decrease in the Pakistani market interest rates, which should positively influence the Pakistani stock market. Overall, with such economic indicators, and given no severe negative shocks and timely resolution of the current political crisis, the current economic crisis ought to be resolved until the end of the year 2009 so should the Pakistani stock market. Yet, the next three months are likely to be an exception.

A closer look at the market suggests that the Pakistani bulls are getting tired and weaker-discouraged by the current political economic crisis prevailing in the country. Indeed, there is a well-known principle, based on evidence of a seasonal pattern in developed markets, which states: "Buy in low and go away!" It is related to a desire of many investors to fix their high returns over the year, before they go into the season in winter. This very pattern appears to have started working for Pakistan as well as the most active period in Pakistan's equity market history suggests. The exception was December 2007, but here the bulls were trying to conquer the grounds they should have got already back, had there been no political crisis. As for the coming June, the KSE index is likely to experience a slow down, and very likely some fall, while over the rest of the summer it is likely to remain relatively flat, preparing for the next rally. This doesn't mean that all shares would stall or fall, of course, some of them might rise, while others-where investors feel they overreacted to some positive news and prospects-will likely start falling, and so, on average, the growth of the KSE index over this coming summer is likely to be relatively flat, with a slight downward correction.

Overall, Pakistan has excellent potential for developing a strong and one of the most important stock markets in South Asia. Indeed, already now, Pakistan's equity market is has already performed with the biggest stock market among frontier markets in Europe and Asia by market capitalization (total stock market value of traded companies). Moreover, Pakistan has remained quite ahead of most markets in term of return, with a still reasonable level of risk. All of this success is despite the fact that the level of corporate governance at Pakistani enterprises, is still quite far from that in developed countries, that Pakistan is still far from finishing major economic reforms and that many companies are yet to make their initial public offerings (IPOs)-all of which creates good potential for further growth.

It is important to note that the key issue remaining in the Pakistani stock market is its relatively low liquidity, which would be the defining factor of its future development, including the likelihood that Pakistani companies choose to be listed in Pakistan rather than in other countries. The hope is that traded Pakistani companies would substantially improve their corporate governance practices; in particular transparency levels and the respect of minority shareholders, and this would attract more buyers. Another realistic hope is that millions of small individual investors, dissatisfied with the current political crisis and real estate investments, would place their funds into the Pakistani stock market, and the government will also provide about Rs. 50 Billion. All of these would help to improve liquidity problems and, most importantly, help Pakistan gain acceptance into the 'club' of emerging rather than the frontier markets. In turn this might lead to an inflow of funds from large institutional investors that diversify their portfolios among all emerging markets. This, in turn, would induce another stock market boom and, eventually, could make the Pakistani stock market become significant in South Asia...!