Pakistan's benchmark KSE-100 index's return showed a 15 percent growth in the dollar terms during the first half of 2016 (1H2016) to 37,784. Bulk of this gain of 14 percent (14 percent in USD) was seen in 2Q2016 due to what Saad Hashemi of Topline Securities said expectations of Pakistan's upgrade to Emerging Markets (EM) by MSCI.
The upgrade news met with exhilarating response from investors as the benchmark index gained 1,042 points or 2.7 percent on June 15 and subsequently closed at an all-time high of 38,776 on June 17. "The market has come off since then because of both profit-taking and also concerns of investors over Brexit and its possible implications for Pakistan economy," said the analyst.
Regionally, Pakistan has outperformed its Asian peers in terms of market performance. It outperformed Sri Lanka, which fell by 10 percent and also Bangladesh, which fell 3 percent (in US$ terms). Pakistan also outperformed Vietnam, which was up 10 percent. Further, MSCI Pakistan Index was up 10 percent while MSCI Frontier Market (FM) Index was down 3 percent.
Foreigners have been net sellers during the period. Foreigners net selling in 1H2016 was $41 million according to National Clearing Company Pakistan Limited (NCCPL) data. "However, if we exclude the one-time inflow of $70 million from the sale of Engro Fertiliser (EFERT) shares, this number would clock in at $111 million," he said.
Foreigners have been net sellers on monthly basis since July 2015, however, quantum in recent months has been on a declining trend with net buying in May 2016 ($3.6 million) and Jun 2016 ($74.1 million including one-time EFERT stake sale). This led the KSE100 index to rise by 20 percent since March 2016. "Volumes continued to remain dry during 1H2016," said Saad. Average daily volume in cash market was Rs 9.0 billion ($87 million) during the period. This compares unfavourably with average daily volume in 2015 of Rs 11.4 billion ($111 million).
Pakistan met all quantitative and qualitative criteria for up-gradation to MSCI EM. Further, MSCI viewed that in terms of quantitative criteria (market size and liquidity), Pakistan showed significant improvement during last few years. "This helped Pakistan to be reclassified to EM," he said.
The following 9 companies are to be included in MSCI EM: Oil & Gas Development (OGDC), Habib Bank (HBL), MCB Bank (MCB), United Bank (UBL), Lucky Cement (LUCK), Fauji Fertiliser (FFC), Engro Corporation (ENGRO), Hub-Power Co (HUBC) and Pakistan State Oil Co (PSO). The simulated MSCI Pakistan Investible Market Index (IMI) has 27 companies. Pakistan's weight in MSCI EM is expected at 0.2 percent. This is much smaller than Pakistan's weight in MSCI FM Index of 9.0 percent and MSCI FM Small Cap Index of 9.7 percent.
Although Pakistan's weight in EM is much smaller, funds tracking EM ($1.4-1.7tn) are much larger than funds tracking FM ($17-20 billion). "Our back of envelope calculations suggests gross inflow of $600 million by EM passive funds," said Saad. MSCI too views that flows in Pakistan market due to EM upgrade would most likely increase.
There has been some political noise at local front specifically after Panama Papers scandal with opposition parties having petitioned against Prime Minister Nawaz Sharif in the ECP. "We believe that the Government and its pro-growth policies will continue and that the Government will complete its elected term. The worse case scenario is a change of guard at the PM level, which also happened in the term of the previous govt," the analyst said.
Pakistan macroeconomic indicators continue to show improvement. A stable exchange rate, rising foreign exchange reserves, low current account deficit and low inflation rate are leading indicators for a better economic environment. Further, State Bank of Pakistan (SBP) cut the policy rate by 25 basis points in the outgoing quarter, contrary to market expectations, to 5.75 percent with chances of further 25 basis point cut likely during remainder of calendar year.
After the recent Brexit and its ensuing impact on both the United Kingdom (UK) and Europe, there are concerns on volatility in both international political and global economic affairs. "We view that negative impact emanating from global volatility will be comparatively less for Pakistan's economy as it is relatively insulated from global markets," he said.
This is because Pakistan's exports are only seven percent of the country's total Gross Domestic Product (GDP). International oil prices have increased by 33 percent (WTI at $49/barrel) during 1H2016. "Given that bulk of locally listed stocks are commodity plays, an uptick in commodity prices will likely result in better performance of Pakistan Market," the analyst said.
However, he said, since imports were around twice of exports, a sustained rise in commodity prices could have negative implications for the country's external accounts. Pakistan market PE of 8.8x is at 16 percent discount from MSCI FM PE of 10.5x. "We believe that Pakistan's potential inclusion in MSCI EM will be a key trigger which can take the local market's PE close to MSCI EM PE of 14.4x". Volatility in global markets, crude oil price trend and foreign activity will remain key risks for Pakistan's market. Other factors to look at are pace of economic recovery, currency devaluation and political scenario.
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