In the context of the Pakistan Stock Exchange (PSX), the 2021 federal budget was largely a non-event, barely pulling the trigger for the next rally.
Likewise, the second round of lockdowns, where authorities have started sealing entire neighborhoods in large cities, will keep investors in check, but Dubai-based portfolio manager Matthew Vogel thinks Pakistani equities will outperform in post-COVID scenario.
“The consensus among investors is that COVID-19 will overwhelm frontier emerging markets, causing immense economic fallout from a collapse in both domestic and external demand. We think another scenario is more likely: that such markets will outperform,” Vogel wrote in an opinion piece for Financial Times on Wednesday.
Referring to Morgan Stanley Capital International Frontier Emerging Markets index, which includes 34 countries including Pakistan, the asset manager said these markets usually suffer from domestic economic weaknesses as opposed to external (international factors).
Pakistan’s equity market has expanded at a compound annual growth rate of more than 11% (in dollar terms) since 1992. The last two decades have been the most impressive where the KSE-100 index, a gauge to measure the market’s performance, frequently gave more than 40% annual return.
“Pakistan equities average annual (dollar adjusted) returns are much higher than MSCI Emerging markets over various periods,” CEO Arif Habib Limited, Shah Ali Habib tweeted, noting KSE-100 gave an average 10-year return of 7.5% compared to 0.1% of the emerging markets during the same period.
However, second half of the outgoing decade has been a dismal story so far with three out of the last four years (2020 included) of negative returns. The government had to apply the brakes on economic growth in line with the conditions set under a $6 billion IMF bailout programme signed last July. After initial suffering, things started looking good. The current account deficit shrank 75% in the first nine months of the current fiscal year, inflation started slowing down, and the central bank cut interest rates–but the worse had yet to come.
Amid early signs of economic recovery, the COVID-19 contagion happened, bringing the already sluggish economy to a grinding halt for at least two months. After the country went into lockdown and chose trade suspensions, Pakistan’s exports fell sharply and remittances slowed.
At home, businesses were shut and factories closed, resulting in a significant dip in the government’s tax revenue. Pakistan’s economy has contracted for the first in 68 years with GDP growth recorded at -0.4% for the first nine months of the current fiscal year. From agriculture to industries and services, no sector met its growth target.
Production of major crops, including wheat, rice and cotton, fell short of the targets. Given the sector accounts for a fight of the GDP and employs half of Pakistan’s workforce, the recent locust invasion is going to make matters worse next year. Locusts have damaged wheat, pulses and vegetable crops in Sindh and can wipe out more than a third of the country’s major crops.
The industrial sector is expected to grow at -2.3% against an estimate of 2.3% as most of the targets within this sector were missed.
Pakistan has set a GDP growth target of 2.1% and market analysts are expecting the KSE-100 (currently hovering above 34,300 points) to test the 39,000-point level in a year. Vogel, the asset manager, argues that countries with sufficient levels of foreign exchange reserves and the backing of the IMF are better placed to bounce back.
“Even Egypt and Pakistan, both highly indebted and seemingly vulnerable, may outperform,” Vogel, said. “Both have reaffirmed their commitments to tax and civil service reforms and have maintained access to IMF programme funding.”
The Imran Khan-led PTI government secured an emergency loan of $1.4 billion from the Washington-based lender to fight the economic fallout of coronavirus pandemic. It also got a debt relief from the Group of 20 wealthy countries who have allowed the former upwards of $1 billion in delayed payments till December and may extend it by another six months.
In two years, the country had doubled its dollar reserves to more than $12 billion by reducing the current account deficit and attracting hot money through higher interest rates. However, the reserves fell sharply in recent weeks to $10 billion.
“Markets like Pakistan react more to domestic factors like politics and economy, but they are not completely insulated from international developments,” said Raza Jafri of Intermarket Securities, adding that falling exports and remittances will affect the current account, which can impact the currency. “For companies, it will affect earnings.”
Pakistani analysts have also pointed to the incentives given to the real estate sector in the federal budget, warning that investors may pull out of the equity market and park their money there to benefit from it.
However, Vogel says investors should not overlook ‘the considerable post-COVID potential’ of frontier emerging markets. “The reasons are straightforward: resilient government balance sheets, improving governance and promising growth trajectories,” he added.