When the year-long wait for Pakistan’s graduation from frontier to emerging market approached, the stock exchange geared up for a surge in orders.
In theory, an upgrade by MSCI should have meant huge inflows of capital from index tracker funds, but when the day arrived, on June 1, the Karachi Stock Exchange 100 suffered an intra-day fall of more than 2,230 bps, as investors headed for the exit.
Some of the redemptions were down to foreign investors, who make up around 10% of daily turnover, but local institutions joined the rout.
Longer-term Pakistan watchers say that the worst may now be over.
‘For those with investments in Pakistan like ourselves, being upgraded resulted in higher prices for stocks we own and was good for our portfolios,’ Mark Mobius, executive chairman, Templeton Emerging Markets Group told Citywire Asia.
However, with Pakistan’s weighting in the emerging market index now just 0.5%, compared to 8% of the frontier markets index. ‘It may not get the attention that it deserves,’ he added.
Pakistan was part of the MSCI EM Index between 1994 and 2008. However, the temporary closure of the Karachi Stock Exchange in 2008 caused MSCI to remove it from the index.
There are a number of concerns still hanging over the country – not least the constant back beat of regional political insecurity – and a possible struggle at the top of its government is alarming in a country not known for smooth transitions of power.
The current prime minister, Nawaz Sharif, narrowly avoided being impeached on corruption charges, after information contained in the ‘Panama Papers’ leaks last year showed that three of his children owned offshore companies.
There are economic warning signs too. Pakistan’s current account deficit rose sharply by 205% year-on-year between July and April. A recent change to the capital gains tax has also rattled some investors. Earlier calculated based on the holding period of an asset, it now stands at a flat rate of 15%.
Foreign investors have been net sellers for some time, according to research by brokerage house Topline Research, which said that 2015 and 2016 saw net foreign outflows of $315 million and $338 million respectively, whereas year-to-date, foreigners have already sold $392 million.
‘Price adjustments have already happened and, of course, there will be corrections along the way. For index investors they will need to have that small weighting in Pakistan. For non-index investors, it will depend on their analysis of the companies and their prospects,’ said Mobius.
‘Pakistan is the most misunderstood market by foreign investors,’ said Thomas Hugger, CEO of Asia Frontier Capital. His AFC Asia Frontier Fund, which has a 26% exposure to Pakistan, made total returns of 155% in the country over the last three years.
Hugger is tapping infrastructure-related projects, textiles, construction and construction-related equipment, such as trucks. He is also looking at the potential uptick in direct investment resulting from the China-Pakistan Economic Corridor, and Beijing’s decision to invest $50 billion in infrastructure in Pakistan as part of the One Belt, One Road Initiative.
However, for Hugger, Pakistan doesn't deserve the emerging markets classification just yet.
‘MSCI looks more at technicals and ease of access for foreign investors. For us, the status of the economy is more important. From that point of view, Pakistan is still a frontier market.’