Table of Contents
- 1 Investment Thesis
- 2 Introduction
- 3 Correlation of Pakistan Stock market with PAK ETF
- 4 Correlation of Pakistan Stock market with the economy of Pakistan
- 5 How is the present economic growth different from the previous one?
- 6 Macro-economic Indicators
- 7 Positive developments indicating glistening future of the economy
- 8 ETF Performance
- 9 Downside Risk
- 10 Conclusion
Improving macro-economic indicators together with falling COVID-19 cases bode well for Global X MSCI Pakistan ETF (NYSEARCA: PAK). This upward trajectory in the economy is largely due to the reforms instituted by the incumbent government. Considering the current scenario coupled with other material events, PAK ETF is expected to perform better than its regional rivals.
Global X MSCI Pakistan ETF at the time of writing this article is trading at NAV of $27.87 per share with a Price-to-Earnings ratio of 8.82x and Price-to-Book Value ratio of 1.04x. In its recent performance, the ETF rose by 16.49 percent within the last three months.
Source: PAK ETF
Source: PAK ETF
On the risk side, the fund has the following risk stats:
Correlation of Pakistan Stock market with PAK ETF
As the above graph shows, this ETF has an extremely high correlation with the performance of the Pakistan Stock Market ((KSE-100 index)). The reason is that the major constituents of the KSE-100 index are also part of the holdings of this ETF. However, the breakdown in the correlation largely occurs due to foreign exchange movements.
Further, the following sectors are part of the KSE-100 index but they are not included in the holdings of PAK ETF.
- Telecommunications and Technology
- Food and Personal care products
The above sectors are not included because the companies that belong to these sectors have lower liquidity and market capitalization. Therefore, any activity or excitement in the share prices of the constituents of these sectors will also lower the correlation between the KSE-100 index and PAK ETF.
Correlation of Pakistan Stock market with the economy of Pakistan
Apart from the small percentage, the majority of the companies that are part of this ETF derive their demand from the economy of Pakistan. Therefore, the future movement and direction of the macro-economic indicators have a material impact on the performance of this ETF. That is why it is imperative to gauge the performance of this ETF in the context of the overall macro-economic conduct of Pakistan.
How is the present economic growth different from the previous one?
The twin deficit problem ((i.e. fiscal and current account deficits)) germinates from the investment-saving gap that exists in the economy. Although such a gap exists in all developing economies, these countries bridge it by facilitating foreign direct investment (FDI) into their economies. For that to happen, the government must introduce investment-friendly policies, espousing fair trade and transparency. Otherwise, these governments have to acquire debt financing in order to pay off their deficits.
Countries that do not possess a conducive environment for investment generally maintain a rent-seeking economy where the productivity is extremely low. Therefore, these countries do not have broad-based exports to finance growth in their current account deficit. So, the only way to spur up growth is to induce policies that result in import-based consumption growth in the economy. This was the typical case of Pakistan.
The country’s economy has rent-seeking characteristics and its productivity was the lowest in the region. Thus, every now and then, a government went to the IMF program to finance its current account deficit and hence had to implement demand suppression policies. Resultantly, the previous bubble of import-based consumption growth burst.
Debt financing is not sustainable as a country needs to repay its debts. The present growth is different as the incumbent government is focused on increasing productivity and exports for inclusive and sustainable economic growth in Pakistan.
The macro-economic situation of Pakistan has improved primarily due to the successful government efforts to curb the spread of the COVID-19 outbreak coupled with the implementation of various reforms. These measures have started to stimulate the economic activity and Asian Development Bank (ADB) in its latest report forecasted a 2 percent growth in the fiscal year 2021. This growth rate ought to be understood in the context of the prevailing global economic environment where a negative growth rate in an economy is a norm.
The perennial economic problem faced by Pakistan is its twin deficits (i.e., fiscal deficit and current account deficit). The present government is earnestly working to mitigate the current account deficit by undertaking the following steps:
- Export Finance Scheme (EFS): This is the short-term financing facility for exports of value-added products with an interest rate of 3 percent per annum. Thus, reducing the cost of short-term finance for the business.
- Long Term Financing Facility (LTFF) for Plant & Machinery: A long-term facility with a financing tenor up to 10 years including a grace period of 2 years. The interest rate applicable is up to 5 percent per annum. This scales down the capital expenditure needed to increase the exports of the business.
- Incentivizing the export sector by lowering their power and gas tariffs, thereby effectively reducing the cost of production. This is going to make Pakistani products more competitive in the international market.
- Increase in financing limit of PKR 190 billion under EFS and LTFF by State Bank of Pakistan (SBP) as more financing is needed for rising exports.
- Ease of doing reforms to increase foreign and domestic investment in an economy. It is to be noted that last year Pakistan jumped 28 spots to a global ranking of 108 from the previous year’s ranking of 136. Hence, the country was declared as among the world’s top 10 business climate improvers, according to the World Bank.
- The materialization of CPEC Special Economic Zones ((SEZs)) to boost exports and investment. Recently, the inauguration of Rashakai Special Economic Zone after Allama Iqbal Industrial City points towards the government’s resolve to build such an economic structure to boost exports in an economy.
- Introduction of Roshan Digital Account (RDA) to encourage overseas Pakistanis to open their digital current and saving accounts without any hassle. Through this measure, the government is expecting to fetch billions of dollars from overseas Pakistanis, thereby increasing its forex reserves.
Positive developments indicating glistening future of the economy
This section enumerates the signs that point towards the sanguine performance of Pakistan’s economy, which will eventually translate into a strong performance of PAK ETF. These indicators are as follows:
- Continuous rise in digital exports as the Pakistani IT sector benefited from better management of the COVID-19 situation by the government. The below graph shows a steady rise in exports despite the COVID-19 situation.
- Growth in Large Scale Manufacturing (LSM) also points towards the rising economic activity. The following graph shows the historical and present trends in the Large Scale Manufacturing Index (LSMI).
Source: Pakistan Bureau of Statistics (PBS)
- A decline in the inflation rate due to contraction in demand warranted a cut in the policy rate by the State Bank of Pakistan (SBP). Therefore, SBP has reduced its policy rate drastically from 13.5 percent to 7 percent since March 2020. In the latest monetary policy statement, the SBP has maintained its policy rate at 7 percent. I believe this policy rate will be maintained for an extended period.
- A large reduction in the policy rate in March 2020 triggered hot money worth $2.1 billion to leave Pakistan. However, I believe there was also a blessing in disguise as hot money increases the riskiness of the forex reserves of any country. It is to be noted that presently hot money is less than $800 million of the total forex reserves.
- A continued rise in liquid foreign exchange reserves. The below graph shows the rising foreign reserves due to the above-mentioned measures taken by the government.
The materials sector ((~15 percent of the ETF)) is expected to rise on the back of the following material events:
As the work on the above-mentioned projects has started, the demand for cement and steel products has started to accelerate.
The Financial Sector (~27 percent of the ETF) is expected to benefit from higher demand for its consumer finance products as the interest rates have reduced drastically by the SBP. Earlier, the investment portfolio of the financial institutions was largely concentrated in the government bonds (i.e. Pakistan Investment Bonds) garnering only a risk-free rate. However, the provision of consumer financing is expected to increase their net interest income.
The downside risks to my investment case are as follows:
- Pakistan’s inability to grow its productivity and exports.
- Sudden rise in oil prices.
- A surge in COVID-19 cases.
- Reduction in the growth rate of remittances.
- The adverse impact of climate change in the region.
- Political turmoil in the country.
Nearly all leading indicators of economic growth are positive for Pakistan; however, the downside risks to my bullish case remain. According to my valuation, this ETF is expected to give a 15 percent return over the year. However, interested investors are requested to consult that table below before making any investment decision. It is noteworthy to mention that Pakistan’s capital market is quite erratic for short-term equity investments. Therefore, it is recommended to have a long-term investment horizon to reap adequate returns.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.