Pakistan’s post-graduation corridor bumps

Gary Kleiman December 16, 2016 4:55 AM (UTC+8)
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Pakistan’s stock market, up 17% on the MSCI Index through November, has been frontier Asia’s pacesetter this year as it prepares to return to the core universe in the coming months and sell a 40% stake to a strategic buyer, with Chinese exchanges bidding in the context of the US$45 billion China-Pakistan Economic Corridor (CPEC).

Capitalization is currently US$80 billion and could reach US$100 billion in the medium term, according to bourse executives citing increased allocation from the index shift and recent successful completion of the 3-year US$6 billion IMF program. In November the Fund’s mission chief referred to a “glass half full” with energy sector cleanup, international reserves accumulation, and fiscal deficit reduction, but underscored the outstanding structural reform, privatization, and bank consolidation agendas which may require another arrangement, especially if Beijing’s US$25 billion in “early harvest” infrastructure and power projects are delayed.

The other leading official assistance providers have been the Gulf and the US, but the former has pulled back to concentrate on regional needs while President-elect Trump signaled no cash infusion despite a cordial phone call reported with Prime Minister Nawaz Sharif.

The Asian Development Bank estimates GDP growth for fiscal year 2016 through next March at 5.5% on solid domestic demand despite agricultural and export slippage. Consumer inflation was stable at over 4% in October, allowing the central bank to keep the 5.75% policy rate.

The 4% of GDP budget deficit should be met under a new responsibility law, although tax revenue remains meager at less than 13 percent of output. Public debt is high at 60% of GDP and a dedicated management strategy aims to cut it to 50% over the next decade, including through continued government borrowing limits from the central bank as its independence is bolstered. In external accounts the current account deficit is negligible despite a 20% trade gap surge on an annual basis through November, as oil import prices stay low and overseas remittances drop only slightly. Reserves now cover over four months’ imports and the currency appreciated over 15 percent during the 3-year Fund period.

Smaller banks await recapitalization, and deposit insurance is not yet operational as Basel III prudential standards are introduced by end-decade. Bad loans linger in the absence of recovery mechanisms and an updated insolvency code. The government has encouraged Islamic bank growth, at one-tenth of system assets, through tax rebates for sharia-compliant products, but capital ratios in the segment lag conventional competitors. Despite governance and commercial viability doubts, a state development bank has been launched which may again assume “quasi-fiscal” activity, the IMF warned in its September exit report.

Privatization plans have been stymied by “political opposition and strikes,” but airline and steel company minority stake sales and electricity generator initial public offerings through the stock exchange are in preparation, according to the Fund. Power sector arrears continue to mount through losses and poor collection as major tariff adjustments are postponed.

The World Bank’s Doing Business ranking dropped two spots to 138 out of 189 countries this year with falls in enterprise startup, credit access and cross-border trading. CPEC has drawn criticism from the local business community, which points out that a bilateral free trade agreement already generates a large Chinese surplus and that additional protection may be needed from the expected onslaught of cheap goods and financing.

The IMF predicts a capital inflow spike to 2% of GDP and elimination of energy and transport bottlenecks, but cautions that even with concessional terms, debt repayment alone will amount to 0.25% of GDP over time. Geopolitical ties are also a complication, as the Gwandar deep seaport just renovated with Chinese sponsorship as a “watershed” in Prime Minister Sharif’s description offers a ready navy outlet to the Arabian Sea.

In Sri Lanka, down 6% on the MSCI Index through November, the government had to turn to the IMF for a US$1.5 billion loan and sell an 80% share in the port for almost that sum after getting into debt trouble. Officials insisted the deal was commercial and dismissed similar strategic concerns, but it reminded investors of the potential pains in China’s One Belt campaign likely to trim South Asian market exposure.

Gary Kleiman
Pioneer and recognized expert in the field of global emerging economies and financial markets. Founder of first consulting firm dedicated to providing independent analysis and advice to public and private sector clients in 1987, and research coverage and firsthand experience covers 75 countries in all developing regions. Advisor on financial vulnerability issues, risk management, portfolio allocation, and financial sector and capital markets strategy and development.
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