June 11, 2007	Monday	Jamadi-ul-Awwal 25, 1428

The inflow of foreign portfolio investment in the local equity market is much lower than in other regional markets, particularly in India. While the net inflow of foreign investment picked up sharply in fiscal 2005, the market was still driven by local liquidity.(see table).

But it looks different now with the foreign portfolio investment responsible for the current boom in the equity market. It played a key role in bringing KSE-100 index to the all time highs of 13000 levels. The investment of over $760 million may be very low compared to regional levels but it is about seven per cent of the market free float.

This number is coming close to the leverage allowed to the local investors through CFS funding which is capped at Rs55 billion (nearly $900 million) — the leverage needs of local market participants is up to 12000 index level.

The UK and the USA are the major source of portfolio investment inflows with their combined contribution of 95 per cent in the total investment in the current fiscal year. However, net outflow has been observed from UAE’s portfolio investments .whereas it has singly contributed up to 40 per cent of the total FDI.

The rising foreign investment in the regional markets have made them expensive and their valuations have touched record highs. The price to earning multiple (P/E) in India is 22 as compared to 12 in Pakistan. However, P/E multiple is a relative term and varies with the prevailing interest rates which, in case of Pakistan, are much higher as compared to India.

The discount rate in India is six per cent where as in Pakistan it is 9.5 per cent. But this factor is more important for local investors unlike foreign investors who compare their returns with the interest rates prevailing in their own country and hence on that basis returns and multiples of Pakistani stocks become lucrative. Another reason for this is that the banking sector has so far remained the centre of attraction for foreign funds and almost the entire sector has benefited enormously after the hike in the interest rates. Also, the excess money in developed markets is flowing towards in emerging markets.

The profits of the listed companies have also attracted foreign interests. Earnings of most of the listed companies have shown phenomenal growth and have mitigated the impact of interest cost on them.

A very important factor that can be a major impediment for the entry of foreign fund managers in any developing country is the exchange rate instability. In case of depreciation of national currency, return in hard currency declines. However, central bank governor and prime minister have made it clear that currency devaluation is not a viable option. Moreover, increasing FDI inflows and remittances have given strength to the currency despite higher current account deficit. This has added to the confidence of foreign investors.

Foreign funds have a very positive stance on Pakistan’s economy. Although they have also incorporated some political risks that can hurt the economy but the interest of these funds in local stocks is not shaken because of political situation and judicial crisis..

Whenever developing markets are driven by foreign funds, there is always a risk of investment outflow. Portfolio investment is the first to disappear at the first sign of any possible economic downturn. Quite often the outflow is caused by government’s decisions or political uncertainty. In December last year, Thailand government, in order to control currency appreciation announced to freeze 30 per cent of new foreign currency deposits for a year on funds earmarked for stocks and levy of 10 per cent penalty on funds withdrawn by foreign investors within an year.

The Thai market declined by 15 per cent in a single trading session and forced the government to take back the restrictions immediately. There is no such scenario for Pakistan. Capital gain tax exemption has been extended for another year.