While the rally at the domestic bourses knows no end, with the benchmark KSE-100 index outperforming major global and emerging markets, giving out a return of 37.45 per cent in 2013 to date, Pakistani euro bonds listed on the Luxembourg stock exchange are doing equally good.
In the last four months, these bonds have surged by more than 10 per cent (excluding coupon payment), which places them amongst the best performing in emerging and frontier markets. During this period, yields on the bonds have declined by more than 300 basis points (bps).
After languishing at considerable discount for almost six years, the price of the bonds maturing in 2016 have now come closer to their par value of $100. Money managers believe it to be a revival of foreign investors’ interest in the Pakistani papers, due to their perception of the country’s improved risk dynamics.
“The rejuvenated interest in the Pakistani bonds is mainly triggered by the revival of investors’ confidence in the economy, and its ability to pay back the principal in time, as the new government, widely labelled as ‘business friendly,’ has come into power,” says Zeeshan Afzal, an analyst who tracks the bonds for Topline Securities.
At the moment, there are three Pakistani’ bond issues that are outstanding. In 2006, Pakistan had raised $500 million from 10-year paper, and another $300 million from 30-year paper. Following those issues, in 2007, the country raised $750 million from 10-year paper. All through those years, the yields on the papers remained extremely volatile, in line with the inherent issues of political instability, fiscal imbalances, low foreign exchange reserves and terrorism.
“In October-December 2008, Pakistan came near default due to these factors, which caused yields to spike to as high as 24 per cent,” said a broker. That incidentally was also the period when the local equity markets had hit the pit. In order to stem the rot, corporate regulators had closed the exit door, putting the infamous ‘floor’ under stocks’ fall.
Nothing could have been worse for shaking foreign investors’ confidence. They raised questions not only about the ‘badla’ system of leverage, but also on the regulators’ attempt to ditch the foreign investors when things went bad.
Earlier this year, investors were uncertain over the fundamentals that underlined the Pakistani bonds maturing in 2016 and 2017. With uncertainty in the air regarding Pakistani politics, fiscal imbalances and the country’s dwindling foreign exchange reserves, the bonds were briskly traded, as no one was willing to hold on to them for long; most thought it prudent to wait until the atmosphere cleared up, giving a clear view of things ahead. As a result, the yields gained momentum and spiked from nine to 9.5 per cent at the beginning of this calendar year, and touched as high as 11.5 per cent by the end of March.
However, with improved investor perception about Pakistan’s election process and the smooth transition of power from one government to the other, yields on the bonds maturing in 2016 and 2017 have declined by 300 and 400bps, respectively, in the last four months.
“Due to rising demand for Pakistani paper, yields have now dropped to about seven per cent, thanks to a clear majority won by the business friendly Sharif’s PML-N,” said this broker. He observed that in a brief span of 10 weeks, the new government has struck a deal with the IMF, resolved the Rs503 billion circular debt issue, and approved a tax-laden federal budget 2013-14. All of this has encouraged foreign institutional investors to allocate larger sums for the equity market, as well as take a harder look at the long since laggard, Pakistani dollar bonds.
Money managers believe that the government should seize this opportunity and tap the international market to raise the budgeted $500 million from sovereign bonds. The new government should capitalise on its ‘business friendly’ reputation so long as it lasts, and issue Global Depository Receipts (GDRs) of state-owned companies.
This is also the right time to launch an aggressive privatisation drive. Foreign investors’ risk appetite for Pakistan, as is evident from falling bond yields, could channel much-needed foreign investment into the country at favorable rates.
With the country’s changed dynamics, there is also a possibility of a change in outlook from credit rating agencies. Currently, Standard & Poor’s (S&P) has assigned a rating of B-/B to Pakistan, with a stable outlook. The new government’s fiscal and energy sector reforms have the potential to improve Pakistan’s sovereign rating outlook, which should further boost overseas investors’ confidence in the country.
“However, as all good things come to an end, the government should speed up the process of attracting foreign exchange through the issue of papers and sale of assets before foreign fund managers start looking the other way,” cautioned a pragmatist.