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Analysis: Investor trust or investor greed?

Updated April 10, 2014

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- File Photo
- File Photo

Pakistan’s return to global debt markets on Wednesday after a gap of seven years is being described by the government as a sign of ‘improving confidence’ of international investors in its economic policies. Seriously? It’s hard to say anything at the moment because Pakistan’s successful comeback to the world’s capital markets to raise $2 billion in cash through the sale of the dual-tranche five- and 10-year notes has been made possible by many other factors, most importantly global investors’ greed for high-yield assets.

In an announcement, a finance ministry spokesman said the success of the transaction ‘highlights’ investors’ confidence in the recent changes in the country’s economic indicators, external finances and structural reforms undertaken by the 10-month-old government of Prime Minister Nawaz Sharif.

Indeed, the recent improvements in the economy, the IMF’s $6.7 billion bailout package and the ongoing peace talks with the Taliban have played a significant part in mitigating the fears of international investors in the past few months. It will still be naïve to ignore the global markets growing appetite for riskier but high-return instruments. And Pakistan offering a return of 7.25 per cent on its $1 billion of five-year note and 8.25pc on $1 billion of 10-year securities is the best they could ever hope for.

The existing benchmark five- and 10-year US Treasury rates are 558 basis points (bps) and 556bps below the return offered by Pakistan on its new debt. The rate differential between the US Treasury and the bonds maturing in 2016 ($500m), 2017 ($750m) and 2036 ($300m) sold by Islamabad in 2007, the last time it had tapped the world markets, was just around 250bps.

Even Sri Lanka that sold a $500m bond earlier this week had offered 5.12pc return on its notes, much below the highly lucrative offer made by Pakistan. Last January, Colombo had given 6pc on its first issue.

“It is the best time for Pakistan to re-enter international debt markets. The investors have for some time been desperate for high-yield instruments and, for that, are ready to invest in riskier regions if the return is good,” argued a Karachi-based bond market analyst, who refused to give his name because his firm is an affiliate of an American bank advising the government on the bond issues.

“Investors are looking for high yields and as long as we are in this kind of low-yield environment they will not hesitate to embrace greater risks that come with lending cash to countries like Pakistan. Even junk-rated African economies have successfully cashed in on the international hunger for higher yields.”

He was of the view that Sri Lanka was able to get a better deal because its economy was growing at an annual rate of 7pc and it had successfully eliminated the Tamil insurgency in 2009. “On the other hand, Pakistan is rated by Moody’s and S&P seven notches below investment grade — the lowest graded economy in Asia — and is facing difficulty in tackling militant violence and insurgencies in parts of the country. The higher rate is the premium that we must pay to generate investor interest to compensate for the risk they are taking by investing in our sovereign,” he concluded.

People like Farid Alam, chief executive officer of AKD Securities, however, don’t think Pakistan will lose much by offering such a staggering return on its bonds if the purpose is not just to raise cash — or to bolster its dwindling foreign exchange reserves — but also to “set a benchmark for foreign direct investors to assess the investment climate in the country”.

“While I agree that we are paying a very high return when compared to benchmark US Treasury rates, we should not forget that countries like Tanzania, Ghana and Zambia, which are 2/3 notches above us in investment grading, have paid an even higher-than-our price for raising cash from the international market,” said Alam.

He agreed that the government could have kept returns on its sovereigns lower had it decided against raising bulk of cash in one go. “But our finance minister has a very large appetite for cash whenever he can lay his hands on it. Still I feel we need to stabilise our currency and put ourselves on the radar of international investors for the success of forthcoming spectrum auction and disinvestment of state businesses in future. Besides, I think it will help us get a better price and reception when the government goes for issuing GDRs (global depository receipts) of companies like the UBL, OGDCL and PPL in international capital markets,” he said.

Alam is not alone in criticising the government move to raise such a large amount at such an expensive price. Many others agree with him. "I am happy that our bonds have received such a good response from the international market. Yet you know the returns offered on the cash are too high. If the government did not have any option but to price the notes high, it should have gone for a smaller — perhaps $500m — tranche. At the end of the day we have added to our debt liability and it will have to be paid off by people like you and me," an investment banker, who also refused to give his name, said.

Like him many fear the government's ability to repay the loan. "When you borrow money at such a staggering rate, you have got to invest it in projects that can yield higher returns to enable you to pay the interest but also return it on maturity," said Sayem Ali, economist for the Standard Chartered Bank. He agrees that the sale will put Pakistan back on the map and help attract much-required foreign direct investment in the country. "If the cash is raised to invest in productive activities like electricity generation, then it is good. But if the government plans to use it to build motorways, then it is bad and if it is used for youth business loans then nothing is worse than it," he argued.