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Foreign investors have continued to seek an exit from the Pakistan stock market for the fourth year in a row. Foreign outflows in 2018 are already $522 million. Market strategists calculate that foreign portfolio investors hold around $4.7 billion in Pakistani equities at the moment, accounting for just 30 per cent of free-float market capitalisation. This represents a dip from $7.5bn of their equity investments in 2013.

Dr Khalid Mirza, chairman of the Policy Board at the Securities and Exchange Commission of Pakistan (SECP), asserts that the market is “10pc economics and 90pc psychology”. He says investor confidence grows when price discovery is right. Foreign investors enter markets that have no hang-ups, he says. He adds that the regulators should promote the market through the enforcement of a good regulatory framework.

The portfolio manager of an investment house that operates from London blames the longstanding uncertainty — political and economic — for the ruined investor sentiments. He says most foreign fund managers paint a bleak picture of the Pakistan economy because of the economic mess.

An incessant fall in the stock market signifies a loss of interest among investors

“There is no long-term economic plan and the conditions of the IMF package hang like the sword of Damocles over our heads.” He reckons that the economy matters and to reinforce his claim he refers to a famous quote by Bill Clinton. When the US economy was sluggish and market gurus were focusing on other matters, Mr Clinton said to the American public, “It’s the economy, stupid.”

The fund manager reckons that the incessant fall of the shares market, which has now started to witness dwindling volumes, signifies a loss of the investors’ interest. This means that the situation can get worse before it gets better. He estimates that the current foreign portfolio investment is $6bn, of which $1.6bn relates to portfolio investment while the rest consists of strategic holdings.

Any unlucky foreign fund manager who ventured into the Pakistan stock market in early 2018 or who lazily held on to his portfolio must already be on the road looking for a new job.

According to former general manager of the Pakistan Stock Exchange (PSX) Sani-e-Mehmood Khan, the PSX has provided a negative return of 6.63pc in 2018 year-to-date.

“According to Bloomberg, the year-to-date return on the dollar works out to a mouth-watering 26.33pc. A foreigner who invested $100 in the KSE-100 index on Jan 1 through SCRA lost 6.63pc due to the market meltdown. But that was not all. On the rupee value converted back to the dollar, his special rupee convertible account takes a crowning blow of 26.33pc.

“All that means that the foreign fund manager who invested $100 in Pakistan equities in January would be left with $68.38 now, eleven months later,” Mr Khan said.

The report titled “Pakistan Investment Strategy 2019” released last week by Arif Habib Ltd mentions that a big chunk of foreign selling was observed in the second half of the year on the back of a sharp currency movement, economic challenges and MSCI’s reallocation of blue-chip stocks — Lucky Cement and United Bank — to the small-cap index, resulting in a major outflow.

Sector-wise, commercial banks witnessed the highest foreign selling of $259m due to a decline in the profitability of big banks followed by exploration and production ($139m) as a consequence of the rupee’s devaluation and a steep decline in international oil prices.

Thanks to their scintillating growth, mutual funds and insurance companies have been able to absorb much of the foreign sell-off. But that is not going to last forever. Elixir Securities Head of Research and Business Development Hamad Aslam says it will be difficult for domestic institutional investors to absorb the liquidity drain in case foreign sell-off continues in 2019.

Even institutional investors in Pakistan opt for a short-term horizon when investing in the equity market. “While Pakistan stocks are cheap on cyclically adjusted price-to-earnings (PEs), the current valuations (unadjusted PEs) are still not enticing enough for them when they can easily make double-digit returns in fixed income markets,” he says.

The celebration of the upgrade to the emerging market by MSCI has died down as it eclipsed Pakistan equities with a paltry weight against around 8pc weight in the frontier market. But an equity strategist sees better times going forward: MSCI has already downgraded three of the six stocks that originally made their way into the MSCI emerging market index. “As market capitalisation and volumes continue to shrink, Pakistan may again be shifted back to the frontier market from the emerging market, which would provide it with a higher weight that could be seen by foreigners on their investment radar,” he said.

Mr Aslam offers optimism, saying that foreign outflows could significantly ease off in 2019 now that most of the overvaluation in the rupee has been adjusted and Pakistani equities have started to become cheap on the basis of cyclically-adjusted PE.

“In fact, it would not be surprising to see foreign investors turn net buyers next year. However, the key risk on that front would not be emitting from Pakistan’s economy, but from the interest rate lift-off in the United States and a potential global sell-off continuing from emerging markets,” he said.

Published in Dawn, The Business and Finance Weekly, December 17th, 2018