The Xenel Industries of Saudi Arabia, the second largest share-holder in Hub Power Company — Pakistan’s largest Independent Power Plant — last week sold its entire holding of 140 million shares and tiptoed out of the country carrying a bagful of $60 million.
As the company or the outgoing investor offered no explanation for the decision to call it quits, some nervous investors started to wonder if it could trigger an outflow of foreign portfolio investment (FPI). Most, however, believe it to be an isolated incident.
It is often said that the current net investment of $2.5 billion by foreign funds in the Pakistani stocks may be reckoned to be insignificant in the aggregate market capitalisation of a huge Rs3 trillion ($34 billion). Yet a market player insists: “The sentimental impact of the entry and exit of offshore investors is disproportionately enormous.”
The State Bank of Pakistan admitted as much, when it remarked in its recent report: “Though the volume of FPI is historically insignificant, the sharp movements in the flows (investment and disinvestment) in recent years can be seen as a source of stock market volatility.”
Fear of foreign investors flocking out has prompted many to see the offshore investor as a spoiler of the market. But cool-headed market participants point out that the overseas portfolio investment acts as engine of growth.
Mr Yasin Lakhani, a former KSE chairman, made an interesting observation in respect of the volatility created by the entry and exit of foreigner investors: “It is a necessary evil,” he said, and reminded that foreigners “flock to equity markets in search of value buying and not for the love of the country.” The veteran broker suggested the country to tap regional markets such as India for inflows. He said that under the umbrella of the South Asian Federation of Exchanges, the KSE enjoyed quite excellent relationship with the Dallal Street.
Over the years, there has been an undeniable FPI growth in capital markets in Pakistan. And many market experts say that the phenomenon is explainable. “It simply is a question of risk and rewards,” says a sitting director on the KSE Board. He mentions that the Pakistani stocks offer yield of nine per cent and are trading at the price-to-earnings multiple of six times.
“When compared to low yields and high valuations of regional market, foreigners’ interest in Pakistani stocks makes sense,” he says. “Historically over 10 to 15 years, the Pakistani stocks have traded at the forward price-to-earnings (p/e) ratio of 8.5 to nine times and the equities are now down to a multiple of six times, which means the downside is limited,” says an analyst.
Until early 1990s, the KSE was a small sleepy place with most stock brokers, having nothing more to show in assets except a one-room office; few rickety chairs, a table and a telephone set. The market would close down the business for the day even on the pretext of death or sickness of a senior broker!
But the Pakistan capital markets awakened to flood of activity when in 1992, the government threw open the doors of equity market for foreigners. The government allowed non-residents to invest and trade freely in the domestic equity market through the Special Convertible Rupee Account (SCRA), which they could open with any commercial bank in Pakistan.
In November 2007, the foreign investment in Pakistan was at its peak, which currently stands at $2.5 billion. Analysts estimate that of the current market float of $10 billion worth of stocks, a quarter of the free float should be in the hands of overseas investors. The foreign funds do not, however, invest across the board, as 70 per cent of their investment has gone in 10 top scrips.
The year 2008 saw equity markets in turmoil all over the world. The SBP noted in its report: “Though most of the emerging markets have experienced reversal in FPI inflows as the global financial crisis unfolded in 2008, the impact of financial markets’ turmoil on foreign equity flows in Pakistan has been negligible. Nevertheless, the country recorded net FPI outflows of $142.9 million in FY08, after registering an average net FPI inflow of $606.5 million in the last two years”.
Many market participants say that foreign investors value international ratings in allocating funds to the emerging and frontier markets. The international rating agencies are still determined to let Pakistan sit among the “Frontier markets,” where it was relegated from the “Emerging markets,” following the close of the exit door in 2008 for 105 days by the market regulators - now admitted by all as an act of insanity.
Going forward, market participants say there is hope. Warren Buffett, world’s second richest man and the top investment guru, whose company Berkshire Hathaway stock is quoted at around 112,000 a piece — the most expensive stock in the world, said recently he liked India, China, Brazil, UK and Germany.
As an afterthought he added Pakistan to his list, explaining that the country’s energy sector offered great opportunity. “But in all that, there is one disconcerting point,” says a major market participant: The pressure on the rupee. The stock broker said that some of his old foreign clients were reluctant to seek entry into the equity market until they were sure of the stability of the currency. “No one putting his money in dollars wants to make an incalculable loss,” he says.
However, offshore investors are not exactly flooding the economy with money. Beyond portfolio, direct foreign flow (FDI) has continued to dwindle in the last three years. According to the Pakistan Economic Survey, the FDI stood at $5.2 billion in financial year 2008, which slipped to $3.7 billion a year later. The trend is continuing. “Flow of foreign money in FPI is an encouraging sign,” admits an economist. “But it is really the FDI which helps in creating jobs, reducing poverty and improving overall health of the economy,” he argues.