What to Do with Pakistan?
Douglas Clark Johnson
By Douglas Clark Johnson
December 31, 2010
I’ve been to Pakistan a dozen times over the years, most of them routine trips to speak with qualified investors and explore opportunities for inward capital. On one of those trips, I picked up a small souvenir from Sindh, a mirror-embellished elephant now sitting on my office table. It reminds me daily of the points of light this intriguing country is capable of producing, affirmed by my visit in early December.
The problem with Pakistan is that few internationalists take the time to understand the place. They tend to see it as some sort of evil twin to India. Pakistan actually constitutes a complex religious society of Sunnis and Shiites, with Ismailis and Ahmediyyas adding further dimension. Then there are myriad ethnic divisions, with the Pashtuns often being singled out in casual banter on national politics.
Despite its reputation, Pakistan may make sense now as both a direct and a portfolio investment opportunity. I consider it the definitive “information arbitrage” story among the world’s frontier markets. One of my rules of thumb is that the private sector is often most energetic in countries where the public sector is most challenged. After all, any corporate management capable of successfully running a commercial enterprise amid such noise is probably pretty good at what it does.
Pakistan has fit easily into this framework for some years. What makes the story timely now is the indirect stimulus impact of QE2. The headlines in a recent issue of Pakistan & Gulf Economist, a local news magazine, are worth noting:
-- “Corporate Invests $135 Million at Port Qasim”
-- “Reality is Not as Bleak as Being Painted”
-- “Attracting Foreign Investments in Balochistan”
The magazine also featured comments by the head of one commercial bank, focusing on fierce competition and the need for change. A fair assessment of publication content also takes note of other headlines, including “Foreign Investment Hit by War on Terror.” But my read is, this is a pretty good contrarian indicator. Certainly the Pakistani executives I met before the year-end holidays seemed to be savoring the potential, while acknowledging the detrimental effects of government corruption and social turmoil.
Pakistan is not for the faint-hearted. But there are material opportunities in the oil and gas, natural resources, textile, and agricultural sectors, given the decline in asset prices seen over the past two years. Foreign direct investment totaled more than $5 billion in 2006-07 and dropped to less than half that amount in the fiscal year ending June 2010. Yet relatively strong foreign direct inflows from the UAE (usually trailing just behind FDI numbers from the US and UK) may form a more definitive sign of expatriate confidence in the local economy. The UAE-sourced data presumably originates largely from non-resident Pakistanis or at least knowledgeable insiders. China has likewise made aggressive commitments in the past.
The US Federal Reserve Board is doing an admirable job of inflating the emerging economies of the world—rather better than the US economy itself, to date. I argue that this wall of money will soon hit dollarized frontier economies like Pakistan. The local Pakistani equity market may be ripe for further gains beyond those seen since the August floods. Given cheap valuation readings, investors may be willing to look beyond near-term concerns such lingering high interest rates and a weak government, aiming for strong medium-to-long-term gains. The expected release of the next IMF tranche in Q1 2011 could act as a trip switch for inward flows.
Investors in Pakistani shares will likely see validation of their commitments if foreign direct inflows improve as we expect over the year ahead. Operating somewhat below the radar of Western economic analysts, both the Saudis and the Chinese are set to lead the charge in project commitments, especially if progress is made on addressing political extremism. Arab and Asian businessmen may have a somewhat different view on country risk than do global pundits.
(c) Codexa Capital