Why are foreigners buying and locals selling equities?
Off late Pakistan has been getting plenty of bad
macro press courtesy, fiscal indiscipline, higher
inflation and the power crisis. This looming crisis was
further aggravated with the havoc caused by the
recent floods, the worst ever in the past century. The
question that consequently arises is, whether
Pakistani macros are heading back to their pre-
Lehman crisis (or 2008 commodity super spike) state or not?
Our answer is ‘No’, but at the same time, we believe, macro
vulnerabilities are clearly advancing.
The aftermaths of the 2008 debacle had been; depleting
foreign reserves caused by a higher twin deficit and in turn,
higher inflation leading to substantial Rupee depreciation.
Relatively speaking, in the present, Pakistan’s reserves are
strengthening; the current account is under control led by
commodity price pass through and a stable real effective
exchange rate, and the global economic outlook is recovering
from its worst. This is also reflected from the recent growing
foreign interest in the local equity bourse, where foreigners
have invested around US$566mn in FY10, highest since the
record US$978mn worth of funds flowed into the KSE in
FY07.
Why are foreigners buying?
As stated in our research report- Foreigners regaining
position at the KSE; dated: 20 Sep 2010 - foreigners own
one-third of Pakistan’s equity free float and accounted for
32.86% of the total traded value at the bourse. The all time
high level of foreign ownership witnessed last was 28.22% in
November 2007. To us, the reasons behind the foreign
interest in 2007 and 2010 are entirely opposite:
2007: The economy was overheating, liquidity was abundant,
reserves were stabilizing and the global funds were in search
of better yields. Hence the preferred sector at that time was
Banking.
Sector of main interest: The banking scrips comprised over
31% of the KSE’s market pie.
2010: Stagflation is over and the economy is in recovery
mode, external discipline has been revived, food and fuel
subsides have been withdrawn, an economic reformation
process backed by the IMF is in place and more importantly,
the US has emerged as the strong ally. The higher external
support is a prime source of comfort for the foreigners this
time around.
Sector of main interest: Oil and Gas share has grown to 36%
of the KSE’s total market capitalization.
FY10 and FY07 comparison
(US$bn) FY10 FY07
Foreign inflows 0 .6 1.0
Inflation 11.7% 7.8%
GDP growth 4.1% 6.8%
Fiscal Deficit 6.3% 4.3%
C/A Deficit 3 .5 6.9
Reserves 16.8 15.6
Exchange Rate 85.5 60.4
Discount Rate 12.5% 9.5%
P/E (X) 8.5 13.2
Market Cap 3 2.0 66.5
Banking sector weight 23.0% 31.0%
Oil & Gas sector weight 36.0% 24.0%
Source: Economic Survey of Pakistan, SBP & JS Research
Why locals are sellers?
The lack of liquidity, non-availability of financing options, the
banks’ risk-averse attitude towards stock investors and
imposition of capital gain tax have been deterring local
participation. Add to that, the federal decision of keeping the
SBP Governor’s position vacant for 3 months, non
appointment of the SECP chairman and having had four
different finance ministers within a short span of 30 months.
And if that were not enough, the recent wide scale floods,
increasing price pressures and the persisting inter-corporate
debt have heavily weighed in on the minds of the locals
encouraging their selling spree.
What to look out for?
Key events to observe are the upcoming monetary policy,
imposition of new taxes under the category of flood
surcharges, foreign flows (from donors) and the blue print of
the interim budget.
Given the recent price pressures, we are not ruling out a
50bps discount rate hike, however, the SBP may restrain
itself in September as the impact of the last 50bps hike in
July is not yet fully transmitted.
The flood surcharges on income bear negatively on the
earning of the corporate sector and inflation’s state. The
GoP has proposed a 10% one–time surcharge on income,
in the Letter of Intent submitted to the IMF recently.
The key to enhancing liquidity and the revival of domestic
economy is foreign inflows. So far US$4.5bn worth of
international commitments have been received apart from
the household charity received from around the world.
The deficit story: initial impressions suggest a 6-7% deficit,
which is a negative from the market interest rate’s point of
view, but beneficial for the corporates, in the shape of a
higher demand for goods and services.
JSGCL
PSX -- Pakistan Stock Exchange formerly Karachi Stock Exchange