Pakistan’s flagship KSE 100 Index has outperformed its Asian peers this year, having strengthened by over 20% since the start of the year alone. Leading financial institutions in the South Asian country, including Topline Securities and Arif Habib, expect the index to extend its gains by another 10% by the end of the year.
Part of the reason for this strong performance is that the stock market in Pakistan has long been undervalued. Political instability, very high rates of inflation, mountains of external debt to pay, a rapidly depreciating currency, and weak macroeconomic fundamentals largely deterred foreign investors from committing capital to Pakistani markets. These factors mean that Pakistani stocks are still cheap, with a one-year forward earnings-based valuation of 3.8x, 50% cheaper than its historical average.
However, in June 2023, Pakistan reached an agreement with the International Monetary Fund (IMF) worth $3 billion which has helped stabilise the macroeconomic situation in the country and encouraged investors to take a more bullish stance on the Pakistani stock market. In return for IMF funding to help Pakistan pay its debts and avoid defaulting, the Pakistani government was obliged to take measure towards “sustainable public finances, through a gradual fiscal consolidation based on reforms to broaden the tax base and remove exemptions, while increasing resources for critical development and social spending.”
These measures have helped boost investor confidence in the Pakistani economy, something which has fed into improving stock market prices. A A H Soomro, an investment and stock market professional based in Karachi, told Disruption Banking that “Pakistan’s stock market ascent is directly the result of extremely low valuation pricing when investors feared the worst-case scenario of economic default, hyperinflation, and currency crises. There was a lot of hopelessness until the country clinched a $3 billion standby agreement with the IMF last June.”
“Since then, the valuations are just returning to mean reversion with the price to earnings ratio (P/E) increasing from 3x to 4.5-4.8x today.”
Soomro is optimistic that this stock market rally could have further to run. For one, after an extended period of volatility, the Pakistani rupee has traded in a narrow range this year, giving investors the confidence to invest in rupee-denominated assets without fearing huge devaluations.
Furthermore, with inflation in Pakistan starting to ease – in August prices rose by a rate of 9.6% compared to 11.1% the previous month – the State Bank of Pakistan could soon be in a position to cut interest rates down from the current level of 19.5%. Lower rates tend to encourage higher stock market valuations because it becomes cheaper for individuals and business to access capital for investments in stocks and other assets.
Soomro noted that “Pakistan’s long-term mean P/E ratio is close to 8x and thus there remains a sufficient upside as well.”
“The next rally would be led by interest rate cuts from 19.5% currently to 13-14% in six months, as well as government privatisation measures and increasing tax revenues.”
It does certainly seem that there is considerable scope for the Pakistani stock market to make gains in the months and years ahead. “The country has tremendous potential as a “catch up story” – a frontier market with demand for products and services increasing as the population grows,” Soomro said.
“Listed sector stocks offer a strong combination of high-quality dividend yields, and private sector conglomerates and growth sectors that have consistently grown by double-digit percentage points in USD terms,” he added. “There are risks that remain, such as low GDP per capita growth, political instability, the geopolitical impact of US-China tensions, and the effects of high debt on economic growth. Nevertheless, the risk-reward ratio is fairly attractive.”
Author: Harry Clynch
#Pakistan #Asia #KSE100 #StockMarket #Rupee
