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Jumbo Chinese Investment to Fuel Up Pakistan

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China’s move to invest a whopping $45 billion in Pakistan is huge news for a country that many investors, foreign direct as well as portfolio, have been reluctant to approach over the past few years.

The $45 billion is likely to be a major game changer for the country into which FDI flows had dwindled to very low levels, said Caglar Somek, partner and global portfolio manager at frontier market investor Caravel Management, even as it is clearly a strategic move on the past of China, which in addition to signing a slew of agreements for trade, energy and investment projects, views Pakistan “as a gateway from South Asia to the Middle East and Europe.”

“For Pakistan, which hasn’t been able to attract a great deal of investment because of security concerns and other reasons, this is going to be an enormous benefit,” Somek said.

China has long been an investor in Pakistan, of course, but the relationship has strengthened notably since the election of Nawaz Sharif in 2013, said Matthew Vogel, Dubai-based head of frontier and emerging market strategy at Duet Group, a $6 billion alternative asset management firm.

Last week’s visit by the Chinese premier’s to Pakistan has upped the official ante and this should increase investor awareness of Pakistan. But even if politics and security issues have clouded Pakistan’s potential as an investment destination in the past, the Pakistani stock market was one of the top performing equity markets in the world last year, Vogel said, returning 33% in dollar terms, and foreign investment flows are increasing.

“Pakistan is a large part of the index and it is tougher and tougher for investors to ignore,” he said. “Even without the longer-term benefits of the Chinese investment, the economy is in a sweet spot right now.”

Improved economic performance under an International Monetary Fund (IMF) program, lower oil prices, greater financial and political commitment from Saudi Arabia and China, as well as increasing domestic business and consumer confidence have all been helping Pakistan. China’s commitment to the energy sector is a huge boost, too, since energy has been Pakistan’s Achilles Heel—a major bottleneck to business success, Vogel said, and a major focal point for the IMF, too.

Now that investors see that China is willing to invest billions into the Pakistani energy sector, they’ll pay greater attention to Pakistan, he said, “and an outlook that I’d say is already optimistic will become even more optimistic.”

The Sharif government is also market-friendly, Somek said, and “even in his previous tenure, Sharif was for privatization because he comes from a business background and he’s liked by market participants. His ministers are in New York quite often and are willing to meet with investors like us.”

Historically, Pakistan’s market has traded at very low price-to-earnings ratio compared to its peers, Vogel said. That’s partly due to country risk, he said, but it means that “investors who entered the market early would have limited downside, and even marginal improvements would yield positive returns.  This was the situation at the time Nawaz Sharif entered office and immediately negotiated an IMF program.”

Because of his early involvement in Pakistan, Vogel has been able to invest in a number of well-run companies in the financial, energy and pharmaceutical sectors, among others.

“We’ve been able to pinpoint some of them because we spend time with management, with suppliers clients, competitors and so on, and because we are really focused on corporate governance standards,” he said. “Pakistan has a surprisingly deep and sophisticated domestic investor base, which by most standards, could be considered as peer to more advanced emerging market countries.”

Pakistan actually was an emerging, as opposed to a frontier market, some years ago, and as such “it has more depth and liquidity than a typical frontier market country, as well as large and dominant franchises that are well run in terms of talking to investors, keeping things transparent and knowing where investors are coming from,” Somek said.

All the same, when it comes to Pakistan, many investors are still nervous. Like Peter Kohli, CEO of DMS Funds, they recall the 2008 Karachi stock exchange crisis, when the index—which had climbed to an all-time high—suddenly plunged by more than 50% in four months, prompting authorities to fix a floor below it, and trapping many investors, foreigners included.

“That is a very bad memory for many foreign investors and they don’t want to go back into the Pakistani market,” Kohli said. “Although things have improved in Pakistan and it has potential, there’s a long way to go still, particularly in terms of security and stability.”