The next frontier
Source: REUTERS/Damir Sagolj
The Islamic Republic of Pakistan has a lot to offer investors as long as they have a measure of risk tolerance. The sovereign’s first bond in seven years drew a lot of demand in April, support that is likely to be repeated in another rare buying opportunity – a sukuk offering, Pakistan’s second in the format, expected later this year.
For equity investors, too, the government’s ambitious privatisation plan should provide some chances to own stakes in the country’s better-performing companies.
Yet, debt and equity investors are going to have to pay close attention to how well the country of 180m, under reform-minded Prime Minister Nawaz Sharif, maintains stability against recently escalating political opposition.
Protracted volatility would likely affect leaders’ ability to implement the reform platform the International Monetary Fund endorsed last year under the Extended Fund Facility. The three-year US$6.64bn aid package went into effect months after Pakistan elected Sharif to office in May.
“[A]ny loss of reform momentum could see the external support, on which the country depends, dwindle, straining its capacity to repay its debts,” said Anushka Shah, an analyst in the sovereign risk group at Moody’s, in an email. “From a creditworthiness perspective, remaining on track with EFF-prescribed reforms should help secure the next tranche of IMF funding, which is key to bolstering its external liquidity position and ensuring macroeconomic stability.”
The IMF praised Pakistan’s reforms in an August 18 release and said GDP growth for year ending June 30 2015 was expected to reach 4.3% versus a provisional estimate of 4.1%.
About a year after Sharif came to office in June 2013, the administration’s plans drew strong support from the credit markets. The sovereign saw its outstanding bonds trading at or near all-time lows this April and took the opportunity to lock in new debt at such low yields. Its US$2bn bond offering attracted US$7bn in demand.
The tranches of five and 10 years, of each US$1bn, priced to yield 7.25% and 8.25%, respectively. The yields are well below what market participants had expected for a Caa1/B– rated country with a series military coups and only one democratic transition marking its history since independence in 1947.
Also, threats are always looming that the government’s reforms will be derailed, sinking its junk credit rating even further. Since August, for example, there hade been regular violent protests in Islamabad, the capital, calling for the prime minister to resign on suspicion of electoral fraud, Reuters reported.
Elected politicians, however, will have to continue with reforms in the face of opposition if they want to keep investor support.
“There are big political risks, of course, but people know what’s happening on the ground in Pakistan, and there are companies still delivering the numbers.”
“Pakistan’s ability to drive structural reforms, despite resurgent political fractiousness, would be a key factor supporting its credit profile,” Shah said.
The government continues to press on. The Ministry of Finance recently hired Citigroup, Deutsche Bank, Dubai Islamic Bank and Standard Chartered to run the books on a US dollar sukuk offering.
If the financing goes according to plan, it is expected to capture the demand from investors for exposure to the country’s growth prospects, as well as those looking to capitalise on the recent surge in sukuk volume. The trade will follow recent sovereign Islamic bonds from Hong Kong, Luxembourg and South Africa in September.
Enticing equity investors
In addition, Pakistan is also enticing equity investors. The benchmark Karachi Stock Exchange 100 Index is also up 17.6% for the year to last Tuesday, when it was quoted at 30,109.5.
“Valuations are pretty cheap and, if you’re getting decent fundamentals, the risk/reward [ratio] makes sense,” said Ruchir Desai, senior investment analyst at Asia Frontier Capital. “There are big political risks, of course, but people know what’s happening on the ground in Pakistan, and there are companies still delivering the numbers.”
The government also intends to raise Rs198bn (US$1.93bn) through a privatisation programme, an important component of the IMF plan, in the fiscal year ending June 30 2015. It has a list of 65 state-owned enterprises in which it plans to sell stakes in the next five years.
In June, the government sold its 19.8% stake in United Bank for Rs38bn, its first capital markets divestment since 2007. Foreign investors, including Lazard, BlackRock and Morgan Stanley, bought almost 80% of the 241.9m shares offered. About a month later, the government sold a 5% stake in Pakistan Petroleum, raising Rs15bn from the sale of 70.1m shares in at Rs219 apiece.
At present, it is marketing 7.5% of state-owned Oil and Gas Development Corp for about US$816m. The government currently owns 74.97% of the company. Bookbuilding runs from October 9 to October 15 with pricing scheduled for October 16. Bank of America Merrill Lynch and Citigroup are the joint global co-ordinators and KASB is the domestic lead manager.
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