Pakistan points in the right direction

By Eric Ellis

The staging of a cricket final in Lahore earlier this year said as much about how Pakistan is faring as the recent rash of upbeat economic data coming from this injured nation.

On March 5, 25,000 cricket fans filled Gaddafi stadium, the country’s biggest sports venue, to watch the final of the Pakistan super league T20 competition.

It was a cathartic occasion for Pakistanis to rally around. At this same venue in 2009, eight people were killed when terrorists attacked the touring Sri Lankan national team. Save a short visit by Zimbabwe’s cricketers in 2015, which was also attacked, Pakistan has been too dangerous a place for international sport ever since.

And for much else too, including foreign investment and International Monetary Fund inspections. The fund’s advisors have nursed a stricken economy that was in their intensive care ward from 2013 until September 2016. Painfully for Pakistanis, the super league’s two seasons had to be held in the United Arab Emirates, along with the national team’s home fixtures, and the IMF consultations too.

So it was a risk to play the super league final on home soil, admits Nauman Dar, chief executive of the country’s biggest bank HBL, which sponsors the league. “But one we felt secure enough to take.” Spicing the mix, the match was between teams from Quetta and Peshawar, the two no-go zones mostly responsible for Pakistan’s toxic reputation, which helped explain the 15,000 police and army personnel mobilized to secure the stadium.

The sell-out match went off without incident. Peshawar easily won the game, but Dar saíys it was Pakistan that won the day. 

So is Pakistan back on the radar? Clearly that’s going to take more than the one-off filling of a heavily secured sports stadium, but Pakistan is certainly trending better than it has for years. And bankers have noticed that on their term sheets and bottom lines.

“The numbers speak for themselves,” says Nadir Rahman, chief executive of investment bank BMA Capital, as he ticks off Pakistan’s improving key indicators. 

“CPI has come down dramatically, exchange reserves are well up, GDP growth is 5.5% and overall purchasing power has increased,” he says. “There’s increased sales of motorcycles, up by 25% in the last two years, car sales are up between 18% and 20%, and durable goods even more. Energy consumption is up 20% per annum, and volumes are booming on the cement, steel and construction side.”

A recent survey from Euromonitor International showed Pakistani disposable income had doubled in six years, while local consumer spending over the same period had risen 83%, against 49% in wider Asia.

Rahman could also have mentioned that Pakistan’s stock market was Asia’s best performer last year with a 52% rise. And that Pakistan stocks are soon to be reclassified by the influential MSCI index from enter-at-own-risk frontier market status to the more investor-friendly emerging market basket, while six PSX-listed firms are to be added to the FTSE’s Global Equity Asia Pacific index.

Pakistan’s bank sector is also in rude health after several buoyant years, according to the State Bank of Pakistan (SBP), the country’s central bank.

For the sector as a whole, pre-tax profit jumped 52% in 2014 and a further 28% in 2015, but declined 4.6% last year as the industry began to feel the impact of the continued downward pressure on interest rates. The SBP said Pakistani banks “recorded a reasonable performance” for the year, given that 31 were profitable and just three made a loss.

HBL’s Dar agrees. “We had a very strong year because we were able to overcome the squeeze of interest rates through significant growth of our low-cost funding,” Dar says.

HBL reported a profit of PRs34.2 billion ($326 million) in 2016, down 2.5% from the previous year when, Dar says, numbers were boosted by a series of capital gains. “If you were to normalize results, we had a 10% increase in 2016,” he says. HBL’s fee income was also helped by snaring a quarter of the $20 billion in remittances sent home by the Pakistani diaspora last year.

“We are all feeling the pinch from the spreads that have been narrowed,” says Shazad Dada, chief executive of Standard Chartered Pakistan, the country’s sixth-largest bank. Standard Chartered Pakistan posted a taxed profit of PRs9.61 billion ($92 million) in 2016, slightly up on the previous year’s PRs9.28 billion ($89 million), a performance described by Dada as resilient.

With revenues from interest rates being squeezed, Dada says he focused on bringing down the cost of deposits, which he claims is the lowest of all banks operating in Pakistan at between 2.4% and 2.45%.

Pakistan’s biggest Islamic bank Meezan, which bought HSBC’s Pakistan franchise in 2014, was one of the more profitable of those 31 banks cited by the SBP as making money in 2016. 

“Our volumes have gone up dramatically,” CEO Irfan Siddiqui says. “We’ve got a strong consumer and SME franchise but the biggest portion of the book is the corporate sector,” he adds, citing big multinational clients such as consumer products giants Unilever and Nestle.

Meezan is currently ranked eighth, but Siddiqui says he’s aiming for a position in the top five within five years. Meezan taxed profit rose 11% to PRs5.5 billion ($53 million) in 2016, and deposits increased 20% despite the historically low interest rates and sharper competition.

Meezan’s NPLs, Siddiqui points out, stand at just 2.14% of his loan book, thanks to tighter scrutiny and major recoveries in 2016. “Pakistan is poised for a solid period of growth,” Siddiqui says.

International investors are starting to notice Pakistan’s recuperation. After October roadshows in Dubai, London and New York, Standard Chartered, Citi and Deutsche Bank led Pakistan into the sovereign sukuk market for the first time since 2014, raising $1 billion in a deal that coincided with Pakistan leaving the IMF ward. 

StanChart’s Dada says the markets were difficult but the issue got away five times oversubscribed. “We’ve been able to capitalize on our unique global-local positioning here,” he says.

Inevitably, Pakistan has found its way into the latest Bric-inspired investment acronym – Varp – joining Vietnam, Argentina and Romania in the rosy view of Tim Love, London-based Global Asset Management’s emerging markets specialist. Love admits that Varp won’t drive the global economy, as was anticipated with the thrusting Bric nations, but “the Varp economies are characterized by strong economic growth, all within the 3% to 6% range, with a young demographic of workers keen to spend money.”

And then there’s the Colombia comparison, cited repeatedly during Asiamoney’s series of conversations with prominent Pakistani bankers, referring to that Latin American nation’s redemption from a war- and terror-ridden narco-state to international investment darling.

However, that’s premature, as the attack by Islamic State on a Sufi shrine near Karachi in February proved a tragic reminder, killing 88 people in one of eight bombings over five days across Pakistan.

As an IMF inspection team cancelled a routine visit to Islamabad citing security concerns again, prominent economist Anjum Altaf of the Lahore-based Consortium for Development Policy Research questioned turning the cricket final into some sort of national watershed.

“How is spending hundreds of thousands of dollars to bribe a handful of foreigners to play a game in a nuclear bunker convincing proof that the country is back to normal?” he wrote in Dawn, the respected Pakistani daily newspaper. “This is self-delusion carried to absurdity.” 

Altaf also took aim at the widespread conventional wisdom, articulated by bankers, tycoons and state officials alike, that Pakistan’s economy is turning because of its newly monied middle class.

In another column, this time in Karachi’s Express Tribune headlined Economic Bullshit, Altaf wrote “yes, of course, more cement and steel is being purchased but is it consumption per capita that is going up or simply a reflection that the population of Pakistan has sky rocketed from 61 million in 1971 to 200 million today.”

“Just keeping up with the additional needs – food, clothing, houses, schools, colleges, hospitals, roads, electricity etc – means that commodity sales would increase,” he wrote. “And yes, many companies providing these commodities are profitable. But does one see foreign investment rushing into new projects?”

Altaf is also unimpressed by the buzz around the much-hyped $56 billion China-Pakistan Economic Corridor (CPEC) plan to transform Pakistani infrastructure with Chinese backing.

“Even the Chinese have to be guaranteed exorbitant returns to be tempted. I fail to understand,” Altaf writes, “how announcing that a permanent force of 15,000 military personnel needs to be deployed to protect a trade corridor would reassure investors that the country is safe for business.”

Pakistan has only just emerged from three years under the IMF’s wing, after an acute balance of payments crisis in 2013 forced Islamabad to take a $6.6 billion emergency loan from the fund, in return for tighter fiscal discipline, a privatization programme and greater independence for the central bank.

This problematic nation has experienced these supposed watershed moments of reform and liberalization before, though they ultimately proved to be more a brief trickle than a fundamental cleansing. In the mid-2000s, Pakistan boomed under military leader Pervez Musharraf and his reformist finance minister cum prime minister, former Citibank luminary Shaukat Aziz, as billions in international aid flowed in to support this reluctant front line in the post-9/11 War on Terror being waged next door in Afghanistan.

But this time it’s different, says an upbeat Rahman of BMA Capital. “Now it’s investor-driven, it’s much more fundamental, it’s time to catch up,” he says.

In an interview last October with Euromoney, central bank governor Ashraf Wathra said he was confident Pakistan now had the wherewithal to go it alone outside IMF care. He cited the near $24 billion he then commanded in available foreign reserves, almost eight times the $3 billion when he took over the SBP in 2014. Wathra said Pakistan was now primed for a sustained expansion phase.

In building reserves, Wathra’s job at the SBP has been made easier by a series of IMF-demanded state asset sales. Finance minister Ishaq Dar told the Pakistan senate in February that the state had raised around $1.7 billion from asset sales since 2013, notably the government’s minority stakes in banking giants United Bank Limited, HBL and Allied Bank.

That’s clearly helped boost national coffers but so has an oil price which had fallen from $110 per barrel when Pakistan embraced the IMF’s emergency funding in 2013, to a low of around $29 in February last year.

Wathra’s steady accumulation of reserves has since tapered off, as the privatization programme stalled and the oil price crept above $50. In early March this year, the SBP reported reserves of just over $22 billion, a number that reminded economists of the IMF’s warning, soon after Pakistan left its care, that reserves “have not yet reached comfortable levels.”

As recently as March, Karachi-based broking house Topline Securities revised down its estimate for reserves at the end of 2016 to between $22 billion and $23 billion from its previous $25 billion-plus forecast, citing weaker-than-expected exports and higher imports.

BMA Capital’s Rahman says higher oil prices are a concern for the economy, but he’s more anxious about government delays in privatizing Pakistan’s vast and burdensome state-owned enterprises.

The IMF made the sale of some 68 state-owned companies a key plank of its support in 2013 in order to ease pressure on state budgets and streamline the economy, given that these enterprises collectively drain between $4 billion and $5 billion a year from state coffers. 

“Privatization is of immense importance,” says UBL president Wajahat Husain, describing the government’s $390 million sale in 2014 of its residual 20% of his own bank as a runaway success.

“I don’t think the will of the government to privatize can be challenged,” Husain says, diplomatically, “but the programme needs to be enhanced, and put into motion.” Husain says the steel sector and the state flag carrier Pakistan International Airlines (PIA) should be prioritized for sale. “One needs to make a call on both of these because they are a perpetual huge drain.”

The government’s reluctance to proceed with more asset sales has led to new tensions between Islamabad and the IMF. The government faces a relative dearth of buyers, as well as bitter opposition from militant unions at the state firms.

“It’s one area where the government really needs to get its act together,” BMA’s Rahman says. “Because of political expediency, the government doesn’t seem able to do that even though it was part of the IMF mandate.” Rahman cites the loss-making railway system, the state’s steel plants, the power grid and national water distribution utilities as being in dire need of turnaround. “These are a big problem for the fiscal accounts,” he says.

A proposal to sell off PIA was shelved last year after ugly clashes with police, a series of strikes that grounded flights, and mixed signals from the government. But in January, the chairman of Pakistan’s privatization commission, Muhammad Zubair, described 2017 as a “strong year for privatization” and pledged that PIA, Pakistan Steel Mills and the partially-privatized state oil company OGDCL would be sold by June this year. Analysts estimate those sales could fetch as much as $3 billion. 

Standard Chartered’s Dada says a continuation of the reform package would lift Pakistan’s GDP growth rate from 5.5% into a range of between 6% and 7%. “We are a perception-driven economy,” he says. “We don’t want execution to slow down because that will have a negative impact. If we don’t continue with reforms, this will be a short-term pickup.”

Pakistan banking’s heavyweights, widely regarded as the state-owned National Bank of Pakistan, and the private-sector quartet HBL, United Bank, MCB Bank and Allied Bank, tightened their dominance over the industry during 2016.

“The concentration of earnings has slightly increased as the share of top five banks in total profits has increased to 63.3% in 2016 from 61.5% in 2015,” noted the SBP. And that stranglehold by the top five looks likely to tighten further as MCB absorbs middle-ranking lossmaker NIB, which it agreed to buy from Singapore’s state-owned investment house Temasek in December.

The SBP has cautioned that with the sustained low interest rate regime extending into 2017 and beyond, bank profitability “may come under pressure.” However, that could be cushioned by what the SBP noted was “the highest quarterly growth in advances to the private sector in the last 10 years” in the last quarter of 2016. SBP said the capital adequacy ratio of Pakistani banks had slipped 16.17% with the rise in advances, but was “still well above the minimum required level of 10.65%.”

As for non-performing loans, now at an eight-year low of 10.1% in the 2016 December quarter, the SBP notes “the risk profile of the banking sector remains stable and its resilience to absorb certain shocks has stayed in a comfortable zone.”

Standard Chartered’s Dada attributes the low NPL levels to the improving economy as banks, keen to clean up loan portfolios, are more willing to cut deals with problem loans because revenues are rising elsewhere in the franchise.

Ratings agency Moody’s agrees. The profitability of Pakistan’s banks is strong, it says. “With an aggregate return on average assets of 1.3%, (the banking sector) compares well against emerging market peers.”

Customer deposits, which make up over 70% of total assets in the banking system, are expected to grow by between 12% and 15% during 2017, Moody’s says.

“Interest rates at multi-year lows and lower oil prices have been accompanied by rising domestic demand and strengthening business confidence – all factors that will support loan demand,” it says. “The government’s pro-business policies, a reflection of its commitment to improving the business climate, will also help lift credit growth.”

Moody’s forecasts GDP to expand 4.9% in calendar 2017, spurred in part by bank lending, which it forecasts will increase by between 12% and 14% during that time.

It also says the $55 billion CPEC programme will be a “major impetus to growth,” which will support manufacturing and construction activities. While CPEC projects will be financed predominantly outside Pakistan, their indirect impact, through a pickup in construction, trading, industrial and business activity in general, will create lending opportunities for the banks.

“Improved macroeconomic fundamentals and the government’s commitment to fiscal and economic reforms have also improved investor sentiment towards Pakistan,” Moody’s says.

However, the rating agency admits “downside risks to the economic recovery remain…owing to the threat of political instability, deterioration in domestic security, or disruption of the government’s reform agenda ahead of elections in 2018.” 

After all, this is Pakistan, and investors have been disappointed by false dawns before.