Pakistan’s stock exchange seems to be performing very well and only last Friday broke all recent records by closing at more than the 53k index. Well, obviously good news overtly, but it would perhaps be good to know that what exactly is causing this buoyancy amidst some very challenging economic times? Interestingly, when one takes a deep dive to ascertain what are the main drivers for the current investors, one finds out that this surge can be broadly bracketed into mainly three categories where the flip side may not be as rosy as it appears on the surface. The first category deals on determining where exactly the capital is coming from and is it healthy for the economy? The answer gives a mixed bag news, some good and some bad. The main individual investors are the ones who are either exiting from real estate or wanting to diversify from mere interest bearing accounts – in order to reduce risk on their portfolios – and the other type of investors are largely institutional investors. For the former type, it is bad news for the economy, because this marks slowing down of real estate sector, which as we know has been one of the primary engines of growth and now faltering, in-turn also signalling headwinds for foreign remittances, since a significant portion of the funds sent home by the international Pakistani diaspora was being invested-in cum meant for this sector of the economy that is now not inspiring much confidence for the NRPs (non-resident Pakistanis). Also, it tells us that though the interest rates are at an all-time high, however, the taxation benchmarks on the interest earnings are flawed. The almost triple taxation (at source, on interest and again on interest beyond a certain threshold of interest income) is hurting the savers and beyond a certain point savings or parking money in Pakistan become uninteresting. Additionally, this causes another concern that while the savers may be de-dollarizing (after the government’s rightful crackdown on the money trade) the fruit is either being borne by Gold where prices are going up but funds become dormant or unproductive or being diverted to the un-documented sector where there is no taxation and therefore returns even higher. Either way, not a healthy sign. On the institutional side, we either see the financial institutions investing heavily, which again shows that instead of finding new avenues of investment, lending and growth, they are just investing in the existing stocks, driving them up, but in the process creating a bubble that could burst anytime sans some real and timely policy correction OR the institutions are largely indulging in buying in their own backyard for want of any better investment opportunities in the market. The fact that very little investment is coming from the long-term foreign investors (sustainable FDI) exacerbates the concern on the brewing bubble!
The second category reflects on precisely in which stocks is the capital finding its way? A dissection of the results here tells us that despite an economic slowdown and high inflation that is taking a very high toll on disposable incomes of average households, some corporates continue to churn out high profits and pay-outs. For example, taking a proxy of 8 leading listed food companies, we find that their growth pace has been much higher in recent quarters and the profits have been ballooning as well: Year-on-Year (YOY) trend shows that profits expanded by 69% and gross margins by almost 100 to 300 basis points. Correlating top line to CPI and food inflation, the food sector’s top line growth pace has also been much higher. Similarly, the FMCG sector has been no exception either where gross margins and operating margins, both expanded between 100 to 400 basis points YOY, leading to a +40% YOY growth, both in profits and EPS (earning per share) levels. Interestingly, these impressive YOY bottom-line expansions clocked-in despite an almost double YOY higher finance cost and approximately 38% higher tax expenses. Ironically, the flip side of all this good performance is that it comes about at the cost of the consumer and almost none of these companies were able to translate this growth where it matters the most: Volume Increases.
Meaning, not only does this imply that the market is shrinking and the companies are focused more on short-term rather than long-term, but also alarmingly that they could in fact be fuelling inflation instead of contributing to tame it. Dangerously, signalling that the competition in the market place may be eroding in-turn allowing these companies to reap artificial, albeit unsustainable results.
Finally, the third category relates to the very structure of the Pakistani Stock Exchange itself. The troubling aspect here is that not only the investment is going into limited and/or specific sectors cum companies, but also that the underlying base of the PSE is extremely narrow, meaning a very few number of stocks have a major influence or weightage on how the index behaves. Ironically a movement in either direction in less than 7 main stocks tends to mark in which way the index is going to go. This in itself is very dangerous, because essentially it means that if only a handful of these major stocks stutter, they can take down the entire market with them. Take for example the cases of the oil & gas sector or the major financial institutions, the main 5 banks, whose fortunes in their own right can determine the fate of the entire stock market. We all know how the financial institutions make their profits in Pakistan, representing an unhealthy case of sovereign lending in an environment that not only ensures them large spreads (profits) or bale-outs through capital injections to avoid the risk of default at the expense of taxpayers money. Needless, to say that with the government of Pakistan being the principal borrower (almost 80-85% in certain cases) and as the national domestic debt gets to be increasingly unsustainable, these banks not only become a tool in the vicious cycle of increasing lending limits to the state for its debt servicing, but also in the process become complicit in crowding out the private sector leading in-turn to an overall shift of the national capital from efficient to inefficient hands. So, just a matter of time that this shift, if unchecked, will not only burst the developing bubble, but will also end up having potentially very disastrous consequences for the future of Pakistan’s economy!