Article by :
Rizwan Khan, ACCA
Global Private Equity, M&A, Investment and Strategy Advisor 19 articles
As the country moves towards a new Pakistan, there is news of hope, change, betterment and an improved government. What does this really mean and what are the challenges? The country stands at a population of 200 million where 39% of the population lives under the poverty line with limited access to basic needs such as clean water, education and quality healthcare. Where does Pakistan stand as an economy and where is it heading?
The recent performance as an economy shows a ray of light with China Pakistan Economic Corridor (CPEC), a rapidly growing GDP rate, however, the financial situation of the country is extremely dangerous. Pakistan is highly dependent on imports, under a huge debt, in a very unstable investment climate, a rising amount of total circular debt and we have a very weak performing currency. An actual improvement to the Pakistan environment should attract new investment, increase the currency strength and increase the quality of life for the poorest of Pakistanis first.
Some of the key challenges the country faces are poorly regulated financial institutions, weak investor confidence, and lack of ethical values in doing business deals, a dangerous financing methodology and a very difficult process of starting businesses. To understand the country’s condition a brief overview an analysis of important economic and financial factors that explore the plans which have been utilized in the Pakistan Economy are provided below.
The gross domestic product (GDP) is one of the key factors used to evaluate the condition of a country’s economy. The GDP shows the size of the economy. It shows the total dollar value of all goods and services produced over a specified period of time. To see how GDP is changing the GDP % change is examined to see how fast an economy is growing.
Pakistan experienced a growth rate of 5.7% in 2017 whereas India and Bangladesh had a growth rate of 7.1%. China had a growth rate of 6.7%. In respect to past years this was the highest GDP growth rate, however, Pakistan has a lot more potential for growth as an economy.
Pakistan’s GDP growth is inhibited by lack of power, infrastructure and education. To overcome these challenges Pakistan needs to invest in all three of these areas. Lack of power causes downtime for so many commercial activities which hurt productivity in big companies as well as small shops such as the local tailor. Infrastructure causes poor access to resources, logistics and quality support for building up new industrial or commercial areas. Lack of education leads to a shortage of qualified resources to start new businesses or even for joining a skilled workforce. Furthermore, an atmosphere with more educated people can lead to less crimes and more productivity as people can get together to create solutions to challenges in a society.
What if all that money in the political campaigns and buying and selling of parliamentary seats was focused on power, education and infrastructure?
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. This is a very important economic indicator for investment decision making. In short, CPI measures the inflation in an economy.
The annual variation rate of the CPI in Pakistan in July of 2018 was 5.8%, 6 tenths higher than the month before. Since September of 2014, It was the highest inflation rate, as cost went up faster for food & non-alcoholic beverages (3.5 percent vs 3.2 percent in May); housing & utilities (6 percent vs 5.6 percent); transport (15.7 percent vs 10.7 percent) and miscellaneous goods & services (7.4 percent vs 7.1 percent). Inflation of 1-2% is a good place to be and anything above 3% raises concerns for an economy. This all translates into a money losing power and more goods & services getting out of reach for the poor. This also shows that every rupee a Pakistani earns or any investment return to an investor is losing its value over time.
3. Balance of Payments/Current Account
This shows the difference of value between total payments to a country and total payments made by a country. A positive balance of payment shows strength in an economy showing that it can cover its cost of running.
Pakistan recorded a Current Account deficit of 5798 USD Million in the second quarter of 2018. Current Account in Pakistan averaged -638.55 USD Million from 1976 until 2018, reaching an all-time high of 1418 USD Million in the third quarter of 2002 and a record low of -5798 USD Million in the second quarter of 2018.
Pakistan does not generate enough income to cover its own expenses. As a nation Pakistan has been slow in the formation of new businesses and many companies consider their low price as a strategic edge. Many Pakistanis are out of Pakistan so they earn and keep their money elsewhere. Pakistan is used by many international IT firms and other companies to set up back offices here. This shifts their expense to Pakistan (which is lower due to lower salaries in Pakistan) and moves their profits to the origin of the country.
Pakistan carries many assets and sources of creating income. The country needs a framework where each of its interest of its deal is taken care of. Furthermore, an improvement in governance, polices and business friendliness Pakistan can attract Foreign Direct Investments that can increase inflow of payments to Pakistan. Foreign Direct Investment in Pakistan increased by 3434.90 USD Million in 2017. Foreign Direct Investment (FDI in Pakistan averaged 2807.85 USD Million from 2010 until 2017, reaching an all-time high of 3434.90 USD Million in 2017 and a record low of 2099.10 USD Million in 2012. Most of the increase is due to CPEC and some can be attributed to foreign buy outs of some firms. The country has potential to attract much more FDI.
4. Balance of Trade
The balance of trade shows the difference between imports and exports. For a country to have a positive balance it must export more compared to imports. A country with a strong buying power may manage to have more imports, however, a weak economy with a negative balance of trade shows a red flag. Pakistan is running a negative balance which is known as a trade deficit.
Pakistan trade deficit widened 65.8 percent year-on-year to PKR 452.7 billion in June of 2018 from PKR 273 billion in the same month a year ago. It was the highest trade gap on record, as imports jumped 43.2 percent, while exports increased at a much slower 12.3 percent Balance of Trade in Pakistan averaged -36727.56 PKR Million from 1957 until 2018, reaching an all-time high of 6457 PKR Million in June of 2003 and a record low of -452668 PKR Million in June of 2018.
Pakistan exports marble, textile and much more but these exports are at a very low price. Surprisingly, this is imported back in with foreign brand names at x10 to x100 prices! This needs to be regulated so the net impact on the Pakistan economy is a positive one. If these brands want the Pakistani material and skill they should pick up the finished goods from Pakistan at a justified price.
5. Interest Rate
The State Bank of Pakistan hiked its benchmark policy rate to 7.5% on July 14th, 2018. This has been the third rate increase since December 2017. The hike has brought the borrowing costs to the highest level in last three years. Policymakers have cited a deterioration in the balance of payments, a rise in government deficit, higher inflationary pressures and a falling rupee for increasing interest rates. The aim of the hike could have been an attempt to control the devaluation of the rupee and to control rising inflation.
If an increase in government spending and/or a decrease in tax revenues leads to a deficit that is financed by increased borrowing, then the borrowing can increase interest rates. High interest rates reduce private investments and decrease consumer spending growth effecting the overall economy in a negative manner.
To lower interest rates Pakistan needs to move towards a stable economic and financial plan where it can manage its balance of payments, enable growth at its grass root levels. With a long term economic plan enabling cyclical flow of money where spending and investing benefits the economy. Furthermore, tax reforms can also increase tax revenue that can enable SBP to lower interest rates. Pakistan has less than 2 million tax filers, with one of the lowest tax to GDP ratios in the world. Tax reforms can help Pakistan’s economy health, provided tax system gains confidence of the people.
The Rupee recently found itself as the 2nd worst performing currency. This is no shock, if you have read through all the details above. Deficits, falling reserves, corruption and unnecessary debts have driven the value of the Pakistani Rupee into a straight nose dive.
There have been some improvements in the last few days where the Rupee gained some value against the Dollar. However, this seems shortly lived under the current plans. Pakistan has taken Dollar denoted loans that it has to pay back. The total loan of 2 USD billion from China and 1 USD billion aid from Saudi have helped. The loans will have to be paid back soon and the incoming bail out funds are like a loan to make ends meet at end of month. The IMF bailout option of 12 USD billion given negative vibes to provide a loan to fulfil future payments and for increasing the Dollar supply in the Pakistani Market.
The currency will not magically improve, but Pakistan can come out of the chaos. The Pakistan economy has suffered more from short term fixes at the cost of structural damages to the overall economic and financial structures. There is political push and pull between China and US on the financial position of Pakistan and where it gets financing from. Pakistan needs to think how it can become a chess player, instead of the chess board that just sits there and waits for things to happen.
External Debt in Pakistan increased to 91761 USD Million in the first quarter of 2018, reaching an all-time high. This is not just debt, this is unsustainable and unplanned debt. It is still a mystery where the debt has gone and how much has enabled the economic growth of Pakistan. The debt was mostly taken to show strong reserves as a sign of a strong economy while ignoring all other economic factors such as GDP growth, fall in savings etc.
There are arguments that a developing nation needs debt to grow but there is barely any sign of structural improvements to the economy, let alone advances in economic conditions. It can be clearly seen that corruption and the financial motives of the regimes that have governed Pakistan have benefited most from the loans up till now.
CPEC is bringing in new projects which are highly concentrated in the power sector. There is fear in the market where local business community are facing problems as they have to compete in practical terms for the first time. As a consequence, there is blame throwing on CPEC for hurting the local business men which is unfair. The local business community should start competing instead of getting stuck in problems. It seems that the country is in a bad habit of protesting every problem and finding an external force to blame it on, instead of figuring out what can be improved.
There are opportunities for investments coming up and the country needs regulation of how the Chinese investors or companies enter the market. If programmed properly, opportunities can be built for local investors to co invest with Chinese companies. The Chinese companies are likely to bring more IP and experience in investing across the globe than the local companies. This will polarize investment sophistication of the Pakistan financial market.
A very unique thing about CPEC is that another country has sold Pakistan’s opportunity to themselves and to Pakistan instead of Pakistan showcasing its investment opportunities to the world.
9. Stock Market
Pakistan Stock Market has a total market cap of 84 USD billion with 559 total listings. Just one company Apple, is on its way to be a trillion dollar company. Apple is stronger that the Pakistani Stock Exchange. India has a total market cap of 2 USD trillion with 1,952 listings and South Africa has a market cap of around 1 USD trillion dollars. There was good news about the market as it was titled the best performing market between 2012 and 2015. At the same time it was added to MSCI index. Fast forward to now, it is the worst performing market in the world.
Pakistan has difficult listing rules which causes many companies to stay private. Pakistan only saw 3 IPOs in 2017 compared to an average of 25 in the 1990’s. At the same time, the stock market seems to be a private club that few members rule and govern with unfair practices leading to low numbers of people benefiting from the market. There is no sense of protection for a small investor. The small investor and the business owners are kept far away from the potential advantages of access to a stock market.
The stock market mirrors the Pakistan economy showing similarities as an unstable, malnourished and structurally weak from its foundations. The new Chinese runners of the exchange may bring about turnaround to the exchange but is there control over the exchange to make sure Pakistan’s needs will be fulfilled?
10. Investment Landscape
The investment and finance world of Pakistan is not a very sophisticated one. New investors find difficulty in finding a clean opportunity. Unfortunately, corruption is not limited to the politicians. There are certain standards of unethical practices that are generally accepted in the market. Some examples are signing a document and then changing stance or not giving complete information or keeping profits off balance. Furthermore, there is a widespread practice of delaying payment and finding new ways to renegotiate terms. The process of fundraising and investment management needs qualified service providers who get paid for their time but there is an emphasis of paying after a job is done or not paying at all. This destroys the whole value chain of finance. Finance and investments run on flow of information and not covering the cost of obtaining valuable information for decision making causes chaos. The qualified professionals find opportunity and work somewhere else, out of the country.
Almost everything in Pakistan sells, from government jobs to documents to political positions. This is not a hidden fact from anyone. Many of the people make money from charging huge amounts of money to get things done. If payments are not made then a small task stays stuck, without regards to how this has created a chaotic corruption culture. Surprisingly, this corruption has been so widespread that is now an accepted level of how things get done in the country. So much so that people have voted with slogans that at least this party spends some money on Pakistan.
Expenditure on development does not reach goals it is meant for and ends up in pockets of politicians and their associates. Projects that do happen have inflated costs and overspending. There are cases upon cases of money laundering and embezzlement that involve banks and nearly every other political party, including their leaders. This is a huge drawback for Pakistan’s economy and is one of the key factors that has put the economy down on its knees. There is a light of hope as institutions have started taking actions against politicians to hold them accountable. It can be argued that the reasons for this may be politically driven, but a step in the direction of holding the corrupt accountable is a positive sign.
What is next?
The economy of Pakistan is like an animal running wild from hunters with no sense of direction or determination to reach a goal. It takes turns and exits where it can find short relief and then takes off running wild again. The economy has to be tamed by the governing bodies and institutions along with the leadership. The key weakening factor is the corruption in the country that has led to high debt, unjustified expenditure and a near complete destruction of sustainable income for the country. The second area is the redesign of the business and finance ecosystems of Pakistan. The regulating bodies, courts, legislation, listing requirements, understanding of monetization, financing cycles and the impact of business, trade and finance activities all need to be mixed together to create a perfectly delicious cake that looks and tastes like heaven. Investors should be able to see and taste their exits in Pakistan.
The priorities of power, education and infrastructure seem basic and obvious. The need of the hour is a long term vision and plan of action with structuring, engineering and construction of sustainable economic and financial plans which emphasizes on grass root level growth in the lives of the poorest of Pakistanis. The country should realize that the challenges, the investment opportunities, distressed assets, growth prospectus and the future plans are all tools to unlock the massive potential it carries through packaging each opportunity and overcoming each challenge with a long term mind-set. The country of Pakistan needs to invest in itself first with honesty and integrity and the rest of the world will follow.
Rizwan M Khan, ACCA Financial Advisor | Investment Strategist Riz_mk@hotmail.com
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I am an investment strategist and business advisor who has globally worked with family offices, leading advisory firms, boutiques, investment companies, financial institutions and startups in various industries.
- Investment Strategy development from entry to exit with management and monitoring methods
- Business Planning for investors or for board approvals or for long term strategic planning.
- Specific expert evaluation of reports and Investment opportunities
- Intrinsic Value Analysis in companies to identify intrinsic values and monetise them
- M&A Strategy, Lead Advisory , International/New Market Entry, Deal Making
- In-depth and decision/oriented market and industry analysis along complete value chain
- Fundraising advisory for growth and turnaround stages.
LinkedIn Profile: https://www.linkedin.com/pub/rizwan-khan/56/175/76b