The downside of PSX’s emerging market status

Increasing integration with world financial markets will make Pakistan vulnerable to swings in global growth

ISLAMABAD: The Pakistan Stock Exchange (PSX) is set to be included in the Morgan Stanley Capital International (MSCI) emerging market index later next week after remaining a frontier market for nine years.

With this, the PSX will join ranks with countries like Brazil, China,India, Malaysia and Russia.

The investor euphoria that has ensued is visible to all. The KSE-100 index, a benchmark for market performance, has soared almost 38% to an all-time high of 51,426 points since the emerging market status was announced on June 14, 2016.



Stock market experts believe that the index will jump to 56,000 points by the end of this year.

To an extent, this scale of investor interest seems justifiable. Countries like Qatar that were given this status before Pakistan attracted massive amount of capital inflows.

Even politicians from the ruling party, PML-N, are bragging about it. Its reference will remain a regular feature in the party’s election campaign. The overall excitement has been such that not many commentaries have been made on how this reclassification may adversely impact Pakistan. There are many ways in which the emerging market status may become a liability for Pakistan.

Financial integration

Increasing integration with global financial markets will make Pakistan vulnerable to swings in global growth. Take the case of global financial crisis that rocked western economies in 2008.

The event that unleashed the financial crisis in the US and around the world was Lehman Brothers’ bankruptcy, which remains the largest Chapter 10 bankruptcy filing in US history.

At the pinnacle of global recession in 2011 when global growth was -1.7%, major Asian stock exchanges like Japan’s Nikkei-225 and China’s Shanghai Composite Index closed the year down 14% and 18% respectively. The KSE-100 index closed 2011 with a fall of just 3.7%. However, the decline may be deeper in case of global recession after the emerging market status.

US interest rate cycle

One of the upsides of being a frontier market has been the relative isolation from the US interest rate cycle. Foreign investors now shop around the world for such markets that are not linked to the US interest rate cycle.

The reason for this is obvious. Stock markets of those countries which are relatively more integrated with the global financial system have tripped every time there has been a hike in the US federal funds rate.

Foreign investors are attracted by the high return offered in the US, which enhances the relative safety of parking funds in the US. Fed Chairman Janet Yellen has already announced one such hike in March 2017.

As PSX gets more integrated with the world due to its emerging market status, its immunity from the US rate cycle will disappear. Any future rise in the federal funds rate may result in foreign outflows from the PSX.

Domestic vs foreign investors

Not all investors are alike. Some of the factors, which Pakistani investors pay attention to, are different from those monitored by foreign investors.

The bull-run at the PSX last year is a testament to this. It was mainly fuelled by domestic investors. Foreign investors were net sellers of over half a billion dollars’ worth of stocks since June last year when the emerging market status was announced.



During this time, the current account deficit kept on rising, public borrowing increased and circular debt re-emerged. The KSE-100 index still hit record levels.

Most of the bumps that the PSX ran into were purely of political nature. The three-month bear run earlier this year when the KSE-100 index shed almost 8% coincided with uncertainty over the Panama Papers case.

It seems that domestic investors are psychologically more pre-occupied with domestic politics.

In Pakistan’s case, we can also expect that foreign investors will pay heed to political conditions in the country. However, what domestic investors seem to miss out at times, foreign investors do incorporate these in their subjective equity valuation.

Issues like rising fiscal deficit and high public debt will surely make them nervous than domestic investors. One factor that will concern them the most is Pakistan’s current account deficit.

If the current account continues to worsen, which it seems so, foreign investors may launch a speculative attack on Pakistani rupee.

Even when domestic investors lay emphasis on such factors, the relative significance attached to them is lower compared to foreign investors.

In few of the cases, there is conflict of interest between domestic and foreign investors as well. This is especially true in the case of exchange rate. Domestic investors prefer a depreciated rupee because of its positive effect on exports.

On the other hand, foreign investors would rather like an appreciated or stable exchange rate so that their returns are not diluted by depreciation.



Policy-makers will need to be more vigilant in their policy responses keeping in mind such behavioural disparities among investors and challenges emerging from the financial integration.

The writer is Research Associate at the Policy Research Institute of Market Economy

Published in The Express Tribune, May 15^th, 2017.

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