Time to Dump India Shares and Buy Pakistan and Hong Kong Equities?

Is it time to sell India short and go long on Pakistan?

Indian shares are highly overvalued while Pakistan and Hong Kong shares are trading at very attractive valuations, according to latest data published by Bloomberg. The Indian shares listed in Mumbai are trading at nearly 22 times earnings, more than twice the price-earnings multiples of Karachi and Hong Kong listed stocks.

Source: Bloomberg

Hong Kong's Hang Seng benchmark gauge for $4.3 trillion of shares was valued at 9.8 times reported earnings on Thursday, a 44 percent discount to the MSCI All-Country World Index, according to Bloomberg. That’s the cheapest level among developed markets worldwide and compares with a multiple of 10.2 for Pakistan’s KSE 100 Index. Russia’s Micex has the lowest valuation among major markets, trading at about 9.5 times profits.

Talking about Pakistan,  Charlie Robertson, London-based chief economist at Renaissance Capital Ltd.  told Bloomberg that “It (Pakistan) is the best, undiscovered investment opportunity in emerging or frontier markets...What’s changed is the delivery of reforms -- privatization, an improved fiscal picture and good relations with the IMF.”  Pakistan is a reform story like neighboring India’s, but only better, Renaissance’s Robertson added.

The massive Chinese commitment to invest $46 billion in Pakistan's energy and infrastructure projects as part of China-Pakistan Economic Corridor has added to the excitement about Pakistan's brightening prospects.

CPEC Projects Map

China-Pakistan Economic Corridor (CPEC) is highly strategic for both China and Pakistan. It is expected to dramatically boost investment and trade activity in Pakistan via 29 industrial parks and 21 mining zones along the western, central and eastern routes.

This (China's $46 billion investment in Pakistan) can not be purely politically driven. Beijing is commercial: CEO’s, not think tank intellectuals, travel with politicians. Barron's Asia

Spurred by Chinese investment, the smart money is taking notice of Pakistan as an attractive investment destination. The investors are looking at the fact that Pakistani stocks have been outperforming both emerging and frontier markets for several years. The benchmark index of the Karachi Stock Exchange (KSE100) is up more than 20% in the last 12 months, according to NASDAQ.com.

Pakistani Shares in 2015:

After a dismal March, MSCI Pakistan rebounded strongly this month, returning 9.1% so far. In April, the iShares MSCI Frontier 100 ETF (FM) rose 4.3%, the WisdomTree India Earnings Fund (EPI) dropped 1.2%, the iShares MSCI India ETF (INDA) fell 1.9%, according to Barron's Asia.

Source: Economist Magazine

KSE-100 Performance:

In 2014, the KSE-100 Index gained 6,870 points thereby generating a handsome return of 27% (31% return in US$ terms), making Pakistan's KSE world's third best performing market. Total offerings in the year 2014 reached 9 as compared to 3 in the year 2013. After a gap of seven years, Rs 73 billion were raised through offerings in 2014 as compared to a meager Rs 4 billion raised in 2013. Foreign investors, that hold US$ 6.1 billion worth of Pakistani shares -which is 33% of the free-float (9% of market capitalization)-remained net buyers in 2014.

Pakistani Shares Valuation:

Even after outperforming both emerging and frontier market indices, Pakistani shares can be bought at deep discounts which make them very attractive, according to Renaissance Capital’s chief economist Charles Robertson.  MSCI (Morgan Stanley Composite Index) Pakistan trades at only 8.4 times forward earnings, a 17% discount to MSCI Frontier Markets. For comparison purposes, fellow frontier south Asia markets Sri Lanka and Bangladesh trade at 13.4x and 21.4x respectively. India, included in the emerging market index, trades at 16.8 times.

Key Sectors: 

Chinese investment in energy and infrastructure will help stimulate all sectors of Pakistani economy. But the sectors benefiting most from the $46 billion investment will likely include banks, energy and building materials, the sectors which are the favorites of  Pakistani billionaire investor Mian Mohammad Mansha.

Being close to the ruling Sharif family makes Mansha the ultimate insider. Beyond his investments in banking, cement, energy and textiles, Mansha is also starting to invest in consumer products sector benefiting from rising incomes, growing middle class and increasing jobs created in Pakistan by the massive Chinese investment. Mansha owns a big chunk of Muslim Commercial Bank (MCB) share. He has recently been pumping more money into energy, cement and dairy businesses. Mansha's DG Khan Cements has announced plans to build a $300 million cement plant near Karachi. In additions, his Nishat Dairies has imported thousands of dairy cows for a dairy farm in Lahore.

Summary:

The $46 billion Chinese investment in energy and infrastructure has brought attention to tremendous investment opportunities in Pakistan, a nation of nearly 200 million people with rising middle class and growing consumption.  Pakistani military's recent successes against the terrorists and China's massive investment commitments are expected to boost investor confidence in the country. Higher confidence will help draw other significant investors to invest in Pakistan over the next several years.

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Will Pakistan's Gwadar Become "Hong Kong West"?

The port city of Hong Kong has played a pivotal role in China's economic and trade expansion on the Chinese East Coast in the Pacific region. Meanwhile, China's Western region has remained relatively underdeveloped.

China's West Coast:

Is China looking to build and use Gwadar in Pakistan as Hong Kong West to accelerate development in its West? Will Gwadar serve as a superhighway for China's trade expansion in Middle East, Africa and Europe? A point to project Chinese economic and military might westward?

Unlike the continental United States which has coasts on both the Atlantic and the Pacific Oceans allowing it easy access to Europe and Asia, China has only one coast, its East Coast along South China Sea.

As the Americans look to Asia with the US Pivot to Asia and the Trans Pacific Partnership (TPP), the Chinese are looking to expand westward with Central Asia as well as Africa, Europe and the Middle East with "One Road One Belt" initiative funded by Silk Road Fund and Asian Infrastructure Investment Bank (AIIB). Pakistan is a crucial partner in this strategy, particularly the development of Pakistan-China Corridor linking China's western region with Gwadar port on the Arabia Sea.

Gwadar Deep Sea Port:

The Chinese see Gwadar deep sea port and the town of Jiwani as Hong Kong West, a gateway to Middle East, Africa and Europe. It will be the most important link in China's Maritime Silk Route (MSR), a sort of superhighway to the West for Chinese trade.

Professor Juan Cole of University of Michigan has aptly described the Chinese strategy as follows:

China’s enormous northwest is much closer to the Arabian Sea than to the port of Shanghai. It is about 2800 km. from Urumqi (pop. 4 million, the size of Los Angeles inside city limits) to Karachi, but twice as far to Shanghai. China has decided to develop its northwest by turning Pakistan into a sort of Hong Kong West. Hong Kong played, and perhaps still plays an important role as a gateway for certain kinds of foreign investment into China. In the same way, Pakistan can be a window on the world and a conduit for oil and trade into northwestern cities such as Urumqi and the smaller Kashgar (pop. 1 mn.)

In addition to a major expansion of the deep sea port,  there are plans in place for building a modern city with several skyscrapers, an international airport, highways and industrial parks in Gwadar, Balochistan. There will be air, road and rail links to move people and freight to and from around the world. Oil and gas pipelines are planned to transport energy as well. When completed, it will be comparable to major international port cities of Dubai, Hong Kong and Singapore.

Baloch Insurgency:

Baloch insuegency is cited as  a key threat to the implementation of the China-Pakistan Corridor in Pakistan. What is often not acknowledged by analysts is the fact that the Baloch insurgency is dying. It's a fact that has recently been described in some detail by Malik Siraj Akbar who is sympathetic to the Baloch separatist cause. Here's what Akbar wrote in December 2014 in a piece titled "The End of Pakistan's Baloch Insurgency?":

"Since its beginning in 2004, the Pakistan's Baloch insurgency is caught up in the worst infighting ever known to the general public. Different left-wing underground armed groups that had been fighting Islamabad for a free Baloch homeland have now started to attack each other's camps......Frustration, suspicion, infighting and division are the common features of the end of a guerrilla fight. Perhaps that time has come in Balochistan. "

Language Map of Balochistan

The announcement of the Pak-China deal seems to have re-energized those who seek to hurt Pakistan. They are now trying to resuscitate the dying Baloch insurgency. Western media has widely publicized an interview of Bramdagh Bugti who is running the insurgency from the comfort of a Swiss hotel room.  In addition, Pakistan's western-funded NGOs are being used to play up the Baloch insurgency in the media with events like "Un-Silencing Balochistan" event and by blaming the ISI for the murder of Karachi activist Sabeen Mahmud.

Summary:

The China-Pak Corridor deal could prove to be transformational for Pakistan's economy, prosperity and rising living standards of its nearly 200 million people. As development work moves forward for Gwadar and China-Pakistan Corridor, I fully expect several hostile nations, including neighboring India, to use their proxies on the ground in Balochistan and some members of the "civil society" made up of some foreign-funded NGOs in Pakistan to make progress as difficult as possible. There will be serious efforts by many to resuscitate the dying Baloch insurgency. Pakistani people and both civil and military leaders need to be prepared to deal with these hurdles.

Related Links:

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