PAK: Political Risks Might Swell Premiums

| About: Global X (PAK)

Summary

Panama leaks have material effect on this ETF.

Political risks have increased amid attractive valuations.

The risk might fade away in the long run.

This article outlines for investors the current political and economic situation in Pakistan that could have material impact on the PAK ETF.

The current spate of Panama leaks has also engulfed Pakistan's politics, increasing the political risk of the country. Historically, Pakistan has been marred by civil-military tussle which didn't bode well for the overall economic situation of Pakistan. The involvement of the Prime Minister's sons in the Panama scandal has weakened the position of the civil administration, paving the way for political uncertainty in the already weakened democratic setup.

Additionally, the sacking of corrupt generals by the COAS (Chief of Army Staff), the most powerful position in Pakistan, has put further pressure on the incumbent government to act against the scourge of corruption within the civil-political administration. However, the dilemma stems from the fact that PM Nawaz Sharif himself is implicated in corruption scandals, unlike the powerful COAS. If the head of the government is party to the problem, then how can he eradicate the corrupt elements from his administration, is the million-dollar question. Nevertheless, the apex commission formed by the PM has not been accepted by the opposition parties, raising doubts over the transparency of such a commission.

Taking the past into account, I believe the army is serious about strengthening the accountability in the country. But it would not go to the extent of demanding resignation from the Prime Minister. This is because the army wants smooth functioning of the democratic setup in Pakistan along with uninterrupted progress on the development projects (such as CEPC) that are strategic in nature.

On the economic front, the extended fund facility program with the IMF should be successfully completed by June 2016. This means that the government has met all the performance and structural targets entailed within the program. In this program, Pakistan has received $5.76 billion out of which $4.4 billion has been paid for the installments of the previous loans. After June, it is up to the government whether they want to continue with the IMF or not. I believe the government should continue with the IMF program to ensure fiscal discipline within its financial policy.

Moreover, existing auto players might not get benefits from the new auto policy, as the new policy provides more concessions to the new brands rather than the existing ones. Thus, the auto sector, which constitutes ~3.2% of the ETF might have its valuations capped to some extent. I believe there is immense potential for growth in automobile sector in Pakistan due to low penetration levels, and the new players can also increase the size of the market, while also eating the market share of existing companies.

In conclusion, I expect the country risk premiums might rise, but in my view this would be medium-term risk, as in the aftermath of scheduled 2018 elections the political temperature will go down. I again reiterate that the PAK ETF is a high-risk high-growth opportunity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.