Friday, March 25, 2016

The China Pakistan Economic Corridor and why I like Pakistan as a long term investment destination

The China Pakistan Economic Corridor or CPEC is an ambitious $47 billion dollar collection of infrastructure upgrades that will transform Pakistan's infrastructure and solve one of the main problems holding back the Pakistani economy, chronic power shortages.

Readers of my work will note that I am big on investing in places that are seeing change to the status quo. These inflection points have been quite profitable for me in the past. The 447 billion dollar CPEC investment surge into Pakistan is an important inflection point for the Pakistani economy.

It is estimated that power shortages in Pakistan cost the economy 2-3 percentage points of GDP per year. However as part of the CPEC $35 billion of the $47 billion to be invested will be in power plants and energy infrastructure. Progress is being made towards alleviating the power shortages even though the Ministry of Power and Water recently admitted they would not meet their goal of ending load shedding by 2018.

As the power issues dissipate and the effects of improved infrastructure begin to take place I expect that the productivity gains in the economy alone will help propel the country into a higher growth mode. The economy grew by 4.4% in 2015 and the government is forecasting growth of 5.5% for 2016. 

Pakistan is not without problems. Their is active terrorist activity in the country and the government has to spend quite a bit of time and money on security. In addition, there is quite a bit of corruption in the country, although the situation is beginning to improve.

There is also quite a bit of poverty and illiteracy (45% of adults are illiterate) with the poverty rate being about 12.4% of the population today down from 34.7% in 2002. However, those in poverty are judged to be there due to earning $1.25 per day of less. Nevertheless, the country is making progress and reductions in poverty along with jobs will lower the security costs as people find it more conducive to work and build a future than become a terrorist.

Pakistan is judged to be a frontier market but with continued economic growth the MSCI has said that it is considering reclassifying Pakistan as n emerging market which is a classification the country lost in 2008. Reclassifying the country as an emerging market would cause additional  money to flow into the country as fund managers will be required to re-balance their portfolios.

The country is fairly cheap but this is a result of the negative perception the country has by investors. The P/E is currently around 8 and the price to book is around 1.5.

I think Pakistan has exceptional possibilities because the Chinese want to help Pakistan as a counter to China's historical and regional rival India. Pumping $47 billion into the country's infrastructure will go a long way to accelerating the development of the economy of Pakistan as the GDP of the country is $271 billion last year. In addition, the infrastructure investment will have a multiplier effect that can expected to further boost GDP.

I am using the Global X MSCI Pakistan ETF (PAK) that trades on the NYSE as a proxy for a long term investment in Pakistan. The ETF has a higher weighting in banks than I would like to see especially considering that non performing loans have been an issue in the recent past. I still longer term that this economy will be surprising many with how well it does over the next ten years. Cramming $47 billion of infrastructure spending into a $270 billion economy will lead to a mini-boom.

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