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Its population of 153 million1 makes it the sixth most populous country in the world. It is strategically located in the region and has access to a long coastline along the Arabian Sea. With a population growth rate of approximately 3%, Pakistan’s population is estimated to reach 240 million by the year 2020. Pakistan Map
Pakistan’s macroeconomic picture has improved considerably over the past five years and the economy is expected to maintain its growth momentum. Pakistan’s Gross Domestic Product (“GDP”) grew by 6.6% in the fiscal year ended 30 June 2006 (“FY 2006”) and the estimates for FY 2007 are between 7.0% and 7.3%2. This economic growth compares favourably with regional trends. The Figure below shows Pakistan’s GDP growth exceeded the regional average last year. Prior to 1999-2000, Pakistan was lagging behind regional average GDP growth. The economic reforms instituted by the Government of Pakistan in 2001 started taking effect, and Pakistan experienced sustained economic growth from FY 2003 onwards. Beyond 2005, higher oil prices are expected to dampen GDP growth rates of Asian economies with high oil import bills. However, Pakistan delivered a GDP growth rate substantially higher than the Asian average forecast of 5.8%.
Government of Pakistan estimate. CIA World Factbook estimates 162 million Asian Development Bank
Gross Domestic Product (% change, year on year) Pakistan 9 8 7 6 5 4 3 2 1
2000 2004 2005 2002 2003 2001 2006
Asia excl Japan
Source: Economist Intelligence Unit Economic Trends Are Positive The government estimates that income per capita in US Dollar (i.e. nominal) terms has been growing at an average rate of 13.5% per annum over the past three years as a result of the improved macroeconomic stability in Pakistan. From US$579 in FY 2003, it grew to US$736 in FY 2005 and US$830 in FY 2006. Pakistan’s income per capita in 2006 was US$2,590 on a Purchasing Power Parity basis. Pakistan's economic outlook has brightened in recent years in conjunction with the rapid economic growth and a dramatic improvement in its foreign exchange position. The latter results from Pakistan’s current account surplus and the consequent rapid growth in hard currency reserves. In addition, expatriate workers’ remittances have risen 400%. The government has sought and received debt relief from international lenders, reducing its external debt from US$47 billion to US$38 billion during FY 2006-07. The government is using Pakistan's surplus to prepay expensive debt and replace it with debt obtained at lower interest rates as a result of Pakistan’s improved credit rating. The government’s economic agenda includes measures to widen the tax net, privatize public sector assets, and improve its balance of trade. Pakistan has made governance reforms, privatisation, and deregulation the cornerstones of its economic revival. As a result, it has received a positive endorsement from international financial institutions such as the World Bank, the International Monetary Fund (“IMF”), and the Asian Development Bank (“ADB”), as well as improved credit ratings from Standard & Poor’s and Moody's. Foreign Direct Investment Is Rising Further external validation of Pakistan’s progress in returning to the international stage can be seen through foreign direct investment (“FDI”) trends. Pakistan received record FDI of US$3.5
billion in FY 2006 in comparison to US$1.7 billion in the previous year. According to Pakistan’s Board of Investment (“BoI”), the communication sector was the largest recipient of investment, at US$1.9 billion, followed by the financial sector with US$329 million and the power sector at US$320 million. The Figure below illustrates the overall trend in total foreign investment in Pakistan and provides a break-up by direct and portfolio investment. According to the Ministry of IT & Telecom, the sector alone is expected to receive investment of up to US$13 billion in the next three to five years. Foreign Investment in Pakistan
Foreign Direct Investment Trends
Total Foreign Investment (mn US$) 1800 1600 1400 1200 1000 800 600 400 200 0 -200 -400
Of which: Portfolio Investment
Foreign Direct Investment
Fiscal year June to June
Source: Pakistan Board of Investment
Foreign Direct Investment (Sector Wise) (By Economic Group) (Million US$) S.No 1 2 3 4 5 6 7 8 9 Economic Group Food Beverages Tobacco Textile Mining & Quarrying Oil & Gas exploration Petro-Chemical Petroleum Refining Machinery other than Electrical 2001-02 7.6 (13.6) 0.9 18.5 6.6 268.2 2.2 2.8 0.1 15.9 10.5 36.1 10.6 7.2 0.0 12.6 0.1 0.0 12.7 3.6 34.2 21.4 0.7 0.4 0.1 24.8 Total 484.2 2002-03 6.0 1.0 0.0 26.1 1.4 186.8 0.8 2.2 0.4 6.7 10.5 32.8 86.2 6.2 0.0 17.6 0.1 2.4 24.3 207.5 39.1 87.4 1.4 0.4 0.9 49.8 798.0 2003-04 3.3 0.7 0.5 35.4 1.1 202.4 1.5 70.9 0.7 7.5 8.7 (14.2) 15.3 13.2 0.0 32.0 8.8 0.0 221.9 242.1 35.6 0.1 1.7 1.9 0.4 57.9 949.4 2004-05 10.0 6.2 6.7 39.3 0.5 193.8 1.1 23.7 2.8 10.3 3.4 73.3 51.0 38.0 3.5 42.7 10.6 3.7 517.6 269.4 52.1 0.0 0.0 13.1 4.2 147.2 1,524.2 2005-06 51.3 6.2 2.5 47.0 7.1 312.7 9.5 31.2 1.2 18.1 1.7 320.6 62.9 34.5 (107.6) 89.5 18.4 0.2 1,937.7 329.2 118.0 3.4 0.1 39.0 5.1 181.5 3,521.0 July-Nov. 2006 6.2 1.7 2.8 28.5 4.0 221.0 2.6 35.3 2.1 7.6 -1.6 76.0 24.2 13.9 1.6 46.6 7.9 0.1 410.3 393.7 84.4 1.3 0.5 10.1 8.8 25.4 1,476.0
10 Electronics 11 Electrical Machinery 12 Power 13 Chemical 14 Pharmaceutical 15 Fertilizer 16 Construction 17 Transport 18 Storage Facilities Communication (IT & 19 Telecom) 20 Financial Business 21 Trade 22 Tourism 23 Paper & Pulp 24 Cement 25 Sugar 26 Others
Pakistan’s Credit Standing Is Improving The government’s aggressive debt reduction strategy has started to yield positive results. Pakistan returned to international capital markets after a gap of more than five years on February 12, 2004 with a US$500 million five-year Eurobond that was oversubscribed four times. The issue was priced at 370 basis points above the equivalent US Treasury bond. The Eurobond was followed by the flotation of a US$500 million Islamic Sukuk bond on January 18, 2005. This bond was oversubscribed two times, encouraging Pakistan to increase its size to US$600 million. The bond was priced at 220 basis points over six-month LIBOR. Pakistan’s economic revival programme received independent validation when international credit rating agencies positively reviewed Pakistan’s position in 2004. On January 24, 2004, Moody’s Investor Services improved Pakistan’s outlook on internal and external currency from “stable” to “positive.” This was followed by an upgrade in Pakistan’s credit rating from B3 to B2 on February 7, 2004. Standard & Poor’s (“S&P”) long-term sovereign rating for Pakistan was upgraded to B+ for foreign currency and BB for local currency on November 22, 2004. This improvement in S&P’s rating reflected Pakistan’s declining debt and debt servicing burden, sustained economic progress, and moderate external liquidity position. Continued Growth Is Forecast The ADB sees Pakistan’s medium term economic prospects as positive. In its Asian Development Outlook 2006 for Pakistan, the projection for GDP growth in FY 2007 is 7.3%.
In spite of a large deficit on the current account, total foreign exchange reserves declined by only $1.2 billion to $11.4 billion, and reserves held by State Bank of Pakistan declined by $841 million to $8.9 billion, in the first 8 months of FY2006. The exchange rate remained fairly stable, and the rupee/dollar rate depreciated slightly from Pakistan rupees (PRs) 59.67/$1 to PRs59.84/$1 during the first 7 months of FY2006. Pakistan’s external debt and liabilities were trimmed by $589 million to $35.2 billion in the first half of FY2006. As a share of GDP, external debt has declined continuously in recent years, from 45% at end-June 2001 to 31% at end-June 2005, and further to 28.6% at end-December 2005.
The expectation of continued economic growth is based on the following fundamentals: The Government of Pakistan is committed to sound macroeconomic policies including market liberalisation in all sectors of the economy and is aggressively pursuing its privatisation and deregulation programme; Pakistan is developing its position internationally as an emerging market and has begun to attract significantly higher foreign investment; and As a corollary to its improving international standing, Pakistan is beginning to exploit its strategic geographic location as the pivot point between the energy assets of the Middle East and Iran on one side and the energy-hungry economies of China and India, two of the fastestgrowing economies in the world, on the other. There has been significant improvement in relations with India during the past year that has contributed to an enhanced economic outlook, by reducing security concerns and improving prospects of trade between the two countries. Legal System Overview Despite having been granted independence in 1947, Pakistan has traditionally been governed by common law principles inherited from the laws promulgated by the British for the undivided India. All laws are codified. The Pakistani legal system is substantially developed due to its reliance on decided cases of other common law jurisdictions, including India, England, Canada, Australia, and Sri Lanka. Therefore, the rights and obligations relating to investment instruments proposed to be used by the Fund (i.e. ordinary and preferred shares, convertible loans etc…) are based on well-established principles of common law and are regularly enforced in Pakistani courts. Financial institutions are able to take their claims against borrowers to special courts that exercise summary jurisdiction. It is usually possible to get a final judgment in such special courts within one year of institution. Execution of the decree so passed can be ordered by the same Court, and special procedures have been promulgated to expedite recovery of claims by financial institutions. The Constitution of Pakistan 1973 conceives of a Parliamentary system of government in which, pursuant to amendments recently made by President Pervez Musharraf, the President has substantial power, and is not a mere titular Head of State. The judicial branch of the state is headed by the Supreme Court of Pakistan, with its principal seat in the capital Islamabad. The Chief Justice of Pakistan is appointed by the President and is traditionally the senior-most judge of the Court. The President is required to appoint the seniormost judge unless there are specific reasons for deviating from such practice. Each province has a separate High Court. The Chief Justice of each Province is the head of the judiciary for that province. Each district has several judges acting on the civil side as Additional District Judges and Civil Judges. An appeal from the final judgment of a sub-ordinate Court lies with the High Court, and from the High Court lies to the Supreme Court. Criminal proceedings are initiated in the magistrate courts or sessions courts. Appeals in respect of matters falling under “Hudood” (Islamic) laws lies to the Federal Shariat Court and to non-Islamic matters to the High Court.
In parallel with the common law practiced in the civil and criminal courts, matters relating to the principles of Islam are under the purview of the Federal Shariat Court (“FSC”). The FSC has the jurisdiction to verify whether any law is in accordance with the principles of Islam as enunciated in the Quran (the Holy Book of the Muslims) and Sunnah (traditions of the Holy Prophet). If the FSC determines any law to be contrary to the injunctions of Islam, unless the law is amended, it ceases to have effect from the date determined by the FSC. An appeal from the FSC goes to the Shariat Appellate Bench of the Supreme Court. Both the FSC and the Shariat Appellate Bench of the Supreme Court consist of not only judicial members but also “ulema” (religious scholars). Venture Capital & Private Equity opportunity Pakistan with its limited institutional private equity activity offers long-term capital appreciation through investment in undervalued companies during its “catch-up” growth phase. Given the rapidly changing environment in Pakistan, private equity investors can invest in a wide range of sectors, specifically enjoying the following underlying characteristics: 1. Where Pakistan has a sustainable and significant comparative cost advantage over international markets; 2. High growth potential with demonstrable pent-up demand in the domestic market; 3. Sustainable growth prospects; 4. Demonstrable market liquidity for exits through public markets, M&A activity and/or strategic investor sale; and 5. Availability of high-quality management resources. Examples of such sectors include: The manufacturing sector, especially textiles and leather where Pakistan enjoys a significant comparative cost advantage and is well positioned to benefit from the expected reduction in global trade quotas; The business process outsourcing sector where Pakistani companies can utilize a cheap and relatively highly-skilled English-speaking workforce; The energy sector that is undergoing deregulation and privatisation at several levels within the energy chain. Pakistan is facing a long-term structural deficit in energy supplies in the face of rapidly rising demand; The telecommunication sector that has been recently deregulated. Pakistan’s fixed line teledensity is only 3.6% with mobile teledensity of just 10%3; and
Pakistan Telecommunication Authority, August 2005.
The transportation sector (particularly buses, trucking and car leasing) that is fragmented and undercapitalized. There are several opportunities to support the emergence of a dominant player to consolidate the industry. Private Equity Exits A clearly identified strategy for a successful exit is the cornerstone of each investment decision. Pakistan has an active IPO market. Multinational and domestic corporations are also active participants in mergers and acquisitions transactions in Pakistan. Examples include: the spin off of ‘Dalda’ cooking oil by Unilever Pakistan to Westbury Group; Unilever’s purchase of a local ice cream brand ‘Polka’; Coca Cola Export Corporation’s purchase of local bottling operations; Evian’s current sale of Evian Fats and Oils operation in Pakistan; Nestle’s purchase of three water companies in Pakistan – Universal Aqua (operating under the “Fontalia” brand), Pak Water Bottlers and Northern Bottles (both operating under the “AVA” brand); The Agha Khan Fund for Economic Development’s purchase of a 51% controlling stake in Habib Bank Limited, Pakistan’s second largest commercial bank; and The purchase of a 51% controlling stake in National Refinery Limited by Saudi Arabia’s Attock Group. Possibilities of Value Creation through Private Equity Managers Pakistan offers a convergence of several value drivers that may help define the investment thesis for private equity investors. . Pakistan’s Attractive Macroeconomic Outlook As previously stated, Pakistan’s macroeconomic position is forecast to continue to improve, with GDP growth projected at 7% or higher for FY 2007 and the year thereafter. Continuing Market Liberalisation and Privatisation Market liberalisation, deregulation and privatisation in Pakistan are cornerstones of the government’s macroeconomic programme. This has led to increased private sector participation, improving efficiency and growth in the economy. For example, liberalisation of Pakistan’s telecom sector in 2002-03 introduced private sector competition in all service classes and attracted FDI of US$3.5 billion in FY 2006. Liberalisation of markets is disruptive but creates opportunities for carefully selected investments to deliver exceptional returns, geared beyond the macroeconomic growth rates. Improving Corporate Fundamentals and Governance Pakistan’s corporate sector has repeatedly posted improved earnings results in the last two to three years. This is reflected in Pakistan’s stock market that has outperformed all Asian markets.
The KSE-100 Index graph shows the positive upward trend in Pakistan’s stock market since 2002. KSE 100 Index
5-Year Progress of Pakistan’s Stock Market
In millions except companies, index and bonds data 5 YEARS PROGRESS Up to 31-12-2001 Total No. of Listed Companies Total Market Capitalisation – Rs. KSE-100 Index: New Companies Listed during the year 747 296,143.67 1273.07 2 Up to 31-12-2002 711 595,205.63 2701.42 4 167.10 Up to 31-12-2003 701 951,446.50 4471.60 6 308.81 Up to 31-12-2004 661 1,723,454.36 6218.40 17 343.70 Up to 14-10-2005 662 2,526,832.42 8863.87 16 368.67
Average Daily Turnover - Shares in 96.91 million Source: Karachi Stock Exchange
An important factor behind the improved corporate performance has been the emergence of a new generation of Pakistani business leaders, often having been educated abroad and with experience in international companies. This new generation of leaders is more willing to implement worldclass management and governance standards. The application of internationally accepted management practices and increased transparency is leading to sustained improvement in corporate earnings and the valuations attached to those companies. Development of the Debt Capital-Raising Markets
Historically, raising debt funding at the corporate level in Pakistan has been relatively complicated since the banking institutions were primarily public sector-owned. Through a combination of inefficiency and lack of incentive, these institutions were not active providers of debt finance. In addition, the debt capital markets in Pakistan are relatively small. With the deregulation and liberalisation of the banking sector over the last five years, there is now a range of private sector banking institutions aggressively pursuing the corporate lending market. The increased availability of debt finance would enable private equity investors to gear the returns on private equity investments. Limited Private Equity Competition While corporate FDI in Pakistan has yielded healthy returns to international investors in the past four or five years, Pakistan has been largely ignored by emerging market private equity fund managers. There are a handful of regional funds whose mandate includes Pakistan, however, they have limited resources in Pakistan and have therefore concluded few transactions. Additionally, there are regulatory and legal constraints on Pakistani financial institutions investing in private equity: i. Investment banks require Securities and Exchange Commission of Pakistan (“SECP”) approval on a deal-by-deal basis for any investment into unlisted equity. This is a complicated and time-consuming process; Mutual funds are prohibited from investing in unlisted equity; and Commercial banks may only invest in up to 30% of the equity in an unlisted company.
These restrictions mean that private equity investing has effectively been left to high net worth individuals (either directly or through their business groups), brokerage houses and other private client businesses. These groups are typically inexperienced in structuring and negotiating private equity investments. This absence of professional private equity funding has, in the past, forced growth companies to seek capital from the public markets at a relatively early stage. Under Pakistani legislation, a company cannot list at a premium to net book value without demonstrating a one-year track record of profits. Private equity funds in such a scenario offer an attractive alternative to such growth companies, allowing them a “breathing space” to further build value before accessing public markets.
JSPE Fund I is Pakistan’s first private equity fund sponsored by JS Group with institutional limited partners including International Finance Corporation (IFC), Saudi American Bank (SAMBA), DCD Group and Global Investment House, Kuwait (GIH). JSPE Fund I will target private equity buyouts, strong strategic minority block positions in public or private enterprises and expansion capital in Pakistan. Headquartered in Karachi, the firm has over 10 professionals based out of Pakistan, Dubai and London lead by three partners Ali J. Siddiqui, Steve Smith & Mohammad Sajid.
For more information on JS Group, visit www.js.com
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