Can Pakistan banks weather the storm?

(AFP)  

The death of former premier Benazir Bhutto has shaken Pakistani financial markets and 2008 will be a challenging year for the country’s banking sector and economy. 

Uncertainty regarding the imminent elections is rapidly increasing the political turmoil and escalating violence is creating further pressure. 

Increasingly, the January polls look vulnerable. Heightened political uncertainty has placed the sovereign credit rating for Pakistan under question by international rating agencies. Pakistan’s risk on the international markets has risen.

Pakistani five-year credit default swaps, used to insure against restructuring or defaulting debt, have widened by around 100 basis points to 480 basis points since the assassination, implying traders felt the country’s debt was a higher risk. Some traders believe the credit default swaps on Pakistan debt may rise to 850 basis points.

The question is whether the political turmoil and unrest derails the economic reform process. Pakistan’s economy has performed very well over the last few years, with strong economic growth and increased foreign investment, including much from the Gulf states. 

The banking sector has recorded strong and increasing returns over the period.  Forecast for economic growth is 7.2 per cent in the new year until June. Many foreign investors have seen Pakistan as a new breed of lesser-developed “frontier markets” offering better returns than mainstream emerging markets.

Contrary to outsiders’ opinion of the country, Pakistan has organisational structures in place that could allow the economy to continue on its growth path. However, the authorities need to ensure the country does not fall into a cycle of chaos.

Gulf financial institutions and investors have been active in Pakistan over the past few years. Dubai Islamic Bank launched an Islamic financial institution (pictured above) that has grown rapidly. There has also been a growing awareness of the benefits of Islamic banking in Pakistan.

Pakistan’s banking sector has attracted foreign interest following a series of reforms and good performances that have led to rapid expansion and increasing income for local banks. Presently only Islamic banking is able to gain new banking licences, meaning that the only way foreigners can get into the market is to buy their way in.

Samba Financial Group, the Saudi Arabian bank, acquired a 68 per cent stake in Crescent Commercial Bank of Pakistan. Other Gulf banks active in Pakistan include Emirates Global Islamic Bank and Qatar Islamic Bank. International banks have also been attracted by the market. Standard Chartered paid $487 million (Dh1.78 billion) in cash for a 95 per cent stake in Union Bank to create the sixth-largest bank in Pakistan. The price paid was 5.6 times the net asset value. ABN Amro acquired Prime Bank of Pakistan.

However, the current situation is likely to delay any immediate investment deals in Pakistan, at least until after the elections, assuming they are held. Citigroup is considering the acquisition of a Pakistani bank and wants to double its branches in a year to capitalise on rising loan demand from consumers and small companies. 

A consortium led by Bank Muscat, Oman’s largest lender, is looking at acquiring Saudi Pak Bank for around $225m. The price would be around 2.8 times Saudi Pak Bank’s current net asset value. The consortium is said not to be put off by the country’s political turmoil.

The potential risk in Pakistan is seen differently by Middle Eastern investors. Bank Muscat sees the move as an important part of its strategy to expand outside its home market as competition intensifies. A purchase would mark Bank Muscat’s entry into banking in the world’s sixth most populous country.

Champions of Islamic co-operation argue Pakistan should be the GCC’s top priority, despite the turmoil. Part of the risk of the current position of Pakistan is that GCC investors may focus more on Pakistan’s neighbour, India. Nevertheless, Pakistan will remain as a target for Gulf investors due to the large size of the market and growth prospects.