Pakistan’s stock market has been on a tear in recent years. The country’s main KSE index has gained close to 400% since 2009, and 40% this year alone—leaving neighboring markets in the dust.

Pakistan’s equities have had a number of things going their way, like an improving macroeconomic environment—rising economic growth and falling inflation and interest rates. The country’s economy grew close to 6 percent in 2016, up from 4.8 percent in 2015, with inflation running around 4 percent, down from 10 percent four years ago. And the 10 year Treasury bond has yielded 8 percent, down from 12.5 percent four years ago.

Then there are a couple of overseas endorsements for Pakistan’s market reforms. Like $1 billion in support from the World Bank – and a couple of domestic acquisitions from foreign suitors, such as the acquisition of Karachi’s K-Electric by Shanghai Electric Power Co.

Another overseas endorsement was the inclusion of Pakistan’s market into MSCI’s emerging market index.

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So what could kill Pakistan’s big stock market rally?

The usual suspects that haunt frontier and emerging markets: inflation, corruption, and revolution. Not always in the same order.

At least that’s the experience of South Asia and Latin American countries which have been in a similar position before.

Pakistan’s low inflation, for instance, is hard to maintain at these levels, as a poor infrastructure creates bottlenecks, which could push prices of basic commodities higher. Besides, Pakistan is heavily reliant on imported oil, which has almost doubled since last January.

Then there’s corruption and cronyism, which lead to large government budget and current account deficits, while constraining competition and technological progress. In spite of some progress in the last five years, Pakistan is still high up on Transparency International’s Corruption Index.

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And revolution can only be around the corner, as the country suffers from poor enforcement of the law, sharp income inequalities, and territorial disputes with India.

Adding to these concerns over the future of Pakistan’s equities is rising US interest rates, which make investing in emerging and frontier markets less appealing than shopping around inside the US economy.

That’s why investors should be very cautious about pouring more money into Pakistan’s equities at this point.

 

Panos Mourdoukoutas is Professor and Chair of the Department of Economics at LIU Post in New York.

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