Pakistan’s stock market has been red hot in recent years. The country’s main KSE index has soared close to 500% since 2009, and 56% in the last twelve months—leaving neighboring markets in India and China far behind.
Pakistan’s stock market rally has been driven by a number of favorable economic fundamentals, such as 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 is yielding 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, a spike in domestic acquisitions from foreign suitors, and the inclusion of Pakistan’s market into MSCI’s emerging market index.
Adding to these fundamentals is investor hype about the potential of the Pakistani economy which could take the equity market much higher.
How much higher? It’s hard to say.
What isn’t hard to say is that the usual red flags that killed previous market rallies are rising again. One of these flags is the growing current account deficit, which confirms that the country is trying to live beyond its means.
Another red flag is persistent government deficits and rising external debt. Add falling foreign currency reserves, and Pakistan is vulnerable to the next spike in global interest rates that can crush its market.
Wait, there’s more. There’s poor infrastructure that creates bottlenecks, which could push prices of basic commodities, and eventually interest rates, higher. Besides, Pakistan is heavily reliant on imported oil, which has almost doubled from a year ago.
In addition, there’s corruption and cronyism, which lead to large government. And that aggravates budget and current account deficits while constraining competition and technological progress.
That’s why the best days for investors in Pakistani stocks may be behind rather than ahead.
(The original article appeared in Forbes magazine)