A Story of Inflows and Outflows

Spearhead Analysis – 27.12.2016

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

With billions invested globally in Mergers and Acquisitions (M&A), there have been success stories as well as failures. The fact remains that M&A activity continues to dominate the corporate landscape with deals consummated for a range of reasons. It could be to gain access to a market, to satisfy the vanity of an egoistic CEO, to achieve synergies, to eliminate competition, and the list goes on. Many benefits have been cited in the context of M&A’s. It is believed that M&A activity can generate cost efficiencies through economies of scale, enhance revenue-generation capabilities through gain in market share, and even provide tax gains. The perceived benefits from Mergers and Acquisitions are the main reasons for companies entering into such deals. Pakistan has seen its share of M&A activity with certain notable deals in recent months. Among others these have included the following recent transactions:

  • Sale of a 40% stake in the Pakistan Stock Exchange to a Chinese consortium with a total transaction value of Rs 8.96 Billion (US$85 Million).

  • Engro Corporation’s sale of a 51% stake in Engro Foods to Netherlands-based dairy cooperative, FrieslandCampina, at an estimated cost of $448 Million.

  • Acquisition of Dawlance Group by the Turkish company Arcelik for US$258 Million.

  • Purchase by Chinese Shanghai Electric Power of a 66.4% stake in K-Electric from Abraaj Group valued at US$ 1.77 Billion.

  • Under the US$51 Billion CPEC-related projects there will be heavy investments in the power and infrastructure projects by the Chinese in Pakistan.

These investments are a welcome sign for Pakistan, as the country is receiving inflows, and there is hope that there would be performance enhancement within these industries through additional investments by the acquirers. At the same time there is a potential downside for the country once the repatriation of profits and dividends commences on these projects. There could be heavy outflows in the near future, which in the face of dwindling Foreign Direct Investment (FDI); lower exports and higher imports; falling remittances; small tax base; and, rising borrowings could place considerable financial pressure on the economy.

It is estimated that the repatriation of profits and dividends during the first quarter of the current fiscal year was around US$335 Million. The outflows in July-Sept 2015-16 were US$359 Million, which was US$24 Million higher than the 2016-17. The worrying factor is the 38 per cent year-on-year decline in FDI in the first quarter of the current fiscal year. This rising gap in lower inflows from FDI and higher outflows from repatriations is a problematic scenario, as the country remains largely dependent on foreign exchange reserves that have been built up through unabated internal and external borrowings. So much so, that the country has surpassed the statutory Debt to GDP ratio.

For Pakistan, with a low level of FDI the possibility of increasing outflows due to repatriation of funds in the form of profits and dividends; and the repayment in the form of interest and principal on loans can have serious repercussions for foreign currency reserves and meeting of financial obligations. This situation is reflected in the rising current account deficit, which rose 136 per cent year-on-year to US$1.368 Billion in the first quarter of the current fiscal year. Thus, while foreign loans and investments might provide temporary economic relief, the long run ramifications could be far greater in the absence of genuine economic reforms for growth.

At present Pakistan faces multi-pronged financial issues:

  • Falling exports.

  • Rising Imports.

  • Rising Debt levels, mainly funding FX reserves.

  • Rising repayment obligations on debt repayments – interest and principal.

  • Falling remittances.

  • Low levels of FDI.

  • Rising profit and dividend repatriation.

  • High proportion of non-revenue generating developmental projects.

  • Abysmally low tax base.

As a result while the M&A transactions are a welcome sign for the country, as are the CPEC-related projects, in the absence of genuine structural changes being implemented to improve the economy, this could create serious economic problems. Concerted efforts need to be put in place to bring in investment into the country for revenue-generating projects and to reduce the reliance on the high levels of debt being incurred. There needs to be ‘real’ build up of FX reserves as opposed to borrowed reserves. Short-term policies need to be shelved and a longer-term view developed. The recent PSX transaction is a positive but needs to be backed up by improvements in the broader economy and the financial sector to leverage the investment advantage. Economic activity needs to pick up with sectoral improvement in exports and a broadened tax base. It can be done, it has been done by other countries, all it requires is political and financial will.

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