Pakistan's stock market has traded at an average price/earnings discount to Asia of more than 30% since 1994, according to a recent report by Citi, and any increase in this discount due to political uncertainty would be a buying opportunity.

ôThe domestic market is unlikely to be immune to downward pressure on equities regionally, but we believe any retreat would be more modest and thus the valuation gap would narrow,ö Citi says.

In recent years, Pakistan's discount to regional markets had narrowed due to the re-entry of foreign investors attracted by an improving economy, a government committed to restructuring and deregulation, a revamped banking sector and cheap valuations, Citi says. ôThese positives are intact.ö

However, the marketÆs risk premium has increased mainly due to recent political uncertainty. Citi believes any correction in Pakistan would be limited. ôPresident (Pervez) Musharraf is holding the keys.ö

Musharraf is the elected President and has announced the lifting of the state of emergency on December 16 followed by elections on January 8, Citi says. Opposition parties are split over participation in the elections. Whatever the political dynamics, Citi expects no major change in economic policies, given the need for external funding.

Earnings of large-cap banks and energy companies are relatively immune to political uncertainties, while the energy players will benefit from higher oil prices, Citi says. Overall, return on equity for the Pakistan market is 25.5% compared with a 10.2% yield for long bonds with a 10-year maturity.

Citi is positive over PakistanÆs economic outlook, noting growth has averaged 7.5% annually, triggered by easy monetary and expansionary fiscal policies that have underpinned a favorable domestic demand-investment cycle.

Pakistan has re-emerged on the global radar screen with a rise in both foreign direct investment (FDI) and portfolio investments, Citi says. The inflows have been rising since fiscal year 2005. FDI, excluding privatizations, that were less than $1 billion around two years ago are now touching $5 billion.

An encouraging aspect of the rising FDI is the transition from privatizations of state-owned entities to acquisition in private sector companies, Citi says. These FDI are from global and regional players in private sector companies. Earlier, privatization had the interest of investors from the Middle East. Most of the transactions are in the banking and telecommunications sectors.

The economic environment is likely to put pressure on government spending
and domestic consumption, Citi says. Companies relying heavily on domestic sales and leveraged for expansion will be vulnerable. The banking sector will benefit from rising interest rates. The fertilizer sector will be protected, as it caters to agriculture and is already selling urea at a discount to international prices.

Key challenges facing the government are to sustain foreign flows to fund the current account deficit and to tackle inflation with rising oil and commodity prices, Citi says. There will be heavy reliance on privatizations and divestments. The Pakistan rupee has been weakening due to uncertainty about foreign flows and has adjusted to higher inflation.

Overall, Citi says high interest rates, weak currency, rising oil prices and fiscal imbalances will be positive for banks, exploration and production and fertilizer companies.