Pakistan — an attractive 'hot money' option for international investors

Pakistan has been an attractive option for international debt portfolio investors. Foreigners are investing through the Special Convertible Currency Accounts (SCRAs), which suggest they foresee stability and good yields.

The SCRA allows foreign investors to convert their money into Pakistani rupees to invest in the country's debt and equity markets and later reconvert it into foreign currency.

Net inflows in the Pakistan government's treasury bills (T-bills) since the start of fiscal year 2024-25 (FY25) stand at $166 million. To put this into perspective, net inflows during the entirety of FY24 stood at $581m.

On the other hand, there was a net outflow of $41 million in FY23 as 'hot money' had been draining out of the country since FY21 on the back of the country’s balance of payments crisis.

According to the auction calendar uploaded on the State Bank of Pakistan's website, the central bank will hold seven T-bills auctions during the on-going quarter. The breakdown reveals that the government intends to borrow PKR 3.475 trillion through them.

In the last two T-bill auctions held on August 21 and September 4, cut-off yields declined by up to 149 basis points (bps) in total. The cut-off yields for the three, six and 12 month-tenures stand at 17.48%, 17.74% and 17%, respectively.

It may be mentioned here that the government, after having sufficient liquidity available, has initiated the first ever T-bills buyback program and bought loans worth PKR 351bn on September 30.

What is hot money?

Hot money refers to funds that are controlled by investors who actively seek short-term returns. These investors scan the market for short-term, high-interest rate investment opportunities. As soon as the institution reduces interest rates or another institution offers higher rates, investors with hot money withdraw their funds and move them to the institution with higher rates.

Investors can move their funds to different countries to take advantage of favorable interest rates.

Foreign investors were highly interested in Pakistan in recent times since its interest rate was (and is) the highest in the region at 17.5% compared to India's 6.5%, Bangladesh's 8.5%, and Sri Lanka's 8.5%.

Read: Foreign investment in Pakistan T-bills rises to near-record level

This means that if a foreigner invested $100 million in Pakistan government T-bills, they would make $17.5 million on a 12-month basis (on average) compared to $6.5 million for India, and $8.5 million each for Bangladesh and Sri Lanka. (the calculations are based on the interest rates of the countries, not the cut-off yields.)

How are various Pakistani assets faring?

Pakistan's assets are trending upward following the International Monetary Fund (IMF) Executive Board's approval of a new $7bn Extended Fund Facility.

The stock market's benchmark KSE-100 index hit all-time high of 82,248 points on Sept 25, gold also broke records hitting PKR 277,000 per tola on Sept 26, and the Pakistani rupee reached a 4-month high of PKR 277.64 against USD on Sept 27.

The country's inflation rate decreased to an almost four-year low of 6.9% in September from a record high of 38% last May. Consequently, the SBP initiated an interest rate cut cycle in June.

Although, the central bank is pursuing monetary easing and its benchmark interest rate has declined to 17.5%, Pakistan's short-term papers still offer the highest yields in the region.

As inflation continues to ease, analysts expect the SBP to consider further interest rate cuts. International rating agency Fitch has projected that they will be reduced to 16% by this year's end, reflecting a broader trend of improving economic stability in Pakistan.

Pakistan's foreign exchange reserves, held by the central bank, have increased by $43 million, reaching a 26-month high of $9.53 billion in the week ending September 20, according to the central bank's latest weekly update.

The current account surplus of $75 million in August and the US Federal Reserve's interest rate cut have also supported the rupee's strength. The Fed's rate cut could result in a further loosening of global liquidity, prompting a shift in capital across asset classes and stock sectors.

Moreover, the IMF approval has boosted Pakistan's credit worthiness. This may lead to a rise in hot money inflows to acquire high-yielding government papers, thereby providing short-term support to Pakistan's foreign exchange reserves and currency.