Pakistan’s Recent Macroeconomic Performance

Pakistan is bounded by India, China, Iran and Afghanistan. Its population of 153 million1 makes
it the sixth most populous country in the world. It is strategically located in the region and has
access to a long coastline along the Arabian Sea. With a population growth rate of approximately
3%, Pakistan’s population is estimated to reach 240 million by the year 2020.

Pakistan Map

Pakistan’s macroeconomic picture has improved considerably over the past five years and the
economy is expected to maintain its growth momentum. Pakistan’s Gross Domestic Product
(“GDP”) grew by 6.6% in the fiscal year ended 30 June 2006 (“FY 2006”) and the estimates for
FY 2007 are between 7.0% and 7.3%2.

This economic growth compares favourably with regional trends. The Figure below shows
Pakistan’s GDP growth exceeded the regional average last year.

Prior to 1999-2000, Pakistan was lagging behind regional average GDP growth. The economic
reforms instituted by the Government of Pakistan in 2001 started taking effect, and Pakistan
experienced sustained economic growth from FY 2003 onwards. Beyond 2005, higher oil prices
are expected to dampen GDP growth rates of Asian economies with high oil import bills.
However, Pakistan delivered a GDP growth rate substantially higher than the Asian average
forecast of 5.8%.

1
Government of Pakistan estimate. CIA World Factbook estimates 162 million
2
Asian Development Bank
GDP Comparative

Gross Domestic Product

(% change, year on year)

Pakistan Asia excl Japan

9
8
7
6
5
4
3
2
1
0
2000

2004

2005

2006
2001

2002

2003

Source: Economist Intelligence Unit

Economic Trends Are Positive

The government estimates that income per capita in US Dollar (i.e. nominal) terms has been
growing at an average rate of 13.5% per annum over the past three years as a result of the
improved macroeconomic stability in Pakistan. From US$579 in FY 2003, it grew to US$736 in
FY 2005 and US$830 in FY 2006. Pakistan’s income per capita in 2006 was US$2,590 on a
Purchasing Power Parity basis.

Pakistan's economic outlook has brightened in recent years in conjunction with the rapid
economic growth and a dramatic improvement in its foreign exchange position. The latter results
from Pakistan’s current account surplus and the consequent rapid growth in hard currency
reserves. In addition, expatriate workers’ remittances have risen 400%.

The government has sought and received debt relief from international lenders, reducing its
external debt from US$47 billion to US$38 billion during FY 2006-07. The government is using
Pakistan's surplus to prepay expensive debt and replace it with debt obtained at lower interest
rates as a result of Pakistan’s improved credit rating.

The government’s economic agenda includes measures to widen the tax net, privatize public
sector assets, and improve its balance of trade. Pakistan has made governance reforms,
privatisation, and deregulation the cornerstones of its economic revival. As a result, it has
received a positive endorsement from international financial institutions such as the World Bank,
the International Monetary Fund (“IMF”), and the Asian Development Bank (“ADB”), as well as
improved credit ratings from Standard & Poor’s and Moody's.

Foreign Direct Investment Is Rising

Further external validation of Pakistan’s progress in returning to the international stage can be
seen through foreign direct investment (“FDI”) trends. Pakistan received record FDI of US$3.5
billion in FY 2006 in comparison to US$1.7 billion in the previous year. According to Pakistan’s
Board of Investment (“BoI”), the communication sector was the largest recipient of investment, at
US$1.9 billion, followed by the financial sector with US$329 million and the power sector at
US$320 million. The Figure below illustrates the overall trend in total foreign investment in
Pakistan and provides a break-up by direct and portfolio investment. According to the Ministry of
IT & Telecom, the sector alone is expected to receive investment of up to US$13 billion in the
next three to five years.

Foreign Investment in Pakistan

Foreign Direct Investment Trends

Total Foreign Investment (mn US$) Of which: Portfolio Investment Foreign Direct Investment

1800
1600
1400
1200
1000
800
600
400
200
0
-200 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05
-400
Fiscal year June to June

Source: Pakistan Board of Investment

Foreign Direct Investment (Sector Wise) (By Economic Group)
(Million US$)
July-Nov.
S.No Economic Group 2001-02 2002-03 2003-04 2004-05 2005-06
2006
1 Food 7.6 6.0 3.3 10.0 51.3 6.2
2 Beverages (13.6) 1.0 0.7 6.2 6.2 1.7
3 Tobacco 0.9 0.0 0.5 6.7 2.5 2.8
4 Textile 18.5 26.1 35.4 39.3 47.0 28.5
5 Mining & Quarrying 6.6 1.4 1.1 0.5 7.1 4.0
6 Oil & Gas exploration 268.2 186.8 202.4 193.8 312.7 221.0
7 Petro-Chemical 2.2 0.8 1.5 1.1 9.5 2.6
8 Petroleum Refining 2.8 2.2 70.9 23.7 31.2 35.3
Machinery other than
0.1 0.4 0.7 2.8 1.2
9 Electrical 2.1
10 Electronics 15.9 6.7 7.5 10.3 18.1 7.6
11 Electrical Machinery 10.5 10.5 8.7 3.4 1.7 -1.6
12 Power 36.1 32.8 (14.2) 73.3 320.6 76.0
13 Chemical 10.6 86.2 15.3 51.0 62.9 24.2
14 Pharmaceutical 7.2 6.2 13.2 38.0 34.5 13.9
15 Fertilizer 0.0 0.0 0.0 3.5 (107.6) 1.6
16 Construction 12.6 17.6 32.0 42.7 89.5 46.6
17 Transport 0.1 0.1 8.8 10.6 18.4 7.9
18 Storage Facilities 0.0 2.4 0.0 3.7 0.2 0.1
Communication (IT &
12.7 24.3 221.9 517.6 1,937.7
19 Telecom) 410.3
20 Financial Business 3.6 207.5 242.1 269.4 329.2 393.7
21 Trade 34.2 39.1 35.6 52.1 118.0 84.4
22 Tourism 21.4 87.4 0.1 0.0 3.4 1.3
23 Paper & Pulp 0.7 1.4 1.7 0.0 0.1 0.5
24 Cement 0.4 0.4 1.9 13.1 39.0 10.1
25 Sugar 0.1 0.9 0.4 4.2 5.1 8.8
26 Others 24.8 49.8 57.9 147.2 181.5 25.4
Total 484.2 798.0 949.4 1,524.2 3,521.0 1,476.0
Pakistan’s Credit Standing Is Improving

The government’s aggressive debt reduction strategy has started to yield positive results.
Pakistan returned to international capital markets after a gap of more than five years on February
12, 2004 with a US$500 million five-year Eurobond that was oversubscribed four times. The
issue was priced at 370 basis points above the equivalent US Treasury bond.

The Eurobond was followed by the flotation of a US$500 million Islamic Sukuk bond on January
18, 2005. This bond was oversubscribed two times, encouraging Pakistan to increase its size to
US$600 million. The bond was priced at 220 basis points over six-month LIBOR.

Pakistan’s economic revival programme received independent validation when international

credit rating agencies positively reviewed Pakistan’s position in 2004. On January 24, 2004,
Moody’s Investor Services improved Pakistan’s outlook on internal and external currency from
“stable” to “positive.” This was followed by an upgrade in Pakistan’s credit rating from B3 to B2
on February 7, 2004. Standard & Poor’s (“S&P”) long-term sovereign rating for Pakistan was
upgraded to B+ for foreign currency and BB for local currency on November 22, 2004. This
improvement in S&P’s rating reflected Pakistan’s declining debt and debt servicing burden,
sustained economic progress, and moderate external liquidity position.

Continued Growth Is Forecast

The ADB sees Pakistan’s medium term economic prospects as positive. In its Asian
Development Outlook 2006 for Pakistan, the projection for GDP growth in FY 2007 is 7.3%.

In spite of a large deficit on the current account, total foreign exchange reserves declined by only
$1.2 billion to $11.4 billion, and reserves held by State Bank of Pakistan declined by $841
million to $8.9 billion, in the first 8 months of FY2006.

The exchange rate remained fairly stable, and the rupee/dollar rate depreciated slightly from
Pakistan rupees (PRs) 59.67/$1 to PRs59.84/$1 during the first 7 months of FY2006. Pakistan’s
external debt and liabilities were trimmed by $589 million to $35.2 billion in the first half of
FY2006. As a share of GDP, external debt has declined continuously in recent years, from 45% at
end-June 2001 to 31% at end-June 2005, and further to 28.6% at end-December 2005.
The expectation of continued economic growth is based on the following fundamentals:

ƒ The Government of Pakistan is committed to sound macroeconomic policies including

market liberalisation in all sectors of the economy and is aggressively pursuing its
privatisation and deregulation programme;

ƒ Pakistan is developing its position internationally as an emerging market and has begun to
attract significantly higher foreign investment; and

ƒ As a corollary to its improving international standing, Pakistan is beginning to exploit its

strategic geographic location as the pivot point between the energy assets of the Middle East
and Iran on one side and the energy-hungry economies of China and India, two of the fastest-
growing economies in the world, on the other.

ƒ There has been significant improvement in relations with India during the past year that has
contributed to an enhanced economic outlook, by reducing security concerns and improving
prospects of trade between the two countries.

Legal System Overview

Despite having been granted independence in 1947, Pakistan has traditionally been governed by
common law principles inherited from the laws promulgated by the British for the undivided
India. All laws are codified. The Pakistani legal system is substantially developed due to its
reliance on decided cases of other common law jurisdictions, including India, England, Canada,
Australia, and Sri Lanka. Therefore, the rights and obligations relating to investment instruments
proposed to be used by the Fund (i.e. ordinary and preferred shares, convertible loans etc…) are
based on well-established principles of common law and are regularly enforced in Pakistani
courts.

Financial institutions are able to take their claims against borrowers to special courts that exercise
summary jurisdiction. It is usually possible to get a final judgment in such special courts within
one year of institution. Execution of the decree so passed can be ordered by the same Court, and
special procedures have been promulgated to expedite recovery of claims by financial
institutions.

The Constitution of Pakistan 1973 conceives of a Parliamentary system of government in which,

pursuant to amendments recently made by President Pervez Musharraf, the President has
substantial power, and is not a mere titular Head of State.

The judicial branch of the state is headed by the Supreme Court of Pakistan, with its principal seat
in the capital Islamabad. The Chief Justice of Pakistan is appointed by the President and is
traditionally the senior-most judge of the Court. The President is required to appoint the senior-
most judge unless there are specific reasons for deviating from such practice.

Each province has a separate High Court. The Chief Justice of each Province is the head of the
judiciary for that province. Each district has several judges acting on the civil side as Additional
District Judges and Civil Judges. An appeal from the final judgment of a sub-ordinate Court lies
with the High Court, and from the High Court lies to the Supreme Court. Criminal proceedings
are initiated in the magistrate courts or sessions courts. Appeals in respect of matters falling
under “Hudood” (Islamic) laws lies to the Federal Shariat Court and to non-Islamic matters to the
High Court.
In parallel with the common law practiced in the civil and criminal courts, matters relating to the
principles of Islam are under the purview of the Federal Shariat Court (“FSC”). The FSC has the
jurisdiction to verify whether any law is in accordance with the principles of Islam as enunciated
in the Quran (the Holy Book of the Muslims) and Sunnah (traditions of the Holy Prophet). If the
FSC determines any law to be contrary to the injunctions of Islam, unless the law is amended, it
ceases to have effect from the date determined by the FSC. An appeal from the FSC goes to the
Shariat Appellate Bench of the Supreme Court. Both the FSC and the Shariat Appellate Bench of
the Supreme Court consist of not only judicial members but also “ulema” (religious scholars).

Venture Capital & Private Equity opportunity

Pakistan with its limited institutional private equity activity offers long-term capital appreciation
through investment in undervalued companies during its “catch-up” growth phase.

Given the rapidly changing environment in Pakistan, private equity investors can invest in a wide
range of sectors, specifically enjoying the following underlying characteristics:

1. Where Pakistan has a sustainable and significant comparative cost advantage over
international markets;

2. High growth potential with demonstrable pent-up demand in the domestic market;

3. Sustainable growth prospects;

4. Demonstrable market liquidity for exits through public markets, M&A activity and/or
strategic investor sale; and

5. Availability of high-quality management resources.

Examples of such sectors include:

ƒ The manufacturing sector, especially textiles and leather where Pakistan enjoys a significant
comparative cost advantage and is well positioned to benefit from the expected reduction in
global trade quotas;

ƒ The business process outsourcing sector where Pakistani companies can utilize a cheap and
relatively highly-skilled English-speaking workforce;

ƒ The energy sector that is undergoing deregulation and privatisation at several levels within
the energy chain. Pakistan is facing a long-term structural deficit in energy supplies in the
face of rapidly rising demand;

ƒ The telecommunication sector that has been recently deregulated. Pakistan’s fixed line
teledensity is only 3.6% with mobile teledensity of just 10%3; and

3
Pakistan Telecommunication Authority, August 2005.
ƒ The transportation sector (particularly buses, trucking and car leasing) that is fragmented and
undercapitalized. There are several opportunities to support the emergence of a dominant
player to consolidate the industry.

Private Equity Exits

A clearly identified strategy for a successful exit is the cornerstone of each investment decision.
Pakistan has an active IPO market. Multinational and domestic corporations are also active
participants in mergers and acquisitions transactions in Pakistan. Examples include:

ƒ the spin off of ‘Dalda’ cooking oil by Unilever Pakistan to Westbury Group;

ƒ Unilever’s purchase of a local ice cream brand ‘Polka’;

ƒ Coca Cola Export Corporation’s purchase of local bottling operations;

ƒ Evian’s current sale of Evian Fats and Oils operation in Pakistan;

ƒ Nestle’s purchase of three water companies in Pakistan – Universal Aqua (operating under
the “Fontalia” brand), Pak Water Bottlers and Northern Bottles (both operating under the
“AVA” brand);

ƒ The Agha Khan Fund for Economic Development’s purchase of a 51% controlling stake in
Habib Bank Limited, Pakistan’s second largest commercial bank; and

ƒ The purchase of a 51% controlling stake in National Refinery Limited by Saudi Arabia’s
Attock Group.

Possibilities of Value Creation through Private Equity Managers

Pakistan offers a convergence of several value drivers that may help define the investment thesis
for private equity investors. .

ƒ Pakistan’s Attractive Macroeconomic Outlook

As previously stated, Pakistan’s macroeconomic position is forecast to continue to improve, with

GDP growth projected at 7% or higher for FY 2007 and the year thereafter.

ƒ Continuing Market Liberalisation and Privatisation

Market liberalisation, deregulation and privatisation in Pakistan are cornerstones of the

government’s macroeconomic programme. This has led to increased private sector participation,
improving efficiency and growth in the economy. For example, liberalisation of Pakistan’s
telecom sector in 2002-03 introduced private sector competition in all service classes and
attracted FDI of US$3.5 billion in FY 2006. Liberalisation of markets is disruptive but creates
opportunities for carefully selected investments to deliver exceptional returns, geared beyond the
macroeconomic growth rates.

ƒ Improving Corporate Fundamentals and Governance

Pakistan’s corporate sector has repeatedly posted improved earnings results in the last two to
three years. This is reflected in Pakistan’s stock market that has outperformed all Asian markets.
The KSE-100 Index graph shows the positive upward trend in Pakistan’s stock market since
2002.

KSE 100 Index

5-Year Progress of Pakistan’s Stock Market

In millions except companies, index and bonds data

5 YEARS PROGRESS

Up to Up to Up to Up to Up to
31-12-2001 31-12-2002 31-12-2003 31-12-2004 14-10-2005

Total No. of Listed Companies 747 711 701 661 662

Total Market Capitalisation – Rs. 296,143.67 595,205.63 951,446.50 1,723,454.36 2,526,832.42

KSE-100 Index: 1273.07 2701.42 4471.60 6218.40 8863.87

New Companies Listed during the year 2 4 6 17 16

Average Daily Turnover - Shares in

96.91 167.10 308.81 343.70 368.67
million

Source: Karachi Stock Exchange

An important factor behind the improved corporate performance has been the emergence of a new
generation of Pakistani business leaders, often having been educated abroad and with experience
in international companies. This new generation of leaders is more willing to implement world-
class management and governance standards. The application of internationally accepted
management practices and increased transparency is leading to sustained improvement in
corporate earnings and the valuations attached to those companies.

ƒ Development of the Debt Capital-Raising Markets

Historically, raising debt funding at the corporate level in Pakistan has been relatively
complicated since the banking institutions were primarily public sector-owned. Through a
combination of inefficiency and lack of incentive, these institutions were not active providers of
debt finance. In addition, the debt capital markets in Pakistan are relatively small.

With the deregulation and liberalisation of the banking sector over the last five years, there is now
a range of private sector banking institutions aggressively pursuing the corporate lending market.
The increased availability of debt finance would enable private equity investors to gear the
returns on private equity investments.

ƒ Limited Private Equity Competition

While corporate FDI in Pakistan has yielded healthy returns to international investors in the past
four or five years, Pakistan has been largely ignored by emerging market private equity fund
managers. There are a handful of regional funds whose mandate includes Pakistan, however,
they have limited resources in Pakistan and have therefore concluded few transactions.

Additionally, there are regulatory and legal constraints on Pakistani financial institutions
investing in private equity:

i. Investment banks require Securities and Exchange Commission of Pakistan (“SECP”)

approval on a deal-by-deal basis for any investment into unlisted equity. This is a
complicated and time-consuming process;

ii. Mutual funds are prohibited from investing in unlisted equity; and

iii. Commercial banks may only invest in up to 30% of the equity in an unlisted company.

These restrictions mean that private equity investing has effectively been left to high net worth
individuals (either directly or through their business groups), brokerage houses and other private
client businesses. These groups are typically inexperienced in structuring and negotiating private
equity investments.

This absence of professional private equity funding has, in the past, forced growth companies to
seek capital from the public markets at a relatively early stage. Under Pakistani legislation, a
company cannot list at a premium to net book value without demonstrating a one-year track
record of profits. Private equity funds in such a scenario offer an attractive alternative to such
growth companies, allowing them a “breathing space” to further build value before accessing
public markets.
Contributed by:

JSPE Fund I is Pakistan’s first private equity fund sponsored by JS Group with
institutional limited partners including International Finance Corporation (IFC), Saudi
American Bank (SAMBA), DCD Group and Global Investment House, Kuwait (GIH).

JSPE Fund I will target private equity buyouts, strong strategic minority block positions
in public or private enterprises and expansion capital in Pakistan. Headquartered in
Karachi, the firm has over 10 professionals based out of Pakistan, Dubai and London
lead by three partners Ali J. Siddiqui, Steve Smith & Mohammad Sajid.

For more information on JS Group, visit www.js.com