Pakistan instability poses fresh investment risks

By Sujata Rao and Peter Apps

LONDON (Reuters) - Pakistan's brief period as a destination for adventurous investors seems over for now, as the killing of opposition leader Benazir Bhutto brings fresh instability to an already volatile nuclear-armed nation.

Bhutto was assassinated on Thursday ahead of Jan. 8 elections that were seen ushering in democracy after a decade of military rule and promoting policies that -- vitally for investors -- would include a commitment to stamp out Islamist militants in areas bordering Afghanistan.

But hopes now lie in tatters that leading Pakistani politicians can create a bulwark against militant Islam and bring in a stable government allied to the West.

"This is the worst possible scenario for foreign investment. Probably there are many months of volatility ahead and this environment of chaos is perfect for Islamic militants," said Luis Costa, head of emerging debt at Commerzbank in London.

"In the first half of 2007, we saw Pakistani assets outperforming which brought in real money managers," Costa said. "We will probably now see a reversal of this trend."

For the past couple of years, Pakistan has lured growing amounts of foreign cash -- the Karachi stock market is up 50 percent year-to-date, making it one of Asia's top performing indices.

While less than 10 percent of this $70 billion-plus market is so far held by foreigners, flows have been rising especially from the oil-rich Middle East, as the attraction of a fast growing economy outweighed the rising political risks.

Foreign direct investment too has been on the up. It almost doubled in the last fiscal year, while in the first five months of the 2008 July-June fiscal year it rose by almost $500 million to $1.7 billion, according to central bank data.