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Role of Karachi Stock Exchange in capital formation.

Role of Karachi Stock Exchange in Capital Formation

The role of Karachi Stock Exchange in capital formation has been thrown in bold relief by the recent boom during which many new records have been established. Last month (April) an unprecedented turnover of 82 lakh shares in a day's session against the previous daily average of 10 lakh bears an eloquent testimony to the interest that has recently been generated in share business. The KSE's price index also touched an all-time high at 1764. All this goes to prove that the stock exchange is playing a vital role in capital formation. Market capitalisation has increased from Rs. 21 billion in 1985 to Rs. 70 billion at present. This is 100 per cent more that the listed capital of Rs. 29.5 billion.

Though the Karachi Stock Exchange had a modest beginning in 1948, today it has come of age boasting of more than 414 listed companies. The investment activity has gained momentum in the wake of introduction of a number of leasing and modaraba companies which are playing a major role in making the stock market buoyant. With these companies offering loans for industrial establishments, the pace of industrialisation has been accelerated in the country. Besides, the dependence of sponsors of new projects on banks and DFIs has decreased because of the positive response of the general public to their offerings and growing interest in share business. More and more entrepreneurs have started depending more and more on the share market for mobilisation of funds.

The investment banks, modarabas and leasing companies have particularly been instrumental in giving a big fillip to investment activity on the share market. They have come into existence at a time when the economy is trying to absorb the impact of the barrage of economic and financial reforms. These institutions plus DFIs have been the principal buyers of stocks in the share market.

Rumours are afloat that foreign investors have entered the market after the radical financial reforms, particularly foreign exchange liberalisation. There is also report that there has been diversion of the investments in the stock market from the real estate market which is going through a slump. Non-resident Pakistanis working in the Gulf and Saudi Arabia are also understood to have transferred their savings to Pakistan after the Gulf crisis to be ploughed in shares.

The stock exchange has thus turned the corner and is well poised to play an even greater role in industrialisation of the country. The liberal incentives provided in new industrial and export policies have created a congenial atmosphere for vigorous investment activity. A climate conducive to foreign investment has also been created. Hence the outlook of the share market is quite bright. In fact, one of the biggest share markets in the region is now in the making. The reasons are not far to seek. The present government's policy of allowing free movement of foreign exchange has started paying dividends. A large amount of money belonging to overseas Pakistanis and foreign investors representing major financial houses of Europe and the Gulf, is coming to Pakistan through indirect channels. This runs into billions of rupees.

The upsurge in investment activity is largely attributable to the fact that the shares quoted on Karachi Stock Exchange ensure higher yield. The average yield across the board at the KSE is 9 per cent which is so far the highest as compared to other neighbouring countries despite the fact the only 50 per cent of the companies listed on the stock exchange are paying dividend. In case of top 25 companies, the average yield across the board is over 20 per cent, while in India the yield is only 2.2 per cent. Elsewhere in the world, it is less than 9 per cent.

Moreover, being a developing economy, the stock market in Pakistan has a vast scope for expansion which in fact is the main feature of attraction for the foreign investors who see a lot of potential in the market as compared to markets in Europe which are now at the point of saturation.

The stock exchange is expected to assume much greater role in capital formation because of the measures announced by the government towards privatisation and motivating the public sector companies to float their equities through the stock exchange for mobilising domestic resources. Until recently, the stock exchange played insignificant role in capital formation both in terms of companies listed on the stock exchange and in terms of their total market capitalisation. It needs no stress that stock exchange plays an important part in allocating funds to most productive sectors of the economy. Stock exchanges have played a pivotal role in developed countries in speeding up economic activity. It has served as a leading indicator of economic activity in the country as also has a deep impact on aggregate consumption and investment.

In Pakistan, Stock Exchange had a stunted growth. It made a modest beginning in 1948 with 54 members and 13 companies on its list. The paid-up capital was just Rs. 110 million. By the end of 1988, the number of listed companies rose to 200 with a paid-up capital of Rs. 18.8 billion. In 1989, the number of listed companies rose to 416 in addition to about 30 companies in the process of listing, with a paid-up capital of Rs. 20 billion. KSE went into operation in 1952. The Korean war boom gave a shot in the arm to industrialisation and in the process investment activity increased. Even agriculturists took part in share business to reap a rich harvest in terms of dividend as well as capital gains. However, small investor could not be induced to invest in shares because of poor publicity, lack of security and such taxation laws which discouraged small investors.

Share business got a big boost in sixties. With the acceleration of the pace of industrialisation, the concept of public limited companies started catching up. At the end of 1962, there were 110 listed companies with a paid-up capital of Rs. 1.41 billion. The economy needed more capital for its growth needs. Hence for mobilising capital, the sponsors looked towards the share market. Business in equities increased from a meagre 4.8 million in 1964 to 250 million in 1970.

Till 1968, the market witnessed a boom. Thereafter, political disturbances started disrupting normal functioning of industrial units, adversely affecting production and profits. Later the Indo-Pakistan war in 1971, dismemberment of the country and large-scale nationalisation of industries by the PPP Government threw the entire economy into a tailspin. The confidence of the private sector was sharply eroded and investment activity came to a grinding halt. This threw the stock exchange in doldrums. As a result, the number of listed companies which stood at 263 with a paid-up capital of Rs. 3.94 billion in 1972 could rise to only 282 with a paid-up capital of Rs. 4.97 billion in 1977. This was the worst period of stagnation in the history of Karachi Stock Exchange.

The share market entered a new era of progress in eighties. The government took effective measures to restore the confidence of the private sector. It also recognised the importance of stock exchange as a vital instrument of promoting investment and enriching the economy and adopted bold measures in the Federal Budget for 1985-86 to promote investment in shares. Liberal tax incentives were provided in relation to the capital market.

These measures went a long way in developing the capital market. The number of listed companies rose from 326 in 1982 to 416 in 1989. The paid-up capital in the corresponding period rose from Rs. 9.44 billion to Rs. 19.71 billion. Studies have shown that there is a close link between stock prices and industrial production. It also indicates that stock market reacts to change in industrial production. Hence there can be no denying the fact that the stock market in Pakistan is fully capable of channelising funds for most productive sector of the economy. Happily, its scope is broadening following the radical reforms introduced by the present government.

The denationalisation policy, in particular, has resulted in upward swerve in share prices of public sector companies. The drastic devaluation of the rupee against dollar has also generated interest in the shares of export-oriented and import substitution industries. Many textile mills are understood to have made windfall gains. Even smallest textile mills is reported to be making an additional ten million rupees every month due to devaluation. This explains heavy trading in textile shares. The overseas Pakistanis who have been jolted by the Iraqi occupation of Kuwait and subsequent loss of their savings have started transferring their funds to Pakistan. Their concept of security has completely changed. Now they are putting their investible funds in the shares of Pakistani companies.

Textile sector represents 60 per cent of GDP and constitutes 30 per cent of all shares listed on stock exchange. Modarabas are other hot favourite of investors. They are considered very good investment as they are tax-free and 90 per cent of their earnings are distributed among the shareholders.

After the change of laws about foreign investment in shares, multinationals have also entered the rings to buy back their shares from the market indirectly which are cheaper as compared to their break-up value and growth prospects. Campaign against bearer instruments has also led to diversion of funds towards the share market. Foreign investors are expected to come in a big way as Pakistan's industry has vast scope for expansion ensuring a very high yield to the investor.

Thus a very bright future lies ahead of the share market. It has already achieved a major breakthrough. As the pace of industrial investment picks up momentum, its role in capital formation is bound to increase the unprecedented appreciation in market capitalisation and daily turnover reflect the growing importance of the share market in the national economy. The number of listed companies is going to exceed 500 in the next few months. KSE has already emerged as the premier capital market of the country.

Thus in the last few years, the Karachi Stock Exchange has shown tremendous growth and the market capitalisation has shot up to 70 billion rupees with nearly 500 listed companies. The rush for the equity listing on the Exchange is increasing considerably. It was long felt that other instruments apart from equity should also receive due consideration in view of the fact that now industries require huge finance which is a burden on government funding. It is, therefore, essential that due consideration is given to the floatation of other instruments apart from equity which should be raised through the stock exchange.

The fact that in recent years all the public issues have been heavily oversubscribed proves the confidence of the investors in the share market and in the projects. It also proves that the shareholders are willing to participate in the industrialisation of the country. If the government policies are long-term, viable, indiscriminatory and not too much in favour of one area, one province or one sector, the interest in share business is bound to increase tremendously.

Another, discouraging factor is non-declaration of dividend by a large number of companies. In 1989, out of 416 companies listed on the stock exchange, as many as 203 did not pay any dividend to the shareholders. The position remained almost the same in 1990 when about 50 per cent of the listed companies did not pay any dividend at all. One-third of the companies are chronic dividend defaulters which had not distributed any dividend for several years. Another one-third of the companies distributed dividend well below the rates of bank interest and inflation.

If these inhibiting factors are removed, the way will be paved for early take-off by the stock exchange. In this way, it will play a more important role in capital formation and industrialisation in the country.
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:market capitalisation in Pakistan
Author:Jabir, Rafique
Publication:Economic Review
Date:Jun 1, 1991
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