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Current trends of the stock market.

To understand the current trends it is necessary to refer to the past. The present is best understood in this context. Our history instructs us. We learn about how the market has behaved at various points in time and from this we can draw conclusions about the future and lessons about what to do and what to avoid. I have prepared two charts, one which shows the history of the market which I have divided into a decade wise presentation. The other chart is a year wise presentation from 1991 to 1997. It is no surprise that the growth of the market has paralleled the growth of the economy. It is also no surprise that most of the growth has occurred since 1991 when policies of liberalisation were initiated.

The '60s' were the decade of rapid economic growth. The private sector was encouraged to invest and a large number of industrial units and financial institutions were created during this period. Industry grew and the financial sector flourished. During this period the two financial institutions which have nurtured the market - NIT and ICP were created. The stock market reflected this growth. The number of listed companies grew from 81 to 314. The economy was rapidly approaching a takeoff stage. The private sector was creating an economic miracle. Had this trend persisted, Pakistan would have been an economic tiger by '80s'. This was not to be. The tensions created by the concentration of economic resources in a few hands and the international trend towards social ownership of assets led to a revision of our economic priorities in the 70's. This change in economic orientation coincided with the breakup of the country When Bangladesh emerged as an independent country at the end of 1971. The new government was imbued with a sense of providing social justice and ensuring a better distribution of wealth. Large scale nationalisation occurred at a time when the economy was recovering from the shock of the division of the country. Stock market reflected the shift from a reliance on the private sector to the faith in the public sector. Through this period the number of listed companies increased by only 23 from 291 to 314.

The decade of the eighties may be divided into two roughly equal parts. The first half belongs to a period of dictatorship distinguished by an attempt to Islamise the economy, the Afghan war and the vast inflow of foreign exchange to finance the war. It is in this period that the fundamental imbalances of the economy began to become apparent. The next half of the decade saw the revival of democracy. It will be seen that with the advent of democracy the private sector began to assume a more important role. It was in the first term of a government elected by popular franchise that the first privatisation efforts were initiated and shares of PIA were offered to the public. 173 new listings were witnessed during the decade of 80's.

The real impetus towards liberalisation gained momentum in 1991. The secondary market was thrown open to the foreign investors on equal terms with local investors. The private sector was permitted to invest in all sectors of the economy except four-proscribed. sectors where investment could only take place with prior government approval for reasons of national security. Privatisation was pursued aggressively. Since 1991, 331 new companies have been listed, listed capital has crossed Rs.207b from Rs.28b in 1990. Market capitalisation has reached Rs.552b from Rs.62b. Average daily turnover has reached 56.2 million shares in current year from i million in 1990. During this period issuers have also accessed the international capital markets. Dewan Salman issued Euro convertible bonds raising US$45 million. Government of Pakistan raised US$900 million through issue of PTC Vouchers to international investors. The shares of PTCL, Hubco and Chakwal Cement are traded internationally through the instrument of GDR. The Government of Pakistan has issued bonds worth US$ 175 million exchangeable into PTCL shares in the international market. Since 1994 the trend of the market has been bearish and share prices have remained under pressure. Let us examine the causes:-

1) An excessive supply of fresh equity in 1994 and 1995. In this period that PTC, Hubco, Faisal Bank, Lucky Cement, Dhan Fibre, Ibrahim Fibre and other billion rupee companies came to be listed. It is also instructive to note that Lucky Cements, Dhan Fibre and Ibrahim Fibre are all equity financed projects.

2) There was also a serious deterioration in the law and order situation in Karachi in 1995.

3) The economy was very weak in 1995 and 1996. There was a widely perceived risk of sovereign default. This perception was strengthened by frequent devaluations and a deteriorating relationship with international agencies notably the IMF and World Bank.

4) In order to achieve revenue targets and to finance uncontrolled expenditure, the government levied excessive taxes in the budget for 1996-97. In fact this period has been characterised by mini-budgets each of which has increased the utility charges and petroleum prices leading to an unbearable increase in the cost of production for the manufacturing sector.

5) Over capacity has been created in the Fibre and Cement industries.

6) The bad economy, the political uncertainty and the depressed stock market have all contributed to weakening our financial institutions. One of the important supports to the market has been the capacity of our financial institutions to stabilize the market. This important support has been weakend.

We come now to the present. The market has begun to show signs of recovery. The improvement has started with the election of a strong government. The government has attached great importance to the revival of the economy. Various economic packages directed to stimulating sectors of the economy have been put in place. A capital market revival package has also been instituted. I may point out that the two important sources of support for the market - the local financial institutions and the foreign funds have been on the sidelines through the last financial year. The local financial institutions were net sellers of shares worth Rs.6 billion in the financial year 1996-97 whereas in the previous year they were net buyers of a like amount. The foreign investors have been net buyers of a meagre amount of Rs.773 million. Inspite of this the market has performed reasonably well. This is a healthy sign. Local individual investors are now present with the strength to lend support to the market. It is unfortunate that investment by individuals is termed as speculation and jobbing activity. Instead of acknowledging the worthwhile contribution of investors their activity is being projected negatively. Let me show the slides which indicate the market activities of local institutions and foreign investors during the Financial year 1996-97 and in the month of July 1997. The future direction of our market depends on two factors, the size of cotton and sugarcane crops and ESAF arrangement with IMF. The expectations on these matters are positive which will help in resolving the immediate problem of balance of payments and help in achieving the budgetary targets of GDP growth. With the revival of the economy foreign investment will be attracted and with the revival of the market, the local institutions will also regain health. Sustained growth and development of the market depends on four macro factors:

1. An enabling environment for investment;

2. Corporate profitability and corporate behaviour;

3. Market infrastructure; and

4. Marketing the market.

I propose to discuss these factors in this order.

1. Enabling environment is composed of three aspects i.e. political conditions, economic conditions and investment incentives.

a) Political Conditions: As result of general election in February this year a strong political government is in place. The parliament has amended the constitution removing Article 58(2)b. Political stability can be expected.

b) Economic Conditions: The government has initiated bold economic policies, reduced taxation, rationalised tariffs and instituted revival packages for various sectors of the economy. As a result of these policies the economy is targeted to grow at 5.1% for 1997-98, inflation is expected to come down from 12% to 11%, exports are targeted to increase by 15%, and budget deficit is targeted to be reduced from 6.3% to 5.5%. This improvement in the economy should be reflected in share prices in the future.

c) Investment Incentives: Here the government has been very positive and our incentives are probably the best in the region. A market revival package has also been instituted. Bonus shares have been exempted from taxation, the tax exempt status of capital gains has been extended to the year 2001, turnover tax on shares has been removed, corporate tax has been reduced and incentives have been provided for the growth of the corporate debt market. Excise duty on borrowing has also been withdrawn which will lead to lower cost of finance for the companies. Excise duty on telephone calls has been reduced from 40% to 25%; the differential will be used mainly to enhance PTCL's profitability; this has a beneficial effect on market sentiment as PTCL is the trend setter.

2. Corporate Profitability and Corporate Behaviour: With the improvement in the economy and reduction in corporate taxations, corporate profits should improve. This will have a beneficial effect on profit distributions and consequently on share values. It is to be noted with regret that the positive impact of investor friendly policies and the improvement in the economy is diluted by bad corporate governance. This is probably the weakest link of our market. For some reason the sponsors seem to believe that they own the company totally and it exists only for their benefit. The shareholders are denied their just rights. All this is changing. Corporate laws are being extensively revised to enhance in investor protection. The CLA and the stock exchanges are also becoming increasingly active to protect the shareholders interest.

The Karachi Stock Exchange (KSE) is moving strongly in this direction. The capabilities of our Company Affairs Department to monitor corporate governance and to initiate remedial measures has been enhanced. The KSE is particularly concerned to check the abuse of intercorporate financing. Thus when Ibrahim Energy had made investments in associated companies without the authority of a special resolution as required by Section 208 of the Company's Ordinance 1984, they were required to reverse the decision. Also when Dhan Fibre which had not yet gone into production and achieved profitability wanted to make investments in an associated company, they were not permitted to do so. We have also recommended to the Corporate Law Authority to take delisted companies into liquidation under Section 305(g) of the Companies Ordinance, 1984. This is the logical final conclusion of the exercise to weed out undesirable companies.

We wish to caution a large number of delinquent companies and their managements, that we will now be more vigilant and active in enforcing corporate discipline. We wish to send an early signal to investors against defaulting companies by having set up a defaulting companies' counter where we have placed those companies which do not fulfil the provisions of law and regulations of the KSE. If the defaults are not rectified within 2 years these companies will be delisted and may subsequently be liquidated. In the changed environment listed companies will be required to be fair and transparent in their dealings with their shareholders. But this change is not being imposed on the listed companies alone. The stock exchanges are being restructured and will now have significant public representation on their boards. The Corporate Law Authority is being restructured and a new Regulatory Authority known as the Securities and Exchange Commission of Pakistan will be created which will have significant public representation. It is to be expected that the representatives of the public on the stock exchange Boards and on the Board of the SEC, will be seized of the necessity to enhance investor protection.

3) Market Infrastructure: Market infrastructure constitutes introduction of:-

a) Automation in trading, clearing, settlements, dissemination of market information and brokers back-office functions.

b) Strengthening of Rules and Regulation and its strict enforcement to protect the market participants from undue risks.

c) Improve quality of market participants to ensure best services to the investors.

Presently KSE's market information system is computerized. The price fluctuations are disseminated on real time basis to all within the Exchange building in broker offices by KSE network, in whole of Pakistan through Fascom and Wavetech by telephone lines and satellite and internationally through Reuters. Most of the brokers back offices are fully computerized and more investments are being put to introduce modem technology in this area. Our clearing house is computerized since 1987 and is working very efficiently since then. And now we are working on setting up of a national clearing system which will cover the transactions of all the Stock Exchanges of the country and will include all the institutional investors in the system. Asian Development Bank has indicated to sponsor the technical assistance in this respect and has also offered to provide US$2 million as soft term loan for setting up the system.

In order to automate trading we have a pilot project of Computerized Trading System (CTS) which is in operation for last one year in the afternoon between 3.30 p.m. to 6.00 p.m. A comprehensive computerized trading system for KATS i.e. Karachi Automated System has started mock trading w.e.f. August 15, 1997 is due to go live on September 4, 1997. This will replace the CTS and Open Out Cry system ensuring efficient and transparency in the order executions. The KSE has invested Rs.100 million in this project and further Rs.80 million would be invested by the members of the KSE in their offices. This system will have 800 terminals expandable up to 1600 terminals with existing hardware and could further be expanded with additional investments in hardware. Presently the system is capable of handling 40,000 transaction on daily basis as against present average of 12,000 transaction in Open Out Cry and CTS.

We are also in the final stages of refurbishing the trading hall in the Exchange where electronic boards have been put to indicate price fluctuations on real time basis. This will not only improve the efficiency of traders in the Hall but will make it more presentable. This project will be completed by end of next month. The cost of this project is Rs.40 million. In order to automate settlement we have achieved the Central Depository System. I am pleased that the Prime Minister of Pakistan Mian Muhammad Nawaz Sharif has consented to inaugurate the system on Sept. 3, 1997. This is a KSE initiative in collaboration with Citibank, IFC, MCB, LSE, ISE, HBL, PICIC, NIT and ICP. The physical handling of settlement has been a big hurdle in further growth of the market. With the advent of the Central Depository our market will mature and achieve international recognition.

We are in process of revising our Rules and Regulations to make them responsive to the needs of present time. In the last few years the introduction of Regulations in respect of members exposures, members default, arbitration, clearing house protection fund and investors protection fund have proved very effective in managing the risk associated with the market operation. These are being further strengthened in order to provide more comfort to the market participants.

During the last few years the quality of services by the Members of the KSE has improved substantially. A number of international securities houses have become members of the KSE. Research reports are being published for the benefit of the investors by the Members of the Exchange. Educated professionals are being hired by the brokerage houses. The Board of KSE has decided to introduce the certification courses for its members, their agents and traders to ensure quality services to the investors. I expect that by the end of this year KSE would become a modem emerging market of the region.

4) Marketing the Market: Our market needs to be integrated with the capital markets of the world. In addition we need the goodwill of international financial institutions such as the IFC, World Bank and the Asian Development Bank (ADB). We are working in close coordination with them. The KSE is a founding member of the federation of Euro-Asian stock exchanges. The main objective of this Federation is to harmonise the Rules and Regulations, Procedures, information dissemination and infrastucture of the member stock exchanges to enhance their capabilities to attract foreign investment into the region. The KSE is a corresponding member of the Federation of international stock exchanges and is seeking full membership. We are also due to sign an agreement to provide technical know how and expertise to the Tashkent Stock Exchange which has been sponsored by the IFC. With the Asian Development Bank there is an ongoing discussion on market development.
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Title Annotation:Pakistan
Author:Habib, Arif
Publication:Economic Review
Date:Nov 1, 1997
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