Stock Market Outlook

  Jun 22 - 28, 1996

In the last pre-budget session on the morning of Thursday 13 June, the stock market was quiet as investors mostly stayed away; the KSE-100 index gained 1.6 points but trading volume dropped almost 60% from the previous day. As the Minister of State for Finance Makhdoom Shahabuddin presented the federal budget for the coming fiscal year, the market dropped 11 points, as many measures were unclear and investors still awaited the Finance Bill. But during the first session after the budget, the market tumbled 52 points to reach the 1641 level as the implications of the budget became clearer. In the second post-budget session there was some upturn as the index picked up 15 points, and the third trading day saw the index rise another 16 points closing at 1672.83. Analysts at Global Securities, however, felt that the market over-reacted and that it was essentially only a few sectors which were badly hit.

Although the government withdrew the facility the ICP and NIT have so far had to deal outside the stock exchanges in a positive move towards further transparency, Arif Habib, the president of the Karachi Stock Exchange, was disappointed, understandably, that the tax on bonus shares and the capital gains tax on insurance companies were not withdrawn. Nasir Ali Shah Bukhari, Chief Executive at Khadim Ali Shah Bukhari and Co expressed his disappointment as well; the legal cover for operations of the Central Depository Company were not outlined, corporate taxes were not reduced by three percentage points promised, and the levying of excise duty on leasing and musharika financing would only undermine the growth of the financial sector.

Although a few sectors of the market were relatively luckier, and escaped harsher measures, most notably the paper and plastics sector, and to some extent the fertiliser industry, the outlook largely seems to be negative with the cement sector being the hardest hit. We outline the key measures in each sector and discuss their impact on earnings and profitability.


Sales tax increased from 15% to 18%, excise duty increased from 25% to 35%, corporate tax rate to stay at 36% and sales tax exemption to stay on Lucky and Saadi Cement.

The hardest hit sector of all, most analysts are posting negative signs on the cement industry. Increased levels of taxation suggest that there will be a pressure to increase prices, but due to the

expected over-supply situation, as Lucky, Saadi and Nizampur commence commercial production, it is unlikely that manufacturers would be able to pass on the increased taxes to consumers. Lucky Cement will continue to enjoy its five year tax exemption and an increased comparative advantage. Furnace oil and electricity are the main raw materials for cement production and increases in the prices of both are expected later in the year. Manufacturers will also have to pay an additional Rs 20 per tonne on packaging material imports since the 10% additional regulatory duty was not withdrawn . As supply is on the increase, demand is sluggish due to slow economic activity and it is estimated that in the next year, capacity utilisation will have to fall to match demand.


The sales tax exemption on natural gas will remain, a 5% sales tax will be imposed on raw material for fertilisers, and corporate tax will be 36% as against 33% in the current year.

Most analysts pronounced the budget as neutral for the fertiliser industry and it is not expected that the strong growth in this sector will be deterred. Urea manufacturers, Fauji Fertiliser and Engro Chemical will remain unaffected as the exemption on natural gas, the main input, remains in place. However, phosphoric acid, which is the main raw material for the manufacture of DAP will be taxed at the rate of 5%; this will affect the earnings of Fauji Jordan Fertiliser since the total project cost will be higher and depreciation expenses will rise. This project is expected to come on line in 1998, and with this and other factors causing an increase in gas prices, there might be some pressure to increase DAP prices as well. The increase in corporate tax will not affect FJFC which has an eight year tax holiday.


A 5% sales tax on the import of power generation and transmission machinery and a rise in corporate tax from 33% to 36%.

The federal budget did not announce the expected 15%-20% rise in electricity and gas charges, although such an announcement is expected later during the year. The imposition of the 5% sales tax, however, will affect only captive power units as project costs increase by 2-2.5% and not independent power plants since there was no change in the power policy. But because profitability is based upon a fixed formula, earnings will not be affected. For independent power projects including Hubco the duty will be passed on and tariffs will also be higher. WAPDA, KESC and captive plants are under pressure to increase tariffs to maintain margins.


Corporate tax increased from 33% to 36%.

The earnings of Sui Southern Gas Co and Sui Northern Gas are based on a fixed return on assets before tax and therefore their profitability will be affected by the corporate tax increase. Further price increases in gas are expected since there is IMF pressure to bring them in line with international gas prices, and since this was not addressed in the budget, it is expected that a mini-budget will be announced soon.

Oil distribution

Prices of petroleum were adjusted downwards just before the announcement of the budget; Rs 400 per tonne or 8.1% for furnace oil, 22 paisas, or 1.3% for motor gasoline, and 20 paisas or 1.1% for HOBC. PSO will be affected by higher corporate tax rate but Shell will remain unaffected as it pays a 0.5% turnover tax.

Commercial Banks

Income tax rates will remain at last year's levels of 60% and will be brought down to 58% in 1997-98, central excise duty on bank cheques increased from Rs 3 per cheque to Rs 5 per cheque, 1% central excise duty of the amount of musharika financing outstanding on the last working day of each calendar month will be charged.

The government has set its borrowing targets at Rs 20 billion from the banking system, and if they do not exceed this level, this will improve credit availability for the private sector. With low interest margins, the proposed reduction in income tax to 58% would have helped the industry; KASB has revised their forecast for earnings growth from 20% to 16% for the next year. According to Global Securities, Faysal bank is the only listed bank to extend lease financing but they will be able to pass on the cost of the 1% CED to consumers since they charge lower rates than leasing companies.

Leasing Companies

A 1% CED will be charged on the month-end outstanding leases, and corporate tax has been increased from 33% to 36%.

Since demand for credit is high, leasing companies should be able to pass on this increase to consumers, but competition within the sector is also high so this may not be entirely possible. The increased corporate tax will decrease profitability.


Tax rates will remain at 36% in 1996-97 against an earlier planned reduction to 33%.

One of the most disappointing areas for the capital markets as a whole since the capital gains tax was not withdrawn for general insurance companies. Since about 45% of revenues come from dividends and capital gains, this move would have increased earnings considerably. In addition to this, tax rates will also remain a 36%.


A 15% sales tax is levied on ginned cotton, yarn and cloth, central excise duty leviable on cotton / blended yarn of Rs 2.5 per kg is proposed to be withdrawn, import duty on export-oriented machinery has been reduced from 45% to 10% on specialized textile machinery are tax incentives will remain, sales tax on the local sale of ginned cotton yarn and cloth has been levied at 18%, corporate tax increased from 33% to 36%.

Textile manufacturers will have to increase their selling price in order to compensate for the sales tax, and profit margins will be squeezed if they do not do so. Manufacturers who export a large part of their production will be better off as exports are sales tax exempt. Prices of ginned cotton yarn and cloth are bound to increase by between 13-15%. The withdrawal of excise duty on cotton / blended yarns will have an important impact on spinning units that rely on domestic sales like Gadoon Textile who sell almost 95% locally. Gadoon will also be exempt from the 15% sales tax since it is located in the Gadoon Amazai Industrial Estate


The abolition of the 10% regulatory duty has been postponed the 40% import duty also remains, sales tax which had been reduced to 10% is up to 18%, corporate tax is up from 33% to 36% tax exemptions in special industrial areas will remain unchanged, no sales tax on imports, .

Local PSF manufacturers will continue to be protected but the impact of the sales tax will depend on the ability of the manufacturers to pass on the increase to consumers. Otherwise the sales tax will particularly affect ICI and Pak Synthetics; Dewan Salman has a five year sales tax exemption as will Dhan Fibres is it begins commercial production before June 30, 1996. But, as pointed out by AKD Securities, spinners buying from them will be unable to recover the sales tax they pay on yarn and since neither will pay on raw materials they will have to sell at lower prices to compensate the spinners. Gross margins are expected to fall overall as supply increases locally and international prices fall.


A 5% sales tax on medicines and medicine raw materials, a 5% excise duty on raw material imports which will raise a revenue of Rs 200 mn, increase in corporate tax from 33% to 36%.

Since more than 80% of raw material is imported, and since most producers are multi-nationals, profitability in this sector will be negatively affected. Costs will either be absorbed or price increases will be seen during the year in the deregulated non-essential drugs. Companies with more nonessential drugs in sales, like Searle, will benefit more as prices rise.

Auto and Allied

Sales tax increased from 15% to 18%, withdrawal of 10% regulatory duty postponed, corporate tax increased from 33% to 36%, import duty on CKD kits increased from 22% to 30%, capital value tax increased

The end of the concessional import duty on CKD imports will result in higher production costs, and the capital value tax and sales tax increase will raise the retail value of cars and other motor vehicles, affecting consumers. According to AKD Securities, the retail price of a Suzuki Mehran, the largest selling car in Pakistan will have to rise by Rs 7500 to Rs 257,500 to keep margins at previous levels.

Paper and Plastics

Import duty on primary raw materials used in the plastic industry to be reduced to 5%, duty on pulp required for manufacturing paper reduced from 35% to 10%, continuation of the 10% regulatory duty and the maximum tariff rate at 65%.

A lucky sector amidst a series of disasters, the paper industry will remain protected as import tariffs are reduced on pulp and import of finished goods will be discouraged.

Sources: AKD Securities, Global Securities, Khadim Ali Shah Bukhari and Co