.



THE CAPITAL MARKETS

Analysts forecast for another bullish run once Pakistan enters into a long-term funding agreement with the IMF and resolves the IPPs controversy

By SHABBIR H. KAZMI
Nov 27 - Dec 03, 2000

The May Crisis, has changed the complexion of equities market in Pakistan. The KSE-100 index after touching 2054 points in March this year closed at 1355 points on November 24, 2000. There is a forecast that the index may go down to around 1100 points by the year end. However, analysts forecast for another bullish run once Pakistan enters into a long-term funding agreement with the IMF and resolves the IPPs controversy. They also warn about eroding earnings potential of listed companies due to cost pushed inflation. Therefore, there is a need to revisit the market to explore potential and factors influencing the performance of listed companies.

First of all it is necessary to understand equities market in Pakistan. It may not be wrong to say that the market is overwhelmingly driven by speculative sentiments. The overriding sentiments of speculation and insider trading have been ruling the market and have often resulted in price volatility as well as price manipulation. The market's response to fundamental investment oriented events has been, at times, dismal and of less significance.

Then, it is more appropriate to explore the market from the change of political scenario in October 1999. A change in perception about economy and stability had a positive impact on equities market. There was increase in daily trading volume as well as improvement in KSE-100 index. However, during the first half (Jan-Jun period) of the year 2000, the market witnessed a sudden boom and bust. KSE-100 index after touching 2054 points on March 22, receded back to 1429 points on May 29 a fall of 625 points.

It may be worth noting that while there was increase in price and daily trading volume, there was no significant improvement in the fundamentals of most of the companies during this period. However, settlements remained low and carry over percentage continued to bulge. Besides, the carry over trade through KATS and LOTS there was direct Badla. While Badla rate went up it was also alleged that a large part of Badla was financed by some financial institutions.

Around the same time some analysts cautioned about the bulging bubble. A group of analysts pinpointed that index direction was being driven by a few groups who had the advantage of undue information and excessive financing facilities. However, the general feeling was that economic fundamentals were improving. At this juncture Karachi Stock Exchange (KSE) decided to examine exposure regulations and issued instructions with regular intervals. Some analysts say that by the time KSE changed the rule of the game the damage was already caused and defaults by members were evident. Hectic efforts were made to save the investors. It may also be said that corrective steps were taken so quickly that brokers did not get enough time to adjust to changed rules.

Whatever happened is history now but it has lesson for those who would like to discipline themselves. The report prepared by the committee constituted by the Securities and Exchange Commission of Pakistan (SECP) to investigate the reasons for the May Crisis is an authentic document to get ready to avoid similar crisis in the future. One may not agree with the content/observations made by the Committee but every one must recognize the efforts made by the members and support by stock exchanges. This report was prepared in a record time, submitted to the SECP and some decisions were made promptly. The Committee comprised of, Etrat Rizvi, Javed Callea, Waqar Malik and Javed Panni.

According to the Report, now referred as Etrat Rizvi Committee Report, "The crisis seems to be a result of an attempt to manipulate the market by some major players and lack of timely response by the stock exchanges." The Report also indicates an inherent weakness of the market. It says, "The stock exchanges in Pakistan represent a classical example of oligopolistic market dominated by a few scrips and a few major brokerage houses. On occasions, certain individual investors have also attempted to take the market to their own desired directions." It also says, "As a matter of fact the trading volume and index are dominated by 10 companies, 10 operators and five Badla providers."

Therefore, there is a need to make this report public. However, some of the points covered in the Report must be of immense interest. These are:

* There was abnormal price increase in a number of scrips as well as trading volume of certain scrips.

* The weekly trading in case of couple of scrips exceeded much beyond the normal level without any improvement in the fundamentals of these companies.

* The carry over trades in a particular scrip exceeded the net free float of the scrip indicating a reckless use of naked Badla.

* The official Badla was around Rs 15 billion for two exchanges whereas the Badla volume up to 1997 had touched a maximum ceiling of about Rs 1.5 billion. The unlimited use of carry over transactions added to the gravity of the crisis.

* The eagerness of the members to trade on behalf of the clients without obtaining sufficient margin and thus exposing themselves and the Clearing House to the risk of default by their clients. Some members going to the extent of taking no margin from their clients.

* Though, both the exchanges have their respective rules governing the exposure and losses, there would have been lapses in the implementation of these rules.

Price volatility

The price increase in certain scrips exceeded the aggregate market trend and had gone beyond the expectation level of the market. The 15 companies identified were: Adamjee Insurance, Bank of Punjab, D. G. Cement, Dhan Fibres, Engro Chemical, FFC-Jordan, Fauji Fertilizer, HUBCO, Ibrahim Fibres, ICI Pakistan, Japan Power, Dewan Salman Fibres, PSO, PTCL and Sui Northern.

During January-May period Engro experienced a decrease owing to an allegedly unsuccessful takeover attempt. Dhan and Salman registered an increase instigated by the acquisition of Dhan by Dewan. FFC-Jordan and Fauji moved within a narrow bandwidth. The price movement in PTCL remained related to the index rise. The prices of HUBCO and PSO underperformed. The price movement in ICI Pakistan and Ibrahim were due to change in market perception regarding PSF sector. The news regarding privatization of LPG business of SSGC and SNGPL motivated the price increase.

Adamjee Insurance and Bank of Punjab outperformed the market without any change in fundamentals. Initially a few individuals traded in these scrips through a selected brokers but were joined by others as part of herd mentality. While average daily turnover touched new heights a very low percentage came for settlement and carry over trade were high. The increase in Badla rates gave negative signal to usual Badla investors. Financial institutions also indulged in margin financing.

Exposure limits

It may not be wrong to say that sudden change in exposure regulations changed the entire complexion of the market. KSE has been reviewing its rules to adjust to changing trend. The Lahore Stock Exchange (LSE), which has traditionally followed the KSE regulations, decided to depart from this in April this year. There is every reason to believe that LSE decided to become a party and opted to protect the interest of brokers at the cost of stock market itself. The approach of LSE was devoid of any rationale. While KSE was prompt in identifying one over-exposed member and settling his account, LSE did not act in a prudent manner. LSE decision may be termed as bias towards Iftikhar Shafi and Nisar Elahi and others. It is worth noting that these two were officially presented LSE plaque on March 4, 2000 recognizing them as leading industrialist and investor.

Crisis aftermath

The financial impact of May Crisis can be assessed from two angles. Firstly, the market capitalization which peaked around Rs 560 billion in March plunged to less than Rs 400 billion in June. The second dimension pertains to the book losses of the related parties. While it may be difficult to estimate the exact loss, the claims on Iftikhar Shafi and his associates exceeded two billion rupees. The contingent losses of other brokers and investors due to sudden crash of the market may not be quantifiable but are definitely very substantial. The most negative impact has been the loss of investors confidence in equities market.

Recommendations

The crisis is still lingering on. Daily trading volume and share prices are under pressure. Various steps have been taken to create an orderly and transparent environment for restoring investors' confidence, yet a lot has to be done. However, each step needs to be taken carefully and cautiously.

Referring back to Etrat Rizvi Report, it is desirable that the contents of this report should be made public. It is also suggested that the SECP and stock exchanges should also follow the recommendations put forward in the Report. It would be desirable to identify the culprits, ask for the explanation and if no satisfactory reply is made available put an embargo on their participation in the market.

A professionally staffed Surveillance Department is needed at the stock exchanges. This department should monitor scrip-wise price movement, turnover, deliveries and carry over trade on each clearing and report variation to Managing Director.

For better risk management and containment of undue speculation, fixed trading cycle should be discontinued and a revolving settlement cycle on T+3 basis should be introduced initially for 10 to 15 volume leaders.

Last but not the least Chairman of KSE should not be the Chairman of Central Depository also and number of outside directors on KSE and LSE should be increased. SECP nominees should play more active role on the boards.

According to a report, the directive by the SECP to prohibit short selling in a few selected scrips (PSO, PTCL, HUBCO and ICI) is a classic example of regulatory behaviour that does more harm than good. A better way to approach excessive short selling was to raise margin requirements and tighten up on broker exposure limits rather than impose a knee-jerk discriminatory reaction on all investors. The report says, "The SECP has no place interfering with the price/value at which a stock trades. Its job is to provide a level playing field and ensure that given sets of rules are followed. Changing rules without notice is discriminatory to a majority of shareholders and could be constructed by market participants as an attempt to protect those caught on the wrong side of the fence."

Outlook

While extreme of volatility may have been reduced, the market still remains in a major corrective mode. Many domestic institutional investors are presently sitting on large book losses and the movement the market moves up, there is a high likelihood that they will take the opportunity to raise cash by selling before December end.

Over the medium term, analysts are cautiously optimistic about gradual improvement in the macroeconomic conditions and reduction in Pakistan's country risk perception. The market may witness a turnaround after Pakistan enters into a long-term funding agreement with the IMF. Investors may accumulate cash to participate in rally with the beginning of the year 2001.