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.
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