. .
A



THE CAPITAL MARKETS

Vibrant performance in store

By AMANULLAH BASHAR
June 17 - 23, 2002

Despite passing through a sequence of disruptive events within and outside the country posing serious threats to the economy of Pakistan, the economic managers have so far succeeded in storming the weather skilfully.

The most sensitive part of the economy i.e. stock market also emerged victorious by showing its depth and grit in the backdrop of mounting tension between India and Pakistan, deteriorating law and order situation and the fall out of the political ups and downs in the region.

In the nutshell, the stock market registered a sharp rise of 46 per cent in equity index, increase in foreign portfolio investment, slower corporate debt market and a number of reforms were the salient features of the country's capital market during the year.

Salim Chamdia, Chairman of Karachi Stock Exchange while talking to PAGE said that as an immediate effect of the escalating border tension between India and Pakistan taking the situation at the brink of war, the market shed around 252 points, however it was a temporary phase which is reflected in the early recovery of 200 points in short span of time.

Chamdia feels that as soon as the situation returns to normalcy, the stock business, which is at the constant growth will further strengthen the capitalization of resources in the country.

Capital market plays a crucial role in mobilization of domestic resources and channeling them efficiently to raise economic production and productivity. The level of capital market development is thus an important determinant of a country's level of savings, efficiency of investment and ultimately its rate of economic growth, Chamdia said.

The government has a major role to play in the development of securities market. The policies on interest rate structure, allocation of credit, controlling inflation level and form of taxation are all critical variables in the development of the securities market.

In recent years, the government increasingly comes to realize the importance of improving the efficiency of the securities market and its relevance to private sector development and economic growth. In the context of Pakistan, securities market has a special significance, as equity instruments are the truest form of riba-free investment besides achieving socio-economic objective of imparting a sense of participation to the general public in the prosperity and development of the country. The government has also embarked on a massive privatization programme in the next couple of years, success of that is totally dependent on the health of the equity market, KSE Chairman recommended strongly.

The first half of the current financial year has been a very difficult for the Securities Market which remained depressed due to prevailing recession the world over, following the terrorist attacks on the World Trade Center on September 11, 2001. However, subsequently in view of a number of positive factors which, inter-alia, included reduction of the lending rates by the State Bank of Pakistan, removal of economic sanctions, cash grants, debt rescheduling support, trade concessions and economic assistance extended by a number of countries, revision of the country's credit ratings favourably and record rise of Pakistan foreign exchange reserves touching the level of 6 billion dollars, stable exchange rate, the market has experienced a remarkable turnaround.

Similarly, the KSE has undertaken a number of development measures, which have positive developments, the Pakistan Stock Market, which has appreciated by 46 per cent since January this year in terms of prices and by 140 per cent in terms of average daily turnover

The above statistics fully reflects the impact of government's positive policies and restoration of investors' confidence as well as increased foreign investment, investment by overseas Pakistani and investment made by local investors.

It may be recalled that the KSE had demanded for exemption of tax on Bonus shares issued by a company, which was previously exempt from tax up to June 2001. Distribution through bonus shares is nothing but capitalization of retained earnings through book entry transfer to paid-up capital. The demand gets approval of the government.

KSE Recommendations for consideration in the Federal budget for 2002-2003.

WITHHOLDING TAX

The new income tax Ordinance, 2001 provides for withholding tax on gross dividend income of every person, which includes Trust also. The section should be amended from withholding tax on mutual funds.

Distribution of 90 per cent earning after setting off previous losses.

Presently mutual funds are exempt from the levy of tax if it distributes 90 per cent of their earnings for the year; the clause should be amended to provide for distribution after set off of any previous business losses.

INCOME TAX ON SALARIED CLASS

Tax on salaried class should be rationalized. A number of tax benefits given to this class have been gradually withdrawn. It is recommended that maximum rate of tax on individuals should be reduced from 35 per cent to 30 per cent and number of slabs should also be increased. Relief should also be provided on reimbursement of expenses, as they do not result in any net cash benefit.

Reduction in tax liability of salaried class is necessary, as this will encourage them to save and invest. Given the chronic inflation, the basic tax exemption should be enhanced to Rs100,000 from present exemption level of Rs60,000.

INSURANCE

The income received by any person from rated and listed TFCs was exempt if issued on or after September 14, 1997. This exemption was withdrawn in relation to income received by any person other than a company w.e.f assessment year 2002-2003. The decision of the government to withdraw the tax exemption status for the listed TFCs would not only be detrimental to the small investors who do not have any other business or trading income but would also adversely affect the development of the debt market in the country and would retard investments and savings growth. Restoration of the exemption for both individual and institutional investors of all listed TFCs.

CAPITAL GAINS

Foreign Fund Managers and institutions prefer corporate Brokerage Houses, as they tend to be more professional in their approach. In the legal perspective too, they are viewed as a perpetual entity in contrast with individual membership, which terminates on the death of the individual.

KSE has demanded of the government to allow one time tax exemption on capital gains on transfer of membership rights or share in a stock exchange from individual to a corporate entity which will help in professionalism of the brokerage houses as well as to enhance their exposure and services for the investors. This will be a one-time feature and should continue without any time limit.

COMMISSION

Till 1998-99, 10 per cent withholding tax deducted on account of brokerage and commission, under Section 50 (4-A) of Income Tax Ordinance 1979, was treated as advance tax for adjustment in final liability. In the Federal Budget 1999-2000, however, there was an amendment to treat such tax deduction as full and final liability of the assessees.

In a number of cases, due to declining revenue and rising expenses, the final tax liability of members turns out to be less than the withholding tax. This deprives the assessees of their legitimate right of claim for refund of excess tax on the basis their actual income. In order to end this anomaly, suitable amendment is suggested.

PERFORMANCE

The Karachi Stock Exchange, despite witnessing a volatile situation during 3rd quarter of the financial year, the KSE-100 index closing with net gain of 46.7 per cent at 1,868.12 points at the end of the current financial year.

It is observed that the previous quarter ended December 31, 2001 had closed on a negative note at 1,273.06 points, owing to the December 13, 2001 attack on the Indian Parliament and the ensuing border tensions, which overshadowed the positive economic development during the financial year 2002.

With Pakistan emerging as key United States ally, market made exceptional gain of 347 points in January 2002, ranking it as top performing emerging market for the month by Morgan Stanley Composite Index (MSCT).

Unfortunately, the market momentum was broken in mid-February by the KSE circular, prudently reminding members of the stringent minimum capital adequacy rules introduced recently. As a result, index dropped by 119 points in three trading days before recovering on the back of strong performance reported by Hubco, MCB and Askari Bank, "Thereafter, sentiment on oil marketing company stocks dominated the market, taking the market to its peak of 1,930.46 on March 14, 2002 as the government announced a much awaited increase in their margins", the market took that as a prelude to the privatization of PSO. But the index was unable to remain above 1900 points and consolidated around the 1,850 levels.

FOREIGN INVESTMENT

The 3rd quarter witnessed an increase in foreign portfolio investment in the stock exchange. During the first two months of the quarter, market saw net inflow of $50 million, which stood in sharp contrast with net outflow of $32 million in the previous quarter. The increase in foreign investment was stated to be in line with the rise in KSE-100 index. This appears to reflect greater confidence of foreign fund managers in the Pakistan market's prospects due to its positive economic outlook, hefty reserves and stable exchange rate.

During Financial Year 2002, the KSE had implemented several structural developments which include complete implementation of the T+3 system, rationalization of risk management measures (deposit requirements, capital adequacy and uptick/downtick fluctuation bands) changes in the carryover market and more recently the launching of the new trading system. On the regulation front, the SECP issued the "Code of Corporate Governance" on March 28, which was included by all stock exchanges in their respective listing requirements.

Debt capital market: The private corporate debt market had seen brisk activity since the beginning of fiscal year with 13 issues (Term Finance Certificate) floated in the market during the financial year 2002. But only one TFC was launched during the third quarter of the year: that of Reliance Weaving Mills Limited. The size of the TFC was Rs150 million, issued on February 6. But the future outlook for TFCs is positive as a number of large issues in the pipeline.

The constant upward growth at the capital market is also reflected in the Term Finance Certificates (TFCs) issued by 13 companies during the financial year. Those companies issued TFCs include Orix Leasing Pakistan Ltd, Sui Southern Gas, Engro Asahi Polimer & Chemicals Ltd, Dewan Salman, Pakistan PTA Limited, Engro Chemical Limited, Security Leasing Corp. Limited, Crescent Leasing. Reliance Weaving Mills Limited, Usman Leasing Limited, in this issue over subscription of 107.070 million has been retained by the company, Shahmurad Sugar Mills Limited, the company has the option to retain up to 30 million i.e. 40 per cent of the total public issues. Saudi Pak Leasing Company Ltd and the most recent issue of Sui Southern Gas Company.

RISK MANAGEMENT

The consultative Working Group on Capital Markets has reviewed the existing risk management measures at the stock exchanges, in particular various proposals being considered at the co-ordination meeting of the bourses and the SECP to remove existing deficiencies in Carry Over Trade (COT) financing. SECP comprises eminent practitioners from the private sector and provides advice on important policy matters. The Group members as well as to deliberate upon some recent events impacting the capital market in the country convened the third meeting to discuss progress on various working papers under preparation.

The COT measures being considered include: COT should be for a period of 10 days and the finance will have option to release it after one day. However, the financier is obliged to rollover for 10 days, if so desired by the financee, while the COT should only be allowed in the shares of very liquid companies:

The margins for COT should be 25 per cent higher than for normal market trades.

The COT shares shall be kept with the CDC or the Clearing House of the exchange or in the case of institutions providing financing, pledged in favour of those institutions and blocked for further use during the contract period of the financing.

It was, however, felt that while these measures will serve as useful interim steps to improve risk management of COT financing, a more permanent solution needs to be developed that will widen alternative avenues for financing against shares, including margin financing.

A sub-committee has been constituted to come up with an action plan for developing these alternatives financing sources. The sub-committee headed by Ali Ansari includes Samir Ahmed, Naseem Beg, Muneef Ibrahim and Ejaz Rahim. The committee is expected to submit its report within 30 days.

The study, being conducted by Dr. Nishat, Professor at IBA, Karachi, is due to be finished by the end of June and will provide guidelines on appropriate exposure levels that would have protected the clearing houses in the past from excessive price volatility.

Based on information contained in the study, the group members are expected to come up with formulae to determine margin requirements on individual stocks which will correlate with the price volatility and hence the risk emanating from the particular stocks.

In order to discipline brokers/ investors, it was proposed that regulations be devised that make it obligatory for brokers to get margins from clients. This will also be in line with international practices. Relaxation may be given to some class of institutional clients.

In view of the recent market happenings the governance of the stock exchanges come under debate.

The meeting felt that while the stock exchanges had taken a number of important steps to introduce independent professional management, there is a significant need to further strengthen the same to reduce perceived interference of the members in the day-to-day running of the exchanges. It was also felt that there is a need to dissipate informal lobbying efforts of brokers applied through the stock exchange. Being a front line regulator, it is important for the management of stock exchanges to independent of any vested interests.

OUTLOOK

The total proceeds from the privatization of state owned units have been estimated at Rs61 billion or $1.8 billion so far. The government aims at bringing major transactions to the market during the current calendar year. The privatization programme starting from 1990s has sold some 109 units. Presently, some giants in the public sector organizations especially in the financial and energy sector are being given the final touches for transfer of hands from public to private sector. The focus of the privatization policy should be the broadening of the ownership base by selling these units through share market. The market has the required depth to absorb these transactions. The most important factor which the economic managers should focus in their policy is to enable the potential investors both individuals and companies to save their earnings. Presently, the high rate of taxation, exorbitant cost of essential items including utilities and multiplier effects on general prices have eroded the saving capabilities of the people in general.

The magnitudes are reflected by the following details since July 01, 2001

Date

KSE-100 Index

Market Capitalisation (Rs in billions)

Average Daily Turnover (Shares in million)

July 01, 2001

1366.44

342

110.96

September 30, 2001

1133.44

285

93.90

December 31, 2001

1273.07

296

96.91

March 31, 2002

1868.12

432

195.95