THE CAPITAL MARKETS
The recent crisis indicates gross negligence of the regulators
By SHABBIR H. KAZMI
Jan 27 - Feb 02, 2003
Pakistan was declared the best performing market for the year 2002. The KSE-100 index continued to move up during the first two weeks of year 2003. Then came a sudden and un-ceremonial collapse. The index lost nearly 350 points in just five days. At a time it was hoped that investors base in Pakistan stock market seems to have started rising, the recent episode has caused a breached of confidence. There were many to claim the responsibility for the boom but is there anyone to take the responsibility for the ongoing casualties?
Many analysts strongly believe that the recent fall has nothing to do with fundamentals, technicals or liquidity. A crisis likes situation arisen only because of the inability of the regulators, both the KSE and the SECP, to read the emerging bubble. Even when the bubble was about to burst, the KSE did not take corrective steps and the SECP had to intervene. The SECP issued notices to 19 brokers for violating the exposure limits. The step was taken to avoid any chances of default that had become eminent.
One may appreciate the SECP move but it would have been better if the Karachi Stock Exchange had taken the initiative. Some analysts say, "It was a well-planned effort of some of the big players to which the KSE management was a partner." This opinion is based on the claim of KSE management that it was strictly monitoring the brokers exposure limit on hourly basis. Whatever happened clearly indicated that the claim was not only incorrect but the management was helpless before the big players.
At a time when Pakistan's equities market were in limelight and foreign fund managers, investors from the Middle East and expatriates were keen to invest, the recent crisis has dampened the sentiments. It strengthens the belief that there are many market manipulators, some of the happenings in the recent past support the view. It is a very strong belief that some big participants, having control on Badla (Carry Over Trade) has the ability to move the market in the direction they like at the expense of whole community of investors.
Saying this much does not free the regulators from discharging their due role. Rather, if they are aware that some of the big players enjoy such a power it becomes all the more important for the regulators to curb their power. About a fortnight back when the COT volume achieved new highs and rate also touched high mark, the regulators should have waken up. However, some analysts say, "Either the regulators are hostage or lack the ability to understand the emerging bubble." It may not be out of context to mention that many analysts hinted towards the emerging bubble but the regulators did pay any attention. This supports another common saying about the regulators, "They only do the job of fire fighting but do not take steps to stop fire breakout." Now the SECP is claiming that its timely intervention has brought down the COT investment as well as the COT rate. But the question still remains, why it did not intervene earlier?
The general consensus is that despite the recent crisis the KSE-100 index has the potential to continue its upward movement. A lot has been written and talked about performance of Pakistan's equities market. The overall consensus is that it has outperformed all other markets. But the question re-emerges will it be able to sustain this high level? Most of the analysts say that since the rally has been driven by dividend yields and earnings potential, to a large extent, investors' appetite will be high. Therefore, the probability of further gains remains bright
Before dilating on the outlook of market for the year 2003, it is necessary to hear what some of the analysts say about the new highs of KSE-100 index. They say, "The index over exaggerates the reality. Truly speaking, it is still below 1,700 level." Mohammed Sohail, Head of Research, Invest Capital, has written at length on the subject in one of the previous issues of year 2002 of Pakistan & Gulf Economist.
Prior to the upsurge of the market, if one can recollect, many analysts were saying, "Most of the scrips are selling below their fair value." They also pointed out that investors were ignoring the 'incredibly attractive dividend yield as well as the improved economic fundamentals in the post 9/11 era. The flow of funds to equities market started mainly due to the declining interest rates and the emerging 'surplus liquidity syndrome'. As long as the funds continue to follow to Pakistan, particularly to the equities market, the euphoria is expected to continue.
Are the dividend yields still attractive? The general perception is that with the persistent rise in quoted prices of leading scrips; dividend yields have started shrinking. However, many analysts say, "Despite significant increase in prices of volume leaders as well as other favourites, the dividend yields are still higher than what an investors can earn from bank deposits or by investing in National Savings Schemes. Keeping the savings as dollars has no incentive. Besides, most of the real investors are not looking for one time gain. They look for regular and quantifiable future income. Therefore, investors' interest in dividend paying companies is natural."
Will the recent crisis distract the real investors? As stated earlier, the recent rally was driven by dividend yield and earning potential. Therefore, the outlook for the equities market is directly dependent on economic fundamental for the corporates. Most of the macroeconomic indicators have improved substantially over the last three years. These include foreign exchange reserves, tax collection, budget deficit, GDP growth rate and debt servicing as a percentage of GDP, trade deficit and the rate of inflation. Therefore, the corporate earnings are expected to remain robust. The higher GDP growth, particularly led by the agriculture, improves purchasing power and leads to higher spending.
Investors also ask a question, be it true that even in the post 9/11 era the earnings of leading scrips were hardly effected? The overall consensus is that the earnings of leading scrips were least effected. Since their revenue was driven from domestic sales, they mostly benefited from robust demand. The demand remained robust mainly due to low inflation rate and higher disposable income. The lower inflation rate was an outcome of strong rupee that contained cost pushed inflation.
It was evident that the equities market did not responded to the various internal and external shocks the way it had responded in the past. Therefore, while there was a global downturn, Pakistan equities market emerged stronger. It was rather unique that this time the investors based their decision on dividend payouts and earnings potential. They have benefited largely by following this strategy and also regret why they could not make prudent decisions in the past.
It is necessary to acknowledge the efforts of various brokerage houses that have been producing intensive and extensive research reports. Similar reports were produced in nineties but their circulation was limited, mostly to the clients. Now the summary or at least excerpts of these reports are regularly printed in newspapers and magazines. Pakistan & Gulf Economist can rightly take pride in being the pioneer in publishing weekly reports from Khadim Ali Shah Bukhari & Company and some other brokerage houses.
Normally the investors look at the dividend payout history of the corporate. However, the credible dividend payment record alone cannot guarantee future dividend payment. Therefore, one should not base his/her investment decision purely on dividend payout history. Along with the payout history, a prudent investor should also look at future earnings forecast and economic fundamentals enjoyed by the company as well as the sector. It may be said that generally those companies, which have credible payout record, also take pride in maintaining dividend payout level.
There are visible signs of revival of the economy and improved capacity utilization in various industries. A number of industrial units have started undertaking BMR and expansion programmes that are aimed at achieving higher value-addition and quality standards. These steps brighten the prospects for improved future earnings. However, to ensure sustained earnings the GoP must take certain measures.
According to a head of research of a leading brokerage, "The country needs some basic changes in the tax structure. So far the capital market players have been demanding that capital gains must remain tax exempt. This is a bad policy and only proliferates speculation. If the government is serious in greater participation of small investors than dividend income should be declared tax exempt and capital gains should be taxed. The corporates and their employees are the largest contributor of direct as well as indirect taxes. Therefore, the amount paid as dividend should not be taxed."
In the past, non-compliance to corporate governance and insufficient disclosure enabled the listed companies to skip dividend payment. Since Khalid Mirza took over as Chairman of Securities and Exchange Commission of Pakistan (SECP), various structural reformed have been introduced. The general consensus is that regulatory framework as well its compliance has improved substantially. However, some critics do not agree with this. They say, "Unless the number of shareholders in listed companies increases, all these efforts remain fruitless and futile."
With the hike in quoted prices of leading scrips, investors have started looking at and even buying second and third tier scrips that is not a good sign. If one can recall Altaf Saleem, the previous Minister for Privatization was of the view that off-loading of shares of state-owned enterprises should correspond to the market appetite. The successful sale of shares of National Bank of Pakistan has proved his point.
It is more or less evident that privatization process of state-owned enterprises like Pakistan Telecommunication Company, Pakistan State Oil Company, Habib Bank, United Bank, Pakistan Petroleum is not moving at the desired level. There is also resistance against sale of entities of strategic importance to foreign investors. Most of these enterprises are earning handsome profit. Therefore, the benefit of privatization of these entities must go to local investors.
It is believed that Privatization Commission is also actively considering the divestment of GoP holding in public sector enterprises through stock exchanges after the successful experience of National Bank of Pakistan. The GoP must also, as a rule, make listing of commercial banks mandatory on local stock exchanges. Privatized banks like Allied Bank of Pakistan, Bank Alfalah and United Bank must be listed on local stock exchanges without any further delay. Following this policy will increase the market float of good corporates and lessen the running after a few scrips. The advantage of this will be less vulnerability of the prices of volume leaders.
In order to increase the market float further, the SECP must make two announcements immediately:1) fixing the minimum paid-up capital requirement at Rs 100 million for all the listed companies and 2) stipulating that sponsors cannot hold more than 51% shares of the company directly or indirectly. The two proposed steps will help in weeding out the companies that do not abide by the various listing regulations, i.e. companies resisting getting 'live' on CDS, timely announcement of financial results and holding Annual General Meetings.
It is important to discuss resistance against getting live on CDS. One group of corporates was pleading that they have small capital base and have hardly any turnover of shares and find no justification in getting live. The other group, comprising of textile companies, even went one step further by challenging the move in the court of law. The court decided that the SECP, being the regulator of corporates, has the authority to resolve the issue. However, it is regretted that despite the court order, the SECP failed to implement its own rules. Analysts are right in demanding that if the listing regulations stipulate getting live mandatory, why the SECP has been condoning the violation?
The various crises, including the latest one, clearly establish the inability of the regulators, both the KSE and the SECP, to oversee the market effectively and efficiently. As regards the latest crisis, if it had happened at all, the heads of the Securities and Exchange Commission and the Stock Exchange would have tendered their resignations. If the Chairman of SECP and the Managing Director of Karachi Stock Exchange, despite their gross negligence, do not have the courage to tender their resignation, must apologise publicly, at least.
KARACHI STOCK EXCHANGE
In the post 9/11 era Pakistan's equities market has virtually outperformed all other markets. The year 2002 started with KSE-100 index at a very low level of 1,273 points. At the end of year 2002 the KSE-100 touched new highs and created new records of daily turnover. The KSE-100 behaviour, despite many external and internal shocks, was contradictory to its historical reaction to such shocks. The positive point is that the local retail and institutional investors have driven the rally. Participation of foreign fund managers was either absent or at the lowest level.
Though, a number of listed companies opted for voluntary de-listing, four new companies were listed having an aggregate paid-up capital of over Rs 6.3 billion. The most remarkable feature was that 15 new Term Finance Certificates (TFCs) were listed having an aggregate value touching Rs 8 billion up to November 30, 2002. The total addition to listed paid-up capital was about Rs 65.5 billion during year 2002 as compared to an addition of Rs 14.7 billion for the previous year.
CENTRAL DEPOSITORY COMPANY
The Central Depository Company of Pakistan Limited (CDC) has completed five years of its operations on September 3, 2002. According to Mohammad Hanif Jakhura, Chief Executive Officer, CDC, "Over the years the depository has been providing state-of-the-art settlement system. This has tremendously helped in promoting efficiency and transparency in the capital market." The National Clearing and Settlement System (NCSS) was launched on December 24, 2001 and the number of securities trades at NCSS is being gradually increased. The CDC also has a comprehensive arrangement with NCSS.
The CDC continues to diversify its operations by adding more features and functionalities, which are synergetic to its core activity. During the year 2001 the CDC handled the first electronic de-merger of ICI Pakistan into two entities. As a result of this de-merger, more than 200 million shares were cancelled and about 90 million shares were issued electronically. The de-merger of this magnitude in a physical environment would have been extremely tedious, time consuming, costly and error prone. This was a welcome change for the shareholders as they were freed from tedious and manual procedures and time delays without any additional cost.
Another business feature added to its fold is the trusteeship of open-end mutual funds from March 1, 2002. Currently CDC is the trustee of three open-end mutual funds. These are: Pakistan Stock Market Fund, Pakistan Income Fund and United Money Market Fund. The reliability and cost efficiency are the two ingredients, which are expected to bring more sponsors to CDC.
The CDC launched Investor Account service from Karachi in 1999 that was also extended to Lahore and Islamabad. It has earned popularity among the investing public. Currently, CDC has about 7,000 investor accounts having more than 1.2 billion securities. As on September 30, 2002 the listed capital at KSE was over Rs 274.6 billion with market capitalization of approximately Rs 463.6 billion. Market capitalization of securities at CDS exceeded Rs 133.8 billion.
According to Hanif, "The implementation of T+3 settlement system has resulted in increased settlement volume. Despite a 20% reduction in transaction fee effective November 2001, the transaction revenue surged by 50% from Rs 71 million in year 2000-01 to Rs 106 million in year 2001-02. This had a positive impact on after tax profit of the depository."