June 05 - 11, 2006

PAGE - KSE-IOO index plunged by 413 points and closed at 10247.60 points on May 29, 2006. There was trading of just 13 million shares, which was very low. How would you comment on it?

AKD: In percentage terms the correction of the index was just under 4%. It needs to be kept in mind that the index has corrected downwards from near its record highs. Considering that between Dec 31, 2005 and April 27, 2006, the Index had risen by 22%, a 4% downside should be seen in broader context. I think most observers have yet to recognize that the era of the KSE-100 Index at 4000 or 6000 levels is over - at least for some time, if the broader economy and corporate sector growth continues at the current pace. Yes, when the index was at 4000 level, a 413 point downturn would be large in a single session (about 10.0%). But the index is now near 10,000 levels and looking at Index movements in absolute terms can be misleading. Further, the fact that volume has been low should make it evident that the correction is more likely technical in nature. Since May, 2006, the KSE-100 Index had become range-based and has now slipped below 10,000. This indicates that the market is awaiting direction for its next move and the near term direction is likely to be the budget. Over the medium term, the direction of the KSE-100 will of course be driven by underlying corporate earnings over the next few quarters. In my view, corporate earnings growth may not be as high in 2006 - 2007 as they will be in 2005 - 2006 due to high base effect. Nevertheless, earnings growth for the KSE-100 companies in 2006 - 2007 should range between 20% -25% and this is pretty good by any standard in the fourth year of economic expansion.

PAGE - What would you say about KSE collapse in March 2005 and March 2006?

AKD: I have publicly discussed this issue many times over the last 12 months so I do not believe it will serve any purpose to repeat myself. Suffice it to say that the sharp correction in March 2005 was not a bubble burst but regulatory miscalculation and lack of coordination with the broader brokerage and investor community. If it was a bubble as some people say, why did the market cover all the losses and surpass itself within just a few months? No, in my opinion, the market was correctly anticipating the acceleration in earnings growth in key sectors such as energy and banking. As far as the March 2006, extremely short lived dip is concerned, it was nothing more than a technical blip accentuated by rumors about tax change which were officially denied by concerned authorities.

PAGE - What should be the response of regulators (both stock exchange managements as well as SECP) to sudden market downturns as we are witnessing now?

AKD: Well, you only need to look at our larger neighbor to realize how proactive and investor focused they are. The Indian stock markets have taken a heavy beating over the last two weeks or so. In fact, between May 05 to May 29, the Indian market Index was down 12.5%. So how did the regulators there react? First, the finance minister himself stepped into the picture and publicly announced that rumors about taxation were false and no such tax was planned. Next, the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) at the behest of the regulator (SEBI) reduced their margin requirements by around 50% in futures as well as spot counters. This timely move helped to reduce margin calls & enabled brokers & investors to square their positions in an orderly fashion. As a result, the market has stabilized despite the fact that foreign funds withdrew US$1.2 billion over a two-week period. In the case of Pakistan, first, the foreign portfolio amount is quite small at US$350 million only and secondly, we have not seen any significant withdrawals. So the situation here is much better. However our stock exchange managements and SECP should be move proactive, in my view, to provide confidence to investors.

PAGE - The Index touched over 12500 points in April. What were the major reasons for that? Some circles believe that there is a lobby which helped KSE touch over 12500 points in the hope that some foreign investment would pour in which would eventually help them. But when this didn't happen, the lobby got disappointed which has led the index lose points. Do you agree? Please give your comments.

AKD: Let me respond by putting the following questions to you. How many times in history has Pakistan's foreign exchange reserves touched US$13.0 billion? How many times in the last 10 years or more, the real GDP growth of the country touched 8.4%? How many times in history has Pakistan's per capita income touched US$800? How many times has the industrial sector operated near full capacity for three years consecutively? How many times has the banking sector posted 100% increase in earnings? Why then, is it such a big deal and such a mystery that the KSE-100 Index touched record territory? The stock market simply reflects the fundamental health and growth outlook of listed companies. And both the health and outlook of Pakistani corporate sector is the best that it has seen in more than 25 years. The market is simply reflecting that confidence.

Regarding the issue of a lobby in the KSE-100, I find it interesting that somehow we always see conspiracy theories in every thing. There are bound to be speculative elements in the market that push the Index one way or the other in the very short term. But if you take a broader-time view, unless the underlying fundamentals change dramatically - either for better or worse - the short term movements should not be relevant for serious, fundamentally oriented investors. That is why I always emphasize that investors should focus on longer time horizon and changes in corporate fundamentals and stay away from rumor-driven trading. Unless investors have a very high risk tolerance, accompanied by strong holding power, they should stay away from short-term, high risk trading, in my view.

PAGE - Do you think that foreign investment in the capital market is like a backbone without which the KSE would not perform as strongly as it had done until recently?

AKD: In a market which has a capitalization of around US$50 billion and foreign portfolio investment is US$350 million - can that seriously be called a back bone? We should remember that the market began its rise in 2002. From 2002 to 2005 it was driven more or less by domestic investors. Foreign portfolio investment in significant terms began only in late 2005. Just as a contrast, across the border in India, foreign portfolio investment totaled US$10 billion in their last fiscal year. I agree that foreign portfolio investment was one of the factors in market buoyancy but to give it the attribute of backbone would be a mistake. High domestic liquidity, inflow of over US$4.0 billion in inward remittances, the huge wealth effect of the real-estate boom, along with excellent corporate sector performance have been the underlying causes of market performance. Foreign portfolio investment has just begun to participate only recently after an absence of nearly 10 years. And despite the recent concerns about emerging market risk appetite after the latest U.S. Fed funds rate increase, I believe that countries showing strong economic growth, stable socio-politics and consistent policies will continue to attract long-term portfolio investments. In my view, Pakistan is one such market and present valuations make it even more attractive.

PAGE - By and large, our capital market is based on speculation. When the market gains points, the small investors due to speculation stretch through borrowing which proves to be very big mistake on their behalf. Please comment.

AKD: The Oxford Dictionary has two definitions of the word SPECULATE. First, "form opinions without having definite or complete knowledge or evidence". And second, "buy and sell goods or stocks and shares in the hope of making a profit through change in their value, but with risk of losing money." As far as the first definition is concerned, in life most of the time when we take a decision or an action it is highly unlikely that we will have "definite to complete knowledge or evidence" in advance as to what the result of our decision or action will be. In this sense, one could say that most of our lives we actually end up speculating about everything we do! looking at the second definition, the key points are (a) hope (of making a profit) and (b) with risk (of losing money). There is an old saying: No risk, No gain". This is true in most aspects of life and that includes investing.

The process of investing has many players and each approaches this process from their own perspective. First of all, let us begin by understanding the nature of investors themselves. Let us start with savers. Savers can be large or small but one thing they have in common is that their current spending is less than their current income. For individuals, on the one end are the very rich. It is understandable that their current income easily exceeds even their high (by average standards) current spending levels. At the other end is the saver who consciously sacrifices current spending in order to save for the future (for children's education, marriage, health emergency, retirement, buying a house, etc.)

For institutions, there are those whose very purpose is to manage surplus savings in order to provide for future benefits of their beneficiaries - these include pension and provident funds, insurance companies, mutual funds, endowment funds and charitable trusts. Then there are institutions and businesses who may wish to deploy a certain percentage of their reserves or capital surplus in assets other then their core business as a form of diversification, so that if their core business income goes down because of economic or business cycle, at least they can still get some return from their investment portfolio. Finally, there are businesses that have seasonal cash flows that may be more than what they need at one point in time. Such business may want to maximize the return on such relatively short-term surplus cash flows (e.g. exporters with 2-4 month horizon) rather than get low returns by placing these in bank deposits.

So one can see that there is a wide universe of different investors. These different investors have different investment horizons, different return objectives, different risk tolerances and different liquidity requirements. For example, very rich individuals may have high risk tolerance and loss absorbing capacity that a small saver can not have naturally. Similarly, the nature of a bank's liability structure (relatively shorter duration) means that in general a bank will allocate only a very small portion of its asset base towards high risk, longer term investments like equities. But a pension fund or a charitable trust has a much more longer term investment horizon so it needs to focus more on maintaining the purchasing power of its future payouts and can also tolerate higher volatility in short-term in the value of its investment portfolio.

All these players make up the stock market. And "pure" speculators actually comprise a small percentage of the total investor universe. It is estimated that are over 500,000 investors in the domestic stock market. Of these only a small percentage can be classified as speculators in the true sense. But as we saw in the dictionary definition, a true speculator also knows the risk of loss. If anyone takes risk without understanding that risk and its impact on one's financial and personal condition, in my opinion that is not speculating, that is being stupid and irresponsible - pure and simple.

As far as the use of leverage is concerned, this has to be done after careful consideration and hard assessment of the full downside risk if such a risk becomes actual loss. How will the margin payment be made? From what resources? How will that impact investor's overall wealth? Will the investor's living standard, quality of life, family suffer if such a loss occurs? After carefully weighing the worst scenario and having ample resource to cope with any loss, should an average investor consider leverage? Otherwise, the focus should be on fundamental, long term investment only.

PAGE - Which scrips and shares are still undervalued and what could be the reasons for that? 0GDCL has also been a market leader. Which companies would the top market gainers in the forthcoming months?

AKD: Based on the earnings growth outlook, I think there is good potential in the Oil and Gas sector. I also believe that Pakistan has yet to fully tap its oil & gas potential. Exploration activity has already picked up in 2005-06 and I expect this to significantly increase in 2006-07 and beyond. With a high success ratio of 1:3 in Pakistan, this should lead to rising discoveries, reserves and production. As this happens, earnings growth will accelerate. So, along with high oil price, volume growth over the next few years should keep the oil and gas sector buoyant going forward. Power generation is another sector that can not be ignored in a growing economy like Pakistan because growth means rising demand for power in the future. The same is true for the Gas Distribution Sector. Whether it is the Iran-Pakistan-India (IPI) pipeline project or the Turkmenistan-Afghanistan-Pakistan (TAP) pipeline project, or the LNG project there will be need for more energy resources and gas is the cleanest of fuels. So gas related businesses have a tremendous future in Pakistan. I think we will also find interesting opportunities in selected stocks in the cement sector, as I do not think that all these huge planned capacity increases will come online on schedule or at the same time. Fertilizer sector is a big defensive sector with steady and growing dividend outlook based on sheer demand and supply dynamics. In the banking sector, the best performance by most banks has already been seen as far as the present cycle is concerned. But there can be potential opportunities as the banking sector consolidates via mergers and acquisitions and further efficiency gains in their post privatization period. Finally, there could be positive surprises over the next 12 -18 months in the telecom sector as the new shape of PTCL after privatization emerges and other consolidations take place in the wireless/cellular segments.

PAGE - Continuous Finance System (CFS) was supposed to be replaced by Margin Finance about a year ago but so far nothing has happened. Now there are talks about CFS MkII to be run alongside the margin finance facility. What are your views about this whole issue?

AKD: I think the question as to why margin finance has not been implemented should be addressed to the financiers and the rule makers. As far as the new version of CFS (CFS MkII) is concerned, I think the SECP is rightly trying to reduce systemic risk in the market and make the process more transparent and safer for the investor while also tackling the thorny issue of the conflict-of-interest between financiers and institutional investors like mutual funds. In my view, there are three distinct aspects to this issue. One is provision of liquidity to the equity capital market and linking that with the broader money market returns (e.g. KIBOR). CFS MkII is a serious attempt to institutionally incorporate the banking system into the CFS mode while providing reasonable returns to the financiers. The second issue relates to creating transparency and distinction between financiers and investors to avoid conflict of interest. But the third issue, which I believe is the most critical, is to increase the breadth and depth of the equity market.

While there is a lot of lip-service paid to this issue, the fact is that limited progress has taken place on this front. Unless the market float is significantly increased, volatility and systemic risk will be high. In the short-run, the best way to achieve this is to rapidly increase GoP owned companies' float into the market including HBL, UBL, OGDC, SLIC, Pak-American & Pak-Saudi fertilizers, Pak-Arab Refinery, etc. Further, the GoP should mandate that all new power sector projects as well as expansions should be listed on the stock markets. Such a move can significantly improve float, reduce weights of some other large sectors and thereby reduce volatility. Over the medium to longer term, in order to make the equity markets more comprehensive of the overall corporate sector in the Pakistan, the GoP should create incentives for listing companies on the stock exchanges.

PAGE - How do you see the on-line trading in the capital market? What is the future of it?

AKD: Over the next 5 -10 years, online trading will become increasingly important but before online trading can really flourish in Pakistan, several major regulatory, infrastructure, market practice and product innovation hurdles have to be removed.

PAGE - Even three decades ago when there was forward trading, there used to be a lot of speculation in the market. We see the same thing today. Do you think that the trend of the speculation will continue in the capital market? What would be the repercussions of such trend?

AKD: We have discussed speculation before. Speculation is part and parcel of stock market investing the world over. What is more important is the effectiveness of risk management systems both in the spot and forward markets, as well as with individual brokerage houses and also individual institutional investors such as mutual funds, pension funds, banks, insurance companies, etc.

PAGE - What is the contribution of SECP in transparency and in the strength of the capital market?

AKD: SECP has come a long way on the positive side over the last 5-6 years. Along the way, there have been some strategic misdirections that have negatively impacted the market. The need now for SECP is really four - fold:

1. Greatly improve its own institutional and human resource capacity

2. Focus on long-term structural and strategic issues related to capital market growth and efficient allocation of long-term risk capital in the economy

3. Actively push to bring new products such as cash-settled derivatives, more incentives for private sector IPO's, Real Estate Investment Trusts, Private Equity Funds, limitation on percentage of sponsor group holdings, creating an active over-the-counters market for technology related or SME focused export-oriented listed companies

4. Improving the regulatory framework for the corporate debt market

In my opinion, SECP should first look at itself as a promoter of a vibrant and deepening capital market as well as a regulator that ensures a fair and level playing field for all players. We are a young market and to focus only on pure regulatory aspect without emphasizing the growth aspect - will invariably delay, if not derail the huge potential of Pakistani capital market and leave it way behind regional markets

PAGE - One of the worst times in the history of the market was in 1998 when the market went down to around 890 points. This was because all the foreign investors wanted to leave Pakistan. God forbid! Incase there is outflow by the foreigners, what would be the state of the capital market?

AKD: You can not have your cake and eat it too, as they say. Foreign portfolio investment is a double-edged sword no doubt. And 1997 and 1998 were bad not just for the Pakistan market due to its specific reasons but also for the whole of Asian region. The only way to protect against wholesale exodus of foreign portfolio investment is to have clear, transparent and progressive economic policies, regulatory regime and overall domestic stability. When any one or more of these pillars starts shaking foreign investment - whether direct or portfolio - will shy away. Not just that, even domestic investment will be negatively effected. I believe that Pakistan, as a country, has a tremendous future and if there is overall socio-political stability and continuation of robust economic growth like now, our equity markets can make a lot of money for both domestic and international portfolio investors.