How they are doing now?

Bureau Chief, Islamabad

Apr 23 - 29, 2007

Around the world capital markets play the most important role of mobilizing resources and channeling them into productive use effectively and efficiently. The same is also true about Pakistan. Globalization, liberalization and advances in information and communication technology, all put together, present an unprecedented opportunities and challenges to both providers and users of capital. The country has benefited marginally only. There is a dire need to identify the impediments. The opportunities are enormous but the country needs better strategy to exploit the real potential.

The improved performance of local stock exchanges may be attributed to consistent and transparent policies, yielding higher economic growth. Privatization not only provided the much needed impetus but also lured small investors to the equities market. Added to this are stringent monetary controls, ongoing capital market reforms and the proactive role being played by the regulators.

The management of local stock exchanges and the Securities and Exchange Commission of Pakistan (SECP) have been working together to evolve the capital markets of the country as progressive , transparent and efficient markets, employing best practices and safeguarding the interest of the investors. This entails not only the revision of existing rules and regulations to bring them in line with best practices but also the promulgation of new laws.

Contrary to past practices now the regulatory policies are being based on the principle of developmental regulation. The emphasis is on market development, while ensuring administering and enforcing corporate laws. The policy is based on consultative rule making, facilitating implementation and enforcing stringent controls.

The SECP has introduced a plethora of reforms in the backdrop of its mission to "Develop a fair, efficient and transparent regulatory framework, aimed at fostering growth of a robust corporate sector and broad-based capital market in Pakistan". Reforms are focusing areas like risk management, governance and transparency; market development; and investor protection and investor education.

One of the major sources for resource mobilization in Pakistan is offering of shares of public limited companies to the general public. In the recent past government also offered shares of state-owned enterprises to general public under its "Privatization for Public" program. The response was very encouraging. However, the subsequent crises made small investors jittery and there was panic selling.

The other notable feature was stalled privatization process. Serious issues developed in some of the transactions that included PTCL, KESC and Pakistan Steel. Similarly, delay in privatization of PSO, SSGC and SNGPL affected market sentiments. Meanwhile, crises in equities markets and boom in real estate drifted investors away from the equities market, some after making a fortune and most losing their life savings.

Debt instruments markets in many countries are even bigger than equities market, mainly because corporates raise funds through various instruments to suit their needs. As against this, investors in Pakistan have been relying on DFIs and commercial banks for project financing. Higher interest rates have often rendered business entities uneconomical. Since lending was driven by SROs least attention was paid on the economic viability of the projects.

Similarly, due to inadequate regulatory framework and poor implementation sponsors of many public limited companies succeeded in fleecing shareholders. As investor hardly got any return on investment, they started believing that investing in shares of listed companies was a zero sum game. Decade of nineties is often termed "dost decade" due to a number of reasons. It was also the worst in the corporate history because hundred of companies were floated, even at premium, but investors in those companies, still regret their decisions.

The index movement was and still driven by trading. Volume of settlement as a percentage of volume traded remains disappointingly low. Trading is often driven by other factors, rather than economic fundamentals. It is true that the driving force of equities market is "speculation", often lacking any plausible reason.

One of the reasons encouraging trading is exemption of capital gains from tax. It seems that this exemption has been granted on the recommendations of those who do not believe in investing. One may argue that if an investor takes "delivery" it is an investment, though for a few days. In fact such a holding could not be termed investment because the motive is to sell it on the first available opportunity to make capital gain rather than holding it for receiving dividend.

There was a general perception that the KSE-100 index is not the true reflection of the market sentiments. One of the reasons is heavy weightage assigned to some of the scrips. It is often said that less than half dozen companies account for change in index, often significantly, OGDC and PTCL are two classical examples.

It is being said that the assigned weightage is linked with paid-up capital. The opponents of this rationalization say that weightage should be linked with free float rather than listed capital. The argument carries weight because trading is linked with free float and not the listed capital.

One of the alternatives could be that more indices should be developed. At present the performance of Karachi Stock Exchange is depicted through three indices, the latest being KSE-30 index. However, analysts are of the view that specific indices for mutual funds, energy companies and telecommunication companies should be introduced so that investors could compare the performance of company with reference to its relevant index.

During the last couple of years there has been a gradual reduction in the number of listed companies but paid-up capital has been on the rise. The major contributor has been listing of large cap companies like OGDC and the latest addition being Standard Chartered Bank Pakistan. The bank automatically qualifies for inclusion in the KSE-100 index on the basis of listed capital. The paid up capital of Standard Chartered alone is more than a number of sectors. However, the free float of the Bank is around one percent of the total capital.

Even if one looks at the paid-up capital there seems to great disparity. On one hand there are companies like Standard Chartered Bank with Rs 38.715 billion capital, OGDC with Rs 43.009 billion capital. On the other hand there are companies like Dominion Stock Fund with Rs 50 million capital and Sterling Insurance with Rs 5 million capital. One really fails to understand the logic behind allowing companies with such small paid-up capital base to remain on board.

Lately, there has been effort by the State Bank of Pakistan to raise minimum paid-up capital requirement for the commercial banks. All the commercial banks have been told explicitly to meet the minimum capital requirement. Earlier effort was made by the SECP to enhance minimum paid-up capital of leasing companies. The latest announcement is about non-life and life insurance companies. The requirement has been raised to Rs 300 million for non-life and Rs 500 million for life insurance companies. The companies with less than stipulated capital would be required to meet the enhanced requirement within the given time frame.

As against this no minimum paid-up requirement has been fixed for the textile sector, the backbone of Pakistan's economy. The rational put forward is that if companies are doing reasonably good business they may be allowed to work with whatever capital they wish to live with.

This argument is contrary to what has been said in the case of commercial banks, leasing and insurance companies. If higher capital is required to improve performance of these companies, the same may also be true for the textile mills. Apparently, the justification is given only to allow the textiles to live the least capital.

According to another analyst commercial banks and leasing companies have succeeded in raising capital because of their good standing and prudent plan. Sponsors of these companies also injected their own money to meet the minimum capital requirement.

As against this, the perception is that neither the sponsors have expressed their willingness to inject their own money nor they could raise capital by issuing right shares. They just cannot go to the shareholders and ask them to subscribe right issue, the reason being that shares of most of these companies are trading much below the par value. Some analysts are also of the view that more than 90% shares of such companies are held by the sponsors directly and indirectly and in case they opt for issuing right shares only sponsors would have to subscribe and apparently they are not ready for this.

Lately there were some proposals for gradually delisting companies having less than Rs 100 million capital and also to raise it gradually to Rs 500 million. This proposal was aimed at making these entities financial stronger economically viable. For example there are spinning mills operating in Pakistan with about 14,500 spindles. These are highly uneconomic units and top of this these are mostly producing yarn of lower counts, where the value addition is virtually negative. These companies also post marginal profit because of having fully amortized machinery.

It is also believed that stock exchanges are also resisting delisting. Some of the brokers, also on the governing board had categorically declined the proposal by saying, "We are in the business of listing not the delisting and any such move would reduce the revenue of the stock exchanges.

There was a suggestion for listing of all the state owned enterprise on the stock exchanges and offer shares of these entities to the general public. There was also a suggestion for making secondary offering of the already listed state owned enterprises as well shares of privatized entities to the general public. This would yield two benefits 1) raising the amount of listed capital and 2) increase the free float. Both these suggestions support governments "Privatization for People" program.

Though, the government has undertaken various measures and policy initiatives to increase investors" base bulk of the shares of listed companies are still held by the sponsors, institutional investors, mutual funds and large net worth investors. This gives them the power to set market direction, initiate buying euphoria and cause panic selling.

It is noted that commercial banks are allowed to invest up to 20% of "shareholders" equity' in shares of listed companies. Still they are asking the government to enhance this limit. However, many analysts are of the view that if the permissible limit in India is 5%, Pakistan should also bring this limit to 5% in next five years. The most import outcome being increase in the free float and curbing market manipulation ability of the institutional investors.

The prevailing situation can be attributed to inadequate market surveillance, non-disclosure of the holdings and inability of the regulators to identify irregularities and take timely corrective steps. The working environment has improved but a lot remains to be done. However, it is necessary to point out that the SECP should take corrective measures with full consultation with the governing boards of the three stock exchanges. The commission should also intervene the least but push hard to improve self regulatory mechanism. It should also play a proactive role rather than firefighting.

The various equities market crises indicate "black holes" as well as regulatory lapses. If the policy planners are serious in portraying Pakistan as preferred investment destination, they have to play their due role. This country has witnessed many financial scams and just cannot afford any more. All must remember that investment has no nationality. It is like migratory birds, which fly to those destinations where environment is conducive.