CAPITAL MARKET

Strong economic fundamentals & pro-market policies are the driving force

SHAMIM AHMED RIZVI, Bureau Chief, Islamabad
Aug 13 - 19, 2007

It is amazing to watch an unprecedented upsurge in the Stock market during the last few months despite a sort of political uncertainty and threatening law and order situation persisting in the country. This is somewhat against the normal characteristics of the market in such conditions.

The second half of the just ended fiscal year 2006-07 has registered about 30 percent growth in the business volume of the three stock exchanges of the country. The Karachi Stock Exchange posted a growth of 38 percent during the year ending on June 30, 2007 with index closing at an all time high at 13772 points depicting a huge gain of 3783 points over June 2006.

In order to find reason for this unusual phenomenon, this corresponded contacted both i.e. the Securities and Exchange Commission of Pakistan (SECP) and the Islamabad Stock Exchange (ISE) to have their views on the subject. Concerned SECP authorities desired to mail the question as the chairman was out of station, while the former Chairman of ISE and a leading broker Omer Iqbal Pasha obliged PAGE with an exclusive interview on the subject.

Questionnaire was mailed to SECP accordingly but no reply was received from them till Thursday last.

Elaborating his point view Mr. Pasha said that the current year could rightly be termed as eventful since it marked the sixth consecutive year of bull-run. The market capitalization also grew at a remarkable rate of 51 percent, reaching its peak at Rs.4 trillion ($66 billion). However, the growth of the market occurred amid very thin volumes. Turnover during FY07 averaged 210m shares, which was the lowest since FY02, as a result of which the average daily value also shrank to a three-year low of Rs 22 billion ($362 million).

During the year, 13 new companies got listed in the stock exchange compared to nine in FY06. The KSE growth, however, loses some luster when compared with the regional markets, which on average depicted a growth of 48 percent, with the Chinese market (Shanghai Composite) witnessing a 129 percent upsurge followed by Indonesia's Jakarta Composite with a growth of 63 percent. When comparing the earnings, multiple and dividend yields, KSE emerged as the second most attractive market in the region.

According to Iqbal Pasha the reason for the buoyancy of the market is no secret. The recently released Economic Survey of the government lists eight factors leading to booming conditions in the market. These included continuous improvement in the country's economic fundamentals, government's commitment to its reform agenda and pro-market policies, stability in exchange rate, regionally cheap valuation of the scrips, large scale mergers and acquisitions, improving relationship with the neighbors, successful GDR offerings and increase in Pakistan's coverage by large international brokerage firms and investment banks.

In addition, Pakistan's privatization program also provided support to different sectors and corporate valuations. While nobody could possibly deny the positive impact of each of these factors, we feel that the biggest push to the market was caused by the interest shown by foreign investors with huge liquidity at their command, looking for investment opportunities throughout the world.

Foreign portfolio investment in Pakistan's stock market during the first ten months of the past fiscal year amounted to $1.82 billion, which was the highest ever inflow of such investment in the country's history. Obviously, like other regional markets, Pakistan's equity market attracted a portion of increased liquidity flowing into Asia.

This could be confirmed by the fact that foreign funds hold 7.72 percent of the market cap, as against 3.28 percent in June 2006. The market cap includes the current foreign holding (adjusted for conversion) of MCB, OGDC, and UBL GDRs. One barometer of this is the Special Convertible Rupee Account (SCRA), which now stands at nearly one billion dollars compared to 350 million dollars a year ago.

There was a time when the fluctuations in the stock exchange used to be directly co-related with the economic performance of the country. A growing and vibrant economy led to a boom in the stock exchange and vice versa. Though this may still largely be true, the health of the economy is not the only determining factor in the change in the market sentiment anymore.

Increased globalization and integration of the world financial markets has widened the scope and range of groups and individuals looking for investment in equities anywhere in the world. As it is, ample liquidity, the world over, is creating a lot of demand for Asian emerging markets. This is so because of better macro-economic conditions in the region, leading to handsome growth of corporate earnings.

Pakistan, of course, is no exception. Last few years have witnessed a reasonably good progress on reforming the economy, a sustained healthy growth and some correction in macro-economic imbalances in the key areas of the economy. Above all, there is now no immediate threat of insolvency to the economy and foreigners feel pretty confident in respect of the safety of their funds because of a comfortable level of foreign exchange reserves.

The corporate earnings, particularly in the financial sector, have been excellent, prompting foreign investors to extend their activities particularly in this sector. The flow of liquidity in the stock exchange has also been facilitated as a result large-scale coverage of the market by foreign brokerage houses and the issuance of GDRs.

According to the Pasha the surge has been driven by a number of factors including: (i) continuous improvement in the country's economic fundamentals, (ii) government's commitment to maintain its economic reform and pro-market policies, (iii) stability in exchange rate as a result of strong build up in foreign exchange reserves, (iv) regionally cheap valuation driving foreign interest in Pakistan's stock market, (v) large-scale merger and acquisition in the banking, telecom and other sectors of the economy (vi) improving Pakistan's geo-political relationship with neighbors as well as globally, resulting in decline in political risk premium of the country, (vii) successful GDR offerings of the OGDC and MCB Bank, amounting US dollars 888 million and (viii) increase in Pakistan's coverage by large international brokerage firms and investment banks.

The market has witnessed concerted foreign investor's interest in Pakistan's stock market as a result of large-scale coverage of market by foreign brokerage houses. Brokerage houses providing research coverage on Pakistan are include: Merrill Lynch, J.P. Morgan, Credit Suisse, Citigroup, and UBS. Lynch was the first to start active covering of Pakistan. The J.P. Morgan has expanded its operation in Pakistan recently in the stock business.

The interest of foreign investors can also be gauged from the fact that J.P. Morgan is only catering to foreign clients as an initial way of doing business. J.P. Morgan's expansion has piqued foreign investors interest as well. Other investment banks such as Credit Suisse have also announced their intention of entering the Pakistan market, while others are looking to forge relationships with local brokerage houses. Several foreign banks have also organized road shows across the globe to introduce Pakistan to the community of foreign investors, interested in fast growing emerging markets.

Foreign portfolio investment in Pakistan's stock market during the first ten months of the current fiscal year amounted to $1.82 billion, which is the highest ever inflow of portfolio investment in Pakistan's history, as against $1.011 billion in the corresponding period of last year, thereby registering an increase of 80 percent. The growth in portfolio investment has been contributed to by issuance of GDR of Oil and Gas Development Corporation (OGDC) and MCB Bank. These GDRs are listed at the London Stock Exchange and are receiving strong investors' interest.

The outgoing fiscal year has also witnessed large-scale merger and acquisition, which provided support to stock market valuation. Several key take-overs have taken place in Pakistan's corporate sector during the outgoing fiscal year.

THESE INCLUDE: (i) acquisition of Union Bank Ltd by Standard Chartered Bank, (ii) acquisition of Prime Commercial Bank Ltd by ABN Amro, (iii) acquisition of PICIC Bank by Tamasek of Singapore, (iv) acquisition of Crescent Commercial Bank by SAMBA, (v) acquisition of PakTel by China Mobile, (vi) acquisition of further stake in Lakson Tobacco by Philip Morris. This M & A activity, which has taken place at very attractive valuations has provided support to valuation in the stock market as well. Peer group companies' stock prices have also reacted as a result of these acquisitions.

Pakistan's privatization program has also provided support to different sectors and corporate valuations. Even though no large privatization has taken place during July-May 2006-07, the government has still managed capital market transactions for OGDC, Iqbal Pasha, concluded.