DISCOUNT RATE RISE: BORROWING TO INVESTMENT CLIMATE

HIGH INTEREST RATE FAVOURS MUTUAL FUNDS GROWTH: CEO ARIF HABIB

TARIQ AHMED SAEEDI (tariqsaeedi@hotmail.com)
Feb 25 - Mar 02, 2008

Despite impact of rise in discount rate on domestic economic activities unfolds multiplier effects it encourages indirectly pooled investment in stock market due to shift of borrowing to investment climate. Across the world, usually central banks revise upward its lending rate to commercial banks as an inflation controlling measure to rein in money supply in circulation. The first half of this fiscal year (2007-08) registered not only growth of private sector lending but also government borrowing from central bank increased significantly. The delay in global depository receipts, sovereign bonds and privatization proceeds had government curtailed its budgetary deficits out of funding facilities of State Bank of Pakistan. Aside by this was the oversupply of money in the economy that outstripped the demand, fuelling core and non food inflation. Additionally, inflow of foreign investments expanded the capital supply base furthering again inflation. Therefore, monetary policy was tightened for H2FY08, capping the money supply in realization that in turn specifically has direct and indirect ramifications on capital market.

Insofar as direct effect is concerned rise in discount rate or bank rate has affected the trading of debt instruments. Debt instruments bear two different interest rates: variable or floating and fixed. Floating rate varies according to revision in discount rate. Basically, every interest rate has a corresponding discount rate. On one side, price of debt instrument with floating rate plummets to catch back diminishing clientele and on the other demand of debt instrument with fixed interest rate is on increase. However, indirect effects are formed by cut in expenditures on business growth projects by companies that may spell bearish sentiment in shareholding.

DISCOURAGING TRADITIONAL BORROWING OF INDIVIDUAL SHAREHOLDER

Outlining the primary affects in relation to stock market, Nasim Beg, Chief Executive, Arif Habib Investment Management Limited said discount rate upward revision mostly affects borrowing dependent companies. And if prolonged for a long time, surge in discount rate greatly hampers the industrial and domestic activities. "I expect that SBP would scale down basis points in the next fiscal year." Prudent strategy of monetary management is the reduction of government borrowings from central bank, he commented while talking to PAGE on telephone. When asked whether discount rate rise is in favour of growth of mutual funds as it discourages traditional borrowing of individual shareholders from banks and thus encourages pooled investment in securities and scrip, he replied that it does. But, he added, high interest rate alienates shareholders as a net result.

Depository companies and commercial banks with increasing debt obligations subsequently passed on rise in interest rate to variable rated financing availed by individuals and businesses. The rise in interest rate discourages shareholders who depend on credit for buying of securities. Because of their limited financial capacity to engage only in trading of odd lots, they borrow from financial institutions on short term bases. And, high interest rate has left them with no option than to either involve in institutional buying or risky transaction as an individual. Mutual funding in this sense becomes the most secure medium of share trading teaming up individual investments for securities. However, this genre of transactions of shares disengages active trading by an individual. Which is why, perhaps mutual funding has enjoyed popularity mostly in people with capital scarcity.

FUTURE CASH OUTFLOW, PRESENT VALUE GUIDING INVESTMENT TREND

Debt with floating interest rate, few of which having overnight debt servicing period, are more likely to be affected by any change in the interest rate. Companies borrow money from commercial banks and other financial institutions in order to meet their organizational expansion needs. For example, they borrow money to support product development or sometimes to spend on non development projects. By virtue of surge in interest rate, they avoid utilizing lending facilities and stop spending on projects, which resultantly disturbs their revenue and profit line. The possible cut in production reduces sale of products. Due to higher debt expenses or less revenue from consumers, they don't go along with the growth expansion venture. Future cash outflow and present value of a share guide the investment trend.

While future cash flow is determined after analysing the present standing of the scrip investment is determined on the present value. However, analyses of risk beyond a certain period of time are indispensable for making investment decision. With poor spending, companies could not give impetus to trading of its shares. Since neither its financial results would guarantee adequate dividends to stockholders nor capital gain would be fine and all in all individual shareholders find it risky to invest. In addition to this, few credits to consumers have variable interest rate. Mortgages and credit cards are susceptible to revision of discount rate. As a multiplier effect, individuals having paid additional bills of, for instance, credit cards and (often) mortgages have left with no or less disposable income to save or invest.

Arif Habib Investment is an asset management company managing seven open and three closed-end mutual funds. It manages about Rs. 23.280 billion (USD 370.72 million) in 10 mutual funds as of January 31, 2008. The company was conceived in the year 2000 and in March 2002 two of its flagship funds: the Pakistan Stock Market Fund (PSM) and the Pakistan Income Fund (PIF) were launched. In the year 2004 both of these funds received the "Performance Excellence Award-2004" presented by The Mutual Funds Association of Pakistan (MUFAP). It is the first mutual fund in the country with permission from the SECP to also invest overseas. It has six investment plans to meet the investment needs of its growing clientele. The company is a part of Arif Habib Group, with Arif Habib Securities Limited (AHSL) as its main shareholder. AHSL is a listed company with a capital and reserve base in excess of Rs. 26.262 billion as of December 31, 2007. Besides asset management, commercial banking and brokerage, the group offers services such as securities research, investment advisory, corporate finance and project advisory services. The Group has also acquired membership of the Dubai Multi Commodities Centre through its subsidiary Arif Habib DMCC.