CAPITAL MARKETS: PROBLEMS & PROSPECTS
PROF. SAEED AHMAD SIDDIQUI
May 28 - June 3, 2012
Capital market is not only a significant component of financial sector but also a barometer of economic stability or instability of the economy of a country. Capital market is a vehicle, which collects capital from the places where it is in surplus and carries as well as distributes at the places that are short of capital. Capital market renders two important functions: first intermediation and mobilization of private savings and second allocation of short term and long term financial resources for investment through different kinds of private and public loans and equity instruments. Capital market plays crucial role in mobilizing and channelizing the indigenous resources for most productive investment activities. If the capital market of an economy is efficient, it provides a wider range of opportunities to local and foreign investors. If information flow is timely available, the investors may have the fair and due chance in sharing profit potentials.
Dr. Mehboobul Haque , the chief economist of planning commission of Pakistan, compiled a list of 22 extremely rich families of Pakistan in 1968 during field marshal Ayub Khan's regime who introduced elite class in business circle. The major part of national wealth concentrated in the hands of these rich families because these 22 families began to control 66 percent of business entities and became the holders of 87 percent shares of banking and insurance sector.
Ten basic industries were nationalized in 1970-71. Nevertheless, these rich families survived even after this drastic step. Majority of these families not only survived, but steadily made themselves strong financially. Even today, the famous and prominent families and groups are controlling about 64 percent companies. In other words, the capital markets of Pakistan even today are the property of a few families.
The following are the reasons due to which capital markets in Pakistan could not develop as they should have been:
1. Crowding out effect makes the capital market weak. It refers to reckless government borrowing from the banking and insurance sector to cover its budget deficit. Consequent to the public borrowing, capital market fell short to provide loans to the private sector to invest. So much so, government did not leave any stone unturned to use pension funds, government securities and other related funds for financing budget deficit.
2. Lack of depth is another problem. Market depth depends on the availability of sellers/buyers of credit instrument on maximum/minimum prevalent price level. Majority of shares of the listed companies in Pakistan are already occupied (sometimes 64 per cent of total floated shares) by rich families or by the institutional parties like ICP (investment corporation of Pakistan), NIT (national investment trust) etc.
3. Limited industrial base of Pakistan makes choice of investors also limited. The industrialists, due to herd mentality, take interest in a few selected industries like textiles, sugar, synthetic fiber, cement etc. The financial sector is unattractive because of non-performing assets and affected due to defaults in an environment where borrowers quality, financial health and the rate of doubtful capability of repayment of loans is increasing persistently.
Although several government-owned companies are also on the list of stock exchange, investors keep themselves aloof of these companies because they suspect that the government, for financing its budget deficit, can use the balance sheets of these companies. Moreover, the management of these companies is also inefficient.
4. Pricing of equities is also a problem. Karachi Stock Exchange (KSE) did not allow the new companies to issue shares on premium up till 1993. So much so, for the companies, which were issuing shares on premium during the boom of 1994, getting approval from SECP also became mandatory for them before issuing premium shares. In spite setting the criteria for new companies to be entitled for issuing premium shares but analysis reveals that it also went failed badly to stop unfair practices.
5. Disclosure of financial status of companies has been also a problem for capital markets. The system of financial reporting in Pakistan has become outdated through which getting correct timely financial information is not possible. Since the financial analysts depend for their analysis on the same faulty and late provided information. Therefore, the absence of details in these financial statements looses the significance of the analysis. The comparison of different companies related with the same industry also becomes difficult due to these insufficient and incorrect financial reports. It is therefore necessary that the government should review and improve the laws concerning the profession of accounting. Moreover, existing laws should also be re-enforced.
6. The central depository system was introduced in Pakistan in 1997. Although all the transactions were brought under electronic entry, this system eliminated the physical trade and handling of fake certificates. Simultaneously, daily turnover increased and immediate transfer of ownership replaced the old system while 45 days were required for delivery, settlement, and transfer.
7. Lack of confidence of investors is another problem. Availability of information at proper time provides equal profit earning opportunity to all kinds of investors. Nevertheless, no capital market in the world can claim perfection in this relation. Every capital market has somewhere an aspect, which makes the market inefficient. Consequently, the insiders or some of the well-informed investors succeed in earning undue profits and thereby the common investors are deprived of opportunity.
8. Interest of minority investors is not protected. The dividend payout ratio of the listed companies in Pakistan remains very low which becomes thought-provoking for investors in minority. For the financial year 1997-98, out of 773 listed companies only 150 companies distributed cash dividend. The investors severely abused the balance sheets of their companies by saying that the companies were supporting the other groups and taking measures for unnecessary expansion. There are proves in black and white that these companies used their cash flow either for investing in other companies or low cost loans. Non-availability of cash dividend was shielded by issuing bonus shares.
9. The equity base of Pakistani companies is 20 to 30 per cent of their assets, which is very low. The private limited companies avoid getting them listed with stock exchange due to the following reasons:
a. The management of the family owned companies do not like to make the common persons co-sharers in their profits. Therefore, the criteria of transparency required for listing is not fulfilled by them.
b. History reveals that low cost debts were available for the development of financial institutions. The cost was further reduced for the projects using locally manufactured machines and equipments. Consequently, loans became attractive due to which the development of large equity based companies was hampered.
c. The ownership of most of the large companies is possessed by industrial groups having huge amount of capital. Therefore, they are not compelled to request public to provide funds.
The existence and growth of capital market depends on liquidity. Federal Board of Revenue, for providing financial support to the stock market, has provided various incentives to the investors mentioned as under
1. Like other fixed income assets, withholding tax on government securities possessed by local or foreign investors, was announced 'full and final'. This announcement can divert the liquidity flow from equity market to risk-free assets.
2. Tax credit has been allowed for the approved pension schemes. The tax rebate claiming for Rs500,000 has been withdrawn. This measure was long expected and it is believed that it would support the long-term economic growth of economy of Pakistan. Nevertheless, it is required that both the government and SECP should introduce serious reforms which may guarantee the market based mechanism.
3. For discouraging banks for setting up AMC (asset management companies) and capitalizing them by issuing bonus shares, withholding tax on dividends from AMCs to the holding bank has been increased from 10 to 20 per cent. This move may curtail the profit possibility for banks.
4. Three months after investing exemption from capital gains tax to small investor has not been allowed rather the period of depositing advance income tax has been extended from seven days to 21 days. It is very minor facility, which should have no considerable positive effect.
5. Tractors, insecticides, pesticides, fertilizers and other agricultural inputs are subject to GST (general sales tax) which is shifted to the final consumers (cultivators) by including in the price of agricultural inputs. Consequently, the cultivators are deprived of ability to afford. The government to make cultivators capable to use these items, sales tax exemption on agricultural inputs has been withdrawn.
6. Value tax on Mudaraba certificates, shares and instruments of redeemable capital has been abolished. This move would encourage listing on stock exchange and buying/selling of Mudaraba certificates, TFCs, and commercial papers. Moreover, marketability of debt instruments for all kinds of investors would increase.
7. The new companies enlisting on stock exchange would be given 15 per cent tax credit on their payable tax.
8. As no mega project on the basis of 100 per cent equity has been initiated in Pakistan since a long time, total tax relief has been allowed on such projects. This measure would discourage people to withdraw their capital from public companies. The capital structure of the large companies generally depends on loans from the public. Therefore, this move would help the mega projects in acquiring maxim capital. Extension of holding period from one to 3 years would expand the stock markets. Life insurance premium for individuals has also been included in this scheme.
9. KSE, maintaining its prominent position, has introduced transparent and justified business procedures for evaluating the efficiency of securities. KSE can be compared with any stock exchange of the region, which has created full confidence amongst its investors. KSE has created confidence in the large number of foreign institutional investors.
10. Leading market indicators show the mixed trend in Lahore stock exchange. LSE has been showing a persistent increase in the points and total paid up capital.
11. Although Islamabad Stock Exchange (ISE) is infant one, it is playing a crucial role in the development of equity markets of the country. ISE, through its dynamic operations, fair and transparent business practices and effective management, has been servicing the investors of listing companies in the country.