Capital market is an important barometer of the health of an economy and important component of the financial sector. It is a vehicle whereby capital is deployed from sources where it is in excess to the sources where it is in short supply. The capital market facilitates:
(i) Mobilisation and intermediation of private savings and;
(ii) Allocation of medium and long-term financial resources for investment through a variety of debt and equity instruments of both private and public sectors.
It plays a crucial role in mobilising domestic resources and in channelizing them efficiently to the most productive investments. An efficient capital market provides a wide-range of attractive opportunities for both the domestic and foreign investors. Timely flow of information gives all the participants a fair chance to share in the potential profits.
Capital markets have however remained vastly occupied and massively hijacked by a few rich families and their business groups in Pakistan.
Capital market in historical perspective
Back in 1968, (late) Dr Mahboob-ul-Haq, chief economist of the Planning Commission of Pakistan during the regime of President; Field Marshall Ayub Khan, issued a list of the 22 wealthiest families of Pakistan, which created a stir in the business and elite circles of the country. According to Dr Mahboob-ul-Haq, these 22 families controlled 66 percent of the business conglomerates and corporations, and owned 87 percent of the share in the banking and insurance sectors. These richest families included Adamjee, Bawany, Dawood, Saigols, Colony, Valika, Fancy, Crescent, Wazir Ali, Gandhara, Ispahani, Habib, Khyber, Nishat, Beco, Gul Ahmed, Arag Hafiz, Karim, Milwala and Dada. These business groups consolidated their holdings during the Ayub Khan regime and remained flourished till early 1970's, when the then Prime Minister, Zulfiqar Ali Bhutto nationalised the industries in Pakistan. This, however, does not signify the logical end to these business giants and groupings, most of them survived and sustained their business during the nationalisation period and flourished steadily in the later years.
Capital market in today's times
Today's ownership structure in the majority of the companies is mostly concentrated and closely held by business group and family-run businesses. It is quite evident that in the majority cases, the promoters or directors, through the 'associated companies' indirectly own the company shares. The family-owned companies have, therefore, controlling equity interests leading to insider control and concentrated ownership in such companies.
There are still 64 percent companies which are controlled by the prominent business groups and families of Pakistan. These groups of companies include Nishat group, Hasham group, Ghulam Faruque group, Amin Bawany group, Gul Ahmed group, Crescent group, Sapphire group, Din group, Adam group, Dawood group, Younus Brothers group, Dewan group, Rupali group, Dawood Habib group, Ibrahim Group, Hashoo group, Attock group, Fatima group, Engro group, Byco group, EFU group etc.
World's stock market
The leading stock markets of the world observed high growth during the fiscal year 2010-11 ranging from 8.1 percent in Japan to the highest market return up to 66.8 percent as dividend in Sri Lanka. The Karachi Stock Market showed an excellent performance as its market return remains at 19.3 percent in terms of local currency in the period July-April 2010-11amidst deteriorating domestic macroeconomic conditions and political upheaval.
Shortcomings of Pakistan's stock markets
The securities markets in Pakistan have remained under- development due to the following reasons:
i) Lack of depth
Market depth requires the presence of a large number of buyers and sellers willing to buy/sell at prices above/below the prevalent levels. The share of most listed companies in Pakistan are predominantly held by:
a) Families (often accounting about 64% of total shares)
b) Institutional participants (such as ICP and NIT)
The remainder is held by public sector institutions, mutual funds and retails investors. Due to the concentration of holdings, the free float of most shares is very small. This in turn leads to illiquidity and failure of stock prices to reflect the intrinsic value of the company. The situation is even worse in the case of multi-nationals in which the parent companies routinely tend to have holdings in excess of 60%.
ii) Lack of breadth
Pakistan's limited industrial base reduces the choices available. The herd mentality in establishing industries has resulted in over-capacity in sugar, textiles, synthetic fiber and cement. The financial sector is affected with high percentage of non-performing assets and defaults in an environment where borrowers quality, financial health and ability to repay is increasingly suspect. Though a number of public sector companies are listed, inefficient management and fear of government using their balance sheet for its own budgetary support keeps in investors away from these companies.
iii) Crowding out effect
Heavy government borrowing to finance successive budget deficits has severely limited the availability of credit to the private sector for capital market investments. Even the pension funds, government securities and related funds have been used for borrowing by the government.
iv) Low equity base of companies
The equity base in Pakistani companies has been very low ranging between 25% to 30% of the assets. Private limited companies avoid listing because of the following reasons:
-- Historically, low cost debt was available from development finance institutions. The cost was further subsidised if the project was based on local machinery. This made debt extremely attractive and inhibited development of a large equity base.
-- Most of the companies are owned by large industrial groups, many of whom have adequate capital at their disposal and do not need to apply to the general public for funds.
-- The management of profitable family-owned entities avoids going public and share the benefits with the general public as well as open its operations to greater transparency that listing on the stock exchange requires.
The Finance Minister has recently proposed to fix a benchmark level of paid-up capital, beyond which companies will have to be listed on all stock exchanges. While laudable, this should be accompanied by legislation that helps avoid concentration of equity in a few hands.
v) Pricing of equities
Until 1993, the Karachi stock exchange did not allow shares of new companies to be issued at a premium. The market boom of 1994, however, saw many companies issuing shares at a premium; subject to the SECP's approval. Although greenfield companies (new companies) have to fulfil certain criteria in order to justify issuance of shares at a premium, experience has shown that such criteria have failed to prevent unfair practices.
vi) Lack of investor confidence
In an efficient capital market, timely flow of information gives all participants a fair chance to share in the potential profits. However, there is no market in the world that enjoys absolute degree of efficiency. There is always some degree of inefficiency, which can be exploited by the insiders, and few well-informed at the expense of the participants.
The degree of informational efficiency at KSE is relatively low and thus, insiders play a greater role. The general investors are deprived of a level playing field.
vii) Financial disclosure by companies
The system of financial reporting in our country is in a very primitive stage. There is an acute dearth of timely and accurate financial information. Since the valuation conducted by analysts is based on published annual reports, the lack of details in financial statements considerably reduces the usefulness of the exercise. This stage of affairs also makes it difficult to make comparison among companies in the same industry.
There is a need for improvement of the government regulations governing financial reporting and the accounting profession. The existing regulations must also be reinforced.
viii) Protection of minority interest
The dividend pay-outs by listed companies in Pakistan remain very low, which is a cause of concern for minority shareholders. For the year 1998, less than 150 of the 773 listed companies paid the cash dividend. The worst offenders in this are the local groups who have been abusing the balance sheets of their companies to support other group concerns or unnecessary expansions. It is quite common to witness cash flows being used to invest in the shares of another entity or to provide low costs loans. The absence of cash dividends is then covered up by announcing bonus issued which dilute earnings and prices.
ix) Positive developments
The central depository system: The central depository system was launched in September 1997. By setting all transactions although an electronics entry, the central depository system has eliminated physical handling and trading of fake certificates. At the same time, daily turnover has increased and immediate transfer of ownership has replaced the previous system whereby 45 days were required for delivery, settlement and transfer.
Incentives allowed to stock markets
Capital markets are driven by liquidity. In order to provide financial support, the FBR has announced a number of incentives to the investors in Pakistan. The following are the most relevant announcements and their likely impact on the country's capital markets.
i) Removal of Capital Value Tax on Modaraba certification/shares/instruments of redeemable capital
This move will encourage the listing of Modaraba certificates, TFCs, Commercial Paper and facilitate their trading on the stock exchange. It shall bolster upcoming debt issues and enhance debt instruments marketability to all kinds of investors.
ii) Tax credits for enlistment on stock exchange
New listed companies would be able to enjoy 15% tax credit of their tax payable in the respective tax year.
iii) Total tax relief for 100% equity financed projects
No mentionable mega-project has so far been initiated based on 100 percent equity financing for a long time in Pakistan so this step in unlikely to draw new initial public offerings (IPO). Generally the capital structure of large scale projects involves debt financing to achieve an optimal level of debt to maximise the shareholders earnings from the business.
The holding period enhanced to 3 years from 1 year bodes well for the stock markets. Life insurance premiums have also been included for individuals.
iv) Tax credits for approved pension schemes
The maximum limit of Rs 500,000 for claiming tax rebate has been removed. This measure was long overdue and will likely bode well for long-term economic growth. However serious pension reforms need to be undertaken by the government and the SECP needs to move towards market-based mechanisms.
v) Advance tax against capital gains tax
Small investors were not exempted from capital gains tax (CGT). Instead minor relief has been given to them by extending the time limit for depositing advance income tax to 21 days instead of 7 days after the close of the quarter.
vi) Profit on debt
Withholding tax on government securities has been announced as full and final tax for individuals as well as foreign investors like other fixed income instruments. This may result in liquidity flows towards risk-free assets, away from the equity markets.
vii) Dividend received by a banking company from its AMC
To discourage banks from setting up Asset Management Companies (AMC), and capitalising them through the issue of bonus shares, withholding tax on dividends from AMCs to the holding bank has been doubled to 20 percent. The move may hamper profitability prospects for banks.
viii) Withdrawal of sales tax exemption on agricultural inputs
Tractors, pesticides and fertiliser have been subjected to GST on domestic and import stage. The resultant increase in cost will likely be passed on to consumers, straining the farmer's ability to afford these inputs.
ix) Karachi Stock Exchange
In the current fiscal year, the Karachi Stock Exchange (KSE) retained its prominent position in Pakistan's capital markets, offering efficient, fair and transparent way of trading securities. This can be compared with any market in the region enjoying full confidence of the investors. KSE is now a part of global equity market with foreign institutional investors holding a significant percentage of the free float.
x) Lahore Stock Exchange
The leading market indicators witnessed mixed trends in Lahore Stock Exchange. The LSE -25Index, which was 3093 on 30 June 2010, increased to 3343 points as on March 31, 2011 with total paid up capital increased from Rs 842.6 billion to Rs 854.4 billion.
xi) Islamabad Stock Exchange
Islamabad Stock Exchange (Guarantee) Limited (ISE), being the youngest stock exchange of three stock exchanges of Pakistan, has been playing an important role in the development of equity market in Pakistan along with other two exchanges to create value for their investors and listed companies through dynamic market operations, fair and transparent business practices and effective management.
Other features of capital markets
i) Debt capital markets
Debt capital market is a market for trading debt securities where business enterprises (companies) and governments can raise long-term funds. This includes private placement as well as organised markets and exchanges. The debt capital market trades in such financial instruments which pays interest. There are bonds and several loans which act as the prime financial instrument of this market. Because of this interest factor, it is also known as fixed income market.
ii) Government securities
Pakistan Investment Bonds (PIBs) as fixed rate government securities provide a benchmark for debt capital market. The government is committed to provide sufficient supply of long term papers in the market to develop the longer end of the government debt yield curve.
iii) National Savings Schemes (NSS)
The Central Directorate of National Savings (CDNS) performs deposit bank functions by selling government securities through a network of 372 savings centers, spread all over the country. The NSS contains a number of instruments with significant concentration on individual investment, NSS scheme are available with a maturity period of 3 years, 5 years, and ten years. It is also worth mentioning that segment of subsidised scheme ie Pensioner Benefit Account and Behbood Saving are available for investment by seniors citizens.
iv) Mutual funds
Mutual funds ascended with an increased thrust as evidenced by a surge in total assets of over 10 percent and reached to Rs 275 billion during July-March 2010-11 as against 4.4 percent growth for 2009-10.
v) Modarabas
Being a distinctive Islamic business model, the modaraba sector has contributed significantly towards the development of non-banking finance sector and achieved a phenomenal growth in terms of profitability. The modaraba sector has enrolled its place in the financial intermediaries and has been able to create a market niche for itself in the financial sector.
As compared to other financial sector of Pakistan the modarabas have strongly faced financial turmoil without any shrinkage in its assets size, number and employment. It may be because of the inherent strength of the Islamic financial system.
vi) Investment banks
Investment banks are facing multiple problems like low capitalisation, high cost of funds and limited avenues for resources mobilisation.
vii) Leasing
The leasing sector in Pakistan faces multitude problems like liquidity issues, low capitalisation, limited sources for resource mobilisation, high cost of funds, level of non-performing assets and limited outreach.
viii) Voluntary pension system
The government has been considering reforming the current pension system. Luckily, the dependency ratio at this point of time is extremely favorable for Pakistan to shift from defined benefit system to defined contribution system.
ix) Real Estate Investment Trusts (REITs)
REITs are new investment instruments for Pakistan's capital market. Therefore, the framework would need adjustments before it takes roots in the investing community. In order to alleviate some of the concerns hindering the evolution of REITs a number of amendments were made to REITs Regulations in 2010. The reduction in the fund size from Rs 5 billion to Rs 2 billion was done to accommodate the capital constraint for launching of REITs projects in addition to introduction of concept of hybrid REITs.
The rates of stamp duty and registration fee for REITs properties in Punjab and Sindh are reduced. In Punjab, the stamp duty for REITs property purchase has been reduced from 2 percent to 0.5 percent and on sale of property from 2 percent to 1 percent. In Sindh the stamp duty has been reduced from 3 percent to 0.5 percent. In both provinces, registration fee on purchase of property by REITs has been waived and reduced from 1 percent to 0.5 percent on sale by REITs.
x) Settlement system
The development of PRISM (Pakistan Real time Interbank Settlement Mechanism) system started as a response to the growing awareness of the need for sound risk management in settlement of larger-value funds transfers in Pakistan. PRISM systems operated by State Bank of Pakistan offers a powerful mechanism for limiting settlement and systemic risks in the interbank settlement process by providing settlement on gross basis and in real time.
In addition, PRISM also contributes to the reduction of settlement risk in security transactions by providing a basis for Delivery Versus Payment (DVP) mechanisms.
xi) Employees stock option scheme Employees Stock Options are used not only to reward employees but also as retention tools and to build long term loyalty of employees to their workplace.
xii) Pakistan Mercantile Exchange Limited
Pakistan Mercantile Exchange Limited (PMEX) formerly known as the National Commodity Exchange Limited (NCEL) is Pakistan's first demutualized online commodity exchange. It was established in April 2002 and commenced operations in May 2007. PMEX provides a regulated platform for trading of futures contract in commodities and currencies. The product portfolio of PMEX has been designed to cater for the hedging and speculative needs of various stakeholders/ investor groups. The futures contracts presently available at the exchange include varying sizes of gold and silver contracts, rice, palm oil, crude oil, sugar, and cotton and interest rate contracts.
xiii) Derivative markets In order to provide investors with basic hedging instruments, financing options and increased investment alternatives, deliverable futures contracts and cash-settled futures contracts are available for trading at the three stock exchanges. Additionally stock index Futures Contract based on the KSE 30 Index and Sectoral Indices for oil and gas sector and banking sector are available at the Karachi Stock Exchange (KSE). Under the cash settled futures, 90, 30 and 7-days cash-settled futures contracts are available.
(The writer is a practising Cost and Management Accountant and author of many books on tax laws, corporate affairs and cost accounting)
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PROFILE OF KARACHI STOCK EXCHANGE
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2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
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(Jul-Mar)
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Number of Listed Companies 658 658 652 651 652 638
New Companies Listed 14 16 7 8 8 0
Fund Mobilized (Rs billion) 41.4 49.7 62.9 44.9 135.1 14.8
Listed Capital (Rs billion) 496 631.1 706.4 781.8 909.9 920.1
Turnover of Shares (billion) 79.5 54 63.3 28.2 43.00 21.2
Average Daily Turnover
of Shares (million) 348.5 262.5 238.2 115.6 173.2 114.2
Aggregate Market
Capitalisation (Rs billion) 2,801.2 4,019.4 3,777.7 2,143.2 2732.4 3147.6
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Source: KSE
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PROFILE OF LAHORE STOCK EXCHANGE
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2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
(Jul-Mar)
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Number of Listed Companies 518 520 514 511 510 497
New Companies Listed 7 10 2 9 25 6
Fund Mobilised (Rs billion) 24.5 38.8 29.7 32.8 67.5 8.222
Listed Capital (Rs billion) 469.5 594.6 664.5 728.3 842.6 854.370
Turnover of Shares (billion) 15 8.2 6.5 2.7 3.4 0.923
LSE 25 Index 4,379.3 4,849.9 3,868.8 2,132.3 3092.7 3342.56
Aggregate Market
Capitalisation (Rs billion) 2,693.3 3,859.8 3,514.2 2,018.2 2622.9 2921.5
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Source: LSE
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PROFILE OF ISLAMABAD STOCK EXCHANGE
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2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
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(Jul-Mar)
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Number of Listed Companies 240 246 248 261 244 236
New Companies Listed 6 12 7 15 2 -
Fund Mobilised (Rs billion) 5.2 30.7 24.6 24.8 73.0 7.4
Listed Capital (Rs billion) 374.5 488.6 551 608.6 715.7 710.3
Turnover of Shares (billion) 0.4 0.2 0.6 0.3 0.2 0.034
ISE 10 Index 2,633.9 2,716 2,749.6 1,713 2,441.2 2605.4
Aggregate Market
Capitalisation (Rs billion) 2,101.6 3,060.6 2,872.4 1,705.1 2,261.7 2531.5
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Source: ISE
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