The role of the stock market is to raise long-term funds for corporations (primary market) while providing a platform for the trading of securities (secondary market). Stock exchanges encourage investment through pooling of resources, enabling corporations to obtain funds to expand their businesses.
In Pakistan where the saving rate has remained sticky at under 15%, the importance of the stock exchange in aggregating savings and then channelizing them to meet the burgeoning investment requirements of the country cannot be overemphasised. Therefore, as an alternative to debt financing, the stock exchange as a whole facilitates productivity levels and hence economic growth, particularly in the present tough economic conditions, where asset pricing is under pressure and bankers have gone too cautious in lending.
It is felt that there is a general ignorance regarding the essential role that Pakistan's stock exchanges are playing in achieving equitable, broad-based and sustainable economic development of the country. From a broader perspective the role of a stock exchange is vitally important for countries moving toward greater integration with the global economy. A functioning stock market makes it easier for firms to find sources of capital in both domestic and international capital markets.
Case in point is the growing number of GDRs that allow foreigners to participate in local offerings without taking currency risk. In the last eight years, several blue chip Pakistani companies such as Oil & Gas Development Company (OGDC), MCB Bank Ltd (MCB), Pakistan Telecommunication Company (PTC), Hub Power Company (HUBC) and Lucky Cement (LUCK) have benefited from GDRs. Besides companies, this has been beneficial for the entire economy in many different ways.
In the case of Pakistan, with per-capita incomes sticky at the US $1,000 mark, the stock exchange helps to create investment opportunities for small investors. They can own shares of the companies just like large investors, and enjoy similar rates of return. In this context, stock exchanges help in redistribution of wealth through stock price increases and dividends with investors getting the chance to share in the wealth of profitable businesses.
A healthy trend in this regard is Online Trading which leads to greater awareness for retail participation and also enhances the benefits for a larger number of people. Simply put, any investor can access the stock market via the internet and without even calling up a broker become part owner of a business conglomerate and enjoy the proportionate benefits.
The stock exchange also serves as an economic barometer and can give important signals to economic policy makers regarding how their decisions related to interest rates, taxes and currency volatility impacts different sectors of the economy. Historically, the KSE has been a leading indicator to changes in the real side of the economy and an effective predictor of growth.
Indeed, the meltdown in CY08 did not come as a major surprise given the then-prevalent macroeconomic difficulties and the recent resurgence in the KSE certainly parallels rapid improvement in the economy. The stock exchange thereby helps both policy makers to adjust their actions and for regulators to effectively monitor.
The stock exchange can also help the government as well as private sector to raise money through privatizations and GDR offerings. Government divestments in the last couple of years have indeed added color to the local stock exchanges and given them much needed float, depth and breadth.
Since the initiation of economic & financial reforms in the early 90's the GoP has raised a total amount of PkR475bn through the successful privatisation of government enterprises especially those in the Financial and Oil & Gas sectors. This not only helped the Government raise much needed funds for priority spending on infrastructure development but also improved the financial performance and service quality of these companies by promoting greater level of competition.
MAJOR PRIVATIZATIONS DEALS In the current backdrop where the fiscal authorities are facing increasing stress due to anemic growth in tax generation and higher defence related expenditures, the stock exchange can provide an avenue for the government to fund long-term projects through revival of the privatisation program.
This will help against the serious crowding out of private sector credit while allowing the Central Bank to continue on the path of monetary easing. At the same time, the stock markets are contributing directly to the government kitty through the tax collected on Capital Value Tax (CVT) and withholding tax on share transactions. With the Government planning to introduce Capital Gain Tax (CGT) on local equities, the contribution of the stock market in solidifying fiscal consolidation will increase.
However, this will depend largely on how interaction with tax authorities particularly of individuals is facilitated. We feel that technology and the level of advancement (eg UIN) already attained may help achieve the objective without unnecessary interaction with tax authorities and hiring of income tax practitioners at year end.
Deduction of tax as advance tax automatically from an investor account based on UIN, each time he sells a stock is a suggested approach. This will not only smoothen up the mechanism but will also ensure receipt of much needed revenue by the FBR throughout the year.
The stock exchange also allows domestic companies to tap foreign savings through foreign flows. This is especially important in the case of Pakistan where there is sizable saving - investment gap of around 5% of GDP. Hence to maintain an optimal level of capital accumulation necessary to support 4%+ level of real GDP growth, continued inflow of Foreign Portfolio gains significant importance.
In the last five years, Pakistan has received cumulative FPI of US $7.2bn which has not only helped to sustain economic growth momentum but also eased pressure on the balance of payments & the PkR exchange rate by partially financing the enlarging trade gap.
In FY10, economic consolidation especially currency stability & lowering of Credit Default Swap spread on the country's external commercial has resulted in Karachi Stock Exchange to attract FPI of US $435mn FYTD. Returning confidence in the outlook of domestic equities by both domestic and foreign institutional investors, can potentially lay the ground work required to attract long term foreign direct investment into the country.
A key component in this regard has been the role of CDC (transparent electronic transfer) and technology innovations that have reposed investor (both local & foreign) faith in the stock market. It is interesting to note that foreign investors used to be a dream a few years ago but are now taken for granted! Higher FPI flows, despite serious security conditions, have led the market capitalisation of the KSE to increase to its current value US $35.2bn as compared to US $27bn in the previous year.
At the same time, improved risk perception of Pakistan has helped raise the average daily turnover at the KSE to 169mn shares from 119mn shares at the end of CY09. Lastly, by diversifying ownership, companies generally tend to improve on their management and efficiency in order to satisfy the demands of these shareholders and the more stringent International Financial Reporting Standards (IFRS) and GAAP in case of GDRs.
This form of corporate governance weans out the weak corporations through acquisitions/take-overs etc. In conclusion, the local stock markets have been playing a positive role in the Pakistan Economy where its contribution stands to magnify in the coming times particularly with the planned introduction of more products (particularly Derivatives) and the proposed Demutualization of stock exchanges.
This should further augment an increase in investor base leading to a larger pool of funds available for capital formation in the country. Already, technological advancements such as CDC (electronic settlement), UIN, online trading are facilitating this progress.
To conclude, equities as an asset class remain largely untapped in Pakistan and once the aforementioned developments take place, it is felt that the general public would gradually diversify itself away from fixed income investments (Banks, NSS) towards equity investments. As such, it is perceived that the role of the stock exchanges in Pakistan's economy should only augment going forward.
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Name Amount realised Transfer
(US$mn) During
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26% (1.326 billion) B class of shares of PTCL 2,618 Jul 2005
OGDCL 9.5% GDR (408,588,000 Shares) 771 Dec 2006
UBL 25% GDR (202,343,752 shares) 650 Jun 2007
PTCL (10%) 898 Sep 1994
Habib Bank (51%) 378 Dec 2003
NRL (51% GOP shares) 276 May 2005
Pak American Fertilisers (100%) 265 July 2006
KESC (73% GOP shares) 265 Nov 2005
Pak Arab Fertilisers (Pvt) Ltd (94.8%) 237 May 2005
United Bank Ltd (51%) 200 Oct 2002
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Total 6,558
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