It takes two to tango

It is indeed sad that we have made a habit of knee jerk reaction and action is only taken when things start colliding head on in any sphere. The capital market had already lost 40 percent as a result of over-leveraging in March Futures Contracts. It was still reeling from the settlement crisis when the furore over COT replacement with margin financing took an ugly turn. Finger pointing was the name of the game. Brokers were blaming the regulations and the banks, while the banks were blaming the Badla lenders and were perplexed at being repeatedly called upon to join in a bail-out package.
A series of meetings were held, in Islamabad and Karachi, which caused more nervousness and the agreed solution was questioned by the members of the exchange before the ink could dry on the press release. The KSE Chairman proposed in writing capping of COT at April 19th level and phasing out at the rate of 12.5 percent per scrip. The Securities and Exchange Commission of Pakistan (SECP) concurred.
The market players cried foul, as they felt this implied that everyone would be a seller and there would be no buyers. As a result the market would head only one way ie downhill. This clearly showed that both the elected members on the board and the SECP bosses did not fully comprehend the market mechanism.
Prime Minister Shaukat Aziz intervened as the turmoil could have disastrous implications for the proposed offloading of government scrips. Minister of State Omar Ayub was asked to tackle the situation. While the brokers called for extension of the August 3 deadline for doing away with COT or a parallel run on the ground that the margin financing system was not yet in place, the SECP refused to budge as it felt that this would derail the reform process that was so painstakingly initiated.
While the brokers and the SECP continued to grapple with each other - finally settling for removing the April 19 cap and reducing the weekly phase-out from 12.5% to 8.25% - banks as a key player remained non-committal about meeting the deadline for funding replacement of COT.
As scrip values continued to fall despite better financial results pouring in, the Prime Minister had to call the State Bank Governor to cut short his Washington trip and sort out the issue.
While, we are dismayed at the existing turmoil, we do see a silver lining on the horizon. Unlike the past, this time the government had not ordered financial institutions to artificially prop up the falling market. Privatised banks remained aloof and 'may-day' calls remained unanswered.
Ultimately, it was left to the Regulator (SBP) to play the role of facilitator with the banks. To be honest, it is not the brokers alone who are the beneficiaries of the COT system. Some leading banks have also provided as much as Rs 13 billion to the system. SBP has refrained from directing credit towards the capital market.
Instead it, has shown them the way to lucrative margin financing and attractiveness of margin financing as a bankable product.
Resistance to replacing COT with margin financing was expected, but SECP has held firm on its deadline and has not been cowed down. However, we need to face some ground realities. In a country of 150 million there are only 1.2 million tax payers.
This may be a reflection of poverty but is also an indication of the size of undocumented economy. In the last public offering (KAPCO) 1.4 million share applications were received as against 650,000 in OGDC offering. This indicates the rising interest of the public in the share market. However, there are less than 25,000 share accounts in the Central Depository Company.
Why? Because we need to give only our NIC number with the share application. To open an account in CDC we also need to give our National Tax Number. Once the COT has been phased out from the KSE net, Badla business will go to the Jodia Bazar. Even now private credit in textile trade emanates from the same spot, albeit over time it has declined as banking has expanded.
We are in a higher growth mode. We need to sustain this by increasing the supply side in the documented sector and curb the demand in the non-documented segment of the economy. This will help in flow of funds to the documented part. Towards that end, a number of initiatives need to be taken: Let us introduce a minimum holding period for exemption from capital gain tax.
-- Let us bring not 10 but 25 percent into the tradeable float of government entities, to lend depth to the market;
-- We need to lower the cost of transaction in real estate by lowering fees and duties along with a law to ensure registration of the transaction at the real value rather than heavy undervaluation as at present;
-- Release more land for development and sale to public at lower prices for the middle class to have access to housing.
In the long term, the big banks have to become pro-active in the capital market to end the stranglehold of the top ten brokerage firms, by establishing asset management subsidiaries and floating mutual funds. The size of their network is unmatchable. At present they shy away due to poor volume in the trading of bonds and government paper. KSE itself must slash the listing cost of TFCs and listing of privately held companies.
The Government could lend a helping hand by lowering the tax rate to listed firms. The bourses should not be completely dependent on government entities for growth in market capitalisation. They must bring in transparency in their operations to generate public confidence. It takes two to tango.