It’s been quiet at PSX, but its CEO is upbeat

KARACHI: The chief of Pakistan’s stock market, Farrukh H Khan, is a positive man. He has to be – it’s in the job description.

Appointed in 2020, Khan saw the KSE-100 Index losing 30% in the first month of his appointment. The pandemic had taken an early toll on Pakistan’s market, but there was panic elsewhere, too. The FTSE and S&Ps all fell. A few months later, the Pakistan Stock Exchange (PSX) was the target of a terrorist attack that took the lives of three security personnel, according to a statement at that time.

Next year, Pakistan was downgraded from its status as an emerging market, a little over four years after it was reclassified from the Frontier Markets (FM) Index by Morgan Stanley Capital International (MSCI). It was also the same year when the PSX witnessed eight Initial Public Offerings (IPOs), including 2 on the newly-launched counter, the Growth Enterprise Market (GEM) board. The number of listings was the highest since 2015, and helped raise Rs20 billion from investors. However, the listing momentum faded soon enough.

Brokers at the time said the KSE-100 is likely to make history in 2022. Almost three quarters in, they stand embarrassingly corrected.

But this kind of pressure and volatility seen by Pakistan’s stock market is not new. An uncertain economic environment, coupled with political upheaval, and a currency that just cannot find its footing in the face of a market-determined exchange rate have left PSX investors looking elsewhere for a while. A rather risk-free banking deposit has always remained attractive, especially when the average discount rate level has been close to 10% in the current century.

Since the start of fiscal year 2018, foreigners have been net sellers of roughly $1.6 billion worth of shares. At the same time, the KSE-100 – widely seen as a benchmark index given its quality of encapsulating a wider array of sectors, companies, and market cap – has fallen over 6% in absolute terms.

More dramatic has been the fall in market capitalisation – the value of all shares on the PSX – that has plummeted from Rs9.5 trillion (roughly $90 billion) to Rs6.9 trillion (roughly $30 billion at today’s exchange rate) during the same period, wiping off portfolios when adjusted for inflation.

Interestingly, combined earnings – arguably the biggest determinant of investor-interest – of KSE-100 companies have gone up massively from Rs594 billion in FY18 to an expected Rs1,103 billion in FY22, data compiled by brokerage firm Arif Habib Limited and PSX show.

Such has been the journey of PSX.

Yet, Khan is upbeat, and he has data to back up his argument.

“You always invest in equity markets with a long-term view,” Khan told Business Recorder in a recent interview. “Over the last 20 years, the KSE-100 has offered an annualised return of 16-17%, even in dollar terms.

“What is not satisfactory is the size of our market. Pakistan is one of the oldest markets in Asia, but we are nowhere where we need to be – and there are reasons. We have operated in a traditionally high interest-rate environment, a large informal economy, and there are tax disincentives.

“Then there were internal challenges – especially since we moved onto the Financial Action Task Force’s grey-list. Account opening process and anti money-laundering requirements became cumbersome. However, we moved to ensure these processes are eased,” stressed Khan, specifically mentioning the Roshan Digital Account (RDA) initiative that enables overseas Pakistanis to open a bank account in the country, paving way for an investor account as well.

“RDA was a big breakthrough. We are now implementing a similar process with support of the State Bank of Pakistan (SBP) in the local market. The pilot is being run. Next month, we will formally launch the local KYC sharing initiative along the lines of RDA.”

All these measures have helped arrest the decline in UINs, a term used to uniquely identify each investor that helps maintain a traceable link for each trade and transaction executed in the stock market. In August, National Clearing Company of Pakistan Limited (NCCPL) data shows, 5,741 total UINs were registered, a substantial 61% increase month-on-month.

“We will keep pushing, but we have reversed the trend.”

From the supply-side, Khan said, there were 10 IPOs last year, launch of the GEM Board, and there have been large Sukuk issues.

“But the key is our market size,” said Khan, swaying the conversation to last-month’s visit by Finance Minister Miftah Ismail.

“This was our plea to him – the situation in the capital markets needs to be addressed on a war-footing. Our market cap has come down to $30 billion when it should have gone up to $300 billion.

“At this kind of market cap, large institutional investors will not take an interest. They need a certain size and (availability of) liquidity.”

Khan, whose experience includes lead managing the London listing of OGDC and who has advised, either on the buy or sell side, on almost 50% of all successful privatisations in Pakistan, said the finance minister was suggested that some of the investments from the different Middle Eastern countries with whom discussions are ongoing should come through the “book-building process”.

“This will ensure transparency in price-discovery. Some of the government’s large unlisted organisations like State Life and Pak-Kuwait can get listed. The government will be the biggest beneficiary.”

Khan said another suggestion to the finance minister was also to increase dividend payout by profitable state-owned enterprises. “They have the cashflows. The market’s average ratio is 40-50%. SOEs have a payout ratio of 18%.

“The finance minister called a meeting of relevant ministries. I am hopeful something will come through.”

Khan also mentioned that the holding period anomaly in the recent Finance Act over the sale of shares and the capital gains tax applicable has also been taken up with the finance minister and the Federal Board of Revenue (FBR).

“There used to be a tax differential between listed and unlisted companies. We have asked them to reintroduce it – if you want to incentivise the formal sector and document the economy. We understand that the situation is such that you cannot reduce tax rates for listed companies. But increase the rates for the unlisted ones to maintain the incentive.”

Khan said the PSX also suggested reviving the four-year tax credit for a new IPO. “It hardly had any tax impact – probably Rs200-300 million. They have said they will re-look into that.”

On GEM Board and startups

As the conversation moved to a trendier topic – startups – Khan said these can make a case for listing on the GEM Board.

“The GEM Board was launched for this purpose. The regulations and cost of listing are much easier than the main board.

“If someone is investing in a startup and envisages an exit in five to six years, then the GEM Board makes sense.

“We signed a MoU with the Pakistan Software Export Board (PSEB) through which they will fund 40 tech companies that meet the listing criteria. I think the mandate for 12-15 companies has already been issued. Our fees are relatively low, but you still need lawyers/investment bankers. Those can become expensive, but the PSEB will pick up those costs.

“Apart from exits, the GEM Board remains a viable option for early-stage companies that want to raise further capital as well. There is ample local liquidity – especially as foreign flows dry up due to international financial turmoil.

“A listed company/vehicle also provides much greater certainty on repatriation of capital/dividends.”

Copyright Business Recorder, 2022