Beginning of a new era

Economic growth hinges on an efficient financial sector that pools domestic savings and mobilizes foreign capital for productive investments.

Nadeem Naqvi, Chairman Karachi Stock Exchange (KSE) is of the view that without an effective set of financial institutions, productive projects may remain unexploited. Giving some numbers, Naqvi said the businesses raised over Rs1.0 trillion through the capital market in the last 10 years, which includes Rs440 billion raised by government through privatisation.

Experts are of the view that inefficient financial institutions will have the effect of taxing productive investment and thus reducing scope for increasing the stock of equipment needed to compete globally. Inefficiency can substantially cut growth from the levels that might have been possible given appropriate policies and market structures.

In order to provide businesses a deep liquidity pool, the government is finally merging Karachi, Lahore and Islamabad Stock Exchanges into a single platform to be named Pakistan Stock Exchange (PSE). However, the benchmark index remains KSE-100 as this has become a brand worldwide.

To recall, Stock Exchanges (Corporatisation, Demutualisation and Integration) Act 2012 was passed by the parliament on March 27, 2012 and signed by the President of Pakistan on May 7, 2012.

In the second phase, the three exchanges are merging and integrating into Pakistan Stock Exchange, for which the KSE has prepared the online trading platform, which is set to come online today (Monday).

In the next phase, real estate and exchange operations of KSE would be separated and it would follow sale of 40 percent equity stake to strategic investor and subsequently other of 20 percent to the general investors and listing of the exchange.

The management committee of PSE plans to complete the strategic sale by the end of 2016. According to Nadeem Naqvi, they are already in talks with London Stock Exchange and Qatar Stock Exchange while Bursa Istanbul has issued an initial letter of interest.

However, analysts are of the view that the integrated Pakistan Stock Exchange would be a sizeable entity and acquiring its 40 percent stake would not be a small investment.

The KSE chairman expects that a consortium of stock exchanges/institutions will be making this investment.

An independent financial advisor will determine the fair value and on the basis of which further negotiations will be carried out. So far Deutsche Bank has been PSE financial advisor, but now a joint advisor comprising a local and an international firm to evaluate the Pakistan Stock Exchange is being appointed. This hiring would be through a local as well as international tender.

Regional alliances are the need of hour and the induction of international exchange operator will encourage cross listings and global capital raising by Pakistani companies.

What does the integrated PSE mean for investors, there will be 413 stock brokers capable of serving investors nationwide through a single, large liquidity pool; free provision of the exchange’s new Internet Trading Platform to all TREC holders/brokers who sign agreement with PSE, which will support small and medium sized brokers to focus on business generation and sales without having to keep large IT infrastructure.

Moreover, regulatory function as frontline regulator will be streamlined with close coordination of the apex regulator in terms of compliance monitoring of market participants and listed companies.

The most important aspect is that a single stock exchange will have a nationwide footprint with regulator supported capital market hubs so that maximum people have access to the capital market.

Without efficiently run capital markets, investors have limited means to diversify their portfolios. As a result, investors may avoid equity stakes because they are too risky. Hence, corporations may find it difficult to raise equity capital.

With developed stock markets, individual can diversify firm-specific risks, thus making investment in firms more attractive.

Last ten-year average annual return for asset classes suggest that bank deposits yielded 4.9 percent; government T-Bills yielded 10.5 percent followed by Government PIBs at 11.9 percent and Defence Saving certificates with 11.4 percent.

The all glittering gold has yielded an average return of 12.4 percent in the last ten years while the KSE-100 index has given a persistent return averaging 24.9 percent in the last ten years.

Pakistan’s equity market is quite underdeveloped having around 220,000 retail investors, 883 domestic institutional investors and 1,886 foreign institutional investors, which leaves a whole lot of room for expansion and development. As many as 555 companies are listed on the Karachi Stock Exchange with a market capitalisation of $67 billion. Underdeveloped or poorly functioning capital markets deter foreign investors because the markets are illiquid and trading is expensive. Direct investment is adversely affected if raising local capital is difficult and costly.

According to analysts, illiquidity and high transaction costs also hinder the capital-raising efforts of large domestic corporations and may push them to foreign markets. A country that restricts its capital markets not only is less attractive to foreign investors but also imposes major economic penalties on local companies. This reduces growth rates below their full potential and makes it more difficult for domestic firms to compete in world markets.

Analysts argue that corporations in countries with poorly functioning capital markets may choose lower value and low risk projects to inefficiently diversify in order to attract investment capital. These projects may not even be within the realm of the corporation’s special expertise. They serve the purpose of diversifying because the capital markets have not provided the means for investors within that country to efficiently diversify. Hence, the stock market may play a key role in economic growth.

The writer is a staff member