We don’t need more capital markets in Pakistan

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On May 4, 2013, Pakistani financial newspaper Business Recorder published an article “Capital Market” calling for more stock exchanges to be established in Pakistan by professor Omer Jawed Ghani of esteemed business school Institute of Business Administration (IBA). The article lacked references to research reports or numbers to back up its conclusion. I agree that information about Karachi Stock Exchange (KSE) may not be as readily available as markets of developed economies, however, with the resources at disposal of author at Institute of Business Administration, (IBA) both human as well as academic, it would not have been hard to collect such information.

The bottom line of the article was that we need more deregulation and competition in capital market of Pakistan_ the very same medicine that multilateral agencies have been pedaling to all developing countries for decades_ without really understanding the structural challenges of economy of the country. The justification used by author for this prescription is presented as “a school of thought has related the rate of economic growth of nations to the growth rate of their capital markets.” This may be true for certain economies, however, the disconnect between the capital market of Pakistan to the real economy of the country can be gauged from the fact that in 2012 KSE was amongst the best performing stock exchange in the world yet the country’s economy continued its downward spiral. Over last 5 years while the economy of the country dragged along, KSE 100 surged from 9,386 (2009) to 19,226 (May 3, 2013) _ compounded annual growth rate of in excess of 15% without making any adjustments. Yet the number of new listings during the period was 4 per year with the exception of 2010 when 6 new companies were listed. These facts would be logic-defying if growth in capital market was really related to economic growth of country.

Author stated that KSE is the only stock exchange in the country. But we also have Lahore Stock Exchange and Islamabad Stock Exchange. I will presume that author wants more stock exchanges in Karachi as Karachi is the economic hub of the country. It should be noted here that there were two attempts in early 2000s to have multiple exchanges. One was a pure ECN (Electronic Clearing Network) set up by AKD Securities but plugged into KSE and the other was PEX Ltd another ECN with a license to become a stock exchange by Jahangir Siddiqui. However, we see that both of them are no longer present on the scene. A good study or research topic would be to understand the reasons why these set ups failed to gain a foothold i.e., were there regulatory lacunas, opposition by current exchanges, not enough demand for the new services etc?

The basic question that needs to be asked is why do we need exchanges and why do we need more of them. The basic purpose of a capital market in this case a stock exchange is to enable the sponsors to raise equity capital for new projects or expansion. The prevailing law and order situation in the country is such that no new projects are being set up except either in retail where the cash requirements are not as much as to approach the capital markets or real estate projects where end users of land themselves finance the acquisition and development of the property.

If we talk numbers, in 2000-2001 fiscal year, number of listed companies on KSE was 747 which has now come down to 570. During certain periods half of the listed companies have either been on trading suspension, default counter or even classified as “non-compliant” segment. This shows that listed companies are not to keen to comply with regulatory requirements_ a problem which will not be solved by a new exchange unless it has lax regulatory requirements which will create more problems than it solves. One can not attribute this to monopolistic tendencies of KSE.

Moreover one needs to understand the impact of listing on a company i.e., increased costs for compliance with regulatory body regulations, higher accounting costs for quarterly and annual reporting to stakeholders, accountability to multiple new shareholders etc. Before 2002, there was a tax differential of 10 percentage points between listed and unlisted companies with listed companies being charged at 35% against a 45% rate for unlisted companies. The tax differential was eliminated in 2002-2003 budget thus making the tax rates equivalent. Hence, there are no offsetting financial advantages to list a company for the increased costs it will start incurring once it gets listed.

Under Finance Act, 1999-2000, it was compulsory for listed companies with free reserves of more than 50 percent of its paid-up capital to distribute at least 50 percent of its taxed profit as cash dividend. This brought good returns to minority shareholders as well as encourage general public to invest in shares in anticipation of good dividends as well as bringing tax revenue to exchequer in the form of dividend tax. This condition was subsequently removed with the result that minority shareholders have been left at the mercy of majority shareholders.

Most common argument against monopolies is that they use exploitative pricing and stifle innovation. It is clear from above facts that under the prevailing conditions in the country, even three stock exchanges in Pakistan are more than enough (reportedly Asian Development Bank in their Capital Market Development Plan 1997 also reached the same conclusion that Pakistan does not need 3 exchanges).

However, if one assumes that KSE has monopolistic tendencies, it would be good to have some numbers and/or research backing it up where KSE charges higher rate for listings, unnecessary tough regulatory requirements or has stifled listing of new forms of instruments despite their being an appetite and understanding of risks such instruments.

A good idea is to have a stock exchange for Small and Medium Enterprises (SMEs). Such an idea _ to have an Over The Counter market for SMEs_ was considered in late 2002 but subsequently shelved because of structural problems present in the Pakistan economy. It may be beneficial to at least revisit this project.
What we need is not another exchange but an enabling environment (political, economic as well as regulatory) for investors to invest in Pakistan. Once the investment starts picking up and investors need more financing, they may list themselves on the available exchanges or we may revisimarket which allows for laxer regulatory requirements yet much cheaper and quicker mechanism for fund raising (OTC market can be used both by SMEs as well as large corporates_ NASDAQ in US is an OTC market).

In conclusion, the need for more exchanges just for the sake of “competition” seems premature.

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