Capital Market Development

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36. Capital Market Development

36.1 Role of Capital Market in Development Planning

In the contemporary global scenario, a large part of the responsibility of economicdevelopment has been shifted to corporate sector from the governmental agencies. Theentire structure and growth of the corporate sector depends on the transparent and prudentfinancial system. An incorrect judgment regarding the financial patterns in corporate sectormay be a cause of heavy distortion in the society by means of volatilities in the stockmarkets, employment opportunities, distribution of income, and demand-supply gap in thecommunity markets. In the present economic structure, overall economic growth dependson the performance of corporate sector, while the financial resources of corporate sector aredetermined by the performance, gravity and strength of the financial markets in a country.As a leading role is envisaged for private sector, financial policies have to be geared towardscapital market development, besides the institutionalization of an effective regulatoryframework. Capital market is a sub-set of financial markets, which provides a linkagebetween the users and suppliers of the funds for long-term investment. A capital marketmainly consists of stock (equity) and bonds markets.

For macro economic management and development planning, an efficient stockmarket can play at least the following three pivotal roles:

i) It can reflect the levels of overall and as well sectoral development, by meansof the market indices and valuation ratios

ii) It can mobilize the funds from the domestic and external sources to thepriority sectors of the economy

iii) It provides the indications, guidelines and information to the investors fortheir investment decision-making. An efficient stock market develops a pathfor smooth, simple and transparent opportunities of investment withoutundue risk and gambling factors

A stock exchange is a place to regulate and perform the activities of stock (equity)market. It is considered as a barometer of the economy, because of its immediate andvisible reaction on the news and transactions of economic importance. Capital market andmonetary policy are closely interrelated as they are determined jointly by the supply ofmoney, interest rates and liquidity position. One cannot ignore the monetary side effects insurvey of capital market behaviour and forecasting. The linkage between the macroeconomic targets and financial and material growth in the different sectors of stock exchangeis indispensable for a balanced economic growth. Harmonization between the rules andregulations developed by the Securities and Exchange Commission of Pakistan (SECP), theState Bank of Pakistan (SBP) and the Central Board of Revenue (CBR) are also required todetermine the balanced strategies regarding the reinvestment of corporate profits (retainedearnings) for modernization and expansion, dividend payments, treatment of the sick unitsand placing of the companies on default counters at the stock exchanges.

36.2 Historical Scenario

After opening up of the economy since early 1990s, modest growth has beenwitnessed in stock market of Pakistan over the years, especially during the years 1995 to2004, despite two major shocks of 28th May 1998 and 9/11 event. Although, the market hasbeen facing a long-term depression in the late 1990s and early 2000s; now it witnessed a


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significant growth in the past three years due to the phenomenal surge in external accountsurpluses reduced returns on National Saving Schemes and low interest rates. This resultedin a massive growth in domestic liquidity.

Table 1

Equity Market at a GlanceKSE 100 IndexFiscal

YearNo of ListedCompanies

ListedCapital

MarketCapitalization(Rs/ Billion) Highest Lowest

AnnualTurnover(Billion)

1999-2000 741 236 383 2054 1276 46

2000-01 747 236 296 1550 1075 23

2001-02 725 261 412 2701 1322 29

2002-03 705 301 756 4604 2356 53

2003-04 685 374 1428 5620 4473 97

Stock market continued performing well and KSE 100 shares index attained therecord level of 10,303.1 mark on 15th March, 2005 under leading contribution of the textile,banking, fuel and energy, communication (PTCL), cement and fertilizer sectors stocks.Market capitalization at the Karachi Stock Exchange (KSE) increased form Rs.382.7 billion inDecember 2000 to Rs.2813.4 billion on 15th March, 2005. All the indicators show a significantand fast-growing improvement in Pakistan stock market. Market capitalization, tradingvolume of shares and the mobilization of funds in the form of new listing (initial publicofferings IPOs), issuance of right shares and debts instruments show the investors

confidence and fundamental improvements in the economy in general and stock market inparticular. Stock market capitalization to GDP ratio is one of the indicators of financial sectordevelopment. The mounting magnitude of this indicator shows that the role andcontribution of financial sector is increasing in the economy of Pakistan. The market has avaluation ratio of 4.0, indicates 300 percent addition in the value of original investmentmade by the investors. The average volume of daily turnover of shares has increased overthe time from 187 million shares in 2000-01 to record level of 1086 million shares on 23rdFebruary, 2005.

Table 2Enhancement In Capital Market

New Listing of Companies New Debt InstrumentsCalendarYear Number of

CompaniesCapital

Mobilized(Rs/ Billion)

Bonus(Rs/

Billion)

Right(Rs/

Billion)Number of

InstrumentsFunds

(Rs/Billion)

FundsMobilization-

excluding bonusshares

(Rs/ Billion)

2000 3 2 5 3 3 0.6 6

2001 3 3 4 2 5 6 10

2002 4 6 3 14 16 9 29

2003 6 5 5 9 6 3 17

2004 16 67 9 12 5 5 83


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The Pakistani stock markets also performed favorably in comparison with otherregional markets as KSE 100 share index witnessed much higher growth in last two fiscalyears compared with the other regional markets stock indices. The market has also beenclassified as the worlds fastest growing market in 2004.

36.3 Sectoral Analysis

According to the Karachi Stock Exchange (KSE) classification, stock market ofPakistan consists of 34 sectors. In terms of market capitalization, Oil and Gas Exploration,Communication, Commercial Banks and Oil and Gas Generation and Distribution are thebiggest sectors, having more than Rs.100 billion investments. However, power generationand fertilizer are also included in the biggest investment sectors in term of paid up capital.Textile spinning and textile composites are also classified as important sectors because oftheir contribution in the economy in terms of employment generation capacity, valueaddition, foreign exchange earnings and the large number of the companies.

Textile Industry

The textile sector is the largest industrial contributor in the national economy ofPakistan and also the biggest in term of the volume of business activities. It is the largestsource of foreign exchange earnings, which contributes more than 65 percent share in theexports from Pakistan. Its contribution is 46 percent in industrial manufacturing, 38 percentin industrial employment, 27 percent in value addition and 8.5 percent in GDP. It has alsoimportant and significant shares in the national exchequer, research and developmentefforts, and the investment and financing activities. It is also important because of itsbackward linkage with the agriculture sector and its forward linkage with the ancillaryindustries.

At present, about 200 spinning and weaving companies are listed on the KarachiStock Exchange. Almost all of these belong to the primary goods in textile sector. Less thanone percent of the listed companies of textile sector belong to garment, hosiery, bed-wear,towels, or made up sectors. This is the reason that value-added textile sector is not includedin the classification of companies by the Karachi Stock Exchange. To promote the value-added production, the value added sector will have to be organized. The small scale,informal, unorganized and cottage units cannot boost the exports in the free trade regimeand in the age of gigantic multinational corporations. Organized sector can boost theexports. It can spend larger amount of money on Research and Development (R & D); it cancompete in the present global environment. It can meet the requirement of the quality,

standardization and environmental measures through listing requirements, transparency,external audits, and several checks by the regulatory bodies including Stock Exchanges,Securities and Exchange Commission, Monopoly Control Authority, State Bank of Pakistanand taxation authorities etc. Lack of big companies in the production of value-added textileproducts was a basic reason of the higher exports of primary and intermediate textileproducts from Pakistan. It was observed in the last two years, that industrialized countrieshave started to shift their textile and clothing units to the poor and developing countriesbecause of the availability of cheap labor and raw material in those countries. By shiftingtheir production activities they can achieve the competitiveness in production cost. Thebiggest companies in the industrialized countries have also decided to go into the jointventures with the textile manufacturers in the cotton producing countries. In fact, this policy

is an adjusting strategy to face the free trade regime. This is a time for Pakistan to induce theforeign direct investment in the value added textile sector. In this way, not only the foreign


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exchange earnings will increase on permanent basis, but also utilization of local raw materialwill be ensured, and the agriculture sector will receive its due share in the form ofreasonable prices of its production, which will lead the reduction in poverty and eradicationof regional imbalances. It is obvious that inflow of foreign investment will further improvethe stock market indicators and the foreign exchange reserves in the country.

Table 3Share in export and corporate culture

Sector TotalCompanies

ListedCompanies

Share in totalexports (%)

Spinning 211 117 10

Weaving 85 19 12

Composite 150 57 -

Processing 350 - -

Garments 1200 4 8Hosiery 600 2 9

Towel 650 3 10

Bed wears 650 2 18

Energy

Energy sector is also an important sector of the economy not only because of theheavy investment and its market capitalization, but also for its role in the economy. At

present HUB Power Company and the Karachi Electric Supply Corporation (KESC) are themajor companies in this sector. The government policies regarding the independent powerplants (IPOs) and privatization of the government owned companies in this sector areimportant in the determination of the future prospects of this sector. This sector hasmultidimensional problems. The shortage of energy, flaws in the distributions network,unionism, improper infrastructure and illegal connections are the main issues, which can bemanaged by the administrative measures. However, the most important economic issue isthe pricing of energy. The World Bank sources have confirmed the industry claims thatPakistani industrialists have to pay the highest cost of electricity among the industrialists inthe countries in the region. It is obvious that this high cost is transferred into the prices ofindustrial products, and makes those products uncompetitive in the international market.Another aspect of this high cost is the acceleration of inflation in the local market. TheMinistry of Finance in coordination with the Ministry of Industries, Ministry of Privatizationand Investment and the NEPRA should determine a policy to ensure the industrialcompetitiveness and protection of the interests of investors in energy sector as well asgeneral public.

Telecommunication

This important sector of the economy is now being passing through a revolutionizedstage. The increasing competition may reduce the profitability of the existing companies.The Pakistan Telecommunication Company Limited (PTCL) has been enjoying a monopoly

for the last several years. Now, because of the inflow of foreign investment and thetechnological improvements in this sector, the role of this industry is being changed. For


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planning purpose, the government should not directly involve in the business of this sector,however government should ensure about the protection of the investors interests. Anotherarea for the government functioning is the strengthening of the law of Monopolies andRestrictive Trade Practices Ordinance. It was observed in the past that companies in thissector had been developing their cartel to exploit the market. With the protection of

investors interest, the protection of consumers interest and security measures are alsoimportant. The new investors in this sector prepare their feasibilities on the basis of presentenvironment. Excess competition in this sector may lead the withdrawal of investment andoutflow of the capital because of enviable profits.

Banks and Financial Institutions

This sector includes the commercial banks, investment banks and Non-bankingfinance companies (NBFCs). The commercial banks and Development Finance Institutions(DFIs) are working under the supervision of the State Bank of Pakistan. While, the Non-banking finance companies (NBFCs) are functioning their services under the supervision of

the Securities and Exchange Commission of Pakistan (SECP). This distribution is based onone of standardized functions of the central bank guardian of money market. Being theguardian of money market, the state bank is responsible to supervise the operation of thoseinstitutions, which can directly affect the money market operation and performance. While,the SECP is responsible for all those companies, which offer their securities to generalpublic. The Non-banking finance companies (NBFCs) are allowed to offer the business in theareas of leasing, investment advisory services, assets management services (open ended andclosed ended mutual funds) and the financing (including housing finance).

It has become a common observation that all the above mentioned institutionscompete to each other. The banks provide the services like leasing and the leasing

companies provide loan facility through finance lease business. In fact leasing businessimplies the operating leasing, which is an ignored area in Pakisatn and a negligible part ofthe total leasing activities. The operating lease is like hiring the equipment on rental basiswithout any transfer of ownership at present or in future. While, finance lease is the transferof assets on ownership basis after the rental period.

It is important that banks and financial institutions are the drivers of the industry;they provide the financing facility to the industry. However, their role should be properlydefined and implemented. It was observed that those institutions have been creatingunbalanced growth because of their businesses in a few concentrated areas like housingfinance, car leasing, consumer financing. The commercial banks should focus on the lending

to the small and medium enterprises (SMEs) for short and medium terms; investment banksshould focus on the equity and debt financing for long term ventures; investment advisoryand assets management companies are already working for the investment in secondarymarket. The leasing companies should not provide loans through finance lease; they shouldpromote the operating lease, which is also important in the process of Islamization. Theweakest area of the capital market is the Modarbas institutions. It is important that Modarbais not a type of business; it is a type of company. However, the majority of Modarbas inPakistan is involved in the leasing, investment and other similar types of business. The roleof Modarbas in the economic value addition has always been questionable. They have notbeen serving in the manufacturing or industrial activities. There is a need to mobilize theModarbas funds for industrial growth by direct investment.


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36.4 Capital Market Reforms

To bring reforms in the capital market of Pakistan, a loan agreement was signed bythe Government with the Asian Development Bank (ADB) in January 1998, under whichSecurities and Exchange Commission of Pakistan (SECP) was set up on 1st January 1999 and

since its inception, it has carried out wide-ranging reforms relating to the rationalization oftrading practices, governance, risk management, transparency, streamlining of rules andregulations and enhancing confidence of the investors in the capital market. Rationalizationof the carry-over trade (COT) system, issuance of the Margin Trading Rules 2004 andRegulations by the SECP and the SBP, induction of the independent professionalmanagement system at the stock exchanges, formation of the Central Depository Company,implementation of the automated national clearing and settlement system, induction of theT+3 systems, establishing a code of conduct under the brokers Registration Rules,strengthening the margin requirements, implementation of the capital adequacy limits onbroker exposure, redefining the minimum net capital requirements for the brokers,replacement of the Blank Selling by generally accepted and carefully regulated Short

Selling, and implementation of the Un-disclosed trading System are included in thoseareas which have been reformed in the last few years by the SECP or its precedentinstitution (CLA).

In addition to the above-mentioned earlier reforms, the following reforms arecurrently under process:

i) Accounting standards and practices are being improved with the help ofprofessional accounting bodies. In the contemporary global economicenvironment, if countries do not have an effective financial system, adequateregulatory laws, transparency and accounting standards, their development

is endangered and will not last. The linkage between the economicdevelopment and financial system cannot be ignored. A good financialsystem and accounting standards lead the higher investment in the economyand investment is a catalyst for economic development. It is needless to saythat a weak accounting and regulatory system can create an environmentwhere the chances of financial irregularities, loan defaulting, bankruptciesand corruption may be higher. All of these are the factors of lower economicgrowth. A significant relationship between the accounting standards andGDP growth has been found in a recent study compiled by the World Bank.According to this study had Argentina raised its accounting standards fromlevels prevailing in the early 1990s to the OECD average, it would have

boosted the country's projected annual GDP growth rate by 0.6 percentagepoint. If the Arab Republic of Egypt could improve its enforcement to thelevel of that in Greece, its growth rate would be expected to rise by 0.9percentage point a year. Overwhelmingly, growth is strongly influenced byinfrastructure to support information gathering and by enforcing contractsbased on such information. Highest standards of accounting, disclosure andtransparency are prerequisites for efficient working of the capital market. TheSECP has taken several steps in this regard including rotation of auditors bylisted companies after every five years, restriction of auditors to provide non-audit services to their listed audit clients and enhancement of penalties onauditors in case of professional misconduct


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ii) The SECP intends also to set up a corporate laws review commission toharmonize the legal and regulatory framework in order to make it moreefficient and cost effective

iii) The Code of Corporate Governance required directors to discharge their

fiduciary responsibilities in the large interest of all stockholders in atransparent, informed, diligent and timely manner

iv) An Institute of Corporate Governance is in the process of being established toprovide an enabling environment for the implementation of the recentlypromulgated Code of Corporate Governance. In addition, the SECP hasdirected each stock exchange to set up a monitoring and surveillance wing tocheck market abuse. Also, SECP intends to promote Corporate SocialResponsibility (CSR) and Socially Responsible Investing (SRI), so thatcompanies can contribute to sustainable economic development by runningtheir business to achieve economic growth, but at the same time, ensure

environmental protection and protect consumer and other stockholdersinterest

Moreover, Securities and Exchange Commission of Pakistan (SECP), has alsostreamlined the issuance of Term Finance Certificates (TFCs), and issued Eurobonds (of $500 million) in February 2004.

Demutualization of Stock Exchanges

The most important and debating step taken by the Securities and Exchange

Commission of Pakistan (SECP) was the Demutualization of the three stock exchanges. It isimportant that more than 85 percent of worlds leading stock exchanges have already beendemutualized. In Pakistan this process is under implementation and it is being expectedthat it will be implemented in the current year. Under this system the stock exchanges willbe converted into profit making organizations and the members of the stock exchanges willbe receiving dividend from the stock exchange income. In this case the members will have toloose their rights of brokerage business. The brokers will be different from the members ofthe stock exchange. By implementation of this system, the transparency and independencywill be ensured. At present members of the stock exchanges do the business of brokerage,which leads to clash of interests and the stock exchange as a rule making, and executionbody cannot work as an independent and transparent institution.

Futures Market and Hedging (NCEL)

The history of hedge trading has long roots in the economy of Pakistan. In the cottonmarket, hedging was a legitimate business, however, in 1970s its requirement was abolishedbecause of the nationalization of cotton trading activities. In 1980s Islamic Ideology Councildid not permit the restoration of hedging. Now, the government has decided to restore thehedging in the commodity market. For this purpose, a company - National CommodityExchange Limited has been formed. The company has been inaugurated and its business incommodity futures trading will be open in the mid of current year. This commodityexchange will be responsible to introduce and develop the derivatives products in thefinancial markets of Pakistan.


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However, the legislative measures are required to protect the interest of producersand consumers of those commodities where prices fluctuations are common. Cotton andgold are included in those commodities, which are included in the priority list of theNational Commodity Exchange Limited (NCEL). For the legislation and harmonization inthe interest of related parties, a coordination is required between the Securities and

Exchange Commission of Pakistan (SECP), Ministry of Food, Agriculture and Livestock(MINFAL), and Ministry of Commerce.

36.5 Prospects for MTDF (2005-10)

Prospects for the Capital Market during the Medium Term Development Framework(MTDF) period (2005-10) are satisfactory and trustworthy. Under the changed scenariowhen Pakistan has been out of IMF program, role and importance of capital market hasincreased manifold. In addition to inviting enhanced inflow of investment in private sector,government now prefers to mobilize resources from the international bond market(secondary market) through issuance of its various bond products rather than approaching

to international institutions and bilateral creditors for loans and credits for implementationof its development projects, which will further deepen the business activity in the capitalmarket. Government has successfully launched the new bonds termed as Islamic bonds inearly 2005. Re-entry of Pakistan in international bond market in 2004, after a gap about 7years (after 1997), proved as a happy and encouraging step which further improvedinternational rating (B + by S & P) and being out of IMF program/ conditionality.Privatization of Oil and Gas Development Corporation (OGDC), Pakistan PetroleumLimited (PPL) and the Karachi Electric Supply Corporation (KESC) are the recent examplesof the resource mobilization through foreign private investment.

The buoyancy in the stock markets, can be attributed to a number of positive factors

including a continuation of pro-growth macroeconomic policies, a stable macroeconomicenvironment, a strong growth momentum taking firm hold, acceleration in privatizationprocess through the capital markets, appropriate reforms initiated by the Securities andExchange Commission of Pakistan (SECP), the availability of adequate liquidity in themarket due to historic low interest rates, good operating financial results from majority ofthe blue chip companies and a visible improvement in the India-Pakistan relationship. Thesefactors despite the downward slide in March/April 2005 are expected to continue to drivethe stock market during the next five years also.

Historical growth in the stock market (in term of market capitalization) shows heavyfluctuations in the long-term, and an uninterrupted positive growth in the last four years.

The negative growth was observed from 1997-98 to 2000-01. Stock market was grown at therate of 39 percent in 2001-02, 60 percent in 2002-03, and 89 percent in 2003-04 while morethan 30 percent growth is expected in 2004-05. During the Medium Term DevelopmentFramework (2005-10), the stock market is expected to grow between 20 and 35 percent,depending upon the monetary and fiscal policies and expected growth in the equities at therate of 10 percent per annum in the form of new listings (IPOs), right shares, bonus sharesand the corporate retained earnings.


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Table 4Growth in Money and Capital Markets

(Rs./ Billion)Market CapitalizationFiscal

Year

Simulated Actual

Equities MarketLiquidity

PublicDebt

MoneySupply

(M1)

Time andOther

Deposits

MoneySupply

(M2)

1990-91 96 68 67 241 24 265 136 401

1991-92 148 218 86 304 -1 303 203 506

1992-93 163 214 100 308 20 328 267 595

1993-94 406 405 124 304 55 359 344 703

1994-95 348 293 254 373 50 423 402 825

1995-96 389 365 279 391 57 448 491 939

1996-97 405 469 307 387 57 444 609 1053

1997-98 231 259 338 398 82 480 726 1206

1998-99 354 289 372 537 107 644 636 1280

1999-00 463 383 409 637 93 730 591 1321

2000-01 453 296 410 707 135 761 765 1526

2001-02 535 412 411 782 163 877 884 1761

2002-03 902 756 598 862 189 1106 973 2079

2003-04 1465 1428 690 1267 105 1372 1115 2487

Base Year Scenario

2004-05 1858 -- 759 1468 103 1571 1276 2847

Forecasted

2005-06 2258 -- 835 1644 100 1744 1418 3162

2006-07 2734 -- 918 1836 100 1936 1574 3510

2007-08 3406 -- 1010 2097 100 2197 1788 3985

2008-09 4288 -- 1111 2415 100 2515 2047 4562

2009-10 5423 -- 1222 2793 100 2893 2349 5242

36.6 Identification of weak areas and Recommendations

National Economy and the stock market correlation: Weak efficiency

In the language of financial economics, market efficiency means a situation wherebuyers and sellers of the securities are in a position to receive the relevant informationsimultaneously and free of cost. Moreover, they must be in a position to use the relevantinformation for price assessment purposes. According to the literature of financialeconomics, an efficient market eliminates the chances of moneymaking or abnormal profitsthrough misusing of information or disinformation. All over the world, the regulatorybodies work to achieve the maximum efficiency in the financial markets. Only in the

presence of efficiency, a stock market can reflect the real picture of the economy.


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It had been being commonly observed that stock market in Pakistan shown a goodpicture when other economic indicators were in undesirable zone, and vice versa. This non-correlation between the macro economic indicators and stock market trends indicates thesystematic problems in the institutional linkages of economy with the stock market. A majorcause of inefficacy and non-correlation between the stock market and the economy of

Pakistan was the isolated functioning and dis-harmonized policies by the differentministries and states institutions.

More than 75 companies were de-listed from the Karachi Stock Exchange during thelast five years. Majority of the companies opted the option of de-listing on voluntary basis. Amajor cause of this voluntary de-listing of the companies was the emphasizing on dividendpayments by the Ministry of Finance and the Securities and Exchange Commission ofPakistan (SECP), while the companies had required the funds for re-investment to expandand modernize their equipment to compete in the free trade regime. In fact, the Securitiesand Exchange Commission of Pakistan (SECP), Ministries of Finance, Economic Affairs,Commerce, Industries, Investment and Privatization, and the State Bank of Pakistan should

work in harmonized way to develop the stock market as deterministic and reflector of theeconomy. The Planning authorities should identify the priority sectors with the help ofinformation and trends provided by the Ministry of Commerce and Ministry of Industries,while, the Securities and Exchange Commission and the State Bank of Pakistan shoulddevelop the strategies to promote the investment in those priority sectors through debts andequity financing by institutional and individual investors.

Low Market Capitalization to GDP ratio

With all the modes of improvement in the past few years, the capital market inPakistan lags much behind the level of development, which many other regional countrys

markets have attained. For example, India, Malaysia and South Korean capital markets aremuch developed and deepened than of Pakistan. Market capitalization in Indian stockmarket was US$280 billion (about 50 % of GDP) as of end 2003, in Malaysias market it wasat US$127 billion as of end 2002 while in Pakistan, it was at US$25 billion (26.2 % of GDP) atthe end of 2004. To develop the capital market to a level where it could be able to prove asan important driver for bringing investment in the country and mobilizing sufficient amountof resources needed for a balanced economic development certain pre-requisites are needed.The availability of funds, good corporate earnings and market efficiency are the elements ofa developed capital market. So far as availability of funds is concerned, it depends on themonetary and fiscal policies. However, a good and dynamic system for the flow ofinformation and research-oriented higher education in economics and finance are the pre-

requisites of market efficiency. Research oriented higher education will produce the abilityto transform the relevant information into security prices, which is an importantcharacteristic of the efficient financial markets.

Poorly Developed Bond Market

Variation in the debt-equity mix depends upon the macroeconomic environment aswell as government controls and intervention in the domestic capital markets. The largest500 companies in the world have 89 percent capital in debts or current liabilities and only 11percent in equities. For the world as a whole the imbalance between debt and equity is evenmore marked. A mere 7 percent of the money raised on the international capital markets has

been raised through equities. This is an indicator of the importance of debt market for thecorporate world. However, Pakistan does not hold a developed corporate bond market. The


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financing of government deficit by public debts, low interest rates and an anti-interestbearing attitudes in the minds of public are some of the reasons for embryonic bondsmarket. The concerned agencies such as SBP & SECP may examine these and other factorsinhibiting growth of Bond market with a view of suggesting measures for its development.

A developed bond market is one of the basic requirements to develop the corporatesector. According to the MTDF (2005-10), the public debt will be reducing and the budgetdeficit kept lower than the average of past four years (2001-05) in the coming years. It willlead to improvement in the corporate bonds market. Moreover, good credit rating of thecompanies, their goodwill in the public minds and the role of monetary policy are alsoimportant determinants of the bond market, which need to be addressed.

Institutional Investment

Institutional investment plays an important role in the development of corporateculture and growth of the financial markets. It enhances the liquidity in capital market by

allowing more players to enter in the capital market. Institutional investment covers thepension, provident and mutual funds and insurance companies. They minimize the risk bydiversification and ensure the better returns. The institutional investment will makeresponsible to the companies, improve the governance and accountability, implement theprofessionalism and improve the savings in the economy. It is a common observation in allthe industrialized countries and Far Eastern economies that institutional investors contributethe major part of the equities in the financial structures of the companies. In Pakistan, 40percent equity shares are held by the directors and promoters, 35 percent by the smallinvestors and only 25 percent by the institutional investors. There is a need to improve thissituation. An enhanced share of institutional holding will not only improve the corporategovernance and earnings but also encourage the saving culture in the economy.

36.7 Downward Slide of March 2005

The sudden slide in Karachi Stock Exchange when its 100 shares index starteddropping from 10303 points peak on 15-3-2005 can be attributed to various factors anddevelopments. By 28-3-2005 when the marked was brought under control at 7708 pointsthrough emergency rescue operations involving banks, financial and other institutions, ithad lost 640 billion rupees of its capitalization. Small investors were the major victims. Thefall also exposed the hidden as well as so far overlooked weaknesses of the stock market andof the regulators. Questions were also raised about the state of affairs in the CorporateSector. All these are summarized as under:

i) Lack of safeguard (s) for small investors / minority shareholders

ii) Lack of sufficient float or non-availability of shares of the listed companies

iii) The rationale behind having an index of 100 shares, selection of shares andweight given to them

iv) Action (s) taken to control inside information and clash of interest

v) Failure of Regulators to enforce timely risk management measures


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Keeping in view the fact that perceptible improvement in saving ratio is directlydependent on the safeguards available to small investors, a workable mechanism has to beevolved. In this regard, the possibility of fixing a sizable number (30 to 40%) of the directorsof listed companies reserved for minority shareholders irrespective of their holdings can beconsidered. In this way not only the interest of minority shareholders will be safeguarded,

the temptation of the sponsors to have more than 50 percent share in their names will vanishleaving and making sufficient float available for the general public who will not be forced toconcentrate their investment on the top 10 to 20 companies. Incentives for listing includingreduction in cost of listing can also be given due consideration. The desirability of reducing100 shares index to a small number (20 to 30 shares) with a simple calculation of index mayalso be considered. As regard the privatized shares, proportional weight may be given tothe shares actually privatized. Development of workable mechanism to cope with themenace of inside information may be taken in hand which will have direct bearing on thesuccess of proposed demutualization of stock exchanges. Providing level playing field evenif government institutions are involved may be vigorously pursued. Suitable policies may beformulated for enhancing the development prospects of Lahore Stock Exchange and

Islamabad Stock Exchange. SECP, on the pattern of Securities Commissions of othercountries of the world may be relieved of the administration of office of Registrar ofCompanies and Regulation of Insurance Sector to enable it to concentrate on its corefunction of regulating stock market and listed companies. To successfully cope with itsresponsibilities SECP has to be fully manned with experts possessing not only the requisiteknowledge and skills but also the vision to anticipate market stress and the technology tomanage it.

Other than the above-recommended policy measures, to maintain a macroeconomicstability with sustained growth and appropriate mix of fiscal and monetary measures,further intensification in the scope of SECP and gearing up in privatization process are also

important steps to boost private investment and strengthen the investors confidence.

Capital Market Development

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