Reviewing the performance of Pakistan’s stock market may look a little appointing for some analysts but many analysts term this a correction and opportunity to the investors to rebalance their portfolio. A point of concern is substantial out flow of funds. However, this can be termed a short-lived phenomenon, if the incumbent government succeeds in overcoming some of the most contentious issue that include: 1) electricity and gas outages getting longer, 2) circular debt once again exceeding half a trillion rupees, 3) country once again inching towards a acute shortage of motor gasoline, HSD and furnace oil and due to PSO once again plunging into serious financial crunch after huge receivable, 4) deteriorating law and order situation, 5) militants making inroads and worst of all 6) PML-N government sinking into serious political crisis, which gives an opportunity to its opponents to say ‘its days are counted’. In such a scenario all the stakeholders will have to play their role to improve economic indicators of the country that can pave way for fresh investment that can help in accelerating GDP growth rate and generating new job opportunities.
Over the years, Pakistan has enjoyed the status of one of the best performing markets, which has not lost its galore. Prices of scrips and benchmark KSE-100 Index has been moving up, may be because of ‘quality scrips in short supply’ because very few companies are being listed. The overwhelming response to Engro Powergen and Mughal Steel clearly indicates that if quality scrips are offered investors are willing to avail the opportunities. Companies like Engro and Mughal have been operating in this country for a long and have a track record to attract the investors but listing of around half a dozen companies at the local bourses is disappointing.
After starting the year with a bang (January’15 returns of positive 7.20%) the benchmark KSE-100 Index has been eroding. The negativity further intensified on last Wednesday with substantial foreign selling. Resultantly, the market saw its capitalization being marginalized by 2.53% in a single trading session (intraday -ve 3.11%), which in effect took CY15TD KSE-100 Index returns to -ve 1.89%.
According to AKD Securities foreign selling was not a new phenomenon (CYTD net sell: US$118 million), it has only recently started to cause concerns. A look at the recent trend of the market suggests that it has shed 9.48% of its capitalization.
Wednesday’s performance can be classified a continuation of the correction phase that has been going on at the Karachi Stock Exchange for the past 31 trading sessions.
The KSE-100 Index, backed by overall improvement in macros, experienced a good run from mid December 2014 where it gained 13.56% in 34 trading sessions. Interestingly, during this run foreigners remained net sellers, offloading positions worth US$46.4 million.
Since then the market has been experiencing a constant descent where it has lost almost 9.5 percent of its capitalization in 31 trading sessions, amid further improvement in macros and healthy profitability, up 27%YoY in 2QFY15.
A clear disconnect between the market and improving economic environment indicates towards an eventual pullback. Recall that since CY08 the KSE-100 Index has seen 19 major corrections (with an average decline of 8% or more which lasted for an average 36 number of days).
The market has seen its capitalization clipped by an average US$3.36 billion during these periods. Going by this precedent, the current correction seems to be at its tail end. Analysts believe an expected 50bps reduction in the policy rates in upcoming Monetary Policy Statement will provide much needed impetus to the market.
Keeping the broader picture in view analysts opine that the current round of correction should be viewed as an opportunity to build fresh positions in the market. Analysts believe the on-going macro improvement will remain the catalyst.
In this regard the regular regulators can be held responsible for the dismal situation. Credibility of apex regulates like SBP, SECP, NEPRA and OGRA being tarnished by the incumbent government. Announcement in reduction of discount rate by finance minister prior to the announcement by Governor SBP put a big question mark on the autonomy of the central bank. Appointment of new chairman at SECP and major reshuffle failed in improving the image of the Commission. On top of all dissolution of Shariah Board dampened investors’ confidence, because it conveyed the message that Shariah Board has failed in delivering the desired results. One completely fails in visualizing what is the ‘Roadmap of SECP’ to reinvigorate the capital market? The general perception is that SECP is being run on ad hoc basis rather than any elaborate long-term plan to bring some structural changes.
Two of the regulatory authorities overseeing operations of energy sector companies, NEPRA and OGRA, have proved to be rubber stamp. Both the regulatory authorities have been persistently allowing hike in electricity and gas tariffs despite nearly 50% reduction in global crude oil prices. These authorities have been allowing hike in tariffs to improve cash flow of utilities, despite being fully cognizant of the two contentious issues facing the energy companies: 1) massive pilferage going on with the connivance of staff of utility companies and 2) failure of the utilities in improving recoveries. The average recovery is around 30%, which keeps on building circular debt, this is evident from the fact that soon coming into power PML-N government paid nearly half a trillion rupees to clear the debt but the amount has once again swelled to more than Rs600 billion. Adding to the disgrace is imposition of Gas Infrastructure Development Cess (GIDC).
Analysts have the consensus that if electrify and gas distribution companies are able to improve their recoveries to 90% enough cash will be at the disposal of these entities to undertake revamping and expansion of the transmission and distribution networks and there will be no need for imposing any new tax.
The reference to regulators is a must because bulk on the daily trading volume comprises of banks, fertilizer companies, IPPs, oil and gas distribution companies. During this past week KSE witnessed a battering due to 1) approval of a reduction of Rs2.08/ unit in electricity tariff of distribution companies (except K-Electric) on account of monthly fuel price adjustment by NEPRA, 2) banking sector continued to lose in anticipation of further monetary easing where the key losers were NBP, AKBL, HMB and UBL and 3) activity remained dull with daily traded volumes declining by almost 8% to 88.3 million shares as compared to 95.9 million shares in the last week.
Victim of circular debt
Leading exploration and production companies OGDC, PPL and PPL and the largest oil marketing company PSO are the worst victim of circular debt, which is also impairing their operations but the government keeps on drawing cash from these entities in the shape of massive dividend distribution. E&P companies have not been able to achieve drilling target due to cash drain and PSO faces virtual default. Analysts fear another POL crisis is in making because of cash crunch faced by PSO that includes impairing supply of furnace oil to IPPs and power plants operating in the public sector.
Yet another blame should also go to SECP for the failure of new listing at the local stock exchanges. Over the years, experts have been demanding difference in corporate tax applicable on public limited and private limited companies. They suggest the difference should be minimum 15% to encourage new listing. The rationale is that the investors in public limited companies are mostly general public, AMCs and corporate entities. Offering shares of public limited companies through IPO and SPO to general public helps in capital formation, achieving greater documentation and higher level of corporate governance that is mainly because sponsors and management are accountable to shareholders.
SECP should be held responsible for hardly any growth in mutual funds. The assets under management of AMCs are less than half a trillion rupees, which is far below the level achieved in India. Whatever growth has been achieved is mainly because of their investment in sovereign Ijarah Sukuk. The other problem is that unit holders are mostly corporate entities rather than the small investors. The sole purpose of creation of mutual funds is to offer a credible investment option for the small investors rather than the corporate entities. Blame should also go to the AMCs, which have failed in extending their outreach. Most of the AMCs have their own distribution networks which are confined to large cities.
It may not be out of context to recommend delisting of companies having less than Rs100 million paid up capital. Some critics may say that this move will bring down listed capital substantially, which is only a perception. At the most listed capital may come down by less than 5% but it will help the stock exchanges and regulators to oversee the remaining companies more prudently. A quick review of volume of KSE-30 and KSE-100 Index indicates that bulk of the daily volume comes from around two dozen companies. The first lot of companies to be listed should be: 1) those on defaulters’ counter, 2) companies not paying dividend, 3) companies not releasing their periodical accounts and holding AGMs in time and above all 4) companies where daily/annual trading volume is almost negligible.
Improving market liquidity
According to credible evidences nearly one-third of total listed capital is held by foreign investors. While some analysts term this a positive factor, others say failure of the Government of Pakistan (GoP) to listed mega entities like State Life Insurance Corporation (SLIC) and good performing electricity distribution companies like FESCO can enhance listed capital and add depth and improve market liquidity. The GoP should also make secondary public offer of companies like OGDC, PPL, SSGC, SNGPL and then issue Sukuk for mobilizing funds for these companies to enable them to undertake BMR and expansion.
Pakistan needs to construct mega size dams and power plants for which funds can be mobilized by issuing dollar denominated Sukuk in the international markets. As regards improving supply, sponsors should be allowed to establish electricity distribution companies. A test case under consider is Fatima Energy that will distribute electrify to bulk consumers, using NTDC network to begin with. This concept has been after successful operation of trains by the private sector using track and other facilities of Pakistan Railways.
For achieving higher GDP growth rate the key areas needs immediate attention are: 1) resolution of circular debt and 2) ensuring uninterrupted availability of electricity and gas at affordable cost by listing of new companies enjoying credible track record and mobilization of funds through bourses.
The incumbent government must come out of increasing revenue phobia and offer incentives for the creation of new productive facilities. This kind of out of box thinking on one hand will improve new productive facilities and on the other hand improve purchasing power of masses. Enhanced demand for consumer goods and consumer durables will automatically increase GST collection.
Last but not the least often governments in Pakistan suffer from ‘confidence deficit’ which shy away the local investors. Policy planners must realize that as long as local investors remain shy, foreign investors will not be keen in investing in Pakistan.