7 Capital Market

7.1 Overview

For yet another year, the Karachi Stock Exchange (KSE) retained its pre-eminent position in Pakistan's capital markets, accounting for over 60 percent of the shares traded (by volume) and, the majority of the debt and equity¹ listings during FY03. Thus, in light of its leading role, the discussion on Pakistan's capital markets has been largely based on the performance of the Karachi market and its benchmark KSE- 100 Index.

 

Pakistan's equity market was one of the best performing equity markets in the world during FY03. Not only did the benchmark KSE- 100 Index continue its FY02 up trend into the succeeding year, its growth rate accelerated, as the Index broke its previous all-time high² to reach as high as 3402.5 points by the close of FY03, up a stunning 92.2 percent for the year. The broader SBP general index of share prices also mirrored this record performance, rising 91.9 percent through FY03 (see Table 7.1).

The rise in the indices, which was visible throughout the year corresponding to a substantial increase in the size of the market; the market capitalization of the listed stocks rose by an impressive 83.0 percent during FY03. As a result, the market capitalization as a percentage of GDP rose for a second successive year, from 1 1 .2 percent by end-June 2002 to 18.6 percent by end-June 2003 (see Figure 7.1).

 

The strength of the market rally, which extended through practically all of FY03, is visible in the substantial increase in both, the average daily traded volume and the turnover ratio. ³ The former rose 75 percent YoY to 214 million shares in FY03, while the increase in the latter was a relatively more sedate 52.0 percent.

 

In terms of the comparative regional performance too, the KSE emerged better than most other equity markets in the world during FY03 (see Figure 7.2).

 

Table 7.2: Sector-wise Corporate Earning

 

 

This exceptional FY03 performance of the KSE-100 was aided by the confluence of a number of positive factors, spread though the year, including expectations of a significant increase in corporate profitability, burgeoning market liquidity & concomitant decline in interest rates, hopes for the early privatization of large profitable public sector companies (e.g. PSO, OGDC, etc.), and the general increase in optimism based on hopes of a broader recovery in the economy. Of these, the first three arguably had the dominant influence.

 

In particular, as shown in Table 7.2, the net profit after tax for different sectors has increased substantially over the past two calendar years, as proxied by the earnings data on listed corporates. During 2002, the corporate earnings on average grew by 53.6 percent over and above 84.3 percent increase recorded in 2001. Specifically, the aggregate earnings of these companies increased by Rs 16.4 billion in 2002, compared to that in the preceding year, with larger increases evident in transport & communication, cotton textiles, and chemicals.

 

7.2 Market Developments in FY03

Initially during FY03, the KSE-100 traded in narrow range around the 1850-point levels, probably reflecting the residual concerns over the tensions with India as well as the

uncertainty over the forthcoming October 2002 elections. However, buying re-surfaced in August 2002 with the announcement of strong corporate results by the market leaders.⁴ This upsurge persisted for the rest of the first quarter with the KSE-100 index breaking the psychological barrier of 2000 points on September 6, 2002 (see

Figure 7.3).

1. India detonated nuclear device, May 11, 1998   2. Pakistan went nuclear, May 28, 1998 3. Change of Government, October 12, 1999 4. KSE-100 Index at 29 month high of 2054.43 5. Trading remained suspended because of settlement problems by some of KSE members on May 30, 2000 6. SEC prohibited blank selling, November 2000 7. Pakistan managed to secure SBA with IMF, end-November 2000 8. SEC ordered change in Article of Association of KSE on December 31, 2000. This was to improve the corporate  governance of the stock exchanges and reorganize them to improve their management and operational efficiency.   9. T+3 settlement system was initially introduced in two scrips (Telecard and Ibrahim Fibre) on April 2, 2001 10. Decision to defer the implementation of T+3 settlement system for couple of months in mid-May 2001 11. Terrorist attacks in New York created jitters in the market, September 11, 2001 12. Terrorist attack on Indian Parliament. Market sustained the shock initially but fell afterwards due to extreme measures taken by Indian government   13. KSE-100 Index fell due to enforcement of minimum capital adequacy requirement for brokers 14. Presidential referendum, April 30, 2002 15. Terrorist attack in Karachi, May 8, 2002 16. The KSE-100 shed8.28 percent in last 15 days of May 2002 due to escalation in tension with India 17. Start of rally driven by good corporate performance and unprecedented liquidity in the market. 18. The up trend, driven by excessive liquidity, was broken due hike in badla financing rates (as brokers faced capital adequacy limits) forcing weak holders to sell. 19. However, market fundamentals (good corporate results, attractive market valuations) and liquidity forced start another rally.

The energy stocks mainly led this market rally with stocks of Hubco, PSO, Shell, Sui North and Sui South in the limelight. The greater interest in these companies stemmed from a number of factors including: (1) high profits for the oil marketing companies (PSO, Shell) as a result of an increase in their margins and (2) positive expectations following progress on the privatization process of PSO, and. (3) the increased attraction due to falling interest rates (Hubco, Sui Northern, Sui Southern).

The market rally continued into Q2-FY03, fueled not only by additional good corporate results, positive political developments⁵ and rating actions on Pakistan's sovereign ratings,⁶ but also the easier monetary stance of the SEP. Specifically, the sharp slide in lending rates (and consequently deposits rates) following the November 2002 discount rate cut by the SBP, significantly raised investor appetite for equity investment. In fact, the continual rise in the market and the relatively easy availability of cheap credit led to a gradual build-up of speculative positions in the market, leaving it vulnerable to a shock.

This vulnerability came to the fore in Q3-FY03 shortly after the KSE-100 index breached its previous all-time high to reach 2920.6 points, when the combination of large open-interest positions and a sharp spike in the Carry Over Trade (COT financing) rates (for details see Section 7.4), punctured the speculative demand.⁷ The ensuing sell-off forced a massive adjustment, and the market performance remained subdued for a period, before the positive fundamentals, led by healthy corporate profits, high market liquidity, and now-attractive valuations re-ignited a rally in March 2003. Thereafter, the ascent of the KSE-100 accelerated, powered by signs of improving relations with India and a business friendly budget (including the retention of a capital gains, tax exemption on equity investments for another year, and indicating the early divesture of government enterprises).⁸ The KSE-100 thus closed the year on a high note, at 3402.5 points.

7.3 Sector-wise Performance of the Karachi Stock Exchange

The three large sectors dominating market capitalization in KSE are fuel & energy, transport & communication, and chemicals & pharmaceuticals. Each one of these sectors has market capitalization of over Rs 100 billion. Together they account for 55 percent of the total market capitalization of the KSE in 2003. In terms of traded value, however fuel and energy is unrivalled with two-third of total value traded. The fuel & energy sector clearly outperformed all other sectors both in terms of market activity as depicted by its traded value as well as in terms of the market size as reflected by the market capitalization. This was mainly under the lead of blue chips in the fuel & energy sector namely PSO, Shell, Hubco, Sui Northern and Sui Southern Gas Ltd; this sector registered a market capitalization of Rs 190.4 billion which was 25.2 percent of the total market capitalization (see Table 7.2).