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| November 11, 2005 | Friday | Shawwal 8, 1426 |
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Out of Saudi Arabia
Terrorists strike again
The faulty barometer
IS the seemingly irrepressible optimism of the local stock exchanges a thermometer of good economic governance — as the government would have us believe — or simply a barometer of speculative greed?
THAT the government wants a parliamentary committee representing all political parties to supervise the reconstruction job in the quake-hit areas is good news. In a country where the relationship between the government and its political opponents has traditionally been characterized by distrust and confrontation, Mr Shaukat Aziz’s announcement deserves to be welcomed, although the opposition’s reaction is not yet known. Talking to the media, the prime minister said the government would share the earthquake data with the opposition and that the parliamentary committee would become a permanent forum to assist in the process of reconstruction. Mercifully, the committee would even include the PPP and the PML-N. We have to use the word “even” because since the army coup of Oct 12, 1999, the military has been persecuting these two mainstream parties. Both of its leaders are outside the country. The 2002 national election and the local body elections held a few months ago saw the administration resorting to manipulations of all sorts to create difficulties for the candidates of these two parties. Against this background, the formation of the committee and the inclusion of these two parties in it would seem to suggest a change in the government’s political stance, wanting to make the reconstruction job truly national and non-controversial. The move is in conformity with the norms of parliamentary democracy in which governments do not behave arbitrarily but consider themselves answerable to the people’s representatives.
The issue must also be looked at from the donors’ point of view. As a report in this newspaper on Thursday points out, many aid-giving governments and agencies want transparency in the utilization of the aid for the survivors of the Oct 8 earthquake. A donors’ conference is scheduled to take place in Islamabad next week, and the aid-givers would like to know how the aid is to be utilized. Their concern on this score is not restricted to reported pilferage of relief goods; it has a wider focus. For instance, the donors would like to know whether the aid would be channelled through the normal budgetary mechanism — involving as this does cumbersome procedures and processes. In that event aid may take as much as a year to make an impact in the form of construction activity. This is not going to help matters since the government itself wants the major reconstruction job to be over in three years. If, bypassing the normal bureaucratic system, aid is channelled through a parallel route, there is every possibility of misuse. This means the government must follow a strategy that will serve the dual purpose of doing the reconstruction job fast and satisfying the donors as to the transparency of aid utilization. In that the announcement by Mr Aziz that a reputed foreign company would audit the relief fund is a step in the right direction.
In the aftermath of the earthquake, the government and the opposition have demonstrated a certain amount of unity of purpose. Even though some opposition leaders continued to accuse the government of a slow response to the tragedy, most opposition parties organized their own relief camps and worked in cooperation with the government. The decision now to have a parliamentary committee with members from both sides of the divide should help create a better climate of political understanding in which consensus can be developed on such key issues as the Kalabagh dam, the National Finance Award, the president’s “uniform” and the broad contours of foreign policy. As the prime minister said in a speech in the National Assembly, the opposition’s attitude in the aftermath of the quake has been positive. The challenge is to sustain the spirit of cooperation one finds at the moment.
MR Nawaz Sharif and his family have finally been issued passports to travel to London for the treatment of their son. This is described as a humanitarian move on the part of the government, although the delay and prevarication in issuing the passports have deprived the gesture of some of its value. Once a decision had been taken to let Mr Nawaz Sharif and his family travel out of Saudi Arabia, the documentation should have been speedily completed rather than let the matter become an “issue”. The purpose of the former prime minister’s trip to London is his son’s illness, but since this is the first time he is stepping out of Saudi Arabia after he was sent there on exile, inevitably the development will be seen to have a political dimension to it. His brother, Mr Shahbaz Sharif, was allowed out some time ago for medical treatment and has since been living in the West. He failed famously in his attempt to return to Pakistan, but other members of the Sharif family have been frequent travellers to the country.
Is the exile chapter coming to an end? Is the Musharraf government softening its hardline attitude towards the leaders of the main parties living abroad — remember Mr Asif Zardari was freed and permitted to travel at will (more or less)? Is the flexibility in the government’s position due to the fact that it feels so confident of itself that it does not consider the Sharifs and the Zardaris a political threat any longer? It’s certain that Mr Nawaz Sharif will now have a freer hand to direct the affairs of his party, weakened by desertions engineered by his erstwhile colleagues who now run the ruling Muslim League. A political comeback by Mr Sharif and Ms Bhutto — who will now be able to meet and consult each other — still seems to be some time in the future. But if national politics has to become truly representative, it can only be hoped that the present military-led administration will be willing to allow full participation of mainstream parties and leaders.
THE three synchronized suicide bomb attacks on Jordanian hotels on Wednesday are the latest demonstration of barbarism by misguided terrorists who believe they can achieve their goals by resorting to mindless violence. It is not known who were behind the triple attacks — the Al Qaeda in Iraq has claimed responsibility — but the modus operandi, the selection of the sites that were attacked and the panic they caused follow the same pattern as earlier terrorist attacks in different countries. Those targeted are ostensibly non-Muslims who are taken to be enemies of Islam and the goal of the Islamists is to save the faith by attacking “the Jews and the Crusaders”. But as has been the case in all the previous incidents, Muslims are also among the victims. By killing innocent people, the suicide bombers and their patrons are violating an important tenet of the faith, namely, to show respect for human life and dignity.
Moreover, the terrorists are to be condemned for the enormous damage they are doing to the cause of the Muslims and their religion. By misrepresenting Islam as a faith that condones such slaughter, the terrorists are attempting to polarize the world between Muslims and non-Muslims. If they succeed in their evil designs, they will unleash forces that will engulf all civilizations. The need of the hour is an inter-faith dialogue so that the grievances one group has against another can be discussed and conciliated. Confrontation — and that too one aimed at destabilizing society and causing havoc — will not resolve any misunderstandings. It will lead to more deaths, disasters and alienation considering that globalization and migrations have resulted in the intermingling of people of all faiths all over the world. Hence the path of peace and dialogue is the only one that can promote understanding between people of all faiths.
Genuine investors would be well advised to read the report of the task force appointed by the Chairman, Securities & Exchange Commission of Pakistan, in April this year, to identify the reasons for the inordinate increase in share prices in the first quarter of this year, and their sudden collapse between March 24 and 27, 2005.
The four-member task force was given 30 days to submit its report. With more zeal than confidence, the task force made a brave effort to unravel the serpentine coils of trades on the stock exchange, a snake pit in which it is often difficult for an outsider to distinguish the head of a transaction from its tail. The task force took three months to prepare its report and even then admitted that its findings represented “not the end of the investigation [but] the beginning.”
The report was in a sense in itself a continuum, an update of earlier studies that had been commissioned by the present government following two previous crises in the stock markets, one in May 2000 and a second one two years later. Not surprisingly, the report of this latest task force has been relegated to the mortuary where those previous reports lie, inert and in cold-storage. The government insists that action is being taken. That is understandable. These reports make nauseating reading even for those used to reading only balance sheets.
It could not have been easy for stock exchange brokers to find themselves exposed for doing business radially as agents and as principals, as inside traders, as off-market financiers, as operators of Benami accounts, as smoke-screens, and as ‘dhobis’ facilitating money-laundering.
It could not have been comfortable for the managements of the stock exchanges at Karachi and to a lesser degree Lahore to be confronted by their signal failure as monitors. It could not have been any easier for the SECP and the State Bank of Pakistan to accept criticism of their brazen role in a scheme by which, because of their intervention, ‘managers of public institutions undertook losses arising from pre-arranged transactions using public money, in clear violation of their institutional mandates.’ The intervention the task force report alluded to was an arrangement by which financial institutions, under the aegis of the State Bank and the SECP — and with the benediction of someone in government — agreed to buy OGDC shares at Rs 117.50 per share from a range of sellers who were expected to default on their futures contracts. The intention was to avoid a collapse of the markets. The pre-facto reality was that fears about a contagious default on the stock exchanges “were exaggerated, and the situation did not warrant ... any intervention contrary to market rules.”
Why then did the government and all its safety valve regulators suffer this panic attack?
To explain this collective paranoia, one needs to remind oneself of the continuing sensitivity of the present government to oscillations in the KSE share index. The white paper that reviewed its performance over its first three years of governance from 1999 to 2002 crowed that, “as a result of market friendly policies pursued by the present government, the stock market in Pakistan has recorded unprecedented growth during the last three years. The KSE share index grew ... from 1189 points to 2014 points.”
Those were modest beginnings. By 2002-03, it had touched 3,400 or so points, then 5,300, and in 2004-05, at the time of the government-assisted intervention, it had soared to 10,303 points. As in the story of Jack and the beanstalk, only the sky was the limit.
To outsiders observing this unnatural phenomenon, this rise was inexplicable. The KSE index seemed to be going up even though the total volume of shares traded was decreasing. To insiders, the causes were all too clear: too many brokers were speculating on too few scrips. And this became apparent to the task force when it discovered that ‘0.1 per cent of investors accounted for 98 per cent of the turnover’, just one broker traded over Rs 115 billion worth of shares in only six stocks, and that the shares of only five companies — OGDC, NBP, PSO, PTCL and POL — constituted 60 per cent of the KSE index (which includes 95 other companies). Consequently, when the market collapsed in March 2005, these five scrips plus PPL (which at that time was included in the KSE Index) were responsible for 75 per cent of the fall.
Speculation at this level in stock exchanges, especially in such provincial ones as the KSE and the LSE, is rarely as a result of a lemming-like mass movement of small shareholders, led on by impulses they cannot control. In a bullish market, every buyer hopes to make a profit, and every seller wishes he had waited to make an even bigger one. It is this very expectation of profit that is the engine of any stock market, and that drives the two and half provincial stock exchanges we have in Pakistan at Karachi, Lahore and Islamabad. A shadow concomitant of the formal trading structure operating within the local stock exchanges is the badla market, an arrangement under which buyers who need financing borrow at rates that fluctuate according to usurious supply and helpless demand. The total financing in the badla market in March 2005 was Rs 33 billion, of which 70 per cent was against shares of the five companies mentioned earlier, most of which coincidentally were in the public sector.
Because badla financing is scrip specific, providers of badla financing can withdraw such financing support selectively, trapping speculators who have over-extended themselves. When the providers of badla financing are the very brokers who have pre-sold scrips in the futures market to speculators, they are in the enviable position of being able to finance their own victims. The unwritten convention is that the rates of borrowing are raised or lowered to winnow demand. At Karachi, the rate in March 2005 was increased from 18 per cent to 24 per cent while at Lahore which is uncapped it went as high as 100 per cent.
Badla financing for scrips such as PTCL and PSO was first withdrawn by financiers and then restored. “Since OGDC was still considered too risky to finance by badla providers, the weakholders of OGDC had to be bailed out with public money through NIT, SLIC and NIC.” This was the outcome of meetings held on March 27, 2005, between the SECP, the KSE, interested and affected brokers, compliant public institutions, and the State Bank. “It is amazing that no minutes have been recorded of this meeting [held at 11.00 pm at the SECP offices at Karachi], nor has any basis been provided for taking these decisions.” In effect, private speculators were bailed out by a consortium of public institutions led by NIT and including such meek cash cows as SLIC and NIC, an intervention that “in effect saved some private investors using public funds.”
Was such a selective bail-out necessary? The task force did not think so: “The mere default by some brokers and investors would not have threatened the integrity or reputation of the market, in which default is one of the normal potential outcomes anyway.”
Being prudent men, and brokers are after all honourable men, the stock exchanges have schemes that provide safety nets for its members and their customers. In the event of a default by a broker, his creditors would have first claim on his personal assets (which would include his seat, valued in Karachi at Rs 60 million) and then could in theory at least look to the Clearing House Protection Fund of Rs 684 million and the Investor Protection Fund of Rs 386 million.
In the March 2005 debacle, these were not tapped. Instead, without waiting for the buyer parties to default, public money was used to prevent the possibility of private failures and to provide sellers with profits they might otherwise have had to forgo.
Gradually, as the market is moving towards paperless scrips and arbitrage is becoming less arbitrary, badla financing will be relegated, despite its popularity for whereas margin financing is construed by the tax authorities as being interest income and therefore taxable in the hands of the recipient, the profits from badla financing are tax-exempt for being capital gains.
To wean the markets away from badla, the State Bank has taken a number of accommodating measures, most recently by permitting commercial banks to raise the limits of their investment in quoted shares from 35 to 45 per cent of their equity in the case of the Islamic banks, and from 30 to 35 per cent in the case of other banks and financial institutions.
This will enable these institutions to pump an additional Rs 20 billion into the market — an insignificant sum considering the present market capitalization of over two trillion rupees. However, when one recalls that 78 per cent of this capitalization is dominated by six of the companies mentioned earlier — OGDC, PTCL, NBP, PSO, HUBCO and KESC — the popular trough where speculators grub for their profits, the impact is predictable.
In 1933, following the Great Crash of 1929, the United States legislated the Glass-Steagall Act that prohibited commercial banks from dabbling on the stock market. It took decades of capital market maturity over 63 years for that law to be repealed. Exactly ten years ago, Barings Bank, one of Britain’s oldest merchant banks, collapsed as a result of inadequately supervized speculation by a trader named Nick Leeson. It was, as one City executive put it, “an accident waiting to happen.” How long do we have to wait for our own Leeson to teach us a lesson?