As per an SECP announcement, the KSE floor was removed on Monday, December 15. The bourse resumed normal trading despite an issuance of a stay order by the Sindh High Court on Saturday. Although traders are relieved about the resumption of normal market activity, the index is expected to see a downward spiral of up to 30 percent in coming days. In the following section, Dawn.com explains how we got here and what the removal of the floor means for the market and buyers.

Why was the floor imposed?

The KSE-100 Index reached an all-time high of 15,760 on April 20, following market reforms and the privatization of state industries. However, surging global food and commodities prices, along with the effects of the global financial crisis, began to dent confidence, leading to prolonged losses at the exchange. The situation was exacerbated by a SBP decision to raise interest rates in May, following record inflation numbers. The market continued its downward trend, with investors attempting to burn down the KSE in July as share prices plummeted amidst political instability.

News of a relatively peaceful transition to democracy led to a rally in early August, but this proved to be fleeting as shares plunged once again in the wake of poor macroeconomic conditions. On August 28, the KSE was ‘floored’, but by this date the index had shed nearly $37 billion since peaking.

Nadeem Naqvi, CEO of the International Investment Company, says that managers were left with only two options at this point: ‘Either to close down the market or to let it crash.’

As the floor has dragged on, capital markets have been in disarray and investors remain uncertain about what comes next.

For more details please see Dawn’s coverage of the imposition of the floor.   

What is the floor?

Share prices for any company listed on the KSE cannot fall below their closing values on August 27. If share prices do fall, trading in those shares must cease.

That said, share prices may appreciate or depreciate up to 5 per cent in accordance with the regular KSE ‘circuit breaker’ limits during any one trading day, unless the floor becomes binding.

For the reaction to the floor’s imposition in the weeks that followed its announcement, please click here. 

What has the floor meant for investors and brokers?

The floor’s imposition, now in its fourth month, has meant a major crisis for brokers since most investors believe share prices to be overvalued at their August 28 levels since the volume of trades has subsequently decreased. As a result, brokers who earn a commission for every trade they execute have seen their revenue plummet. The chairman of the AKD group of companies Mr. Aqeel Karim Dhedhi has gone so far as to say the floor is ‘destroying brokers and devastating capital markets’ in interviews with private TV channels.

Many investors have lost faith in the capital markets and are dumping their holdings in ‘off-market transactions’ - trading between two parties not carried out or listed on the exchange. These trades often incur heavy losses, with stocks being sold at 60 to 70 per cent of their listed values.

For an in-depth look at the effects of the floor on the investment community, please click here.

What has the floor meant for companies?

Economic theory dictates that a weak stock market and rising interest rates at commercial banks makes it more expensive and difficult for companies to raise funds to either expand their operations or meet day-to-day expenses. Indeed we see that the IPO market in Pakistan has dried up, while the KIBOR (a benchmark for commercial bank-rates) has climbed. This reduced business spending translates into lower demand for labour, resulting in higher unemployment and weaker economic growth.

However, the stock market comprises a very small fraction of the entire Pakistani economy – roughly 2 per cent of GDP as opposed to well over 50 per cent of GDP in the US – meaning the vast majority of companies do not raise money through stock issues.

Moreover, Dr. Hammad Siddiqi of the Lahore Institute of Management Sciences points out that the majority of financing does not rely on commercial banks and instead draws on a parallel, unregulated system of ‘cash collateralized borrowing’ from a host of smaller players, including ‘hawala middlemen.’

Weakness in the stock market and commercial banks may therefore not have a strong impact on the current business outlook, as unregulated agents have likely already priced the softening economy into their loans and are unlikely to change their outlook following the floor’s removal.

For a look at the hawala system and Pakistan’s parallel economy, please read Dr. Siddiqi’s article here.

What has happened to share prices while the floor has been in place?

Since the floor was implemented, Pakistan has experienced record inflation, and a balance of payments crisis which necessitated an IMF bailout. At the same time, US ratings agency Standard and Poors downgraded Pakistani government debt to ‘junk’ status. Political instability has also continued to grow, with the army locked in warfare against militants in NWFP and Baluchistan.

At the same time, world financial markets have taken a severe beating, with the US’s Dow Jones Industrial Average shedding over a quarter of its value since August 28, while a number of financial titans including Bear Stearns, Lehman Brothers and Wachovia have gone under, and many more such as Citibank have had to be bailed out by the US government.

It is not surprising, therefore, that investors remain downbeat about both the imposition and the pending removal of the floor, with a senior trader calling it a case of ‘damned if we do and damned if we don’t.’

For a glance at the roots of the US financial crisis and its fallout, please see this related article.

What is likely to happen when the floor is removed?

Given developments since the floor was imposed over three months ago, investors are likely to bid down share prices significantly once the floor opens.

Mr. Haji Ghani Haji Usman, a highly respected broker, believes that ‘small investors, who already seem to have lost eight out of 10 rupees from investment in equities, are likely to dump their remaining portfolio to salvage whatever they can.’

The current market consensus seems to be a fall in values of at least 15 to 20 per cent from their current levels, but the KSE’s ‘circuit breaker’ mechanism means that only a daily fall of up to 5 per cent is possible before a stock ceases trading. Hence we can expect losses to continue for several days before markets find their equilibrium level.

Off-market transactions may provide some insight into current valuations of companies; please click here for details.