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Stocks’ steep climb to the North

Updated August 05, 2013

THE stock market is producing immense wealth for investors in equities. The unprecedented boom witnessed in 19 months, from January 2012 to end of July 2013, has lavished upon investors a return close to 85 per cent.

The benchmark KSE-100 index has witnessed a steep climb to the North, from 11,347 points in January 2012 to 23,092 at the close of business last Thursday. All of this represents an index upsurge of an incredible 11,745 points.

Only a year earlier in 2011, the Karachi stock market had produced a negative return for investors. Most stock brokers argue that the double-digit dividend growth and low valuations of Pakistani equities was the fuel that fired the stock boom.

Yet, critics are attributing the giant leap in stock prices to other weird reasons, the foremost being the possible inflow of ill-gotten wealth following the grant of amnesty in early January 2012 that facilitated ‘whitening’ of ‘black money’ by unscrupulous elements.

On January 11 of last year, then-Finance Minister Dr Abdul Hafeez Sheikh had announced a blanket approval of all proposals forwarded by the Securities and Exchange Commission of Pakistan (SECP) for the country’s capital market. Also, acknowledging that investors had made legitimate but undocumented gains during the capital gains tax (CGT) exemption period (1974-2010), the government decided that ‘no questions would be asked by the Federal Board of Revenue about the source of funds to be invested in stocks till June 2014, and to treat total wealth as white from 2014 onwards’.

After the initial controversy, the matter was set at rest. However, an article in The Economist’s July 27 issue, titled, “Inefficient frontier — stocks soar, suspicions swirl,” has again triggered the argument. KSE officials are incensed by magazine’s allegation that “The soaring performance can partly be attributed to an amnesty announced in January 2012.” Some, the weekly magazine said, saw it as ‘a gift to corrupt officials and criminals’.

Mr Muhammad Ali, who was the chairman of the SECP at the time the amnesty was granted, dismissed such assertions. He told Dawn last Thursday that the acceptance of SECP proposals by the government did have positive ramifications on the market. Investors who had fled after having lost their fortune in the stock crisis of 2008 started to head back to the market, which helped deepen the markets and generate higher volumes.

The former SECP chairman asserted that money laundering was not possible through the conduit of the stock market. “The money put in stocks has to be kept for 120 days to qualify for ‘no questions asked’,” he said. For investments for less than that time, the tax authorities had the right to question the source of funds. “It would mean tying up the money for four months in risk-prone equity investment” he said.

He asserted that that the June 2012 report of the global monitoring agency Financial Action Task Force did not identify any breach of its four basic principles, or any negative impact on the implementation of the Anti Money Laundering and Combating the Financing of Terrorism Regulations.

Nadeem Naqvi, KSE managing director, stressed that the phenomenal rise in stock prices at the local bourse was a result of the revival of investor confidence. He argued that that foreign institutional investors (FIPI) had spearheaded the stock boom.

“Since June 2012, foreign institutional inflow had amounted to a huge sum of $500 million, quite in contrast to the July 2011-June 2012 outflow of $190 million,” he said. Much of this was due to the buyback of shares by Unilever Overseas; the investors had ploughed back the sum received, resulting in liquidity in the market.

Naqvi said that the inflows into the emerging markets were shifting to frontier markets, and Pakistan reaped ample benefit of this spill over. He pointed out that in April 2008, before the stock market crisis, the index at its peak was at around 15,676 points, and the ratio of market capitalisation to GDP stood at 46 per cent. With the index now at over 23,000 points, the ratio is currently 25 per cent, which shows that the Pakistani bourse is still not fundamentally overvalued.

Raza Jafri, head of research at AKD Securities, said that amnesty could surely be one of the reasons that precipitated the stock boom, but there were other more important considerations. He listed them as the steep drop in interest rates from 15 per cent to nine per cent, and the hefty growth in corporate profitability, even in some sectors that were long regarded as laggards, like textiles and cement.

Jafri observed that for the year ended June 30, corporate profits had grown by 25 per cent, which, minus the low performing oil and banking sectors, would stand at 50 per cent. Besides, investors had been attracted to the equity market because of its high returns. “Over the last 10 years, investment in Pakistani equities have produced an average yearly return of 22 per cent, which is unrivaled by any other class of investment asset,” he said.

A major stock broker said that suggesting the stock market could be used for money laundering was nonsense. “Who says the stock market is the best conduit to whiten black money?” He argued that there were numerous other, almost invisible ways to wash off the dirt from ill-gotten wealth, the easiest of them being the prize bonds scheme. “It is a low-cost and most widely used conduit to whitewash black money, without leaving a telltale trail,” asserted this broker.