The fault in our capital market

Updated December 16, 2019


The stock market sits along fault lines that no one has really been able to overcome in the past decades.

The best-performing market in Asia in 2016, which provided stellar returns of 46 per cent, has continued to falter after its benchmark index hit an all-time high of 53,124 points on May 25, 2017.

In the subsequent two and a half years, investors lost 40-50pc of their savings. Several attempts at helping the market recover have proved futile. The last such effort that saw the market gain 19.8pc in about five months (July 1–Dec 6) was celebrated by investors as the highest return that any bourse provided in the region. It raised hopes that the Pakistan Stock Exchange (PSX) might have bottomed out.

Yet the market is back on the slippery slope with most pundits holding a grim prognosis for the near term. Although market commentators quickly switch from blaming the economy to political problems for the market crisis, there are some fundamental flaws in the PSX that the regulators have been unable or unwilling to correct.

The perennial problem is the lack of depth in the market. The number of listed companies is low and, therefore, too many investors are chasing too few stocks that produce consistent dividends.

With thousands of companies seeking registration with the Securities and Exchange Commission of Pakistan (SECP) every month, the aggregate number of registered companies has risen to over 110,000. In contrast, the number of companies listed on the stock exchange has dwindled over the years to 558. More than 100 of these companies are placed on the defaulters’ counter, which is a red flag for investors.

Issuers put over a dozen IPOs on hold owing to unfavourable stock market conditions in 2017

Around 400 companies are actively traded on the market, but only about two dozen of them command as much as 80pc of the traded volume each day. Few new companies wish to enter the stock market. The number of new entrants has evaporated from at least 25 a year some years ago to just one initial public offering (IPO) in 2019. Over a dozen IPOs were in the pipeline for 2017. But the issuers put them on hold owing to unfavourable market conditions and a fear of under-subscription.

The PSX chairman sees a beeline of new offerings post-March 2020. For the moment, however, an old-timer at the PSX was frank to admit that companies sought listings mainly for two reasons: to avail tax benefits or settle family disputes by dividing the majority holding among squabbling siblings. Besides a lack of depth, there are other major issues that impede the growth of the Pakistan equity market.

Low investor base

The number of equity investors has failed to swell. It remains firmly below 250,000. Most critics suggest that despite the numerous investor awareness seminars, no serious effort has been made by the regulators over the years to attract new investors.

Some suspect that a handful of big market participants who command nearly 90pc of the daily trade have no inclination to expand the investor base. Many believe that no more than 20 large investors are the major players who handle much of the trade on any given day.

SECP Policy Board Chairman Khalid Mirza told Dawn that the greatest impediment to growth of local bourse was the absence of competition. “As long as there remains a single stock exchange in Pakistan, there will be no development in the capital market,” he affirms.

Failure to introduce new products

Almost all trading on any given day takes place in the ready market and single-stock deliverable futures.

A few other products lie dormant owing to scarce trading. There are complexities in their handling. When 40pc shares in the PSX were offered to the Chinese strategic investors, they promised they would introduce innovative products like options and derivatives. But nothing has materialised so far.

A former general manager of the PSX, Sani-e-Mehmood Khan, gives an insight into the Chinese change of plans. “China’s interest in seeking a stake in the PSX was out of sheer frustration. MSCI declined to consider China-A stocks for the MSCI Emerging Market (in 2015), and later on explicitly indicated to consider Pakistan for the status of the Emerging Market (EM)”.

He says the Chinese excitement cooled off after China was also alleviated to the EM status. Now Pakistan and China are competing for the same piece of cake.

The lopsided KSE-100 index

Introduced in November 1991 with a base value of 1,000 points, the benchmark comprises stocks of 100 companies out of all listed entities. Three sectors — power, banks, and oil and gas exploration and production — command nearly 68pc weight in the KSE-100 index.

Stocks from these sectors, which can be counted on the fingers of one hand, have the power to set the direction of the market on any given day. Shares in the five big banks — United Bank, Habib Bank, MCB Bank, National Bank and Allied Bank — and three scrips in the oil and gas exploration and production sector — Oil and Gas Development Company, Pakistan Petroleum and Pakistan Oilfields — along with a few other stocks Like Engro Corporation and Lucky Cement can determine the direction of the market.

Although often in brisk business, the cyclical cement, steel and textile sectors — the last one with the highest number of listed companies — collectively hold no more than 20pc weight in the index. Hence, fluctuations in the stock prices in these sectors have only a slight impact on the index.

Published in Dawn, The Business and Finance Weekly, December 16th, 2019