On the last day of November 2001, the Karachi Stock Exchange (KSE), as represented by the 100-member KSE-100 Index, stood at 1,355 points. Exactly a year later, the index ended at 2,285 points. That is a year-over-year gain of 930 points or a wholesome 68 per cent surge. Stock market investors collectively made some Rs200 billion.

Almost over the same period, Morgan Stanley’s MSCI 9-member Pakistan Index has soared by 106 per cent. Out of the 50 stock markets that MSCI tracks around the globe, the KSE has come out as the best-performing stock market.

Incidentally, on 11 September 2001, the KSE-100 index hovered around 1,250 points. Thanks to Osama, the index has since doubled (before its most recent retreat). The index’s historical high was set at 2,661 points back in 1994. The index has been consistently loosing value for the past seven years. It saw a low of 830 points in the last quarter of 1998.

Over the past few years, foreign fund managers have all but abandoned Pakistan. Morgan Stanley liquidated its Pakistan Fund (smbol: PKF) in March 2001. What really is behind the more recent surge in stock prices?

Over the short run, stocks act just like commodities. The law of supply and demand becomes the principal determinant of price. The KSE is currently capitalized at around Rs525 billion or $9billion. Of the entire capitalization a good three-quarters of all listed securities are held by sponsors. The actual tradable pool of shares is thus a fraction of the capitalization. The pool is small to begin with and there hasn’t been any major addition over the past several years. In 2001, for instance, there were only four Initial Public Offerings (IPOs) of stocks. The new offerings were that of the Arif Habib Securities, the Fayzan Manufacturing Modaraba. the Wordcall Multimedia and the NBP. The aggregate value of these IPOs was just over Rs2 billion.

To be certain, the supply of stocks has not increased much in the past several years. Come September 11, and there is all kinds of money flowing into Pakistan. According to the SBP records, home remittances have gone up from $1 billion last year to $2.4 billion this year. Technically, not all of the money coming back is home remittances. Pakistanis settled in the US, for instance, have traditionally sent only a small percentage of their income back to Pakistan. What has happened in the post-September 11 era is that Pakistani-Americans — being interrogated by FBI as to the sources of their incomes — began sending their savings back to Pakistan. In 2000-01, money coming in from the US amounted to $134 million. In 2001-02, the same figure reached $778 million.

The UAE is another case in point. Geographical convenience and banking secrecy had encouraged many Pakistanis to stash away their savings at banks in Dubai. The actual or threatened crackdown in Dubai also brought back a lot of money. In 2000-01, money coming in from the UAE amounted to $190 million. This year the amount had gone up to $469 million.

Not all of the newly arriving funds are destined for the stock market but investment avenues in Pakistan are rather restricted to real estate and stocks. In essence, demand for stocks has gone up sharply while the supply has been more or less flat. That is what is really behind the boom.

The second factor behind the surge in stock prices has been the drop in the rate of interest. Here we must thank Federal Finance Minister Shaukat Aziz. When the military government took over the average weighted lending rate at nationalized commercial banks stood at 15.53 per cent. As of September 2002, the same had come down to 11.62 percent. Most lending in Pakistan is done to the corporate sector where total advances hover around Rs800 billion. The almost 400 basis point (4 percentage points) decline in lending rates translates into lower financial costs for the corporate sector. The savings could have amounted to a colossal Rs 32 billion resulting in an almost equivalent increase in corporate profits, and thus an increase in the price of their stocks.

A third factor that might eventually further reduce the cost of borrowing for the corporate sector is the growing Term Finance Certificates (TFC) market. Over the past year, at least 17 TFC issues amounting to Rs12 billion have come to market. This is indicative of the corporate sector trying to access the suppliers of credit in a more direct way eliminating the banking sector as an intermediary. At this stage this private debt market is not efficient. Blue chip companies can actually raise money through the banks at less than available through the TFC market. In the foreseeable future, corporate may indeed be able to raise capital at a more favourable rate of interest directly from the suppliers of credit than they do via the banking sector.

The bottom line is that there is currently too much money chasing too few securities. Prices are thus going through the roof. Pakistan’s corporate sector hasn’t all of a sudden become more efficient neither is it expected to generate a significantly higher future stream of profits. In other words, there has not been any change in the fundamentals of the corporate picture either for the better or for the worse. Pakistan’s external sector is more stable than before but that has to do more with America’s war on terrorism than because of any intrinsic factor.