KARACHI, March 22: Commenting on the performance of the capital market, the second quarterly report of the State Bank of Pakistan acknowledged that the Karachi Stock Exchange had posted stunning 112.2 per cent growth for all of the year, rendering Pakistan as the best performing market in the world during the calendar year.

But the report pointed out that Q2-FY03 (Oct-Dec) had accounted for over half the calender year 2002 increase in the KSE-100 index, which saw market capitalization at the KSE rise to Rs588.4 billion, at 28.4 per cent increase during the quarter.

The report identified five important drivers of the market rise, two of which were stated to be more important: One, the burgeoning rupee liquidity, driven in large part by continuing forex inflows into the country, that drove down interest rates and second, expectations of early privatisation (raising speculative interest in some scrips).

Other factors cited by the Central Bank for the phenomenal rise in stock prices, were: (1) substantial improvement in economic fundamentals (2) a further easing of border tensions with India and (3) relatively cheap market valuations and declining returns on alternative investments.

The bank reported that the impact of increased liquidity was evident in the spectacular 120.7 per cent Q2-FY03 increase in average daily trading volumes to 245 million shares. “In fact the dizzying rise in turnover ratio (value of stocks trade over the total market capitalization) in the latter weeks of the quarter, suggests that speculative interest was indeed a significant contributor to the rise during the period,” the Bank said and added that the view was supported by the fact that badla volumes that had already risen significantly since July 2002 rose substantially higher in the corresponding period.

The badla rates averaged approximately 16 per cent in Q2-FY03, as against an average of approximately 12.7 per cent for the previous three quarters. Moreover, badla financing volumes too, were 44.9 per cent higher during Q2-FY03, averaging Rs5.7 billion daily as compared to Rs3.9 billion daily in the previous quarter, the report said and added: “Such a high (and rising) dependence on badla financing clearly indicates vulnerability of the market to any adverse development or change in sentiment.”

The SBP observed that recognising such risk, a new procedure of COT financing was launched from November 11 by the SECP. Under it, all carryover transactions are to be for a period of 10 days in order to mitigate the potential risk of the sudden withdrawal of massive funds from badla operations as happened in the past when financing was done on a daily basis. As a result of this measure, the badla players were initially uneasy and withdrew funds, pushing badla rates to 30 per cent.

“However, lacking attractive investment opportunities elsewhere and gradually adjusting to the new badla rules, those funds soon returned to the market, normalising the rates at around 15 per cent, on average, for the rest of the quarter,” the report concluded.