Sunday, 16 December 2012

Reflections from my stay in Pakistan VII: the Capital Market

In the mid-1990s, Pakistan's Corporate Law Authority (today's Securities and Exchange Commission of Pakistan) issued draft rules for the establishment of mutual funds in Pakistan. The proposed framework was clunky and financial market participants did not bite. Fast forward a couple of decades to 2012 and mutual funds are a major part of Pakistan's capital markets. Large domestic banks such as Habib Bank and United Bank have dedicated fund management companies with significant assets under management (AUMs).

Indeed, the asset management industry calculates its AUMs at approximately USD 4 billion as at November 2012. That may not sound like a lot but it certainly provides enough fees to support a nascent industry for an economy of approximately USD 500 billion (purchasing power parity terms). Additionally, the statistic points to significant growth potential in the coming years, especially as new products are introduced by innovative institutions.

To be sure, Pakistan's domestic capital market has made tremendous strides in several areas other than mutual funds. The bond market, also non-existent until the mid-1990s, has grown and achieved critical mass, allowing corporations to issue debt at market rates in short periods of time. In fact, many of these bonds are purchased by fixed income mutual funds catering to the needs of yield chasing savers.

The stock market's picture is decidedly more mixed. Undoubtedly, the Karachi Stock Exchange's (KSE) market capitalization has grown along with trading liquidity. However, on a relative basis the KSE has lost ground. The KSE is no longer in the MSCI Emerging Markets Index, having been relegated to a frontier market alongside countries such as Nigeria and Sri Lanka. Additionally, the quantum of new listings on the KSE has declined considerably, especially during the last few years, reflecting the broad slowdown in domestic large scale manufacturing.

Besides the traditional stock and bond markets, Pakistan's capital market has a new entrant: the Pakistan Mercantile Exchange (PMEX). In many ways, the PMEX is the most exciting development in the recent growth of Pakistan's capital market. The PMEX became operational in May 2007 with the purpose of introducing futures contracts into Pakistan. Presently, the underlying assets for the contracts include commodities, including agricultural products and interest rates although more contracts are in under development.

For an economy with a large agricultural base, the PMEX has the prospect of revolutionizing the lives of farmers and users of agricultural products. It will permit them to mitigate the risks associated with uncontrollable factors such as the weather. For example, farmers may sell cotton 'forward' and know in advance the sales revenue from the season's cotton crop. Similarly, textile units can lock in cotton prices in advance through the use of cotton futures; thus bringing predictability to production costs.

Notwithstanding these positive developments, the Pakistani economy remains weak due to mismanagement and corruption. Investment in new large scale manufacturing facilities has all but dried up, mainly due to the unreliability of domestic electricity supplies. Profitable corporations are holding back from fresh capital outlays until political risks diminish and / or interest rates moderate. Moreover, small and medium sized enterprises are also suffering as a result of inflation, sluggish macroeconomic growth and high interest rates.

Ultimately, Pakistan's capital market will only be as dynamic as the economy which it services. Unless steps are taken to increase economic growth, the country's debt and equity markets will continue to lag other emerging market nations.
Imran is a business and management consultant. Through his work at Deodar Advisors and the Deodar Diagnostic, Imran improves profits of businesses operating in Singapore and the region. He can be reached at

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