Roller coaster Karachi index a victim of its own success

It has been said that when office peons, telephone operators and security guards start buying into stocks, or when waiters and busboys prefer share tips to cash gratuities, it is time for the wise to exit the equities. A steep and surprising rise in share values on the Karachi Stock Exchange (KSE) during the weeks leading up to March 15 was followed by a 30 per cent plunge on April 12. It was a time when the small, the inexperienced, the unwary and the greedy got their fingers burnt. The statistics are astounding. The KSE index was at a modest 1,322 on January 1, 2002 but within 39 months had hit 10,303 - a gain of 679 per cent. Between January 1 and March 15 this year the index surged 65.5 per cent with about shares soaring 200 per cent. 'The interest of foreign buyers in the Pakistan stock market had just begun when the collapse came,' said Aqeel Karim Dhedhi, the chairman of AKD Securities, a Karachi brokerage firm. 'Though it may be a little cruel to say so, the so-called 'small investors' ought to know that there is no free lunch, greed never got anyone anywhere and hopes of earning money overnight without working can and do backfire.' Different theories have been advanced to explain the index's roller coaster ride. 'It was a privatisation story,' Mr Dhedhi said. 'At least 1,400 of the final 2,000 points in gains were because of stocks like Oil and Gas Development Co, Pakistan Petroleum, Pakistan State Oil, Pakistan Telecommunications Co and National Refinery - all of which are headed for privatisation.' The second driver was the continued robust growth in corporate earnings over the past three years, when companies logged an average annualised growth of 20 per cent in their bottom lines. Investors were also encouraged by the corresponding growth in dividend payouts. The planned entry of several mutual funds into the fund business was expected to inject even more liquidity into the market. It was estimated that up to 40 billion Pakistani rupees ($5.24 billion) worth of funds were in the pipeline. Once the funds were ready for business, demand for shares was expected to rocket, putting even more upward pressure on stock prices, analysts said. A fourth factor behind the rally was expectations of gross domestic product growth in the first quarter topping 7 per cent and hitting as high as 7.5 per cent on the back of a significant increase in industrial production. 'The government was, in fact, holding up the KSE index as an index of the success of the official economic policy, or its trophy,' said Tanvir Abid, head of research at Live Securities in Karachi. 'And once the government began holding up the KSE as a badge of success, the exchange officials hesitated to come up with cautionary signals, much less ring alarm bells.' KSE managing director Moin Fudda said among the crucial policy factors behind the boom were the government's improved economic management, a positive change in the geopolitical situation - especially after the stepping up of peace initiatives with neighbour India - and the lifting of economic sanctions on Pakistan in relation to its nuclear-weapons development programme. On the monetary side, he cited huge inflows of foreign remittances by expatriate Pakistanis, an unprecedented surge in foreign exchange reserves and better operational results of blue chip firms. As expected, the market boom carried with it the seeds of a bust, as the size of leveraged positions became a huge risk. Mohammed Sohail, director for research and broking at Karachi-based Jahangir Siddiqui Capital Markets, said that adding together investments in carry-over transaction financing, the futures market and out-of-market financing took the aggregate leveraged position to about 100 billion rupees. 'It was a frightening figure and led to the feeling that there could well be a crisis, a threat to the clearing house or broker defaults,' Mr Sohail said. 'It was hardly a time for small investors to be getting in and making long-term investments.' Habib ur Rahman, chief executive of Atlas Asset Management in Karachi, said that heavier margin requirements should have been imposed on investors entering into forward sales contracts with stockbrokers. These margins should have been imposed in slabs stipulating higher margins as a broker's exposure to an individual investor went up. 'It would have made speculation progressively more expensive for rash investors,' he said. 'Also, the KSE should have made margin calls on stockbrokers against their outstanding forward contracts if prices of shares the brokers had bought forward went up from their contracted price.' Some analysts believe that the market boom has been driven by pure speculation and divorced from the country's economic realities. Experts say that unemployment has risen in Pakistan during the past few years and the much-trumpeted rise in foreign exchange reserves has hardly helped generate productive economic activity. 'The true state of Pakistan's economy is reflected in the reluctance of investors to engage in productive activity, or set up major industry,' said Mr Sohail. 'Banks, despite liquidity, are reported to be having problems in lending. Banking is preoccupied with serving itself rather than the economy.' There has been a partial recovery since the lows of the end of March and early April. During the same period, market capitalisation was up by 18.4 billion rupees to 2,017.7 billion. While market operators are once again talking about the index surging, investors are clearly in no hurry to get their fingers burnt again.