Monday, June 28, 2010

Pakistan Capital Markets: Mobilizing for Growth

A Summerized form of article, with ideas generated by the speech of former State Bank governer (Ms. Shamshad Akhter) in 2006.

Pakistan’s financial sector has been transformed completely from the past during the recent years; which could more clearly be described as the “first generation of reforms”. Some noteworthy factors to discuss are firstly, the mobile cash flow in the economies of region after the East Asian crisis. Secondly, the change in the global financial flows of capital from the east to the west, against the previous west to east scenario. This situation is mainly because of the imbalances the US economy currently faces in the form of budget deficits. The situation however, is remarkable since the US $1.7 trillion reserves are sufficient enough for the East Asian economies to finance their economic needs, and also opens up new opportunities for developing economies like Pakistan to find for itself, new capital flows to financing its needs from what these countries have to offer. This could make a new beginning of financial flows which the speaker this is beneficial for Pakistan in the long run.

Thirdly, the incorporation of the financial world and the yet though, the imbalances that implicates as a result of the strong clan of the G8 countries and investments only in some parts of the world, that has lead to capital deficient countries, with exposure to currency risks. This as a a result has made some countries to tighten their monetary policies to make sure they are inline with the financial stability for the long term.

With careful macroeconomic policies along with measures to deepen the financial markets and institutions, along with framework of rules that nourishes the financial sector, Pakistan can achieve its target of future prospects. Pakistan, with 5% average economic growth and with private sector credit, although improved, but is not up to the mark with the Asian economies. This shows that Pakistan is far behind from the competition when compared from Malaysia, Singapore, Thailand and Korea in terms of dept of equity markets, bank assets and bonds outstanding. Therefore, the market currently faces “lack of depth, breath, and maturity”.

However, with the new system and reforms such as the CDC and UIN in place, Pakistan is set to cover all its problems. Privatization and consolidation of banks with strict abidance to the Prudential Regulations, and the increased role of corporate governance, Pakistan has been marked as just close to India in terms of finance and efficiency.

Considering the equity market, the lack price discovery mechanism with much speculation taking place makes the market inefficient in terms of determining stock prices, which hurts small investors that enter the market. The solution to this problem is to increase market depth and breadth by IPOs much more frequent and vibrant with implementation of rules and regulations that wipe of chances of risks.

Another aspect that has leaded to improve the image of Pakistani markets is the integration of banking sector with capital markets. The approval of banks to open subsidiaries for brokerage has lead to improvements in governance and systems and the way capital markets work. Incorporation of the asset management companies and banks, in order to provide open-ended and close-ended mutual fund benefits to small investors has also been helpful in designing a level playing field for everyone and has also provided rights to small shareholders.

With integration of both in the developed markets, it is seen that the risk transferring and sharing is much easier. It has also leaded to the creation of instruments such as derivatives and securitization, which has been an important tool for financial leveraging.

Taking examples from the US, Europe and Chinese economies and banking practices, Pakistan need to decide which option to go for, since it would be a important decision and a prerequisite for economies of scale.

Lastly, the emergence of derivates market in Pakistani capital market is a step towards increasing the depth and breadth of the economy of the country. The State Bank has allowed foreign currency options, forward rate agreements and interest rate swaps which is slowly but surely gearing itself in the market.

With the current scenario in place, Pakistan has tremendous growth opportunities by private capital flow due to the savings trend and gathering that is in the region. Much also needs to be done though in the form of expanding the capital market and the banking sector. In line with Basel II accord, and much experience to understand from in terms of international market, Pakistan should be able to decide the path that needs to be followed to form a framework of rules that are important to liberalize the market effectively.

Moiz Damani is currently a student at Shaheed Zulfikar Ali Bhutto Institute of Science and Technology, pursuing an MBA degree with specialization in Finance.

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