Investment in capital market of Pakistan

Most media reports, editorials, commentators and talk show experts

vehemently assert that growth in Pakistan is consumption led and fuelled by bank
credit. If they are right then the latest data available is indeed very intriguing. Gross
fixed capital formation during 2!"# was $s.%.&2 trillion ' an increase of (.) *
over last year. +his was over and above an increase of 2,.# * recorded in 2&"!. In
constant price terms -after ad.usting for inflation/ this translated into real growth rates
of %.( * and 0.( * respectively. 1onse2uently, Investment ' G3P ratio rose to 2
*. +his trend is confirmed by other collateral indicators ' imports of machinery and
e2uipment, exports of engineering goods, sale of cement and steel etc.
+he first 2uestion that arises is4 Is it the public sector or the private sector that
is contributing to investment in the country. 5bout three"fourth of total investment
-$s.%.& trillion/ was made by the private sector while public sector corporations
-$s.2% billion/ and General Government -$s.%) billion/ provided the remaining
one"fourth. +hus it is obvious that investment in Pakistan is led by the private sector.
+he next 2uestion that needs to be addressed is4 where is the private sector
obtaining resources for such large investment6 Is it getting the bulk of financing from
the financial sector6 7efore we address this 2uestion we should examine as to which
sectors of the economy does the private sector invest in6
+able"I provides the latest information on the sectoral breakdown of
private sector investment and the growth recorded for each sector. If appears that
manufacturing, transport and communications and housing together account for ) *
of fixed capital formation by the private sector. +he fastest growing sector of any
substantive nature is +ransport and 1ommunications.
Private 8ector 1redit by banking system in 9:! ' the year for which
complete data is available ' is reported to have been about $s.& billion. 5fter
excluding consumer loans and other types of loans the private business enterprises
received approximately $s.( billion from the banks i.e )!* of total bank credit for
private sector. +wo million borrowers of consumers finance, personal loans, credit
cards, auto loans etc. received $s.% billion or an average amount of $s.!;"
from the banks in 9: !. <ur =experts> think that in an economy of over $s.).!
trillion it is this paltry amount of $s.% billion of consumer finance that is actually
%
responsible for all the growth. Investment of $s.% trillion, on the other hand, does not
do anything and sits idle.
?et us now turn to the private sector credit provided by the banking system in
9: !. ?arge scale manufacturing got the highest share of $s.%#( billion or !& *,
8M@s $s.,2 billion or 2)* and the remaining sectors of the economy claimed about
$s.&! billion. +he working capital re2uirements borrowed by the private businesses
from the banks are estimated at $s.%# billion while $s.2 to & billion goes for trade
financing. +hus $s.% to %2 billion of bank credit was used for fixed investment by
large, medium and small enterprises in agriculture, manufacturing and services
sectors. +his implies that the banking system caters to % to %2 percent of fixed
investment re2uirements of the private sector. Initial public offerings by the non"
financial private corporate sector through stock markets and the term finance
certificates -corporate bonds/ issued in 9: # were able to mobiliAe around $s.2
billions. Bon banking financial institutions are estimated to supply another 2 to (
percent of fixed investment. Mutual funds with assets of over $s.%2 billion are
mainly involved in badla market for e2uity trading and it is not obvious as to how
much allocation they made for the purpose of investment. Insurance sector can furnish
another % to 2 percent of fixed investment. 9oreign direct investment would have
contributed another % to %.! percent of private sector investment after excluding
privatiAation proceeds.
+aking all these hard numbers -mainly banking sector, 93I, IP<s and +91s/
and soft estimates -B791s, Insurance etc./ the organiAed financial sector provides at
best only 2* of the financing for private fixed capital formation undertaken in the
country. 5round ,* of fixed investment is raised by the private sector investors
through internal generation of funds i.e reinvestment of corporate earnings, self
financing, informal sector or family and friends. 1orporate profits have grown at an
average annual rate between 2! to ( * during the last four years and have been
largely reinvested. Cowever, such a large dependence on internal sources and self
financing is also a ma.or limiting factor that is keeping private sector investment '
G3P ratio so low relative to other countries in the region. Most of the debate in the
country on low investment ratios has been centered around factors such as
infrastructure, ?aw and <rder, skill shortages and bureaucratic hassles. @very one of
these factors is 2uite valid and efforts should be made to overcome these constraints.
7ut after all Pakistani businessmen and entrepreneurs from all walks of life invest
about $s., billion of their own resources and funds every year. Indeed this high
2
e2uity ' debt ratio of ,42 is too onerous. 5ssume that this pool of $s., billions of
investible e2uity available is leveraged in a way that the overall e2uity ' debt ratio
becomes )4(. +he total fixed investment by private sector will rise to $s.%%&
billion adding $s.%& billion to total investment which will move the investment '
Gdp ratio up from 2* of Gdp to 2%.,*.
<n the demand side, the credit starved sectors of the economy are crop
production, livestock and fisheries, food processing, agro"based industries, small and
medium manufacturing, transportation and marketing of dairy, poultry, meat, fruits
and vegetable, housing for own occupation. Investment in most of these activities is
highly inade2uate in relation to the rising incomes and demand for these products and
services in the country. 8elf financing and informal sources are either highly volatile,
erratic and uncertain or expensive and therefore limit the volume of funds available
for investment in the above mentioned activities. +he inade2uacy of this investment
has serious repercussions. +he consumers in the urban areas and towns suffer as
supply shortages push up prices of these commodities. Bon"agriculture activities
which supplement farm incomes in rural areas cannot be expanded and thus fail to
provide the cushion for rural poor. 8o from an economic viewpoint, investment ratio
is sub"optimal, supply shortages persist, urban 1onsumers face inflationary pressures
and the rural poor remain vulnerable to vagaries in prices and output of ma.or crops.
5s the Government has to import these commodities to meet domestic demand and
contain inflation the trade balance comes under pressure.
Dhat can be done to raise the additional resources for private sector
investment in these underserved sector6 +he answer to this 2uestion will depend upon
a combination of incentives and institutional changes.
9irst, the public sector borrowing re2uirements from the banking sector
including the 87P have to be curtailed. 5s infrastructure and human resource
development " the mainstay of public sector development programmed ' are long
gestation pro.ects they should be financed though domestic bonds of %"2 years
maturity such as Pakistan Investment bonds, external borrowing on soft terms from
the Dorld 7ank, 537 and I37, external bonds of longer duration in international
capital markets, non"banking instruments such as Bational 8avings 8chemes and
Postal 8avings 8chemes, floatation of shares of public corporations in e2uities market,
G3$s and 53$s. 8uch a reallocation will free up the assets of the banking system to
be utiliAed for private sector investment in the underserved sectors and credit starved
activities of the economy described above. 5s most of these activities are labour
(
intensive the flip side of this diversion from public sector credit to private sector
would be increase in employment and rural incomes in the short to medium term.
8econd, the value chain of the financial sector ranging from capital
markets at one end and micro"credit at the other, with the banking sector followed by
non"banking finance companies in the middle should have a better and more clearly
delineated division of responsibilities. ?arge and well established corporate,
multinationals, capital intensive private infrastructure pro.ects should access domestic
e2uities market and corporate bond markets for their fixed investment re2uirements.
In my humble view the criterion for success of a stock market is not how much index
has moved up and down, though it is important. It is the volume of capital raised by
the firms and companies for new investment, expansion, moderniAation, restructuring,
ac2uisitions, start ups etc. and the number of new companies getting listed that are the
most pertinent indicator. 8ome of the large firms needing foreign exchange or having
export oriented industries should take advantage of bench marks established by
sovereign borrowing in @urobond, Islamic 8ukuk and E8 dollar bond markets by
floating their own corporate paper in international capital markets. +his diversion of
demand of the borrowers with lumpy appetite for funds will make additional li2uidity
available to the banks to concentrate on mid market borrowers. +he banking sector
will have to, per force, move away from coAy and laAy relationship banking to
struggle in areas such as agriculture production and marketing, dairy, live stock,
fisheries, 8M@s, urban and intercity transport, storage and processing facilities, super
markets, housing, commercial office buildings, municipal finances etc. +echnology
and human resources ac2uired by the banks in recent years should help them in tiding
over this shift.
+hird, the space for institutional investors has to be expanded by
encouraging, facilitating and attracting private e2uity funds, private pension funds,
provident and gratuity funds, $eal @state Investment +rusts, endowments, insurance
companies, mutual funds, asset management companies to mobiliAe savings from
retail savers and provide those funds for long term investment financing. 1ompetition
and attractive rates of return will help both the savers and investors. +hese institutions
will also act as a potent force for improved standards of corporate governance, better
disclosure and transparency. +he rules for mergers, ac2uisitions and takeovers,
corporate restructuring, should be altered to extract value from inefficient, imprudent
and dishonest firms. +hus we will be able to have the beginning of a responsible, well
performing and globally competitive corporate sector. +he matching of long term
&
assets and liabilities through these institutions will mitigate the risk of maturity
mismatch in the system..
9ourth, mortgage financing which .ust took off in the country only a few years
ago has been stifled. +he artificial and speculative rise in the prices of Erban ?and has
made house building out of reach for a large segment of middle class. 5t the same
time the instruments developed by the banks to supply funds are still plain vanilla
type and are not of much interest to the borrowers. 9ixed interest rate mortgage has
not yet become popular with our bankers while other sophisticated products are not
yet available. 9inancial engineering can help in ade2uate risk sharing arrangements
between the borrowers and banks and lead to a resurgence in mortgage financing for
the middle income class of the country.
+he analysis above clearly reveals that the 1apital Markets in Pakistan '
e2uity as well as bond markets ' have not yet played a significant role in mobiliAing
savings and allocating them for long term private sector pro.ects, infrastructure and
housing. +he scope for an expanded menu of products and instruments is 2uite vast
and the potential has not been tapped. 8hort term trading and capital gains should not
detract us from the fundamental ob.ective which capital market should strive to serve.
Table-I
Dhere does private sector invest in Pakistan6 -$s. 7illion/
2!"#
Provisional 2&"! Growth
5griculture %% ,, %!.(*
Mining %) %2 &!*
Manufacturing 2, 2&! %&.&*
?arge 8cale 2%( %0( %*
8mall 8cale #) !2 (%*
1onstruction %! %( 0*
@lectricity F Gas 2# 0 %,!*
+ransport F 1ommunication 2#, %!( )!*
+rade 2, 2% (2*
9inance F Insurance & (% (%*
<wnership of 3wellings %!% %20 %)*
8ervices %2 0& 2,*
+otal %! )0# (%.#*
8ource4 9ederal 7ureau of 8tatistics
!