The new government has taken a welcome step-- the decision to divest the Development Finance Institutions (DFIs). These institutions in the name of playing a crucial role in providing term finance for industrial and agricultural projects were only introducing distortions into the financial system. Instead of working for the welfare of the country and the economy, they were merely acting to promote the welfare of the elite at the expense of the taxpayer as is evident from the long list of defaulters on loans and the relatively limited industry (or capital base) that has been installed.

It seems that the only financial agency that might still remain on the books of the government might be the National Investment Trust. That would be a mistake.

Do not neglect the Stock Market!

In our country there is limited appreciation of the stock market and it is often neglected when it comes to thinking up economic reforms. I am writing this to make an appeal to prevent such a neglect.

The stock exchange is an important segment of capital market where the shares of joint stock companies listed on the Exchange as well as debt securities are traded. At present there are three Stock Exchanges in Pakistan, one each in Karachi, Lahore and Islamabad. The Karachi Stock Exchange is, however, the only actively traded equity market accounting for 90 per cent of total volume of trade in stocks and share in the country. The size of the stock market is rather small. The market remains plagued with difficulties which range from outright fraud to market manipulation. The result is that unlike other countries, the saver remains away from the stock market and would rather put his money in land, gold or foreign exchange. All three of these activities are not likely to generate growth and employment. We must therefore attempt to make the stock market more transparent and attractive to the ordinary saver.

At the minimum the following two changes should be made to allow some development to take place in the stock market.

1. Privatize government mutual funds.

The activities in the Karachi Stock Exchange are largely influenced by the domestic institutional investors namely NIT, ICP and SLIC. Under the existing Rules, it is a condition of every consent issued by the Controller of Capital Issues to a company seeking public participation in its equity that it gives to NIT the right of first refusal to 10 per cent of the capital to be issued to the general public. Another government owned institution namely ICP also trades in KSE extensively. However, the pre-emptive rights of the NIT over new issues are not available to the ICP. The ICP has since its inception, sponsored the listing on the KSE of 21 closed-end mutual funds. They also play a significant role in the under-writing of public flotations and in establishing syndicate. The State Life Insurance Corporation(SLIC) has a portfolio consisting of shares of companies. It is commonly held among keen investors that the share-holding pattern of a typical company listed on the KSE is: sponsors of the company 50% of equity, institutions (public sector) 25%, other large institutions about 10 percent, This leaves about 15 percent to be traded on the market and therefore available to the small saver.

There are at least three good reasons why the divestiture of these agencies from the ownership of the government is likely to be important for the development of the stock market. a. Public sector agencies that hold shares in the stock market are know to have used their holding for non-market activities such as a display of confidence in the incumbent government. Given their large presence they can dump and acquire shares at key political moments and hence affect market movements. But this only serves to shake the confidence in the market. b. Since the managers of public sector funds are not judged merely by profitability conditioned, they are not immediately concerned with the market value of the stock and often do not perform the kind of scrutiny of the managers as a private fund would. Most private funds would keep abreast of company development and would work hard to change any management that is not acting in interests of the shareholder. Public sector funds on the other hand can often allow bad management funds and protection from the market. c. Given the large amount of the stock that these public sector stock funds are holding for non-market reasons, there is limited availability of stock in the market. In general the share-holding pattern of a typical company listed on the KSE is as follows: sponsors of the company 50% of equity, institutions (public sector) 25%, other large institutions about 10 percent, This leaves about 15 percent to be traded on the market and therefore available to the small saver. The price every day is being determined on a very small base of investors.

2. Create a Securities and Exchange Commission

Capital markets are currently being regulated by various government agencies, including the Ministry of Finance, the State Bank of Pakistan, the Corporate Law Authority, and the Controller of Capital Issues. The existence of multiple regulators hinders the smooth functioning of capital markets.

The Corporate Law Authority was initially established to handle legal matters pertaining to companies. However, many such issues are still being handled by other regulatory agencies. This makes the streamlining of efforts particularly cumbersome. For instance, flotations of commercial paper are subjected to several approval processes. Such agencies as the Controller of Capital Issues, the Corporate Law Authority, the State Bank and the Stock Exchanges are involved in various aspects of the approval and flotation process, making this process rather long winded and cumbersome, thereby discouraging companies from issuing securities.

To meet the demand for an increasingly sophisticated market for securities and to strengthen the supervisory structure there is a need for establishing a single regulatory body to promote and ensure the orderly development of the capital money market. It is, therefore, recommended that the Corporate Law Authority or some similar agency should be empowered to deal with all capital markets issues. In the United States, for example, all issues pertaining to the functioning of the securities market are handled by the Securities and Exchange Commission (SEC). Because this regulation is the primary work of the SEC, it can ensure that the application of rules balances the requirements of a dynamic marketplace with the need to protect investors from unscrupulous parties.

The need to create a one-window operation is highlighted by the fact that the current set up has slowed down the reform effort. Even in a situation where the government has, as a matter of policy, pursued the development of a new financial product, the regulatory structure has proved so cumbersome that the efforts have not borne fruit.

The SEC should be an autonomous and independent body at par with the state bank. As the state bank is charged with the responsibility of the money market, the SEC should have the responsibility of the capital market. Like the state bank governor the chairman of the SEC should be a tenured appointee for a term of six years and should be a member of all major economic decision-making committees. Again like the state bank the SEC should be subjected to reporting and auditing requirements and should not have recourse to the budget.

The SEC should be charged with the custodianship and the development of the capital market in Pakistan. It should ensure transparency and security of transactions. This would require speedy information dissemination and registration, the ability to conduct paperless transactions, depository agencies etc. The SEC would also be allowed to develop the market for new instruments as needed. A dynamic SEC would be a very vital and much neglected component of our domestic resource mobilization effort.

A final word

In both the state bank governor and the SEC chairman appointments, the rule should be adopted that these will be professionals of repute who have no market presence and that civil servants are not eligible for these jobs. The reason is that the civil servant is too beholden to the government for his career and therefore can be influenced. The professional who is hired should have no possibility of getting another government job other than say teaching and research after his tenure. We have seen how often the promise of a post retirement offering or another position has made many people commodities that can be purchased. In any case, the monopoly of the civil service on key positions is inefficient. What wee have accepted for the legal profession, ie., that judges should be good professionals, has to be accepted for other professions too.