Download Role of Capital Market in Economic

KARACHI STOCK EXCHANGE
ROLE OF CAPITAL MARKET IN ECONOMIC DEVELOPMENT
A Presentation by:
by: Nadeem Naqvi
Managing Director
Karachi Stock Exchange
October 01, 2014
www.kse.com.pk
Why the Capital Market – Background (I)
 Bulk of commercial bank deposits are for less than one-year maturity
 As a result, they can engage in only a limited amount of maturity
transformation, i.e. borrow short-term and lend long-term
 In era gone by, long-term financing for industry used to come from public
sector development finance institutions (DFI’s) such as NDFC, PICIC,
IDBP, Bankers Equity who received long term funding from multi-lateral
agencies and lent long term to industry
 Poor governance & losses led to closure of these DFI’s
 Despite their operating weakness these DFI’s did play an important role
in the industrial development of Pakistan from 1960’s to early 1980’s
KARACHI STOCK E XCHANGE 01
Why the Capital Market – Background (II)
 It was hoped that a new set of DFI’s could fill the void, so we had
government-to-government joint venture Investment Companies such as
Pak-Kuwait Investment Company, Saudi-Pak, Pak-Brunei, Pak-Iran, PakChina, Pak-Oman
 Unfortunately, with a few exceptions, the JV Investment Companies did
not fill the void of providing significant long term project finance
 Globally also, infrastructure and long-term finance has moved from
national DFI’s to capital markets in the last two decades
 In Pakistan, absence of a liquid private sector debt market has meant
that there are limited sources available for both the public & private
sectors to access long term capital needed for sustainable economic
growth
KARACHI STOCK E XCHANGE 02
Role of the Capital Market in Pakistan
 Despite the above noted limitations, Pakistan’s Capital Market has
played an important role in enabling the public and private sectors to
access long term funding
 In the last 10 years, the total amount of equity capital and debt raised
has been nearly PkR 1,000billion
 Out of this, over PkR 170billion was raised by the Government of
Pakistan via privatization through public offerings
 If the debt capital market is seriously developed there is no reason why
an enormous amount of savings (both domestic and international) can
not be tapped for infrastructure and industrial development by the
public and private sectors
KARACHI STOCK E XCHANGE 03
Capital Market & Economic Growth Linked
Development of Capital Market has been found to be closely
linked to the stage of economic development
CATEGORY
FRONTIER
ECONOMIES
TRANSITIONAL
ECONOMIES
PER CAPITA
GDP
Less than US$ 2000
US$ 2,000
to
US$ 8,000
EXAMPLES
(2011)
Financial Markets Development
• Nigeria - $1,500
• Increasing monetization of economy
• Vietnam - $1,400
• Growing demand for financial services & products
• Egypt - $2,780
• When GDP per capita reaches $2,000 30% of
population typically has bank accounts
• Indonesia - $3,500
• Colombia - $7,100
• Unofficial economy shrinks as SME’s need greater
financing from the formal sector
• Role of capital market grows
• S. Africa - $ 8,070
EMERGING
MIDDLE INCOME
ECONOMIES
Source: E&Y
US$ 8,000
to
US$ 20,000
• Malaysia - $ 9,980
• Pension Funds / Insurance Companies become
important institutional investors
• Mexico - $ 10,050
• Consumer credit gross
• Turkey - $ 10,520
• Businesses become larger needing greater amount
of long term funding from capital markets. Debt
market becomes increasingly important
KARACHI STOCK E XCHANGE 04
Pakistan Stock Market Performance
 KSE-100 Index increased by 20% from Jan-April 2014. KSE100 Index constitutes about 80% of total market capitalization
 KSE-100 Index increased by 49% in CY2012 and 49% in
CY2013
 Pakistan market has been top five best performing stock
markets in the world for last three years
 Market Capitalization in US$ terms has reached US$71billion
 Despite the above, Market Cap/GDP Ratio is just only 30% at
present compared to 46% in April 2008, the previous market
peak
KARACHI STOCK E XCHANGE 05
KSE-100 Index: Scaling New Heights
32,000
Mkt Cap/GDP = 46%
Mkt Cap/GDP = 27%
30,000
28,000
26,000
24,000
22,000
Previous High Index
Apr 18, 2008 15,676
20,000
18,000
16,000
14,000
Market Floor
Oct 9, 2008
12,000
9,181
All Time High Index
Jul 24, 2014
30,475
10,000
Market Low
Jan 26, 2009
8,000
6,000
25-Sep-14
16-Jun-14
05-Feb-14
27-Sep-13
19-May-13
08-Jan-13
30-Aug-12
21-Apr-12
12-Dec-11
03-Aug-11
25-Mar-11
14-Nov-10
06-Jul-10
17-Oct-09
08-Jun-09
28-Jan-09
19-Sep-08
11-May-08
01-Jan-08
25-Feb-10
4,815
4,000
KARACHI STOCK E XCHANGE 06
Major World Indices Performance (July 2013 to June 2014)
45.0%
41.2%
40.0%
35.0%
31.4%
31.0%
30.0%
25.0%
20.2%
12.1%
11.7%
11.5%
10.0%
6.2%
5.9%
5.0%
China
Philippines
Malaysia
Hong Kong
MSCI EM
Brazil
Vietnam
India
Pakistan
0.0%
MSCI FM
3.5%
2.3%
1.2%
Indonesia
15.0%
Thailand
20.0%
KARACHI STOCK E XCHANGE 07
Historical Asset Class Returns in Pakistan
*10-Year average annual return for asset classes
Ban k D epo sits
4.5%
Govt. T-B il ls
10.6%
Govt. PI Bs
11.3%
Defen ce Savi ng s C erts
11.0%
Gol d
KSE-100 In dex
12.7%
26.1%
*CY2004 - CY2013
KARACHI STOCK E XCHANGE 08
Foreign Portfolio Investment has driven Market
 Foreign Portfolio Investment inflow was US$676mn during
FY14 vs. US$569mn FY13
 Average Daily Value Traded was PkR9.4bn between Jan to
June 2014 while for whole of 2013 it was PkR7.6bn and in
2012 it was PkR4.7bn
 In 2008 the estimated leveraged position in the market was
between PkR70bn and PkR80bn. At present, within Margin
Trading System the leverage is around PkR5.0bn while it is
estimated that leveraging via banking system is around
PkR10bn
KARACHI STOCK E XCHANGE 09
Foreign Portfolio Investment Net Flows
(US$ mn)
400
341
350
300
233
250
200
150
92
100
65
50
81
70
36
16
(46)
(48)
(100)
4QFY14
3QFY14
4QFY13
3QFY13
2QFY13
1QFY13
4QFY12
3QFY12
2QFY12
1QFY12
(150)
2QFY14
-94
(111)
1QFY14
(50)
KARACHI STOCK E XCHANGE 10
Market Capitalization to GDP Ratio
50.0%
46.3%
45.0%
40.0%
36.7%
35.0%
36.9%
31.8%
30.0%
27.0%
25.2%
23.0%
25.0%
20.0%
16.7%
18.5% 18.2%
17.0%
15.0%
10.0%
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
KARACHI STOCK E XCHANGE 11
Percentage of Companies Paying Dividend
45%
44%
44%
43%
42%
42%
41%
40%
39%
39%
2010
2011
39%
38%
37%
36%
2012
2013
KARACHI STOCK E XCHANGE 12
Current Dynamics of KSE
 KSE was Demutualized on August 23, 2012 and turned into a company
limited by shares with an equity base of nearly $80 million
 The Board of Directors of KSE now has 6 public interest directors
nominated by the SECP including the Chairman, 4 representatives of
previous members of the Exchange and the MD
 Within 24 months of Demutualization 40% stake with management
control has to be sold to strategic investor, 40% will be retained by exmembers/now shareholders and 20% will be offer to the general public
via IPO and the shares of the Exchange will be listed on itself
 Strategic investor can only be a (i) stock exchange; (ii) derivatives
exchange; (iii) commodities exchange; (iv) depository company, with 10
years’ experience, US$200million capital & high reputation
KARACHI STOCK E XCHANGE 13
Demutualization ushers in a new Era
 Segregation of Commercial and Regulatory Functions of the
Exchange has led to formation of the Regulatory Affairs
Committee (RAC) of the Board composed of only SECP
nominated directors to minimize conflict of interest and have a
strong compliance and governance eco-system
 RAC oversees the Regulatory Affairs Department (RAD) which
is headed by the Chief Regulatory Officer, reporting directly to
the Chairman of RAC
 Deutsche Bank has been appointed as the financial advisor to
explore and identify strategic investor to purchase upto 40%
equity stake with management control in KSE
KARACHI STOCK E XCHANGE 14
Separation of Regulatory & Commercial Functions
 As per the Demutualization Act 2012, KSE’s organization structure has
been segregated into separate regulatory and commercial functions to
avoid any conflict of interest
KSE’s POST DEMUTUALIZATION ORGANIZATION STRUCTURE
BOARD OF DIRECTORS
(4 independent directors)
Regulatory Affairs Committee
(6 independent directors,
4 broker directors)
Other Board Committees
Chief Regulatory Officer
Managing Director
Regulatory Affairs Department
Commercial Functions
Listed
Securities
Wing
Brokers &
Investors
Affairs
Compliance &
Enforcement
Wing
Operations
&
I.T.
Marketing &
Product
Development
Finance,
Admin. &
Legal
KARACHI STOCK E XCHANGE 15
Risk Management
INVESTOR PROTECTION





Brokers quality & capability
Strong financial penalty & personal accountability
Preemptive risk management regime
Power to the Investors
Investor Protection Fund
SYSTEMIC RISK MITIGATION




Market Liquidity
Robust margining regime
Trade settlement guarantee
Clearing House Protection Fund
KARACHI STOCK E XCHANGE 16
Strengthened Regulatory Regime post 2008 Crisis
 Strong risk management system & State-of-the-art technology
platform
 Seamless electronic integration of Trading (KSE),
Clearing & Settlement (National Clearing Co.) and Custody
(Central Depository Co.)
 Fit & Proper Criteria for brokers; KYC & Anti Money Laundering
guidelines implemented
 Universal Identification Number (UIN) for every investor & autotagging of CDC sub-account with the UIN and KSE’s KATS code for
investor protection
 Rs 800+ million paid from Investor Protection Fund of KSE to
investors affected by 2008 financial crisis, with 50% of claims fully
settled
KARACHI STOCK E XCHANGE 17
PAKISTAN
MACRO PERSPECTIVE
Macro Highlights
CORPORATE EARNINGS
Listed non financial companies’ sales growth has averaged 17% p.a. over last four years; after
tax earnings have grown by 25% p.a. and ROE has ranged from 19-22% during this period.
ECONOMY (DOMESTIC)
Economy has shown recovery from the 2008 global financial shock with real GDP growth
rising to 4.1% in FY13-14 and expected to reach 4.5% in FY14-15
ECONOMY (EXTERNAL)
C/A deficit was contained at 1% due to remittances by overseas Pakistanis(US$15.8bn in
2014) & Bilateral & Multilateral Hours
FOREIGN DEBT
Foreign Debt as % of GDP declined from nearly 31.5% in 2009 to 24% in 2014. Pakistan
was able to raise US$2.0billion Eurobonds after nearly 10 years
KARACHI STOCK E XCHANGE 19
PAKISTAN: Large domestic demand base

Total consumption is 68% of GDP

Private Sector Consumption is 75% of Total Consumption

Between 2009-2013, consumer spending grew @25% p.a. versus about 10%
for Asia*

This was driven by (i) substantial rise in rural incomes due to high global food
prices & govt. support to agriculture; and (ii) sharp rise in remittances sent
back by overseas Pakistanis

Consumer companies were main beneficiaries, with listed consumer sector
earnings rising by over 22% p.a. between 2009 and 2013 and expected to
grow by 18% in 2014
*Source: Euromonitor International
KARACHI STOCK E XCHANGE 20
Pakistan’s Resource Profile
 25th largest economy in the world
 7th largest labour force
 50% of 180 million population below the age of 25
 4th largest milk producer
 4th largest sugarcane producer
 4th largest rice exporter
 5th largest copper resources
 6th largest coal resources
KARACHI STOCK E XCHANGE 21
Actual Economy larger than official numbers

Official GDP (FY13-14) = US$250billion → Per Capita = $1,368
HOWEVER,

The undocumented economy is estimated at 50% or more of Official

Thus, EFFECTIVE GDP = US$375billion → Per Capita = $2,055

Top 20% of households have estimated annual income of $8000-10,000

This represents around 30 million strong middle class

By 2020, this population segments’ annual income should be $12000-15,000
and effective GDP should be OVER $500billion
KARACHI STOCK E XCHANGE 22
Mind MAP for Pakistan’s Industrialization
ENERGY
SELF-SUFFICIENCY
& IMPORT SUBSTITUTION
BASIC
INDUSTRIES
INFRASTRUCTURE
AGRICULTURE
AGRI
VALUE ADDED
PRODUCTS
TRADITIONAL
INDUSTRIES
RESTRUCTURING
COAL
OFFSHORE &
SHALE OIL &
GAS
COAL BASED
LIQUIDS
REFINERY
PETROCHEMICAL
COMPLEX
POWER
COPPER &
MINERALS
ALTERNATIVE
ENERGY
COPPER
COPPER
SMELTING
STEEL
STEEL
FABRICATION
ROADS
RAILWAY
PORTS
MAJOR CROPS
YIELD INCREASE
DAIRY CORPORTE
FARMING
FRUITS &
HORTICULTURES
FISHERIES
VALUE
ADDED
MILK VALUE
ADDED
HYGIENIC
VEGETABLE &
FRUIT PRODUCTS
MEAT & FISH
PRODUCTS
INDUSTRY
EXPORT
INCENTIVES
INSTRUMENTATION
REJUVINATING
SIALKOT
INDUSTRIES
CARPETS &
COTTAGE
INDUSTRY
EXPORTS
TEXTILES
INTEGRATED
MANUFACTURING
& ELECTRICAL
COMPONENTS
KARACHI STOCK E XCHANGE 23
Industrialization will need large long-term funding
How will critical infrastructure and industry creation by financed?
 Both domestic and global savings have to be tapped for this
purpose
 Multilateral / supra national financial institutions will need to
play a major role in raising long term finance for infrastructure
& industrial projects (eg. IFC offshore Rupee Bonds)
 The funding mechanism will have to be different from the past
 New mechanism will need to be centered around capital
market as the primary clearing house for supply & demand of
long-term capital
KARACHI STOCK E XCHANGE 24
Key Hurdle in Involving Private Investors in Devl. Projects
 In many cases external economic benefits for the society / citizens as a
whole may not translate into near-term and easily quantifiable
economic benefit for private sector investors, eg:
i.
Congestion removing signal free urban road by passes
ii.
Farm-to-market roads
iii. Water-purification schemes
iv. Environment protection projects (mangrove swamp rehabilitation
to safeguard coastline, reforestation, etc.)
v.
Alternative energy projects providing long-term environment
sustainability but requiring short term subsidies through
incentivized tariff structures, tax-incentives to suppliers & investors
KARACHI STOCK E XCHANGE 25
Sources of long-term debt
There are several tried and tested sources of long-term debt:
 Infrastructure bonds with underlying assets as primary collateral
 Local currency global bonds with Supranational (eg. IFC) credit
rating
 Diaspora bonds with special incentives for overseas Pakistanis
 Provincial / Municipal revenue bonds with special tax exemptions
and steady cash flow stream
 Global infrastructure securities had market capitalization of
US$1.1trillion at the end of 2012
 It is estimated that demand for infrastructure funding in emerging
markets will be US$1.0trillion ANNUALLY until 2030 with Asia
accounting for 50%
KARACHI STOCK E XCHANGE 26
Capital Suppliers’ Perspective
 Infrastructure bonds are of particular interest to suppliers of long
term capital (global pension funds, insurance comps.) because:
1. Such bonds enable creation of long term underlying assets
essential to support economic growth
2. Infrastructure generally generates steady cash flows and above
average yields
3. Infrastructure projects have limited competition and usually high
barriers to entry
4. Although initially capital intensive, infrastructure assets have
modest operational expense and therefore have high operating
margins that support debt servicing
5. Presence of underlying assets means that possibility of Shariah
Compliance financing options are also available
KARACHI STOCK E XCHANGE 27
THANK YOU
Serving Investors & Industry
Stock Exchange Building, Stock Exchange Road, Karachi-74000, Pakistan.
Tel: 111-001-122 Website: www.kse.com.pk