Dr Adeel Malik and Usman Hayat
On June 24, the KSE-100 rose by 960 points, or about 9 percent, setting a new record for a single day’s gain. This record was set after the SECP and the KSE decided to take certain extreme measures, dubbed as “Measures for Market Stabilisation,” after the KSE-100 had declined by about 29 percent since April 2008.
The objective of these measures, as stated in the SECP’s press release on June 23, is to address the threat of “systemic risk,” that is, the chain reaction of defaults in meeting settlement obligations. Simply put, when one buyer fails to make the payment for the shares he bought, it causes the seller to fail on his payment to another buyer, and so on. Since participants in the stock market also have exposure in other areas–such as banking, real estate, foreign exchange–large-scale defaults in stock market can be quite contagious, threatening a wider financial crisis.
The measures taken by the SECP and the KSE include changing intraday price limits, restricting short positions in futures, easing margin requirements and giving the market participants hope of a Rs20-billion “market stabilisation fund” to be created in future. Most of these measures are essentially overnight changes of market regulations that are aimed not just at preventing a fall in prices but at pushing them upwards.
While each of these measures taken is objectionable, the one that is simply absurd is reducing the lower price limits from 5 percent to just 1 percent and doubling the upper limit to 10 percent, perhaps a record in its own right. What this means is that the price of a stock may rise by 10 percent but will be allowed to fall only by 1 percent compared to its price the day before. This is just a step short of the regulators deciding the share prices, rather than the market forces.
The message in the press release was clear: market participants, the KSE as the frontline regulator of the market, and the SECP as its apex regulator, wanted the market to rise. Those familiar with the market are well aware that on such occasions there is usually a buying spree from public-sector institutions and a nod from the government. The message was understood and the result is a record rise in KSE-100.
This new record in the stock market raises some fundamental issues about the stock market.
First, by resorting to this extreme action, the KSE and the SECP have accepted that they have not been able to ensure sound management of settlement risk, which is their fundamental regulatory responsibility. These measures have come just about a month after the KSE changed its rules overnight in May to rescue the speculators who were unable to settle their positions in single-stock futures. Earlier, overnight rule changes had also been used in June 2006 and March 2005 to rescue potential defaulters. These instances prove that years of “reforms” and pursuit of “international best practices” in risk management have not been able to change the reality on the ground. The only lesson speculators learn from these rescues is that, come next time, instead of being liquidated and shown the door, they would once again be rescued by the very institutions which are supposed to act against them.
Second, these measures would shake investor confidence–or whatever is left of it–in the integrity of Pakistan’s stock market. The news about these measures and the subsequent records was covered not just by the domestic media but also the international media. Everyone, including foreign investors, has seen how an unholy alliance of market participants and regulators can be made overnight to artificially push up prices to save some speculators. Be clear that the speculators who were about to create a systemic threat were not small-scale Pakistani or foreign portfolio investors but brokers and their big clients with exposures running in billions. Once again, it is proven that the market does not rise or fall because of economic factors but largely due to factors specific to the market, such as dominance of highly leveraged speculation, that is, “satta” financed by “badla.” While economic indicators have worsened between April and June, nothing has happened that could be termed force majuer as suggested in SECP’s press release. In fact, in the past the KSE-100 kept soaring in the face of suicide bombings, rising inflation, power crisis, flour crisis, sugar crisis, the Red Mosque carnage, the May 12 killings, and so on.
Third, the measures taken by the SECP have not been analysed in the news media in the right perspective. The news media has focused more on the glamour of the “record” than the propriety of the measures underlying it. Most of the commentators invited in the electronic media to discuss stock-market issues are owners of brokerage houses, employees of brokerage houses, or employees of companies associated with brokerage houses. There are very few independents that have the expertise and the courage to analyse stock market issues from the point of view of public interest. It’s about time that mainstream media anchors also pick up issues in financial markets because these issues have a bearing on public welfare and are inevitably linked to the mainstream governance issues.
In sum, the record that the KSE-100 has made on June 24 is not a record to be proud of. This market may have very little ability to make an economic contribution, but it has all the potential to create a financial crisis. Clearly, the market is in need of reforms, not the kind of makeover of the past but solid steps that can change the reality on the ground. Perhaps the single-most important step would simply be to respect the rules and never rescue speculators who are about to default on their settlement obligations.
Enforcing the rule of law in the stock market is the responsibility of the securities regulator, but the SECP or, for that matter, any other regulator, no matter how autonomous on paper, can only do its job when the government would let it do so. During the heyday of the Musharraf regime, the Shaukat-Salman team of economic managers was extremely intolerant of any sign of independence and strength in the SECP. After the unceremonious sacking of the SECP chairman in January 2006 for not toeing the government’s line, it became clear to all that what the regulator does or does not do is best seen as the will of the government rather than the will of the regulator. Not unexpectedly, following the blow dealt by the-then government, there has also been a persistent weakening of the SECP from within as the regulator has been struggling to hire or retain key employees who have the required expertise in stock-market issues, a problem that has magnified in recent months.
Following the February elections, there is now a newly elected Parliament which is evidently sensitive about its supremacy. People are now yearning for change and expecting this parliament to deliver rule of law and economic justice. A key test of this Parliament is whether it is able to bring rule of law to the stock market or whether we are likely to witness more crises, more rescues and perhaps more records–records that we can’t be proud of.
Dr Adeel Malik is a lecturer in development economics at the University of Oxford. Usman Hayat is an independent securities markets consultant. Emails: firstname.lastname@example.org and email@example.com
Source: The News, 2/7/2008