Is 'black money' fuelling the rise of Karachi's stocks

As Pakistan’s economy struggles, its exchange soars.  But critics claim weak regulation has opened the door to insider trading

Karachi

Every weekday morning for the past 22 years, Yacoub Habib has arrived at the Karachi Stock Exchange (KSE). He doesn’t need to come here to trade, he says, he could do that online. Instead, he comes to pick up tips.

Recently, Mr Habib has been on hand to witness history. On 15 June, the KSE’s 100 index hit a record high of 23,097 points. In 2012, the exchange was ranked one of the top five performing in the world. In what may seem an irony, while Pakistan’s overall economy may be struggling and while the government of Nawaz Sharif recently had to accept a £4bn IMF loan, its main stock exchange is booming.

Over the past 12 months, KSE managing director Nadeem Naqvi has been heading roadshows in front of investors at the Shanghai Stock Exchange, the London Stock Exchange and the New York Stock Exchange as the Karachi bourse looks for a foreign partner. It last year changed from a member-owned not-for-profit organisation to being controlled by its shareholders. In his address to investors in New York, Mr Naqvi boasted that the benchmark KSE-100 index had risen by 25 per cent from January to May 2013 and that over the previous 11 months it had jumped 52 per cent.

Critics claim the well-performing stock market is partly the result of legislation passed last year that allowed a huge influx of “black money” to enter the system. But officials insist it rather reflects a booming undocumented sector and a growing middle-class hungry for retail products.

“If you look at the top companies of the KSE, their earnings since 2010 have grown at 22 per cent,” Mr Naqvi said in an interview in his office. “Sales were at 15 per cent and returns on equity were 20 per cent per annum.”

Over the previous 12 months Pakistan has emerged as one of a handful of booming frontier markets. Along with places such as the Ivory Coast, Bulgaria and the United Arab Emirates,Pakistan has remained an attractive destination for investors. A report by the Bank of America Merrill Lynch showed that £1.3bn exited emerging market funds from January to mid-August, while frontier funds saw inflows of £930m over the same period.

Critics claim the KSE, which remains modest in size and where only around 60 of its 569 list companies trade regularly, has benefited from legislation introduced at the beginning of 2012 which allowed people to buy stocks without questions being asked about the origination of money used to purchase those shares. There were even claims that some of the money could be coming from drugs or weapons dealing. Activity on the exchange shot up, with the volume of trades leaping to 173 million a day from 79 million, following the new law.

“We have the means to have black money in Pakistan legally,” claimed Syed Adil Gilani, an adviser to Transparency International, an anti-corruption group.

But Mr Naqvi said the new rules, which expire in June 2014, had been a response to its efforts to introduce capital gains tax. It was only eligible for funds that remained invested for six months and he said there was no evidence the market was being used to launder black money.

Some say the exchange could still do more to tighten regulations. In recent months some of the exchange’s top companies have faced allegations of insider dealing. Among those tycoons investigated was Aqeel Karim Dhedhi, who heads one of the country’s largest corporations, the AKD Group.

Reuters reported that a member of Pakistan’s Securities and Exchange Commission (SECP) accused a number of traders, including Mr Dhedhi’s brokerage, of buying shares in the state-run Sui Southern Gas Co before an official announcement, allowing the company to raise its prices.

The National Accountability Bureau, another federal investigative agency, concluded it was insider trading. But the SECP said its own investigation showed no evidence of fraud. The SECP whistleblower in the case has been suspended from her job.

Speaking in his office, Mr Dhedhi maintained his innocence. Asked about the problem of insider trading, he said: “It’s all over the world... If the regulators tighten the rules and they try to implement them, then we can get rid of it.”

One of Mr Dhedhi’s business colleagues, Ali Ansari, CEO of the Engro Corp conglomerate, said the fundamentals for companies to do well in Pakistan were already in place. He said the last 10 years had seen the growth of an expanding new middle class. Government policies, he added, favoured a number of major industries, including textiles and fertilisers. Such policies were reflected in the results posted by the KSE.

“There is no bubble here. We are firmly based,” he said, drawing a comparison with neighbouring India. Referring to Pakistan’s chronic shortage of electricity which is estimated to cost the economy up to 3 per cent a year in potential growth, he added: “The only issue we have here is with the power sector. We have to deal with it. I think in three to five years we will have come out of this problem.”

Nadeem Haque, an analyst based in Lahore, said it was not uncommon for stock exchanges to be “ahead” of a broader economy. Yet he also argued Pakistan had many positives – soaring remittances from Pakistanis working overseas had increased consumer spending, the informal economy was growing and sectors such as car manufacturers and textiles were benefiting from certain government policies.

“The government finances are not growing, but it is following outmoded policies,” he said. “That is why they are turning to the IMF. ”

Mr Habib, the small-time investor who visits the KSE every day, said he believes the exchange will continue to grow. Yet he also called for better enforcement. “Regulations are very weak,” he claimed. “But they need to be implemented.”

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