Financial Markets

Financial Market in Pakistan

Prepared by
Abeer Arif
Nazish Ali
Hapsha Mukhtar
Suman
Submitted to: Sir WaqarSaleemBaig
Dated: 31stDecember 2015

Financial Markets

Statement of Dedication
This report is dedicated to my Lord, parents, and my friends. I could not have completed my
journey without their love, support, and encouragement. Throughout my journey my parents
have show great support for me and they have always stood be me, and believed in me and my
abilities, even at the times when I had given up hopes. But for the support and inspiration that
these individuals have provided, I would not have been able to attain this goal. In all things that I
do, I consider the impact it will have on them, and I appreciate their support in doing the same.
Throughout the process of this dissertation, I found out that it is the desire to become successful
in life, which at the end of the day makes the journey worthwhile.

Financial Markets

Acknowledgement
I am very grateful to my parents and my teacher for showing their love, support and
encouragement at every phase in my life. I am also thankful to my family and friends for being
supportive and for motivating me which enabled me to accomplish my goals. I wish and express
my gratitude to my teacher who guided me throughout my report which has helped in compiling
this report. I am thankful to my teacher for guiding me and was always there when I needed him.
This report has become a learning experience for me where my teacher increased my knowledge
at every stage of the report. This research report was a very good learning experience for me as I
enjoyed quality time with my friends and teacher.

Financial Markets

Table of contents

Statement of Dedication..................................................................................................................2
Acknowledgement...........................................................................................................................3
Introduction......................................................................................................................................8
Background of the Study.........................................................................................................8
Aim of the Report..................................................................................................................10
Objectives of the Study..........................................................................................................10
Rationale of the Study...........................................................................................................10
Literature Review...........................................................................................................................11
Financial markets and their Economic Functions:.................................................................11
Price Discovery..............................................................................................................11
Liquidity.........................................................................................................................11
Reduction of transaction costs.......................................................................................11
Financial Intermediaries and Their Functions.......................................................................12
Financial Markets in Pakistan................................................................................................13
Overview of financial market of Pakistan.............................................................................13
Capital Market...............................................................................................................14
Stock Exchange.............................................................................................................14
Stock Exchange in Pakistan...................................................................................................15
Money Market.......................................................................................................................16
Money Market Mutual Funds................................................................................................16
Types of Money Market Mutual Funds.........................................................................17
Institutional Money Market Mutual Funds.................................................................17
Retail Money Market Mutual Funds...........................................................................17
Financial Institutions.............................................................................................................17
Banks.............................................................................................................................17
Central bank...................................................................................................................17
Commercial Banks.........................................................................................................17
Investment Banks...........................................................................................................18
Microfinance Bank........................................................................................................18
Islamic Banks.................................................................................................................18
Insurance Companies.....................................................................................................18

Financial Markets

Leasing...........................................................................................................................19
Modarba.........................................................................................................................19
Methodology..................................................................................................................................19
Design of the Research..........................................................................................................19
Analysis of the Data and Emergence of Relevant Themes....................................................20
Ethical Considerations...........................................................................................................21
Data Analysis and Discussion........................................................................................................22
Money Market and Long-term Government Bond Market...................................................22
Treasury Bills (T-bills)...................................................................................................22
Pakistan Investment Bonds....................................................................................................24
Interest Rate Volatility...........................................................................................................25
Performance of Foreign Exchange Market............................................................................27
Trends in the Foreign Exchange Market................................................................................29
Performance of Capital market..............................................................................................30
Conclusion.....................................................................................................................................33

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List of Figures
Figure 1: Financial Intermediaries and Their Functions..................................................................5
Figure 2: Pakistan Stock Exchange Market.....................................................................................7
Figure 3: Pakistan Interest Rate.......................................................................................................8
Figure 4: Deepening of the T-Bills Secondary Market..................................................................15
Figure 5: Volatility of Overnight rates...........................................................................................18
Figure 6: Maturity Profile of EMO................................................................................................18
Figure 7: Movement of PKR against US dollar.............................................................................21
Figure 8: Regional markets v/s KSE-100 index............................................................................24
Figure 9: Number of Investors accounts at CDC...........................................................................25
Figure 10: Number of Brokers accounts at CDC...........................................................................25

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List of Tables
Table 1: Treasury bill Auctions Summary.....................................................................................14
Table 2: Pakistan Investment Bonds..............................................................................................16
Table 3: Open Market Operations (billion Rupees).......................................................................17
Table 4: Foreign Exchange Market size........................................................................................19
Table 5: Performance of Capital market........................................................................................23

Financial Markets

Introduction
Background of the Study
Efficiently functioning financial markets (particularly capital markets, foreign exchange
and money market) are viewed as an integral part of a vibrant financial system. At the same time
as the money market presents financial intermediaries with a platform to borrow and lend in
short-term and square their respective positions, the foreign exchange market primarily provides
enabling environment for international trade. Likewise the capital markets present long-term
finance (debt as well as equity) for the corporate and the government sector. In essence, all three
markets function in a coordinated way such that there are some functional complementarities
and some substitutions. All three markets play a critical role in transmitting the signals of
monetary policy in the economy. In fact, the financial markets initiate the transmission of
monetary policy (Specifically the forex and the money market) and then filter to other financial
intermediaries (institutions and banks), households, firms, lastly influence the economic growth,
and inflation. The establishment of efficient and healthy financial market is highly imperative
for the constant growth of the economy; subsequently, the development of the country. Financial
markets perform a crucial role in channeling funds from people and organizations that have
surplus funds to those who have a shortage. The channeling of funds is critical because
generally those who save money are not always the ones who engage in business ventures,
hence financial markets are essential for bringing such people together.
In General, financial markets have three basic classifications: (1) Bond Markets, (2)
Equity Markets or Stock Markets, and (3) Exchange Rate Markets. Bond markets deal with
securities or debt instruments that promise to pay a fixed payment or interest rate after a
specified period of time. Equities such as common stocks are claims to share the net income and
the assets of a firm. Stocks usually pay dividends periodically to their shareholders and are
considered long-term securities with no maturity date. Equity is a residual claim on a firm. A
major advantage of owning bonds, rather than stocks, is that a firm must pay all of its debt
holders before it pays its equity holders. The advantages of holding equities like common stocks
are that the holder of such stocks will benefit directly from the appreciation of a firms asset
value and its profitability. A debt holder cannot profit from such appreciation since their return is
a fixed amount. We can also classify financial markets based on the maturity of the traded
securities. These can be subdivided as the money market and the capital market. A money

Financial Markets

market is a type of financial market that deals with only short-term debt instruments. Capital
market deals with long-term securities. Money market securities are more liquid and have
smaller fluctuations compared to long-term securities. The stock market provides an organized
market place for bringing buyers and sellers of stocks and securities together. It forms an
integral part of a countrys capital market and facilitates capital formation. The stock market can
serve as a barometer to gauge the economic well-being of a country. It performs an essential
function of mobilizing and allocating savings for the long-term funding requirements of
business and industry. Fluctuations in stock prices have a potential effect on the economy
because any changes in stock prices can affect peoples wealth and, as a result, confidence. An
efficient stock market will help raise funds for investment purposes, and hence is an important
factor in any firms investment decisions. Therefore, studying the dynamic efficiency in price
signals in the stock market is important.
Understanding the flow of information between stock markets around the world or stock
markets within a particular region or country is important for discerning any long-run
relationships among those markets. Exchange rate fluctuations are a major source of uncertainty
in international transactions. In an international economy, the need for a foreign exchange
market is an essential ingredient for carrying out international trade. One needs to comprehend
the dynamics of foreign exchange markets. Are there stable long-run equilibrium relationships
among or between different currencies traded in the markets? What are the driving forces behind
any long-run equilibrium between foreign currencies of major trading partners? These are the
questions that will be addressed. Fluctuations in foreign exchange markets can have a direct
impact on consumers and businesses alike. For example, a weaker currency at home can lead to
higher prices for foreign goods and services, and thus can hurt domestic consumers. On the
contrary, a weak currency could benefit domestic producers due to higher demand for domestic
goods in the foreign markets. Movements in exchange rates can create problems for a country
whose currency is pegged, for example, to a dollar. This research encompasses the changes in
different areas of financial markets operating in Pakistan.
Aim of the Report
There are three types of financial markets currently operating in Pakistan (Capital,
money, forex). All the three markets have witnessed substantial changes during the period of

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10

2001-06. The purpose of this particular research is to analyze performance of money, forex,
and capital market in Pakistan during FY01-06.
Objectives of the Study

To develop comprehensive understanding of financial markets and their functions

To identify different types of financial markets operating in Pakistan and their functions
To analyze the performance of money, forex and capital market in Pakistan during FY0106

Rationale of the Study

Majority of the researches in the past have focused at the interdependence among
different stock markets and stock indices across U.S., European, and Asian markets (for
example, Bessler and Yang 2002). Much of the empirical work focuses on developed countries
such as the U.S., U.K., France, Canada, Germany, Australia, Switzerland, Japan, and Hong
Kong. These countries make up the worlds largest stock market in terms of market
capitalization. However, there is no study, to date, concentrating either underdeveloped countries
or markets within a particular country. This vacuum in literature is partly due to the
unavailability of data. However, with the revolution in information technology one can obtain
the essential data from the stock markets in numerous of these less developed countries. This
research is an effort to bridge the existing gap. It furnishes an understanding of different types of
financial markets and particularly focuses on the performance of financial markets in Pakistan.
This research enriches the existing literature on financial markets and provides a comprehensive
view of changes in the financial markets of Pakistan.
Literature Review
Financial markets and their Economic Functions:
A financial market is a market where financial instruments are exchanged or traded.
Financial markets provide the following three major economic functions:

Price Discovery
Liquidity
Reduction of Transaction Costs

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Price Discovery
Price Discovery function implies that transactions between buyers and sellers of financial
instruments in a financial market decide the price of the traded asset. It is these functions of
financial markets that signal how the funds available from those who want to lend or invest
funds will be allocated among those needing funds and raise those funds by issuing financial
instruments.
Liquidity
Liquidity function presents an opportunity for investors to put up for sale a financial
instrument, without liquidity, an investor would be forced to hold a financial instrument until
conditions arise to sell it or the issuer is contractually obligated to pay it off. Debt instrument is
liquidated when it matures, and equity instrument is until the company is either voluntarily or
involuntarily liquidated. All financial markets provide some form of liquidity.
Reduction of transaction costs
When the participants of the financial markets are charged and/or bear the expenses of
trading a financial instrument. In the market economies, the economic justification for the
presence of instruments and institution is linked to the transaction costs; thereby, the surviving
instruments and institutions are those that include the lowest costs of transactions. The main
elements involved in the determination of transaction costs

Asset Specificity
Uncertainty
Frequency of Occurrence.

Financial Intermediaries and Their Functions

Financial intermediary is special financial entity that is responsible of allocating funds
when there are situations that make it complex for investors and lenders of funds to directly deal
with borrowers of the funds in the financial markets. Pension funds, investment banks, regulated
investments companies, insurance companies, and depositary institutions are all included in the
financial intermediaries. The financial intermediaries also play the role of creating more

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12

favorable transactions terms than could be realized by the investors/ lenders and borrowers
directly dealing with each other financial market. The financial intermediaries are involved in the
following functions

Obtaining funds from lenders or investors and

Lending or investing the funds that they borrow to those who need funds.
Asset transformation provides at least one of three economic functions:
Maturity intermediation.
Risk reduction via diversification.
Cost reduction for contracting and information processing.

Figure 1: Financial Intermediaries and Their Functions

Other functions that can be performed by financial intermediaries include:

Facilitating the trading of financial assets for the financial intermediarys customers

through brokering arrangements

Facilitating the trading of financial assets by using its own capital to take a
positioning a financial asset the financial intermediarys customer wants to transact
in.

Assisting in the creation of financial assets for its customers and then either

distributing those financial assets to other market participants.

Providing investment advice to customers.
Manage the financial assets of customers.

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13

Providing a payment mechanism.

Financial Market in Pakistan

The financial market of Pakistan comprises of three elements

Money markets that presents short term funds

Capital Market that makes long-term funds available to industries and business

Forex Market

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Overview of financial market of Pakistan
Capital Market
Capital market corresponds to the market in which long-term debt securities and
corporate equity are issued and traded. Financial instruments that are traded within the capital
market involve bonds and shares, Capital markets and specifically the stock markets in Pakistan
have significantly progressed over the last decade.
Ever since, when the boom initially came about because of the liberalization strategies of
the administration at the time, we have seen numerous significant advancements, for example, a
complex increment in the quantity of recorded organizations and the traded volumes,
introduction of automated trading and settlement systems on the pattern of the world's modern

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14

stock exchanges, as well as intensifying competition for the business evident from the quality of
research being published and distributed. As the workings of capital markets in Pakistan are
gradually presented to the business sector drives, the effect of different instruments of financial
strategy will accept more prominent essentialness. In the rising situation the viability of fiscal
arrangement will to a great extent rely upon the development of non-bank financial
intermediaries, the determination of loan costs, and the substitutability between cash and
different resources. The cash request capacity has been as often as possible evaluated for
Pakistan. The substitutability of money related resources under exchange total systems is
examined. We supplement the above examination by contemplating the determinants of financial
resources and measure intra-resources substitutability inside of a framework wide portfolio
system.
Stock Exchange
Stock exchange is the place where the stocks and bonds are exchanged. The chief
function of the stock exchange is to allow the local authorities, governments, companies, and
public to raise capital by selling some part of the ownership. It also provides an avenue for
buying and selling
the securities. Such
form of securities
entail bonds, trusts,
derivative and
shares. It
additionally
presents facilities
for the issues and

Figure 2: Pakistan Stock Exchange Market

redemption of the securities. Similar, to other commodities, the demand and supply influence the
prices of bonds and shares. In order to list a security on the stock exchange, there are certain
requirements. Transactions in the stock exchange are conducted by members only. Stock
exchange serves both as a primary market for the initial public offerings and as a secondary
market for their subsequent buying and selling.

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15

Investors are not bound to sell stock or bond through the stock exchange. They can directly deal
with the seller. Similarly, there is no compulsion that stock must be traded on the exchange. The
securities can change ownership out of the exchange which is called over the counter or curb
dealings.
Stock Exchange in Pakistan
In Pakistan there are three Stock Exchanges where we can invest through broker.
1. Karachi Stock Exchange (KSE)
2. Lahore Stock Exchange (LSE)
3. Islamabad Stock Exchange (ISE)
In this report we have thoroughly discussed about the Karachi Stock market (KSE-100).
Over the decade KSE 100 has shown a phenomenal growth. Since the turmoil of 2008 with the
above mentioned graph we can see that there is a growth of almost 30,000 points approximately,
which yet is a lucrative. Over the past few years Pakistani stock market has been attractive
avenue for the foreigners to invest, this foreign investment has also played its role the growth
and rapid raise in the return graphs of the KSE index.

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16

Money Market
A segment of the financial market in which financial instruments with high liquidity and
very short maturities are traded. The money market is used by participants as a means for
borrowing and lending in the short term, from several days to just under a year. Money market
securities consist of
negotiable
certificates of
deposit (CDs),
bankers
acceptances,
Treasury bills, and
repurchase
agreements (repos),

Figure 3: Pakistan Interest Rate

etc.
Interest rates have a major link with the inflation of a country. In the given graph above we can
see that the government has been successful in decreasing the interest rate which has been
effective for the inflation control and it simultaneously supported the rapid growth of the stock
market. This decrease in the interest rate also changed the perception of a lay man who uses to
keep his money frozen in savings account they moved towards investments in setting up new
businesses and it on the same hand created opportunity for employment of unemployed. This
effective move and strategy of the government also supported in the depreciation of the PKR.
Money Market Mutual Funds
A money market fund refers to the mutual funds that only invest in money market
instruments. The instruments of money market are types of debt that mature in less than one year
and extremely liquid. Treasury bills constitute the bulk of money market instruments. Securities
in the money market are relatively risk-free. They are generally the safest and most secure of
mutual fund investments. Attention on interest rate offered should be considered when inventing
in money market fund.

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17

Types of Money Market Mutual Funds

Money market funds are of two types:

Institutional Money Market Mutual Funds

Retail Money Market Mutual Funds

Financial Institutions
Banks
Bank is an entity that presents a range of financial services for instance, borrowing and
lending money is termed as banking. The banks can be broadly classified into two types

Central Bank
Commercial Bank

Central bank
Central bank is the government monetary authority and issues currency, holds the
reserves of others banks, regulates the supply of credit and sells issues of securities for the
governments.
Commercial Banks
Commercial banks is a type of bank induces overall population will store their reserve funds in
the banks Also offers an extensive variety about benefits For example,

Deposit Mobilization
Money transfer
Financing Working Capital
Financing other trade related mode (import and export)
Investing in government securities
Call money operations
These banks are of three categories
Public Sector Banks,
Private Bank and
Foreign Banks

Investment Banks

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18

Investment banks carryout a range of functions. Their primary function is to support the
companies in raising the equity capital. In addition, they offer services such as fixed income
instruments, foreign exchange and shares listed on the stock exchanges. Commercial banks
cannot take deposits. They manage their affairs by charging fees such as
retainer fee, advisory fees based on the transactions, commission on underwriting and other
financial services.
Microfinance Bank
A microfinance bank would cater the credit needs of poor family units and their little ventures. In
this way microfinance bank give credit to those poor who are not viewed as reliable by the
business banks and other money related foundations. What's more, they give essential training in
start of small business, straightforward accounting, and bookkeeping. The fundamental purpose
of microfinance foundations is easing of destitution through helping poor persons to win some
cash particularly the ladies.
Islamic Banks
Islamic bank refer to a banking activity which is in accordance with the Sharia, the
Islamic Laws. Otherwise, there is no difference between the traditional banks and the Islamic
bank.
Insurance Companies
Insurance is a hedge against the risk of an unforeseen and questionable misfortune. In
different context, it is the equitable exchange of the risk of a misfortune, starting with one
substance then onto the next, in return for installment. For this administration, the safety net
provider charges an expense called premium relying on the risk included. Other than customary
insurance organizations, there are numerous Islamic insurance organizations in Pakistan known
as Takaful administrators. Takaful is an Islamic insurance idea in view of shared co-operation,
obligation, affirmation, assurance, and help between gatherings of members. These organizations
put stock in advancing the cause for Takaful and in addition advancing the insurance business in
a Shariah Compliant i.e. halal and completely Riba-Free insurance.

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19

Leasing
It is a contract where proprietor of a benefit consents to permit somebody to utilize it for
a fixed rental. It can be for fixed or uncertain timeframe. It is a coupling contract which sets out
terms of lease contracts between the proprietor and the client. Leases are of different types (i) a
monetary lease and (ii) a working lease. The money related lease is long haul and noncancellable contract where the client accepts a percentage of the risks of possession and has the
privilege to keep the benefits or get it exchanged to its own name in the wake of satisfying the
fundamental conditions. In working lease, the proprietor exchanges just the privilege to utilize
the advantages which is returned back toward the end of the lease.
Modarba
If is a form of affiliation which has two different parties: (i) the financier and (ii) the
manager. The financer takes no part of administration of the business. The profits are distributed
among the subscriber whilst the manager is paid the customary salary. Modarba is one the modes
of Islamic finance. It is like mutual fund minus its un-Islamic features. Not only in Pakistan, has
the Islamic financial services industry witnessed a phenomenal growth all over the Islamic
world. It has proved its resilience in this time of global financial turmoil.
Methodology
Design of the Research
It is essential for all the researches to have an explicit, systematic, and disciplined
approach towards the analysis of various topics by the utilization of methods that are most
appropriate for answering the research question. A qualitative research design focuses on the
perspectives of the observer towards the reality. It does is not involves manipulation of the
variables and involves the data that cannot be presented in numerical format. The emphasis of
this design is on the description and interpretation of the descriptive data that leads to the
generation of new concepts and organizational processes. Considering these significant aspects
of qualitative research design; this research has been performed through the aforementioned
design. There are two methods of data collection that includes primary and secondary data.
Primary data provides access to first hand resources while secondary data provides information
that has been presented by previous research. Therefore, a secondary qualitative research design

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20

has been selected for performing this study because it provides the opportunity to address the
aim and objectives of the research. Secondary method of data collection has been employed that
is based on the selection of the researches hat supply significant amount of data related to the
topic. The data was extracted from different past researches and official website of State Bank of
Pakistan. The data obtained from the preceding sources allowed the researcher to analyze the
performance of the financial market of Pakistan between the years 2001-06. Scrutinizing the
existing data has become possible through this research design, as the researcher was able to
collect significant information. This has assisted in the development of several themes for
providing information that is essential for performing the review.
Analysis of the Data and Emergence of Relevant Themes
Information provided through the researches and the official website of State Bank of
Pakistan has contributed to the collection of data for the review. Analysis of this information has
formed the basis of interpretation of the outcomes of literature review. The analysis has resulted
in the emergence of themes that are pertinent to the financial markets in Pakistan. The
framework for conducting the literature review has been supplied by the identification of themes.
These emergent themes have formed the structure of the review to be performed in a thematic
manner for providing the information that is significant to the topic.
For this particular study, thematic analysis was utilized to examine the data collected.
This analysis technique allows the researchers to critically examine various dimensions of the
Financial Markets in general and in the context of Pakistan. This data analysis technique allowed
the researcher to organize the entire literature review in a systematic manner. Moreover, these
themes also allow the researcher to examine those intrusions that are effectual without
comprising on the principles that were developed in inclusion criterion.
Thematic analysis plus critical evaluation of the collected data from past researches and
State Bank of Pakistan were utilized to extract the key findings of the study. It was found to be
exceptionally crucial to link the concepts from the primary researches together into group or
divisions in order to maintain the implication of the findings and outcomes of the study. The
concepts identified through this technique allow that researcher to study the quality, context and

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21

features of the researches under review. The information gained while assessing the study relates
to the exploration of the steady correlation between information recovered and dissection drawn.

Ethical Considerations
It is important to observe the ethics prior to initiating a research. Ethical considerations
posses a central position during the process of research. The ethics of a study are referred to the
speculative, rational and moral aspects of utilisation of anothers data in a way that does not lead
to its manipulation. This phenomenon is related with the features of responsible research that
focuses on the intensity of attentiveness and legalized repercussion that must be agreed upon by
the researcher when performing a study. The researcher is conscious of the fact that honesty is
fundamental, not only to permit direct familiarity, but to prompt a level of dependence and
trustworthiness in the outcome of the research. The primary principles of research are frequently
universal and comprise matters such as sincerity and reverence for individual rights. Therefore, it
has been ensured by the researcher that the findings and results obtained in this study are the
facts stated in the preceding literature and not based on representation of the actual statements
and ideas of previous researchers. Any counterfeit allegation or information has not been
depicted by the researcher in this report. Considering the fact that researcher is a reviewer of the
work of other researchers, it has been ensured that all the findings and information has been cited
and referenced appropriately.

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Data Analysis and Discussion

Money Market and Long-term Government Bond Market
Corresponding to the incredible advancement made by financial sector, specifically the
banking sector; SBP proceeded with its endeavors to advance money market and enhance
money related administration works on amid FY01-FY06. Subsequently, amid the period the
currency market saw (an) expansion inside and out of both primary as well as secondary
markets; (b) enhancement in efficiency; and (c) fall in volatility in short-term interest rates.
However, in relation to the long-term government bond market, mixed situation was observed.
At the start, the invention of the Pakistan Investment Bonds (PIB) resulted in the creation of
comparatively vibrant enduring government bond market. Nevertheless, the limitations in the
supply in the later time, ultimately in small activity in primary as well as secondary market of
Pakistan Investment Bonds making the longer-end of yield-curve non-representative of true
long-term interest rates.
Treasury Bills (T-bills)
The debt administration changes and measures to enhance fiscal administration by the
State Bank of Pakistan amid 1990s, helped in making a genuinely well working primary and
secondary financial market for transient government paper by FY00. In continuation of change
procedure, enhancements were made in fiscal administration amid most recent 5 years, which
together with sensational development in monetary sector exercises brought about further
increment in the profundity and productivity of money market. By and large, all banks were
approved to specifically take an interest in the closeouts of government securities. Since
treasury mastery crosswise over establishments was unequal, this setup was bringing on some
wastefulness in the market. This is reflected in high offer spreads in T-bill auctions amid
FY9500.

Financial Markets
Table 1: Treasury bill Auctions Summary

FY95
FY96
FY97
FY98
FY99
FY00
FY95- 00
FY01
FY02
FY03
FY04
FY05
FY06
FY01-06

Number of auctions
Held
Scrapped*
26
1
24
0
24
0
22
2
24
2
26
2
146
7
25
0
26
0
26
1
26
3
26
1
26
0
155
5

Number of bids
Received
Accepted
1,880
1,008
545
332
766
541
2,493
1,094
1,532
410
758
251
7974
3636
722
334
1,409
547
2,487
754
1,401
479
1,709
750
1367
643
9095
3507

Bid spread
in bps
190
53
107
213
196
125
147
58
69
73
85
77
31
66

*: Represents number of events, when entire auctions were rejected; Source: SBP

23

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Figure 4: Deepening of the T-Bills Secondary Market

In essence, these developments depicted the enhance efficiency and depth of primary
market of T-bills. The progression by the primary market of T-bills also led to enhanced
efficiency and depth in the secondary market of T-bills. A rising trend was observed in the
average daily trading volume of T-bills during FY01-06. In a more specific manner, it can be
seem that average daily trading volumes in T-bills rose from Rs14.6 billion in FY02 to Rs 45.2
billion in FY06. More essentially, the the rising trend in the trading volume was accompanied by
welcome declining trend in the volatility of interest rates in the secondary market as
demonstrated in the figure above . In addition, the average bid-offer spread of 6-month Repo rate
also depicted a downward trend showing improved market efficiency.
Pakistan Investment Bonds
A noteworthy highlight amid the period under audit was the presentation of the long haul
government bond, i.e., Pakistan Investment Bonds (PIBs). Prior in June 1998, the government
has quit issuing the then long haul government paper Federal Investment Bonds. Hence; there
was no long haul government bond that could meet the investment needs of banks, NBFIs,
insurance agencies, benefits reserves, and corporate bodies. However, the interest for a long
haul investment instrument by corporate (barring banks and NBFIs) kept on being met by the
National Saving Schemes (NSS).

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Table 2: Pakistan Investment Bonds

FY01
FY02
FY03
FY04
FY05
FY06

No. of Bids

Amount

Acceptance as

Held

Offer

Accepte

Offer

Accept

Offer

% of
Target

6
13
7
7
3
1

261
1,374
1,595
1,273
126
182

d
182
486
323
626
17
133

58.8
238.4
212.0
221.3
8.0
17.1

ed
46.1
107.7
74.8
107.7
0.8
11.2

78.4
45.2
35.3
48.6
9.6
65.8

94.1
115.8
113.4
85.4
8.6
112.4

Nevertheless, the FY05 and onward, PIB market witnessed severe liquidity crunch
illustrated in the preceding table. As short-term interest rates started rising in the in fourth quarter
of FY04, PIB became unattractive for market players due to expected large revaluation losses.
Banks moved to offload their PIBs holdings to lead a sharp increase in long-term interest rates in
secondary market in June 2004. In turn, the corporate sector also held off their demand as buyer
preferred to wait for interest rates to stabilize. As short-term interest rates continued the uptrend
throughout FY05, the demand for PIBs remained low
Interest Rate Volatility
Decrease in volatility of transient financing costs was another key improvement in the
money market amid FY01-FY06. As appeared in Figure 10, coefficient of variety of overnight
loan costs witnessed a sustained declining pattern from FY02 ahead, demonstrating that the
volatility in the fleeting financing costs has lessened after some time. This was made conceivable
basically because of enhanced liquidity administration by State Bank of Pakistan. Two focuses
are imperative in such manner; in the first place, SBP has fundamentally expanded the
recurrence of mediations in the market through Open Market Operations (OMOs) (see Table
below ); and second, following Q4- fiscal year 2005, SBP began leading OMOs of short
development; notwithstanding for a day.
Table 3: Open Market Operations (billion Rupees)
Injection Absorptio Frequenc

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FY01
FY02
FY03
FY04
FY05
FY06
Source:

45
242
55
73
55
530

n
103
56
67
411
611
733

y
28
36
10
33
52
92

SBP

Figure 5: Volatility of Overnight rates

26

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27

Figure 6: Maturity Profile of EMO

Performance of Foreign Exchange Market

During the fiscal year 2001-06, the foreign exchange market in Pakistan has undergone
major structural changes transforming from a volatile, segmented and thin market in fiscal year
00 to a stable, unified and relatively deep market in fiscal year 06.At the same time, the start of
foreign currency loans has increased the sensitivity of the foreign exchange flows to the changes
in interest rates (both in domestic and international markets); this has improved the exchange
rate channel of monetary policy transmission mechanism, as well. At the same time as the
foreign exchange market was undergoing significant changes under the Stand-by Arrangement
(SBA) program of the IMFit was the astonishing development following September 11, 2001
events that transformed the market dynamics. Exclusively, the international efforts against the
informal fund transfers diverted the foreign exchange flows to the formal channels that resulted
in collapse of the kerb market and virtual unification of exchange rates. It is eminent to mention
here that during periods prior to September 11, 2001 events, the foreign exchange market was
segmented into the inter-bank and the kerb market, with the kerb market premium varying in the
range of 7 to 9 percent. The collapse of the kerb market provided State Bank of Pakistan a
chance to streamline the businesses of the money changers by corporatizing them into exchange
companies. Therefore, the market segmentation which was a major distortion in the foreign
exchange market was eradicated. The sharp rise n forex liquidity in the interbank market also
enabled the State Bank of Pakistan to build up its foreign exchange reserves to unprecedented
level. Such high level of foreign exchange reserves has improved the economys ability to
absorb the external shocks and helped in stabilizing the exchange rate period of time nurtured
the liability dollarizaton (i.e., encourage foreign currency loans) in contrast to asset dollarization
(i.e., foreign currency deposits) in the past. Although the exporters and importers were allowed
to borrow in foreign currency from domestic banks since 2001, this facility was hardly used in
the past. One of the key reasons for the lack of demand for foreign currency loans was the
continuing downward pressures on exchange rate. However, with the reversal of expectations in
the foreign exchange market (following collapse of the kerb market) and relatively higher
interest rate on Rupee loans, foreign currency borrowing became more attractive.

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28

Table 4: Foreign Exchange Market size

These foreign currency loans have strengthened the linkage between the foreign
exchange market and the money market. Specifically, as foreign exchange loans adds to the
interbank foreign currency liquidity, the foreign exchange market has become more sensitive to
changes in interest rates (both in domestic as well as international markets) and expectations
regarding the exchange rate movement. In fact, traders can substitute Rupee loans for foreign
currency loans as they now have the viable choice to borrow either in foreign currency or in the
local currency.
Trends in the Foreign Exchange Market
While discussing the trends in the exchange rate, the advancements in the foreign
exchange market between the fiscal year 2001-2006 periods can be broadly classified into three
phases that are also represented in the figure below. The First phase (i.e., fiscal year 01) is
characterized by a shift in exchange rate regime from managed float to free float, and severe
pressures for the Rupee depreciation. The second phase (i.e., fiscal year to H1- fiscal year 04)
shows substantial enhancement in external account an unprecedented event in the history of
Pakistan that led to continuing appreciation of local currency for an extended period. The final
phase started from H2-FY04, where exchange rate again came under some depreciation
pressures.

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Figure 7: Movement of PKR against US dollar

29

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30

Performance of Capital market

Low interest rate environment coupled with investor friendly policies of the Government
along with the positive geopolitical developments that led to the turnaround in the
macroeconomic situations also had a significant impact on the equity markets of the country. The
increased investors confidence together with strong improvements in the corporate earnings is
reflected in the remarkable performance of the equity markets, especially since 2003. Although
the market encountered some major corrections, it remained among one of the best performing
markets in the world. In terms of the size of the market, and growth of indices, all the three stock
exchanges of Pakistan showed phenomenal growth. The Karachi Stock Exchange (KSE)
registered more than 700 percent increase in market capitalization and over 600 percent increase
in the index over the period of last five years. The same trend is also visible in the Lahore Stock
Exchange (LSE) and Islamabad Stock Exchange (ISE).
FY0

FY0

Total number of listed

0
762

1
759

2
725

705

666

659

658

companies
Total listed capital (Rs

229.

239.9

260.6

300.9

377

439

496

billion)
KSE-100 index

0
1,52

1,366

1,770

3,402

5,279

7,450

9,989

KSE all share index

0.7
942.

.4
870.4

.1
1,118

.5
2,168

.2
3,480

.1
4,876

.4
6,708

SBP General Index of

7
128.

118.7

.8
106.7

.5
204.9

.2
323.3

.9
362.8

.4
427.0

Prices
Initial public offering

8
3

10

11

(IPO) (in numbers)

New debt instrument

10

15

12

listed (in numbers)

Amount (billion Rs)
Trade volume (million

0.8
48,0

5.4
28,85

10.1
29,00

10.7
52,72

3.3
96,29

15.6
87,97

7.0
78,63

shares)
Market capitalization

97
394

9
342

5
412

0
756

7
1,422

2
2,068

3
2,801

(billion Rs.)

FY0 FY03 FY04 FY05

FY06

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Market capitalization as

10.3

8.2

9.4

15.7

25.2

31.4

36.3

percent of GDP
Value of shares traded

1,87

1,073

804.4

2,270

4,862

7,167

8,707

(billion Rs.)
Average daily turnover

7.8
193.

.0
118.3

120.4

.6
214.3

.0
386.7

.6
351.9

.5
319.6

(million shares)
Trading days
Turnover ratio
Portfolio investment

2
249
4.8
73.5

244
2.9
-

241
2.2
-10.1

246
4.1
22.1

249
3.4
-27.7

250
3.5
152.6

246
3.1
351.5

(US$ million))

31

140.4
Table 5: Performance of Capital market

Market capitalization of KSE as a percent of GDP, which stood at 36.3 percent at the end
of FY06 shows continuous improvement during the last five years. The rising market
capitalization indicates that in terms of the size, the market has been improving faster than the
economic growth. Another indicator, which reflects the market activity, is the trading volume
that registered a phenomenal surge during the period. In both FY03 and FY04 the trading
volume increased by more than 80 percent. Although the volume growth has been negative
during FY05 and FY06 but comparing the absolute volume traded during FY06 with FY99 the
increase is still many folds. Almost the same reflection is evident from average per day turnover
of shares and turnover ratio29 during the recent years compared with FY00 or earlier. In terms of
numbers of new initial public offerings (IPOs) too, there was significant improvement, with
number of IPOs rising from just 14 during FY00-FY03 to 27 during FY04-FY06. The number of
listed companies at KSE although showed some decline but the constant increase in total listed
capital indicates that, healthier companies in terms of market capitalization and other selection
criterion, have replaced the weaker ones. The performance of KSE-100 was outstanding even if
compared with some of the established and emerging markets of the region. As can be seen from
the Figure 8, the growth in KSE- 100 index outperformed all the major markets of the region.
This made Pakistans equity market not only attractive for the domestic investors, but also for the
foreign fund managers. The investor base witnessed continuous rise during the last five years and
especially so, during 2005 reflecting increased investor confidence. Investors accounts
maintained with the Central Depository Company recorded an exceptional growth of over 117
percent during FY05. While both individual and corporate accounts increased, the major growth
was witnessed in the individual accounts. As compared to 28.0 percent growth in the corporate

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account individual investor account recorded an increase of 120.8 percent.

Figure 8: Regional markets v/s KSE-100 index

Figure 9: Number of Investors accounts at CDC

32

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33

Figure 10: Number of Brokers accounts at CDC

Conclusion
Money related business sectors seen a surge done volumes same time enhancing
further As far as effectiveness Throughout FY01-06. Those long haul administration bond
(PIB) business will be at present immature generally because of supply imperatives. PDs
ought to assume a part over instructing their corporate customers with settle on finer
estimating choices also change. Those disappointment clinched alongside advancement about
long haul legislature bond advertise likewise adversely influenced those corporate security
showcase.
Increased size and role of financial markets is a welcome sign, however it is associated
with greater risks. Though market has already started to use simple derivative products, there is a
need to further develop derivative market to provide market with better risk management tools.
In equity markets, the March 2005 crisis hints towards market manipulation. Though number of
investors has grown tremendously over the years, few big brokers can still maneuver the market.
An alternate component imparting precariousness on equity businesses may be those vicinity for
badla/CFS financing that helps speculative exercises without correct exposures. Setting off
forward, there will be an have will further reinforce advertise ethics, differentiate investors base
What's more uproot badla financing together for superior danger administration instruments. The
outstanding performance of the equity market during 2001-2005 has brought Pakistans capital

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34

market to attention of the global fund managers. International investment firms such as Morgan
Stanley, Merrill Lynch, Goldman Sachs, etc. have entered the markets in association with the
local fund managers. With market capitalization reaching 2.8 billion, or equivalent to 36 percent
of GDP as of end June 2006, the significance of the equities market has increased for Pakistan as
well. Two major crises however indicate that there is plenty of room for improvement. These
events not only provide an opportunity for self-assessment but also highlight the need to
strengthen the governance of the exchanges.
To restore investor confidence, the SECP is systematically pursuing the strengthening of
the governance of stock exchanges by restructuring of Boards and appointment of independent
management. At the same time, strengthening risk management systems and demutualization of
exchanges is also being encouraged. Continuation of investor friendly policies, outlook of
improved corporate earnings and persistence with privatization, and improvement of regulatory
framework is likely to keep Pakistans equities markets attractive for both local and foreign
investors. The future outlook of the Pakistani bourses is indeed bright.

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References
http://sbp.org.pk/publications/FMR/Chapter_1.pdf
http://sbp.org.pk/publications/FMR/Chapter_4.pdf
http://www.sbp.org.pk/publications/FSA/2005/Chapter_7.pdf
file:///C:/Users/FAS-CW-2/Downloads/7_Financial_markets.pdf

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