BCom Notes Part II Economy of Pakistan Banking And Finance

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Banking And Finance

Monetary Policy

The development of financial markets and institutions is a critical and inextricable part of the economic growth. Financial sector deepening (financial development that includes not only an expansion in the financial sector, but also an improvement in institutions so that the financial system can allocate capital to its more productive uses more efficiently) and economic growth are empirically linked. The banking sector of Pakistan was nationalized and public sector financial institutions were expanded during the early 1970s, based on the objectives of directing banking activities towards national socio-economic objectives and ensuring complete security of depositor’s funds. The dominance of the public sector in banking sector and non-bank financial institutions, coupled with centralized policies marked with administered interest rates, domestic credit controls, high reserve requirements, use of captive banking system to finance large budgetary requirements of the government and controls on international capital flows were responsible for deterioration of financial institutions and their inability to play a vital role in economic growth of the country.

Monetary Policy stance of the State Bank of Pakistan has undergone considerable changes over the last several years switching from an easy to a broadly accommodative stance and then from a gradual tightening to an aggressive tightening stance till date.

Tight Monetary Policy pursued during the year slowing down the credit growth to private sector from 19.8 to 12.4 percent. The volume of credit also declined substantially in the same period clearly suggested that the policy stance has considerable success in shaving off excess demand in the economy. The impact of tight monetary was felt considerably in textiles, cement, commerce and personal loans. However, other factors also contributed to slower growth in private sector including credit from non-banking financial institutions, availability of foreign private loans and issuance of corporate bonds in international capital market by private sector companies, mergers and acquisition in the banking industry and continuous monitoring by the State Bank of Pakistan of the personal loans not being used for speculative activities.

Money Market

Money market of Pakistan is engaged in short term lending and borrowing of money. To take one example a company with surplus short-term funds might deposit these funds with its bank, which in turn uses, the money to purchase treasury bills issued by the State Bank of Pakistan. Money market links the following three institutions.

1. Banks and all other financial institutions.

2. Companies and trading firms.

3. Central Bank.

State Bank continued to exercise tight monetary policy and therefore it intervened quite frequently in the inter bank money market to achieve the desired results. Tight money market conditions were also reflected in rising interest rates in the secondary market, particularly the short-term rates as 6 month and 12 months. Tight market conditions also led the commercial banks to raise the average deposit rate thus general deposits are benefited. Strong demand for Treasury bills continued in the current fiscal year also. State Bank accepted Rs. 688.8 billion from primary market of treasury bills during the nine months of current year compared to Rs. 1052.0 billion in the last year (12 months).

Capital Market

Capital market play crucial role in investment promotion and economic development of a country. To make Pakistan’s capital market an attractive window for potential investors govt. has taken a number of initiatives to streamline the taxation system especially on dividend income of foreign investors, extension of tax exemption on capital gains and permission for the private sector to launch open-end mutual funds etc. As a result of successful implementation of the successive reform measures the capital market has been growing by leaps and bounds and has emerged as one of the important pillars of the economy.

The pace of country’s privatization program has gathered greater momentum as a number of public sector banks and corporations have been privatized while some other are in pipeline. Under new privatization strategy, government is selling off its shares of state controlled enterprises by listing them on the bourses as well as a view to broadening and deepening capital markets. The low interest rate environment of the last three years has been a positive development for the country’s stock markets as investors seeking higher returns entered the markets with a bang; causing boom in stock exchanges.

The improved performance of stock market can mainly be attributed to consistent and transparent economic policies resulting in strong economic growth, a successful privatization processes attracting foreign investors in prestigious organization like PTCL and National Refinery, sound monetary policy of State Bank, maintenance of fiscal discipline and capital market reforms including development measures introduced by stock exchanges with full support of Securities and Exchanges omission of Pakistan. The privatization of government units through bourses helped to broad base the equity ownership to a significant level.

There are several factors that contributed to the bullish sentiment in stock markets during the last several years. These factors includes:

1. Speedy privatization process.
2. Attracting foreign investors in prestigious organizations like PTCL and National Refinery.
3. Early resolution of the IPP issue.
4. Allowing foreign investor to repatriate their funds without any restrictions.
5. Reduction in the interest rates by the banks.
6. Recovery of outstanding/over due loans.
7. Rescheduling of foreign debts and prepayment of the expensive foreign loans.
8. Continuous improvement in economic fundamentals such as economic growth, sound monetary and fiscal policies with fiscal deficit under control.
9. Higher revenue collection.
10. Lower inflation.
11. Rising export earnings and stable exchange rate.
12. Declining debt burden and higher industrial growth.
13. Efficiency in trade through automation and curbing insider trading.
14. Strengthening the structure of the Security Exchange Commission of Pakistan.

As a result of these important development capital and stock markets in Pakistan grew by leaps and bounds during the last seven years and emerged as one of the best performing markets in emerging economies

Mutual Funds

Mutual Fund is an institution established for investing a pool of funds in various type of securities/shares for the benefit of investors. A small investors is unable to diversify his portfolio of funds simply because of high investment required for diversification. Mutual funds provide a means of diversification of investment by small investors. Initially mutual fund collects funds from small investors and when sufficient funds are gathered, and then they are invested into securities of different types, thus diversifying the portfolio. A management company manages a mutual fund. A Portfolio Manager, whose responsibility is to satisfy the desire of the investors, manages the portfolio of mutual fund. The fund manager invests money on behalf of the investors. The fund manager is paid a management fee. If there is a profit or gain on investments, it belongs to the investors. In case there is a loss, it is also borne by the investors.

Types of Mutual Funds

1. Open-End Mutual Funds

An open-end fund does not have a fixed pool of money. In it subscription and redemption of shares are allowed on a continuous basis. The price at which the shares of open-end funds offered for subscription and redemption is determined by net asset value after adjusting for any sales load or redemption fee. In Pakistan there exist 13 open-end mutual funds listed at Karachi Stock Exchange.

2. Close-End Mutual Funds

A closed-end fund has a fixed pool of money, which is collected when the fund is set up. In it shares are initially offered to public and traded in secondary market. The trading usually occurs at a slight discount to the net asset value. Now mutual fund managers have developed a variety of investment products to cater for the requirement of investors having different needs.

A mutual fund can generate profits from three different sources i.e.,

1. dividend
2. capital gains
3. appreciation of share price

Mutual fund generates income from dividends received from other joint stock companies whose shares the fund holds. A mutual fund uses this dividend income to distribute dividend to its own stockholders. The capital gain generated by mutual fund is also used to pay dividends to investors of the fund. Mutual funds also increase investment of their shareholder through appreciations of share price of mutual fund. In Pakistan there exists 23 close-end mutual funds listed at Karachi Stock Exchange. There is tremendous growth potential for mutual funds as vehicle to maximize their earnings from share-market. Commercial banks and insurance companies have also emerged as big institutional investors. Government also provides safety nets to the investors by regulating the mutual fund business.

Pakistan’s Mutual Funds sector is still at the nascent stage and has yet to achieve mainstream status. The regulators along with the institutions need to promote international best practices and corporate governance, spread consumer awareness and maintain investors confidence, Pakistan’s mutual fund industry is witnessing exceptional growth owing to upturn in the country’s economy. Initially the market was dominated by public entities like ICP, NIT but with the emergence of private sector assets managers, the mutual fund sector is heading in the right direction. Currently mutual funds accounts for only 2.4 percent of the country’s GDP compared to 6 percent for India and 69 percent for the USA. Mutual fund accounts for 16.5 percent of Pakistan’s national savings