Development of Capital Markets
Abdullah, Mian Mumtaz, Economic Review
Capital Markets play a very important role in the economic growth of countries by channeling savings into the most promising investment opportunities. A market based economy needs financial markets which are free to price and allocate capital efficiently and in the process transmit efficiency to the real sectors of the economy. However, to develop efficient and dynamic capital markets it is essential that a proper climate is ensured. Governments can lay the foundation for capital market development by establishing an effective policy framework. The elements of such a frame work include:
a) Implementing consistent policies that encourage use of long term financing by corporate entities.
b) Removing disincentives or establishing incentives to increase the demand for securities by individual and institutional investors.
c) Providing necessary protection to investors to increase their confidence.
d) Organizing and improving the financial intermediation process in the primary and secondary market.
e) Improving disclosure and accounting standards to provide more reliable information to investors and;
f) Removing legal barriers to market development.
Keeping in view the above elements we can analyse the development of the capital market in Pakistan. The principle of following consistent and uniform policy for encouragement of use of long term finance has been followed to a certain extent only. All Governments have tried to encourage long term financing by giving various incentives. One of the major incentives given in the last ten years has been the protection from foreign exchange value fluctuations by prescribing a Foreign Exchange Risk fee. However, this was to safeguard the investors from consequences of fluctuations of foreign loans. Other incentives and policies have had an indirect bearing on the use of long term financing like exemption of certain bonds from income tax and zakat. But again it has not been a uniform policy and has been rather selective. To encourage the bond market, such incentives need to be given to all bonds which are floated, even by the private sector, on a uniform basis or not to any one individually. Again fiscal policies must be consistent and any variations can disturb the development of the market. An example of such inconsistent policy is with regard to the taxation of dividends. It was not taxed initially, later on it was to be taxed at 7-1/2 per cent of such income above Rs. 15,000. It was increased to 10 per cent and later on the limit was also removed. But perhaps the most glaring inconsistency in Government policy has been the withdrawal of Income tax, exemption status from the Modarabas. This exemption was given through a low and implied permanency. It was intended to promote an Islamic mode financing but the moment it started taking off, the exemption was withdrawn.
The second principle regarding removal of disincentives and grant of incentives to increase demands for securities has been more consistently followed. Every Government has tried to give more and more incentives to encourage the securities market. The present Government has gone beyond incentives encouragement and has removed the disincentives in the way of development of the capital market in Pakistan. The previous Governments had financial structural policies which favoured deposit banks and Government securities in general and thus slowed the growth of securities markets. The establishment of commercial banks, investment banks, leasing institutions and mutual funds in private sector were made difficult, although they were the key securities market savings mobilization and allocation institutions. The present Government has adopted policies which are aimed at liberalizing the financial markets. Measures taken by it in this connection which have encouraged the development of capital markets include:
a) Privatization policy of the Government and expansion of the corporate sector whereby areas hitherto reserved for public sector were opened to the private sector. …