WORLD ACADEMIC JOURNAL OF BUSINESS & APPLIED SCIENCES-MARCH-SEPTEMBER 2013 EDITION

Journal of Economics & Finance (JEF)

AUGUST 2013 VOL.1, No.1

Stock Market Reforms and Its Impact on FPI in Pakistan

Dr. Rashid Saeed, Muhammad Arshad, Rab Nawaz Lodhi, Zeeshan Fareed (Corresponding author) COMSATS Institute of Information Technology, Sahiwal, Pakistan Accepted 19 August 2013 Abstract In this paper, the impact of stock market reforms is analyzed on foreign portfolio investment. Time series data is collected on these variables and correlation and regression test is applied on this data. E-views version 7 is used to analyze the data. Correlation shows positive relationship between variable which suggest that reforms are deriving factors of foreign investment. Results show the positive relationship between SMR and FPI. Key Words: Foreign Portfolio Investment, Correlation, Stock Market Reforms 1. Introduction Stock exchange is a physical location where buying and selling of share takes place. Stock exchange is a place where different companies list their stock and provide the facility to liquidate investments (Pankow, 2005). Stock markets make available the mechanism where people who want to purchase stock can buy stock from other people who already possessed them. Stock market is not only a place to match sellers and buyers but also to agree them at one price. Stock market is not place to buy stock direct from the company but from the investors who already owned them. Thats why stock market is a place where investors liquidate their investment by selling them to other at stock market. (J.Angel, 2002) In past role of stock exchanges was only limited to rules issues and clarification of existing framework aspects. But with the passage of time regulatory functions were shared between stock exchanges and supervisory agencies of capital markets. In addition to these improvements in corporate governance and obedience of different legislations is also monitored by stock exchanges. (Koldertsova & Alissa, 2009) In this paper study is made to observe the impact of stock market reforms on foreign portfolio investment in Pakistan. Reforms that were implemented in different periods are considered to attract foreign investors .whether these reforms brought desired results depends upon two situations. First when these reforms implemented then to what extent these reforms where followed up and monitored to achieve expected results. Second there also some other factors which have also direct effect on FPI. These factors effect positively and negatively to FPI. So it may happen that reforms have not so distinct influence on FPI but the factors like GDP and Government stability are attractive indicators for foreign investors to invest in stock market. But in opposite context it may also happen that stock market reforms have played an important role to incline for investment but the factors like exchange rate and government instability are hurdle for investor to make investments. But from past studies it is cleared that stock market reforms ever had vital role to bring foreign investment. Particularly in the era of globalization and competition it is not only compulsory for developing countries to make attention of investors to their stock markets but also have same importance for developed countries to introduce various reforms
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regarding capital markets to retain and attract more investors. 1.1 Problem Statement Stock market reforms are very important source of motivation for investors. Study regarding the stock market reforms and its impact on foreign portfolio investment is not conducted yet in Pakistan. So there is need to explore the relationship between stock market reforms and FPI. 1.2 Objectives of the Study To check the relationship between stock market reforms and foreign portfolio investment To examine the role of stock market for foreign investment 2. Literature Review The Securities and Exchange Commission of Pakistan (SECP) issued a fresh directive for reducing a number of directors of stock exchanges which was a vital step towards demutualization. It is worldwide realization that for efficiency and transparency of operations of bourses stock exchange demutualization is of basic importance. According to SECP directive 13th August 2002 all stock exchanges must possess eight directors who will be elected four from the members by stock exchange general body other fours will be placed from amongst professionals by the Commission. A director will be the MD of stock exchange. Chairman of the board of directors will be elected from non- member directors by the board were a major change. Prior the directive an exchange was consisted of 17 directors, seven nominated by SECP and remaining by the members. MD was in addition to these who were allocated by the board. The dominancy of brokers with vested interests decline to much extent and most welcomed by small brokers who had little share in previous brokers dominancy role. These were the measures which attract independent institutional investors and Asian Development Bank toward Pakistanis capital market. Along with the protection of interests of members Regulator also protects the interests of capital issuers and investors thats why Code of Corporate Governance was made a part of listing by Regulator. (Rizvi, 2002) Stock market that is well-managed attracts the investment from foreign in country. Investigations have shown that there is positive relation between FDI and stock market reforms. (Raza, Iqbal, & Ahmad, 2012) What would be done to attract investment in developing countries there was need to take major steps. In 1980s and 1990s steps regarding stock market liberalization were taken by developing countries. Due to this in emerging markets market capitalization was increased by 1007% as compared to developed markets 253%. (Qayyum & Husain, 2005) Dual listing means listing of securities on more than on stock exchange. Dual listing play prominent role in stock investment. If dual listing happened before market segmentation and there is unique security that is dually listed would lessen the market segmentation with the improvement in risk sharing. (Serra, 1999) Cross listing means that listing of securities on stock exchange in foreign country along with domestic country. Cross listing is more important than dual listing as it generate more foreign n investment than dual listing. Investors awareness and liquidity both can be improved by listing on foreign stock exchange. Firms can obtain incentive of cross listing by lowering capital cost. (Serra, 1999) Cross listing has lot of benefits for any country. Advantages like development needs, diversification of wealth, greater efficiency, low cost capital cost, enhance market access for small size stock markets and lessen the effect of outflows of foreign investment in the shallow markets. (Adelegan, 2008) Pakistans stock market indicated a reasonable spirit in the background of stout economic growth. However political instability resulted in low. A floating stock market can be recognized in the continuity of macroeconomic policies by government and apex regulator the Securities and Exchange Commission of Pakistan implement stock market reforms. A record maker Karachi Stock Exchange became 6th best performer among the emerging stock exchanges in year 2007. 652 companies with paid up capital of amount Rs.690.1 billion were
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listed on 30th March 2008. During May-July 2007-08 political and economic events played a significant role in settlement of investors sentiments positively and negatively in local bourses. (Servey, 2008) Market friendly actions were taken in 1990s that include privatization on state owned enterprises and commercial banks, industrial sanctions deregulations, permission for private sector to establish commercial & investment banks and allowing foreign investors to trade shares openly at stock market with facility of repatriation, foreigners have equal access for borrowing from local banks and permission to have ownership up to 100% shares in a venture, disinvestment proceed and to remit dividend. These all steps act as catalyst in stimulating the confidence of foreign investors in countrys stock market. Within in interim of four years (1990-91 to 1993-94) price index of Karachi raised by 48.3% along with aggregate market capitalization uplift from 68.4 to 404.6 billion rupees, increase in number of listed companies from on Karachi Stock Exchange from 542 to 724 and total turnover in shares from 0.4 to 2.2 billion . In next four years 1994 to 1998 several international and domestic adverse factors dominated stock markets in Pakistan. (Statistics, 2002) To resolve these adverse factors a number of structural initiatives were taken to make improvement of workings and depth regarding Pakistans stock market. Furthermore infrastructural facilities were strengthened by restructuring the Corporate Law Authority (presently Security and Exchange Commission of Pakistan) and promoting free market environment. Overseas Pakistanis and foreigners were permitted to bring new investments with no any prior approval by exemption of some specified industries. For the encouragement of small savers to participate in stock market they were given fiscal incentives. In 1995-1996 out dated Capital Issue Act 1947 was abolished for improvement in self-regulatory character of stock exchange in Pakistan. Other steps that were taken included tax exemption on capital gains, on bonus shares and on fixed income securities for foreigners investments. As per expectation however all these incentives could not be helpful to restore the confidence of investors in response to all positive measures that were taken. The salient developments of Pakistans capital markets were a) establishment of Central Depository System b) trade automation in all three stock exchanges c) establishment of Credit Rating Agencies. To bring transparency in stock market, a proper system was introduced for the inspection of records and books of brokers. Failure to compliance with regulations one had to face penal action. (Statistics, 2002) 3. Theoretical Framework 3.1 Model of the study Figure 1 3.2 Measurement of dependent and independent variables In this study stock market reforms (SMR) is our independent variable and foreign portfolio investment (FPI) is dependent variable. 3.3 Hypothesis Ho=There is no positive relationship between SMR and FPI H1= There is positive relationship between SMR and FPI 4. Methodology This study is conducted for a country of Pakistan. Series data is collected that covers the period of twenty seven years from 1985 to 2011 that enable to evaluate the impact of stock market reforms on foreign portfolio investment. The data source is International monetary fund (IMF) supplemented with International Financial Statistic and World Development Indicator. The study is conducted by using tables, graphs and statistical techniques specially using correlation analysis and regression test with the help of software (E-views version 7). FPI = + 1SMR + SMR=Stock Market Reforms FPI=Foreign Portfolio Investment
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=Represents the Intercept =Error term Table 1

1=Coefficient of Stock Market Reforms Figure 2

Table 2 5. Results Table 3 shows the P value .07 which is less than .1 so, our null hypothesis is rejected and our alternative hypothesis is accepted. The beta co-efficient is 39.72 which explained the dependent variable 39.72%. The R-squared value is .12 which shows the goodness of fit of our model and this value shows that our model is not good enough and also Durbin-Watson has less value than 2 which is not consider statistically good and this is due to less number of observation.Table 3 6. Conclusion The time series data that is collected about stock market reforms and foreign portfolio investment is tested by applying analysis of regression and correlation. Results show that there is positive correlation between variables which indicates that stock market reforms derive foreign portfolio investment in Pakistan. So it means that reforms implemented by Security and Exchange Commission of Pakistan (SECP) and government of Pakistan induced investments in all three stock exchanges namely; Karachi Stock Exchange (KSE), Lahore Stock Exchange (LSE) and Islamabad Stock Exchange(ISE). 7. Recommendations This study suggests that stock markets reforms play vital role in attracting foreign investment in any country. So when any stock market in is introduced then there must be proper check and balance on it and its post evaluation results be carefully monitored. Reforms should be flexible so that these can be restructured by considering the feedback and responses of investors. Management of stock exchanges and government are key player that can not only introduce different reforms in stock market but also can monitor these reforms. 8. Limitation of the study Due to less number of observations the results are not more significant that can be improved by increasing the number of observations. The above model may be influenced by some other control variables like GDP and exchange rate so; model can also be improved with the help of control variables. 9. References Pankow, D. (2005). Understanding stocks and stock markets. FE-605 -4. J.Angel, J. (2002). Market Mechanics. 24. Koldertsova, & Alissa, H. C. (2009). The Role of Stock Exchanges in Corporate Goveranve. Rizvi, S. A. (2002). STOCK MARKET REFORMS. Islamabad: Pakistan Economist. Raza, A., Iqbal, N., & Ahmad, Z. (2012). The Role of FDI on Stock Market Development: 4. No.1, pp.26-33. Qayyum, A., & Husain, F. (2005, March). Stock Market Liberalizations:. Serra, A. P. (1999). Dual-listing on international Exchanges. 5, No.2, 165-202. Adelegan, O. (2008). Can Regional Cross-listings Accelerate Stock Market Development. WP/08/281. Servey, E. (2008). CAPITAL MARKETS. Islamabad. Statistics, G. (2002). Capital Market. Islamabad.

Stock Market Reforms

Figure 1: Model of Study
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Foreign Portfolio Investment

WORLD ACADEMIC JOURNAL OF BUSINESS & APPLIED SCIENCES-MARCH-SEPTEMBER 2013 EDITION

Sr. No. 1 2 3 4 5 6 7 8 9 10 11 12 13

Year 1985 1991-94 1992 1994 1994 1995-96 1997 1998 1998 1998 2001 2002 2007

Stock Market Reforms Stock market liberalization Repatriation,100% ownership in venture and disinvestment Cross listing & Dual listing Trade automation Establishment of Credit Rating Agency Abolishment of outdated Capital Issue Act 1947 Establishment Central Depository System No prior approval for investment Promotion of free market environment Restructuring of corporate law authority Online internet based trading Demutualization of stock exchanges Floating stock market

Symbols Lib Rep CL DL TA CRA CIA CDS AI FME CLA IBT Dem FSM &

FPI $ millions 110.35 92.49 to 1,471.36 371.94 1,471.36 1,471.36 3.68 to 260.86 279.00 19.00 19.00 19.00 192.00 722.00 2,086.00

Table 1: Stock Market Reform Summary Sr. No. 1 2 3 4 Year 1985 1986 1987 1988 SMR 1 1 1 1 FPI 110.35 83.42 132.35 126.90 Sr. No. 15 16 17 18
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Year 1999 2000 2001 2002

SMR 10 10 11 12

FPI 120.00 9.00 192.00 722.00

WORLD ACADEMIC JOURNAL OF BUSINESS & APPLIED SCIENCES-MARCH-SEPTEMBER 2013 EDITION

5 6 7 8 9 10 11 12 13 14

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

1 1 2 3 3 5 6 6 7 10

15.50 87.35 92.49 371.94 293.05 1471.36 3.68 260.86 279.00 19.00

19 20 21 22 23 24 25 26 27

2003 2004 2005 2006 2007 2008 2009 2010 2011

12 12 12 12 13 13 13 13 13

276.00 246.03 770.00 1969.00 2086.00 269.00 608.00 108.00 118.00

Source: International Monetary Fund Table 2: Time Series Data on SMR and FPI Dependent Variable: FPI Method: Least Squares Date: 05/27/13 Time: 07:52 Sample: 1985 2011 Included observations: 27 Variable C SMR R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) Coefficient Std. Error 101.3798 39.72071 0.118307 0.083040 539.4216 7274392. -207.1158 3.354549 0.078962 193.9746 21.68702 t-Statistic 0.522645 1.831543 Prob. 0.6058 0.0790 401.4919 563.3172 15.49006 15.58605 15.51860 1.325694

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

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