ON August 27, the Karachi Stock Exchange board decided to place a ‘floor’ mechanism to prevent the stock prices from falling below the closing prices of that day.

The reason cited for this, at that time, was to avert a collapse of the stock exchange clearing system and allow it a few days to ‘cool’ down.

It remains to be seen how many brokers or institutions will actually go belly up if and when the market re-opens to normal trading. But what is not realised is that putting curbs on the capital market will actually be counter-productive.

Pakistan has had about 4-5 years of high growth and witnessed massive foreign direct investment (FDI) and foreign portfolio investment (FPI). These inflows supported external accounts to a great extent and gave much needed cushion to the economy. However, over the past year or so, there has been a fall in both the FDI and the FPI which is mainly attributed to various reasons such as volatility in global equity and financial markets, deteriorating domestic politics and changing economic scenario.

As foreign money inflows started to slow, the currency, which was quite stable over the past few years, lost almost 25 per cent of its value versus the greenback since January. This entailed a reversal of funds flows, as large foreign funds started to divest their portfolio investments. With the rupee sliding, foreign funds decided to go for aggressive selling , putting further pressure on both foreign exchange reserves and the economy.

The stock market capitalisation has been eroded by about $40 billion in a short span of time. This has also resulted in wealth erosion across the board with brokers taking a big hit, as proprietary positions continued to build up, and clients defaulted on their obligations. The brokers felt that it was imperative to enforce a floor, otherwise, apart from some brokers, the stock market clearing house could default.

They argue that had the floor not been placed , the result would have been disastrous. However, no one can say for sure this would have actually happened. In fact, had the floor rule not been enforced, the market may have fallen initially but also found a reasonable bottom. Foreign funds may actually have come in to buy shares which offered value and growth. Confidence may have actually been better than it is today, as many brokerage houses do not have much to do.

Yes, it can be argued that had the stock market remained open, it would have caused more financial losses to brokers, banks and other financial institutions which have links with the capital market. It would have put further burden on the central banks reserves because of the outflows from the capital market by foreign funds. But, it can be argued that if we allow foreign funds to come into the country, we must also allow them an exit strategy.

Had the markets been open today one may have seen the markets fall but at the same time some of the longer-term funds looking for value may have come in to buy as well.

Another step taken by the SECP on the instructions of the Mutual Funds was to ban any further investment or redemptions. Local mutual funds had cited a rise in redemptions but owing to the floor mechanism, the same could not be honoured, which had put further pressure on the funds.

In normal circumstances, local mutual funds would have actually put money in falling stock prices, but sadly, curbs were put against redemptions and further investments which would be undone three days after the market reverts back to normal trading.

This decision has eroded market confidence, and the mutual fund sector, which is still at its infancy stage, has received a jolt and money will take time to flow back into this industry. These investors will go back to the government-sponsored scheme such as the National Savings Schemes.

The new advisor on finance Shaukat Tareen should undo these steps to bring back market confidence. He must also make sure such steps as market intervention, changing of rules overnight without any consultations with stakeholders, must be avoided in the future.

The only way to restore market confidence is to leave the market to its natural course and ensure that rules and regulations are strictly followed.

The writer, a stock broker, works for a private equity firm.