The Karachi stock market is on a roller coaster ride. After having outperformed the rest of Asia until March 14, by which date the KSE-100 index had topped 1930 points, from 1322 on January 1— showing a gain of as many as 600 points in less than three months— the market has fallen back to shed almost one-half of all those gains in the recent sessions, as nervous investors peer across the horizon to look out for the war clouds.

Valuations of some of the blue chip stocks have turned as cheap as 6 to 7 times the prospective earnings. But except for the bold and venturesome, investors in general are understood to have put their stock picking plans on the hold— this also being the budget season. Several stock brokers and equity analysts are expecting the federal budget 2002-03 to be a tantalising mixture of sweet and sour measures for the capital markets.

Until the recent flare up of tensions on the country’s western borders, the Finance Minister had been confidently talking of the upcoming budget—third from the present government— as “tax free and investment friendly”. This optimism having been sparked by the transformation of Pakistan’s once-weak balance of payments position into an unbelievable current account surplus of close to 3 billion dollars. “It’s a dream come true for the economic managers of Pakistan”, says an analyst. Whether that view would change after the recent events on the borders needs to be seen.

The expected measures in the forthcoming federal budget, which would directly impact publicly traded equities and the stock market include: restoration of tax exemption on bonus shares; exemption of income from Term Finance Certificates (TFCs); elimination of exemption of capital gains tax for foreign investors; imposition of tax on all income from National Savings Schemes and reduction of the corporate tax rate. The Karachi stock exchange is also urging that Investors’ Protection Fund and the Clearing House Protection Fund be exempt from current taxes. “The main focus of investors will be the capital gains tax on foreign institutions and the cut, if any, in the corporate tax rate”, says Mohammad Sohail, head of research at brokerage house, InvestCap. He explains that the government had provided a 3-year tax exemption (till assessment year 2005) on capital gains from trading in shares, but reports indicate that it could be withdrawn for foreign institutions and funds. There is also the general expectation in the air that corporate tax rates may be reduced. Public limited companies are currently taxed at 35 per cent while the corporate tax rate for private limited companies is 45 per cent. Will there be a reduction of another 5 per cent corporate tax rate this year? Some analysts doubt that it would come to pass for the entire corporate sector, given the stagnant tax revenues in the last two years. The CBR’s budgeted tax collection target of Rs 458 billion for the current year, has had to be revised downwards for no less than three times— thanks to a lenient IMF view this time around. The fresh post has been set at Rs 414 billion, but says an analyst: “The way things are moving, even touching Rs 400 billion will be a miracle”— the 10-month (July-April 2001-02) collection being just about Rs 306.5 billion.

Market is also expecting a 4-5 per cent cut in corporate tax rate for commercial banks. The tax had been reduced from 58 to 50 per cent in the last budget. “Government might now go on to reduce the banking sector’s tax rate to 45 per cent, boding well for its profitability”, says Saad Hashemy, head of research at brokerage firm, IP Securities. He also sees the local cement industry to receive some benefits so as to make it competitive for exports to Afghanistan.

Restoration of tax exemption on bonus shares is important for investors in stocks. Last year, the government had imposed tax on bonus shares, but that had to be lifted following investors’ protests. Another positive for the equity market could be the possible abolition of tax exemption on income from National Savings Schemes (NSS). In the previous budget, income from NSS exceeding Rs 300,000 was taxed at 10 per cent. That slab may now be removed with income lower than Rs 300,000 also to be brought under the tax net. The government has already announced that it would adjust NSS rates every six months in line with the prevailing interest rates in the economy. Analyst at InvestCap expects the rates on those schemes to be reduced by 80 to 100 basis points, from July 2002 as yield on long-term government bonds has come down in the last six months.

Only two new equity offerings have come up on the Karachi stock market, so far this year: One, the share issue by World Call Multimedia and second, the disinvestment of 10 per cent government stake in National Bank of Pakistan. But, like last year, companies have continued to raise cash through the offer of Term Finance Certificates (TFCs). The corporate sector is asking for an exemption of TFC income from taxes. Withholding tax at 10 per cent has to be paid on profits from TFCs. In the previous budget, individuals holding TFCs were brought into the tax net. The public offerings of most of the recent TFC issues have been over-subscribed, which mirrors the investors’ mood. There is an obvious preference for fixed income offered by TFCs, over the volatile and high risk investment in stocks.