Interest rate cut improves KSE-100 index but fails to attract foreign investment

As a reaction to a 150 basis point slash in the discount rate by the State Bank of Pakistan, the Karachi Stock Exchange 100-index gained 300 points in the first trading session after the announcement on Monday, October 10 to close at 12,154.

KSE-100 index is used as a benchmark index because of it includes the top-100 companies based on market capitalization and is the most liquid market in Pakistan.

SBP reduced its discount rate from 13.5% to 12% on Saturday, October 8 in a bid to encourage investment and subsequently initiate economic development. Traditionally, interest rates have never been reduced by more than 100 basis points, but an aggressive approach by acting SBP Governor Yaseen Anwar has taken many analysts and investors by surprise.

A fall in interest rates attracts investment to the financial markets because returns fall in the saving accounts and prices of bonds increase. Hence, theoretically and practically speaking, interest rates and investment in stock markets are inversely related.

Previously, the interest rates were intentionally kept high so as to focus more on the fiscal front. However, with no significant improvement in the taxation system and failure to control non-developmental government expenditure, a monetary expansion seems to be the most suitable option for economic growth.

A monetary expansion refers to a phenomenon where either the government indulges in open market operations or alters interest rates in a bid to expand or contract the economy.

Of late, volumes have dried up in the KSE-100 and foreign investment is being pulled out largely due to the increasing tensions between Islamabad and Washington. This trend is not favourable for the country, which has been plagued by economic distress and power crisis.

However, this decrease in interest rate has not attracted foreign investment significantly. In two trading sessions after the announcement, there has been a net outflow of $2,185,889 from the KSE, which is not a positive sign for the investors. A depreciating rupee has a major role to play in the outflow of foreign investment.

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Posted by Hammad Malik on Oct 12 2011. Filed under Business, Latest News. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry