Financial Literacy and why it matters

This is a continuation of the last week’s article, but today’s article aims at explaining why financial literacy matters, that challenges of financial literacy are far, wide, and global – not only for us – even though ours may be larger and with urgency for actions.

As it were, financial literacy is a key pillar for any financial inclusion framework, and a critical success factor for financial mobilization and in extension achieving not only the efforts to finance the socio-economic development intent, but also helping humanity achieving at least nine of the 17 United Nations Sustainable Development Goals (SDGs). For instance, it is being said — eliminating poverty and achieving gender equality is simply not possible when two thirds of adults worldwide remain financially illiterate and women continue to trail men in financial decision making.

But, when people make reference to ‘financial literacy’ what do they real mean. Financial literacy may mean different things to different people. However, Investopedia defines it as an understanding of various financial areas including managing personal finances, money, and investing—which covers a range of applications that can vary from bringing marginalized communities into the mainstream in low-income countries to removing gender disparities in affluent countries, and everything in between.

In 2014, Standard & Poor’s in partnership with Gallup World Poll set out to get a handle on these issues. They surveyed 150,000 respondents across 140 countries regarding their understanding of basic concepts of risk diversification, inflation, numeracy, and compound interest. Those answering three of four questions correctly were deemed to be financially literate.

The survey revealed that although the problem of financial illiteracy is universal, women, low-income individuals, and the less-educated suffer from greater disparities in financial knowledge. Country-level financial literacy rates range from 71 percent (across Scandinavia) to 14 percent (Afghanistan, Albania) of the adult population. Worldwide, 35 percent of men are considered financially literate while 30 percent of women are considered financially literate.

Tackling Financial Illiteracy: The truth is, the problem of financial illiteracy is solvable, and when overcome, it can unlock solutions to an array of social challenges by making access to finance more widely available. Strategies to raise financial literacy rates are simple and require relatively low and non-recurring investments.

The stakeholder system for imparting financial literacy on a global scale is vast and disparate, but still there are adequate resources as explained here below:

Funding: Financing for the effort is coming from both public and private sources. One of the earliest champions of financial literacy, U.K.’s Department for International Development (DFID), created the Financial Education Fund to promote financial literacy in several African countries. The World Bank’s Universal Financial Access Program has recently led efforts to enable universal financial access for all. Other such as the Mastercard Foundation, Bill and Melinda Gates Foundation, etc have also actively invested in this cause. At some specific local levels, there are recognizable efforts by public and private sector actors towards this front.

Regulation: From the legal/regulatory perspective many central banks are currently working to strengthen financial literacy. In Tanzania for instance the Bank of Tanzania (BOT) through Financial Consumer Protection Regulations requires fair and equitable treatment of consumers who take out loans and other financial services and the BOT has directed banks to ensure consumer protection and education programs are implement across bank branches country wide. This is partly the recognition that a customer will typically never know enough and therefore informed consent and service provider liability should be introduced at the point of transaction.

Technology: on technology there are a number of start-ups, consulting firms, and quasi-governmental organizations that have developed low-cost assets or solutions for financial literacy. For instance, the Bill and Melinda Gates Foundation in partnership with other institutions have created mobile podcast videos focused on teaching financial literacy. Here at home, DSE runs an annual edutainment program (DSE Scholar Investment Program) to train and educate students on matters of savings and investment from the practical aspect.

Measuring Impact:  Impact assessments for financial literacy interventions are rare, however outcome indicators are well established. The simplest of these include the rate of literacy and gaps in literacy rates in terms of age, gender, nationality, or income group. One can rely on these and other indicators to demonstrate rising levels of financial literacy. For example, impact is measurable based on the level of activity in newly opened bank accounts or investment account in the stock exchange or the off-take of financial products, etc.

Nevertheless, as financial literacy improves, we would expect to see account balances continue to rise along with banking and investment activity. One measure of financial literacy is the increase in the average number of financial and investment products in a household. Therefore, impact assessments should determine, for example, whether there is an increased off-take in credit or life, accident, and health insurance policies, or if there is an increase in the number of digital financial transactions or there is an increase in investment activities at the local stock exchange, etc.

The need for collaborative efforts: If we are to achieve further economic growth, there is a recognition that financing such growth requires that sources are diverse, innovative and largely internally mobilized. This being the case, such approach and achievement will be made possible with the support of increased financial literacy and improved education. For wholesale improvements in education, the public, private, and social sectors must continue to seek opportunities to collaborate. Without partnerships and a systems approach, this herculean task cannot be completed. Efforts from organizations like the World Bank and OECD, laudable as they are, have only scratched the surface of the challenge. Such initiatives require the local support from a larger number of financial services players collaborating with key stakeholders to create an ecosystem of alliances that also include innovators, nonprofits, social enterprises, incubators, educators, and skills development agencies.

Forging true partnership toward this goal demands a different mindset, one that requires courage and compromise. Partners must accept that private players will drive business value through their involvement. It is logical that banks and financial institutions invest in inclusive finance and financial education as it will only contribute to enhancing the market pie for financial services. This is a win-win outcome, and a key to unlocking solutions to our “finance for growth”.

Enhancing Financial Literacy for Economic Benefits

Lack of understanding on how financial markets works is one of the significant deterrents to participation in the financial markets and in particular the stock market and share ownership. Research show that lack of literacy prevents households from participating in the stock market. Research further indicates the welfare loss from non-participation in the stock market can be sizable. Thus, the role of financial literacy should not be under-estimated. And as more people within societies live into a system where they have to decide how much to save for retirement and how to invest their retirement wealth, it is important to consider ways to enhance their level of financial knowledge or to guide them in their financial decisions.

As it were, individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. On the other hand individuals have become increasingly active in financial markets, and market participation has been accompanied or even promoted by the advent of new financial products and services. However, some of these products are complex and difficult to grasp, especially for financially unsophisticated investors. At the same time, in many economies market liberalization and structural reforms in social security and pensions have caused an ongoing shift in decision power away from the government and employers toward private individuals. Thus, individuals have to assume more responsibility for their own financial well-being. 

Are individuals well-equipped to make financial decisions? Do they possess adequate financial literacy and knowledge? Existing research on this topic indicate that financial illiteracy is widespread, and individuals lack knowledge of even the most basic economic principles.

Some of the aspects for consideration as our society evolves includes asking ourselves questions such as what is the importance of financial literacy and what is its relation to the stock market development? Are financially knowledgeable individuals more likely to hold stocks? Is there a causality relationship between financial knowledge and investing in the stock market? The truth is that the lower the understanding of basic economic concepts related to economic growth (GDP), inflation and interest rate compounding outperforms the limited is the knowledge of investing in stocks, units and bonds, and what about the concept of risk diversification, on the working of financial markets?

Given what we know with regard to the limited knowledge about economics and finance among us, then it somehow says that financial literacy should not be taken for granted is we pursue domestic financial mobilization in the financing of our development. The truth is that majority of households possesses very limited financial literacy. Furthermore, given that financial literacy differs substantially depending on education, age and gender — this suggests that financial education programs are likely to be more effective when targeted to specific groups of the population. As such, privatization programs or policies and legislature actions for listing of companies from specific strategic sectors should take into account that, when put in charge of investing for their retirement, financially unsophisticated individuals may not invest in the stock market, not because they lack funds for investing in targeted companies but largely due to lack of the specific financial knowledge. Thus, to work effectively, privatization and strategic sectors’ listing programs need to be accompanied by well-designed financial education programs.

It is noted that the challenge of limited financial literacy is not only for us, but most financial literacy surveys also conducted worldwide show that a majority of the population in most nations do not have sufficient knowledge to understand even the basic financial products and the risks associated with the products. Thus, the majority of individuals may not adequately plan for their future and are likely to make ineffective decisions in managing their finances. The same is true for us where a significant proportion of the population has a very limited understanding of financial products and services. This is particularly the case among the rural poor but also across the relatively more affluent peri-urban and urban mass market.

As a result, efforts on improving financial literacy and educating consumers around financial products and services has become an essential means toward greater economic, social and financial inclusion as well as an important complement to market conduct and prudential regulation. For capital markets in particular, investor education is important to promote greater retail participation in the market on a sound basis – in other words the best protection for investors is education.

Again, for us, financial literacy, consumer education and investor education is in its early stage and programs for educating the public are conducted on a sectoral basis across the financial services sector. In most cases, within each sub-sector, whether banking, pensions, insurance or capital markets, these are done separately by the regulator, self-regulatory agencies, industry associations, and among individual firms. There are also external based efforts, mostly by non-profit, donor-funded, organisations which also provide financial literacy and education targeted at lower income groups. However, such pursuance are largely in silos and not coordinated.

That is to say though each of these initiatives is useful in its own right, a holistic and coordinated approach to financial education is needed to ensure consistent messaging and to educate consumers as to the benefits and risks of the full range of financial products on offer in market, including banking, insurance, retirement, capital market products as well as informal financial products.

At the same time, however, it is important to recognise that different strategies need to be applied to different groups of the population, owing to the heterogeneity of demand for financial services across the country, both demographically and geographically. By way of example, the content of financial education targeting the Tanzanians in the rural areas should differ significantly from the financial education provided for the urban retail mass market.

On Harnessing the Power of a Savings Culture

Learning how to manage money is an important life skill and getting the right balance between spending, saving and investing is fundamental for a better life and wellbeing.

It was somehow clear during the partial lockdown, where it was observed that a significant portion of the population could not manage to sustain themselves without daily income, and only a few were able to sustain themselves without it. This brings to the fore the whole aspects of the necessity of financial literacy especially the harnessing of the culture of saving in a society.

By the way savings is said to be one of the wise practices. For instance, the bible teaches that saving money is a wise practice for many different reasons.  Proverbs 6:6-8  says: Go to the ant, you sluggard; consider her ways, and be wise, it has no commander, no overseer or ruler, yet it stores its provisions in summer and gathers its food at harvest; and Proverbs 13:22 says: A good man leaves an inheritance to his children’s children. Without the discipline of saving, you cannot be able to have food or cater for health challenges during difficulties, nor would you able to leave inheritance to your children, let alone your children’s children.

Now, given that most of the households in Tanzania depends on their daily wages, striking the balance between savings and spending remains quite a challenge. In most cases families are left with minimal or no savings. Yes, according to the recent world bank report, Tanzania like most African countries’ savings rate is still relatively low, at around 30 percent of the gross domestic product. One may argue that this rate is better than many other countries, however for that argument to hold one needs to also consider the low level of our per capita income, the quantum is still relatively lower.

One way to promote a savings culture is through financial literacy. Financial literacy enables us to possess the set of skills and knowledge that allows us to make informed and effective decisions related to the management of our financial resources. Understanding basic financial concepts allows us as the people to know how to navigate in the financial system and financial markets. It is obvious that people with appropriate financial literacy training make better financial decisions and manage money better than those without such knowledge.

So, it calls for all stakeholders – from private and public sector – to continue to stress the importance of financial literacy and developing the savings culture among us. Specifically, for us who are in the financial markets, whether in the banking sub-sector or the capital markets, or pensions, or insurance to inculcate financial literacy among Tanzanians. This is not only important but also a matter of necessity because individuals and households lacking adequate access to affordable and convenient formal financial services may be severely constrained in participating fully in an inclusive economy, if they lack basic financial knowledge.

Furthermore, financial education can help individuals to understand the basic principles of money management, including how to plan and budget as well as how to manage their finances. They can learn how to build a personal saving plan, or create a personal portfolio investment plan – all to support short-, medium- and long-term savings and investment goals; whether for building a house, or funding children’s education, or to generate sustainable income during the period of retirement.

One may rightly ask: why is it crucial for people to save, while they have periodical sustainable sources of income, i.e. those employed and earns monthly salaries? The answer is simple, the matter of savings is never defined by whether you earn or the amount of you earn at this moment. It is actually a matter of principle, let go back to the wisdom from the spiritual and faith. The book of Proverbs 21:20 says – In the house of the wise are stores of choice of food and oil, but a foolish man devours all he has. Also Proverbs 13:11 tells us – Wealth [gotten] by vanity shall be diminished: but he who gathers money little by little makes it grow. So, educating oneself and pursuing the discipline of savings and investing for the future is where wisdom [towards financial freedom] begin.

But the matter of savings as it applies to individuals, it applies to nations as well. Any nation needs to create the saving culture and the saving-investment identity. This is necessary for the national income, because the amount saved in an economy will be the amount that can be directly invested or intermediated for investment in new physical machinery, new infrastructure, new inventories and the like; for, it is true than in an open economy private saving plus governmental saving plus foreign investment domestically equates into physical investment. In other words, the flow of investment must be financed by some combination of private domestic savings, government savings, and foreign savings – it is good to enhance domestic private and government savings.

Going back to personal finance – from overspending and financial setbacks to incurring massive debt and simply just not making enough money, it seems to me that there are always several huddles that one has to overcome. Therefore, cultivating the habit of savings is very important and can be helpful in many aspects of life. A good saver can set aside funds for business, a good saver is debt free and has already made a right as well as bold step towards financial freedom. A good saver can also reach certain goals that cannot be attained on the limited income that one gets.

Investors: On Business Ownership, Dividends and Capitalization of profits

Shareholders attitude towards management is largely determined by management’s demonstration of performance as far as company’s strategic, operational and financial performance is concern. Shareholders has the right to demand for clear and satisfying explanations when performance results appear less than what should be, and yes shareholders have the right to demand for improvement, or even consider the removal of underperforming management (via a Board of Directors) – if it comes to that. As it turns out, poor performance has an impact on the investors’ returns, share prices, valuations, wealth creation as well as sustainability of the company. However, as the process requires, with very few exceptions, that underperforming management are changed by action of shareholders during their Annual General Meeting (AGM). Good governance standards and practices requires that it is the responsibility of the Board of Director, who are also entrusted with such fiduciary duty, to place, replace or remove companies’ management, of course on behalf of shareholders.

Investors: dividends vs. capital build up

Dividend payments are dictated by the company dividend policy, normally a frequent subject of debate between the investing public, majority shareholders and company management. In general the investing public wants a more liberal dividend policy, while management (and sometimes strategic investors/majority shareholders) in most cases prefers conservative dividend policy which allows companies to keep the earnings in the business to strengthen the company by enabling availability of efficient financial resources for future growth and expansion. And so, in a way management asks shareholders to sacrifice their present interests, benefits and preferences for the good of the enterprise and for shareholders future long-term benefits. The basic argument being by paying smaller rather than liberal dividends the company can use the money for shareholders’ direct and immediate advantage by retaining the funds for profitable expansions and growth.

Nevertheless, on a sweeping through history and time, the attitude of investors towards dividends has been undergoing gradual but significant changes, for instance years ago it was typically a weak company that was forced to hold into its profits, instead of paying them in the form of dividends, and the effect was almost always adverse to the market price of those shares. But currently it is quite likely that strong and growing enterprises will be the one that deliberately keeps down its dividend payments.

There has been always a strong case for reinvesting profits in the business where such retentions could be counted on to produce increased earnings, relative to when investors will be paid dividends and investing by themselves in other companies or asset classes. But, even then there are strong counter-arguments, such as: profits belong to shareholders, and they are entitled to have them paid out within limits of prudent management; that many of the shareholders need their dividend income to live on, otherwise why invest?; that the earnings they receive as dividend are real money while those retained might not be materialized or show up later; etc – these arguments are in some cases very compelling that stock markets shows persistent bias in favor of liberal dividend policies (and payments) as against companies that paid either no dividends or relatively smaller ones.

In these past few decades, however, the profit reinvestment argument has been gaining ground, informed/intelligent investors have come to accept a low-dividend-pay-out policy, this is so much true that in many cases for profitable and growth companies low dividend payments or even absence of any dividend seems to have virtually no effect on market prices (but the key word is “profitable and growth companies”); i.e. the case will not be the same for loss making companies.

All being said, it is fair that shareholders should demand of their management’s either a normal payout of earnings – say two-third of the profits – or else demand a clear-cut demonstration that the reinvested profits would produce a satisfactory increase in their investment valuations, wealth enhancement or investment earnings are more than alternative investment options. In many cases a low payout is clearly the cause of an average market price that is below the company fair value, and here the shareholders have every right to inquire and probably complain.

Otherwise, it is also important to mention and for us to understand that sometimes a stingy dividend policy could be imposed on a company either because of its financial position particularly in cases where most of its earnings are used to pay debts (according to debt conventions) or bolster its working capital or in cases where the company is in the sector whose regulations requires that a certain level of earnings cannot be paid as dividends, i.e. in the case of banks where there are sometimes thresholds and need for regulator’s approval on dividend payments. When this is the case there is nothing much that shareholders can say about it – except perhaps to criticize the management for permitting the company to fall into such unsatisfactory financial position, or complain as to why regulators in some cases and in such sectors are less considerate, as far as investors interest are concern.

On the democratization of corporate entities via inclusive ownership

Given this, that’s why the debate and movements related to the spirit and culture of distinguishing between a society oriented towards capital versus the people gets the necessary policy and political attention, especially ever since the idea of corporate entities operating as legal persons came into being. Because of this, many within societies prefers to see the relevance of companies within societies are judged based on principles of democracy, which include accountability, integrity, and transparency.

Corporate entities and human lives are greatly intertwined – corporate entities/companies as it is for humans are all persons in eye of the law. Companies are proportionally engaged in determining some key aspects of human lives – from where we sleep, to what we eat, what and how we wear, how and where we work, how we commune and communicate, sometimes to how we decide and govern ourselves, the list goes on and on. As it is for us humans, companies have their own rights and obligations, and armed with these “rights,” corporations have increased control over resources, jobs, commerce, political engagements, and even in the making of laws. And the fact that companies have limited liability – this somehow decreases citizens authority over them.

Let me draw our attention to statement that was issued sometime in 1981 and then later in 1997, and the other one  that came in August 2019 — by the Business Roundtable, a group comprising CEOs of most of the largest corporations in the US.

This “Statement on Corporate Responsibility” reads: a group of the CEOs of the largest US firms, recognizes six constituencies – customers, employees, communities, society at large, suppliers, and shareholders – as forming the ‘web of complex, often competing relationships’ within which corporations operate. It accepts the idea that ‘shareholders have a special relationship to the corporation’ but doesn’t allow their interests to trump all others.”

Here is an excerpt from the Business Roundtable statement: “Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholders must receive a good return, but the legitimate concerns of other constituencies also must have appropriate attention. Striking the appropriate balance, some leading managers have come to believe that the primary role of corporations is to help meet society’s legitimate needs for goods and services and to earn a reasonable return for the shareholders in the process. They are aware that this must be done in a socially acceptable manner. They believe that by giving enlightened consideration to balancing the legitimate claims of all its constituents, a corporation will best serve the interest of the shareholders.”

As it is, this statement is anchored on the need for rebalancing the share of income and wealth in favor of all stakeholders in the manner companies are governed, and hence the case for expand democracy in companies’ ownership and eventually finance and the economy. That is, if left unchecked — corporate greed and interests can destroy the social and economic fabric of communities, where a small group of people owning and running corporations make decisions that increasingly determine overall societies’ economic, social, environmental, governance, policy and political future.

As matters stands, the richest few own disproportionate share of global capital income – including capital gains, dividends, and interests.

While corporate profits that presently go to a small number of ultra-wealthy families are at or near an all-time high, returns on other corporate stakeholders – employees, governments, and other operatives within companies’ eco-systems as a percentage of economies do not match up.

And yes, it is also a fact that those who control these corporations have strong allegiance to profits, executive bonuses, and the value of shares of companies. What happens to employees, what happens to the environment, what happens to the community in which their corporations’ function, what happens to government tax revenue income matters very little.

This type of corporate entities operations, governance and ownership is not an economic model that is sustainable for the long end. Societies can do much better and cohesively while encouraging enterprising spirits and business success at the same time encouraging more transparency, accountability, payment of fair share of tax revenue to the government, etc.

The truth is, we can grow and develop in an economic model that create jobs, increases productivity while corporate are democratized by sharing part of their ownership stake with other stakeholders – employees, customers, suppliers, communities, governments, etc. and all have a say in the decision-making process that impacts their lives, and a fair share of returns to their involvement.

That’s why the US Business Roundtable issued the statement on the purpose of corporations that came in August 2019 redefining the purpose of a corporation to promote ‘an economy that serves all’, among others, it says: “[People] deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. That the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.

Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.

While each of our individual companies serves its own corporate purpose but do share a fundamental commitment to all stakeholders. And so, they do commit to: (i) delivering value to customers; (ii) investing in our employees — starting with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world; (iii) dealing fairly and ethically with our suppliers — dedicating to serving as good partners to the other companies, large and small; (iv) supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses; and (v) generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate.”

Financial Literacy for a Better Retirement

This week – from 5th to 11th October has been set by the International Organization of Securities Commissions (IOSCO) and the World Federation of Exchanges (WFE) as the World Investor Week. It is a week meant to promote investor education and protection. Capital Markets regulators and stock exchanges across the World are engaging communities to raise awareness about the importance of financial literacy and how it can improve life outcomes, encouraging people to make savings and investments as part of their lives. A the DSE we are using the week to engage the public to the fact that financial literacy, financial inclusion, inclusive economic growth, and share prosperity goes together and could be enhanced when many in the society knows how finance works.

While we are on this, let’s be reminded that the 1st of October was an International Day for Older Persons.  Therefore, in today’s article we will link these two aspects which are all relevant to our lives. Read on:

Our priorities, goals and needs change constantly as we journey through life. Lifestyle choices like cars and holidays occupy and dominate our thinking early on as we start our career, then as years go-by imperatives such as renting, buying or building a house come along.

After that we have education for our children, health care for us and our families and all the things that goes with growing families and expanding responsibilities. All the while, we have to keep an eye of the possibility of a comfortable retirement with some form of “financial freedom”.

Juggling these competing financial needs, on a limited and finite income stretches most of us to the core. However, the part of the secret to succeed in these challenges lies in starting early, making plans and sticking, as much possible, to those plans. Have you ever heard words such as “financial freedom”, “the freedom fund”, or “the Rule of Seven”? – where you are encouraged to make regular and sustainable savings in pursuing to create a fund which is made up of investments in income producing investments (i.e. dividend paying shares, income-earning cash (i.e. fixed deposits and treasury bills), bonds, real estate’s rental income, royalties, etc) whose ultimate objective is to enable you live a relatively similar life as the one you had when you were earning regular income from your day job during the active career years.

What I am saying is that you should get into the good habit of saving and investment, early in life. The earlier you start the better, because the small amounts you save and invest– with a compounding effect – turns into large sums over time. When you are trying to accumulate wealth for future, the longer you have your money invested the more it will grow in value.

The other advantage in starting early is the mindset it helps create. You begin to see savings not as some sort of luxury but as an essential part of your overall financial plan and execution. Basically, savings and investment should be an integral piece of your planning and seen as important as your rent, or loan repayments or, school fees. The best way to approach this is to have personal plans and create the budget to support implementation of those plans. If there won’t be conscious and deliberate efforts to ensure all these are put down on paper – then the follow-through would also face challenges. Unfortunately, most of us, approach matters of income and spending via focusing on the short-term, the here and now, where we act as if what is here now is far important to what lies ahead of us not so long down the line.

Because of lack of plans or the habit of putting matters on hold until the last minutes, or according priority to matters that are not, we end up spending money on things that we do not even need or know about. In this context, getting the basics i.e. personal planning, budgeting and budgetary control is essential.

Earlier [above] I introduced the concept of compounding, in accounting and finance this is a key term, and this is how it works — let us assume that your savings are kept in the form of bank deposits with a fixed term and your return is interest earnings. In this case, there will be the effect of compounding interest – meaning that the interest you earn each period is added to your principal and re-invested, so that the balance doesn’t merely grow, it grows at an increasing rate. It is the basis of everything from a personal savings plan to the long term growth of the stock market. It also accounts for the effects of inflation, and the importance of paying down your debt. What it also means is that the earlier you start savings the better. Let us assume that you are now in your early 30s and started saving, your chances of getting enough funds, not only for retirement, but also for buying/building a house, taking children to good schools, etc are much higher relative to if you started savings at 40s where the struggle to achieve financial freedom will be far much higher. Now, personal and financial planning is key – setting out your goals, setting out the plan to achieve the said goals and prioritizing objectives for executions.

But before you proceed with any savings plans, you have to map out your action plan for getting there. In other words, you need to determine if you have the spare cash to make savings. Thus, you need to construct your personal balance sheet and cash flow statement that seek answers to some important questions to see where you financially stand. Only once you have paid off all your short-term debt and you have income left over should you consider saving.

So, first thing you need to consider, is to settle your finances and outstanding high interest debts. This is not a rule but a prudent advice because if you have debt that is costing you say 20 percent in interest per annum and your invested savings is growing at more than 20 percent per annum and you can liquidate your invested savings to repay the debt, you are then doing very well, but this is often difficult to achieve and thus it is advisable or rather recommendable for you to take a simple approach, which says invest your savings, do not borrow or get into debt to make a saving investments. Look at your current financial position, i.e., your personal balance sheet and cash flow statement to understand where you stand.

In any case, even if you are on your 40s or 50s, you still have 20 or 10 years before retirement, and there is still quite a lot that can be done. It is never too late to start, what is important is that you have to have a sensible savings and investment strategy, act on it and seek help from financial advisers, when needed.

The Role of the Exchange for a Middle-Income Economy

Exchanges are important contributors to the growth and development of domestic economies. They help funnel domestic savings towards long-run investment, thus sustaining household consumption through additional returns and contributing to the accumulation of domestic wealth. At the same time, well-functioning exchanges enhance the ability of young growing companies, as well as more established corporations with expansion plans, to access the capital they need to grow their businesses.

Exchanges also provide information, offering direction, acting like benchmarks to the real economy. The development and sophistication of local capital markets can be measured along several dimensions (returns, volatility, size), with liquidity and price efficiency being perhaps the most important indicators of capital markets development.

The role of exchanges is particularly important in the case of markets like ours i.e. markets that have not yet attained the performance of developed markets and are in low/middle income country. Our kind of markets typically underperform when compared to developed markets: we are less liquid, less efficient, more volatile, and are sometimes characterized by lower corporate governance standards. Understanding what factors are constraining the development of our market is therefore of paramount importance to sustain our growth and to bridge the performance gap with developed markets.

Such understanding becomes more urgent given the impact of COVID-19 pandemic in the economy. We predict our economy to grow at estimated less of 5.6 percent, which is almost 1.5 percent of our pre-COVID projections. While, like other emerging markets, we will suffer less than developed economies, but there is an impact. As the pandemic slows down the growth prospects of some aspects of our market, it is of even more crucial importance to reignite the engine of our economic growth, by allowing capital markets to perform its activity by facilitating the allocation of funds to where they are most needed.

Capital market development and economic growth

There has been a substantial amount of research documenting how capital market development is positively related to economic growth, both in developed and in developing markets. Different channels through which capital markets affect economic development have been identified: well-functioning  capital markets increase domestic savings rates as well as the quantity and the quality of investments, they help growing companies to raise capital at a lower cost, making them less dependent on bank financing; they also encourage financial discipline and reduce the costs of information, which contributes to a better allocation of resources.

Therefore, nurturing capital markets development in a middle-income economy can be seen as an indirect way of enhancing the underlying economic conditions of a country, a task which has become even more urgent after the impact of COVID-19. Even, the most recent studies in countries such as South Africa (Khetsi and Mogale, 2015), Malaysia (Nordin and Nordin,2016), or Turkey (Coskun et al.2017), to mention just a few, have also confirmed the positive relation between stock markets and economic growth.

Against this background, some questions naturally arise: how can an exchange identify those elements that may be withholding it from further development? What changes to the ecosystem can have the greatest positive impact on the exchange’s performance? How can the exchange most efficiently stimulate the market in a way that is optimal? How can the exchange strengthen its role in rebuilding the economy in an inclusive and socially responsible way?

Each of these questions will have a different interpretation and may result in a different set of conclusions and recommendations. But regardless of the differences, it is useful for the economy to promote a general framework linking the characteristics of a market and of its ecosystem with the attributes of a well-functioning market. For example, various research shows that international investors are attracted by better stock market conditions, that is, by better liquidity, lower volatility, or higher corporate governance standards.

Research has also found that higher foreign participation and trading are in turn associated with better stock market characteristics, that is, with lower stock market volatility, an improvement of corporate governance standards and better competitiveness and profitability of domestic listed companies. This suggests international investors are attracted to better markets and, at the same time, exert a beneficial influence on them, generating a virtuous circle. Therefore, making middle-income markets, like ours, more attractive for international investors is a way to further stimulate stock market development, and, indirectly, economic growth.

However, other than that, stimulating financial inclusion on the demand side (investors), i.e. via the use of fintech as a tool to stimulate retail participation in the stock markets is recommended. As we know it, financial technology has made access to financial services easier, for companies and households alike. While this is a global trend, we, like other emerging markets face a more challenging environment than developed economies, in terms of existing infrastructure, attitude towards financial services, legal framework and overall level of technological developments. Success stories like that of mobile payments show that Fintech broadening financial inclusion need to develop tailored solutions for capital markets as well.

The element of enhancing the role of stock market in a middle-income economy would be to innovate financial products that enable retail participation in markets. As noted above, markets like ours have a challenging environment — financial institutions wishing to attract local savings need to consider that the local infrastructure, the attitude towards financial services, the overall level of financial literacy and the legal framework might not be as supportive as in developed markets. To attract domestic savings, especially from rural areas, stakeholders in the capital markets need to develop tailored and innovative solutions.

To stimulate financial inclusion on the supply side (issuers), financial literacy as a way to stimulate participation, by potential issuers, and especially small businesses is highly recommended. As it is, private companies often rely on traditional sources of finance (such as bank lending) because they are unaware of or do not have the necessary preparation to tap into alternative sources of finance. Supportive private companies with financial literacy programs can have a positive effect on listings.

Stock Markets, Development and Corporate Governance

It is self-evident that any modern economy needs, as its foundation, a solid infrastructure base: ports, roads, electricity, airports, telecommunications, railways, etc. As it were, the state, fund managers (for pensions and others), along with insurers and mutual funds do invest in assets with long term duration to match their long term obligation, and infrastructure development by nature are characteristically long dated; they offer the state, fund managers, insurers an ideal investment opportunity. For the state, it is by way of taxes and issuance of bonds. For the buyers of bonds issued by the Government, they benefit from good returns which are guaranteed, and with minimal risks. What is crucial in all of this is striking the balance, so savings and pensions also gets their way in other financial assets.

The recent trend of less money chasing the equity market and more money chasing bonds have at least two effects. First, they hurt funding private and its productivity, which is propelled by innovation and equity risk investment. Second, the trend may not be all bad, in that they do present opportunities and more attractive returns for growth investors who are willing to tolerate a longer investment horizon. At the highest level, investors – so crucial to driving capital into infrastructure, innovation and businesses that drive economic growth, to the detriment of growth tomorrow.

On the other hand, though, Tanzania’s median age is 18 years, and two third of the population is under 25 years – for such a young society, one would ask why there is an increasing preference to bond-like instruments and the structural movement of portfolios away from stocks? Pension funds, insurance companies, mutual funds/unit trusts, and retail investors are all into this trend where bonds allocation is by the day becoming relatively significant compared to equity allocation. This is also reflected to the domestic market capitalization vs. outstanding listed bonds, where the ratio has favorably changed towards bonds from the ratio of 58:42 three years ago into 43:57 ratio of domestic market cap to outstanding bonds today.  And the situation for the equity is not helped by the structural and regulatory fact in that savings in banks and pensions in pension funds don’t find their way into equity.

The recent shrink in our stock market is because investors are reducing the amount of money, they allocate to equity issued by companies, as the appetite to finance the growth of private sector firms wanes by the day. Making the situation even more difficult is our experience which indicate that our domestic portfolio investors are willing to finance, invest and trade equities of more matured companies compared to SMEs and start-ups, now amid slowing growth, investors are even increasingly pursuing stable income from investments. This means committing even greater proportions of their capital to safe assets like bonds, or established companies and projects rather than backing smaller, riskier investment in start-ups or SMEs. Smaller businesses are thus starved for capital, finding it hard to attract investments or borrow, even though they play a critical role in economy and job creation. 

The trend of less money chasing the equity market, and more money chasing bonds, diverts funds from equity risk investment and hurts productivity, reducing the capacity for innovation and enterprising, damaging sustainable growth. In as much as the stock markets represents a path for businesses to fund investment and create jobs, this “de-equitization” trend is worrisome and could be destabilizing to both the bonds and equity capital market in the near future. 

But then there is an argument that as a society we need to appreciate the march towards the existential importance of an equitable society where in part corporate entities may foster an influence as they may wish to pursue more democratized stance in their corporate and business conduct while becoming more inclusive, transparent and the willing to expand by using capital markets route. We need to weave these intents into our corporate conduct fabric. Especially the matter of corporate governance – but then where do we strike the balance, for achieving both ends? in any way we need more funds into the equity finance for private and public enterprises, and we need more investors.

A recent study by the Aspen Institute indicates that in the US more than half of all households own some stock, and for those with college graduates over 70 percent have stock holdings. This says that apart from companies accessing capital markets to finance their expansion and growth, but there is also willingness of citizens to participate in investing in such companies. In our case less than 1 percent of the populations have an investment account at the stock market.

But why does it matter? Stock markets produce much more than just numbers that scroll across a ticker. They are the center of corporate power and accountability. Each share of stock that one own, does not afford them only a share in the ownership of entities and factors of productions, but also a chance to make decision on how corporate Tanzania is run. Owners of stock elect Board of directors who oversee companies, select CEOs, establish corporate priorities – including expansions and growth which then creates jobs and revenue to the Government. And so, come to think of it, shareholding is so consequential that it enables “corporate democracy” which if understood, makes one more entrenched into the “political democracy”. Let us get more involved.

Macroeconomic Variables vs. Market Performance

There are several factors that influence share prices and the level of return for investors. Key factors are: (1) demand and supply; (2) economic variables i.e. GDP, inflation, interest rates and exchange rate; (3) corporate actions; and (4) psychological or market cycle-related factors. In today’s article, we will focus on the economic variables.

The value of the company, its return on investment and share price reflects the perception of its earnings performance and growth. If the stock market detects something about a company that may harm its earnings flow, its share price falls. If the stock exchange hears good news about the company — its earnings, new innovations, expansion to other geographical locations, etc that have future earnings growth potential — its share price in most cases will increase.

Share prices change because sellers and buyers are constantly reviewing companies’ news and especially its earnings prospects. Therefore, in this context, one may claim, there are two factors that determine a change in share prices – future expectations of earnings and the price to earnings multiples, as we have learnt in a previous article. Both factors depend on an evaluation from buyers and sellers as they learn more about and understand the listed companies.

Apart from fundamental company performance-related factors, investors are also looking at other market information, including economic news (such as economic growth, inflation, changes in exchange rates, change in interest rates, etc) and also political events that can cause share prices to rise or fall. In the short term, the share price is also affected by intangible factors such as hype and word-of-mouth.

Share prices performance on companies listed in the DSE, like other stock markets, are also influenced by the happenings of other markets and economies (though it may not be as direct for the case of the DSE). If there is a substantial fall in other major markets prices and indices, Tanzanian share prices are likely to be under pressure as well, mainly because of foreign investors participation in our market. Foreign strategic investors own a large part of companies listed in our stock market, and foreign portfolio investors commands almost two-third of our periodical trading activities.

Stock market performance largely depend on the state of the economy, economic activities, future outlook and quality of decisions made. Economic policies, among others affect economic variables which are then extended into companies’ earnings and prospects. Specifically, economic variables that affect the stock markets are:

  • Interest rates
  • Inflation or the rate of change in consumer prices
  • Rate of economic growth (measured by Gross Domestic product – GDP)
  • Exchange rate
  • The health of other key economies

Interest rates and inflation

Interest rates affect companies’ earnings directly because their debt repayment costs rise and fall depending on the interest rate changes.

Interest rates determine how much it costs the company borrows or what an investor should expect on their investments. A rise in interest rates increases the attractiveness of fixed interest investments (such as bonds) relative to shares. High interest rates also increase a company’s borrowing cost. It also means taking money directly from profit to pay the company’s bankers. Rising interest rates also affect the level of economic activity and consumer spending.

Alterations to interest rates is one of the economic monetary policy instruments used by Central Banks. Central may lift interest rates to choke off any stirring of inflation, as a result of bubbling economic activity. During a period of tight liquidity, interest rates rise increases production costs. Conversely, interest rates fall when there is ample liquidity. People have more purchasing power, which is positive for business expansion and share investment. During these times, interest rates are used as tools for mopping up excessive liquidity.

Inflation simply refers to how much the prices of the goods and services that you buy go up by each year. It is usually written as a percentage. One of the reasons that people invest in the share market is to try and beat inflation.

The stock market dislikes inflation: inflation pushes up costs for companies quicker than it can pass them on to customers, adversely affecting earnings. Conversely, when a central bank believes that economic growth needs to be stimulated or an economic decline reversed, it will cut interest rates.

Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples, and high inflation drives low multiples). Deflation, on the other hand, is generally bad for shares because it signifies a loss in pricing power for companies.

The exchange rate

A company that exports or imports products or services, or has receipts or payments in other currencies, is affected by the exchange rate between the local currency and foreign currencies. The most important of these currency crosses is the rate of the local currency to the US Dollar. Higher local currency in relation to the USD, can be good for certain sectors of the economy, making both exports and local import-replacement industries more competitive. It’s particularly good for local producers and businesses who sell their products in USD but take their profits and report their earnings in local currency.

Apart from an indirect impact of foreign exchange to investors in securities (shares and bonds)— investors, especially foreign investors are also directly affected by the movement in the exchange rate. The fall of the local currency against the United States dollar have negative impact in market valuations, size of the market and indices performance but also in trading activities.


Gross Domestic Product (GDP) is the value of all goods and services produced in the economy. When GDP decreases, the economy contracts and companies’ earnings fall and when GDP increases, the economy expands, and companies’ earnings rises. Therefore, any prospects of positive economic (GDP) outlook attract investors in the market — but the opposite is also true, prospects of negative outlook in the economic activities reduces investment in the market.

The health of the key economies

Foreign (strategic and portfolio) investors accounts for more than two-third of ownership and trading activities in our local market. The recent and ongoing global case of COVID-19 pandemic has negatively impacted the equity segment of the market mainly because due to other emerging priorities, immediate cash obligations by fund managers, and the focus on less risky investments.

In the short term, when there is bad economic news – stock markets come under pressure and some of the immediate actions is the decline in liquidity, prices, indices and market size. Unless there are rescue policies and packages, it takes time before good news ensures.

Market participation, Liquidity and Price formation

Consistently with the literature, it is evident that when liquidity is low in the stock exchange, prices becomes more inefficient, and trades’ impact on prices increases. There is also evidence that trading participant types contribute heterogeneously to price formation, in most cases, with retail and foreign investors being better informed investors, while domestic institutional investors contributing marginally less to price discovery. This pattern holds for different liquidity levels, and that lower liquidity is associated with lower price efficiency and higher price impact of trades for all trading participant types. This is a normal phenomenon key to developing markets and is key in informing the enhanced growth and development pursuance.

As it were, stock markets have two main functions: the first is to provide platform for liquidity creation (and enhancement); the second is to ensure that prices incorporate new, relevant information (in the process of price discovery) and enterprises are as close as possible to the fundamental value of (listed and traded) securities. While the concepts of liquidity, price discovery and price efficiency are distinct, they are in fact closely related: not only has liquidity been found to lead to both better price discovery (Riordan and Storkenmaier, 2012; Frijns et al., 2018) and enhanced price efficiency (Chordia et al., 2008a; Chung and Hrazdil, 2010), but literature also suggests that prices are better reflective when are more readily to incorporate new information.

It is well-established that different types of market participants (i.e. retail investors, domestic institutions, foreign institutions) contribute differently to trading activity depending on a jurisdiction’s historical, cultural and institutional factors (WFE and Oliver Wyman, 2016), i.e. trading participants contribute heterogeneously to liquidity. Even more importantly, the literature agrees that different types of trading participants possess different levels of information (Chan et al., 2007; Froot and Seasholes, 2001; Gonçalves and Eid, 2017; Grinblatt and Keloharju, 2000; Xu and Wan, 2015) and abilities to interpret market movements (Dvořák, 2005), and therefore contribute heterogeneously to price formation. Thus, a question is does the contribution of different trading participants to price formation also varies depending on liquidity?

To respond to such and the like questions, a recent study by World Federation of Exchanges (WFE) used the proprietary timestamped limit order book and trades data from the Stock Exchange of Thailand (SET). SET’s choice in addition to other factors, such as specific information on trading participant categories (i.e. retail, domestic institutions and foreign institutions), liquidity — which for the case of SET is spread across stocks of all sizes, and efficient price discovery; but primarily SET is characterised by high levels of transparency, with over 95 percent of the trades passing through the limit order book, few bilateral (block/pre-arranged) deals, and no designated market makers. In addition, the Thai market has no fragmentation, a relevant feature as fragmented pools of liquidity are a confounding factor in the estimation of both liquidity and price discovery. These factors are aligned across frontier and emerging markets.

According to the study, trades between different investors’ categories are characterised by heterogeneous information contents, supporting the assertion that the interaction between market participation, price formation and liquidity defines the speed to which the growth and development of a stock market is determined. At SET, for example, there is evident that the most informative trades are between retail investors (R-to-R), between foreign institutions (F-to-F), and between retail investors and foreign institutions (R-to-F).

There is further evidence that the contribution to price discovery of F-to-F trades is more pronounced for lower levels of liquidity. Trades between domestic institutions (D-to-D) and between retail investors and domestic institutions (R-to-D) are instead the least informative.

In accordance with the study, it is evident that higher illiquidity is associated with larger price impacts for all trading participants. This evidence suggests that retail and foreign investors contribute proportionally more to price discovery than domestic institutions, which are to larger extent likely to be the buy-and-hold institutions – a similar experience to our market. The evidence that both retail and foreign investors positively contribute to price discovery adds to more value to our own experiences, understanding and lessons to be drawn for our better future.

As it is with SET, it applies also for us that domestic institutions (i.e. pension funds, insurance companies, etc) play a marginal role in the price discovery process. This pattern is consistent across all liquidity levels, though the price impact of trades increases monotonically with illiquidity for all participants’ types.

From a theoretical perspective, it is unclear who should possess better information between domestic and foreign investors, as on one hand international investors have to face cultural and language barriers that put domestic investors at an informational advantage, though on the other hand foreign investors are typically more experienced traders/investors than domestic ones. Therefore, determining whether information is largely held by domestic or foreign participants is an empirical question.

Under normal circumstances it is expected that domestic investors should have an overall information advantage, even though there are many cases where some foreign institutions are better informed and performers probably due to their superior experience in multiple jurisdictions. It is further clear that brokerage firms, who also conduct research and advisory services, have a role in providing better information, as clients of global brokers have higher long-run profits than clients of either local or regional brokerages. In our case however, the role of brokerage firms on research and investment recommendation leaves more to be desired.

Based on the above we conclude that price discovery can largely be attributed to retail investors and to foreign investors in the mid-low liquidity segments. That, trades by domestic institutions are impactful only when foreign institutions take the other side of the trade, consistently with domestic institutions being large buy-and-hold players whose trades are not motivated by speculative reasons. Under such circumstances, it can be argued that for progressive development of the market we collectively need to create structures, products, infrastructure and institutions that will enable more retail participation, this is ideal for liquidity enhancement, better price discovery and valuations as well as wealth enhancement which is one of the key functions of a stock market.