The Case for Governments’ Continued Engaging with Stock Markets

Last Friday, I was invited as one of the speakers in the launch of Maseru Securities Market. In my talking points early on that day’s procession I had requested Lesotho’s Minister of Finance, Dr. Mamphono Khatetla and the Governor of the Central Bank of Lesotho, which hosts the Exchange, Dr. Retselisitsoe Matlanyane to seriously consider the need for continued Government’s support for the Exchange.

My request for the Government’s support in their newly formed local Exchange was in the following areas: government’s privatisation through the Exchange, listing of Government securities in their Exchange, provide fiscal incentives to encourage more issuers (for IPOs) and investors, as well as Government subventions, particularly those focused in financing public education and awareness creation campaigns. As it were, my plead came from an experience in running the Exchange in an African environment.

In her keynote remarks, the Minister, to my delight, promised that the Government will continue to support the Exchange in anyway possible, that is until it becomes self-sustained and a stage where private sector can take it over. To start with, she indicated that the Government of Lesotho will list some of the previous state-owned entities, in which the Government retained shareholdings in trust on behalf of the people of Lesotho, during privatisation.

Why am I compelled to think African governments’ continued role in the local exchanges, many of which are still in their nascent stages, is vital?

For one fact, we are coming from a low base and a different school of thought on how we run and organise our economic activities so that in the end such economic coordination and set up propels many people people within the society towards a happy life. We don’t have enough knowledge and experience, to run economies in an open market and transparent manner. Economic liberalisation and democratisation of our governance and decision making coupled with globalisation, particularly in these past few decades, has left many African countries with no choice but embrace what is available and necessary. Fortunately, what is bailable and necessary, in this context, is for governments to find an optimal combination of tools that will efficiently finance our economic development. One such tool is the capital market.

The truth is, in the past two decades, Africa has seen a relatively good growth in number of stock markets. Stock exchanges in the continent has grown from five (5) in mid-1990s to now 26 exchanges. So, in terms of number of exchanges, Africa has made some strides in the right direction, however, we may need to note is that most of these stock markets are lacking the depth, liquidity and valuations to attract many players. How do you achieve the depth and liquidity necessary for a vibrant stock market? one of the few solutions is to use already existing structures and systems (i.e. state-owned entities) as a launching pad for the growth of what seem to many as a new concept, which is also difficult to digest. The other, is to encourage central governments, local governments, sub-nationals, parastatals, etc to use local capital markets to mobilise funds for financing some of the development projects such as infrastructure.

Due to less than expected governments’ involvements with local capital markets, issues such small amount of IPOs are contributing to inefficient and ill-equipped stock exchanges across the region. And, since there are some existing deep rooted structural and cultural challenges related to how public and private sector enterprises are financed (and run) in Africa. Issues such as the love for lack of transparency, or the need for high standard of governance or more disclosure, or fiscal management discipline, etc contributes in making both public and private sector to consciously and willingly sacrifice the efficiently priced source of capital.

Otherwise, governments’ could see the necessity of encouraging transparency, good governance, etc within the business community and society at large by privatising many of the state owned entities via exchanges, this is leading by example and there is a strong economic and moral argument for governments to pursue this approach.

Upon a choice to pursue this approach, there is an opportunity here to seriously contribute to Africa’s economic development, and industry experts are constantly calling for governments and stakeholders to focus on stock exchanges and get them up to speed.

Emphasis on African stock exchanges growth is even more pertinent now as the region is seeing a growing demand for new issues (IPOs). Over the last fives years, for instance, valuations achieved through private equity exits in Africa via a stock market listing, yielded a higher return than could have been achieved in any private transaction, proving that investments in African listed firms are paying off like never before. What’s more, the amount of investors looking to invest in Africa’s small, medium or large-cap funds is growing as these markets continues to develop. As for now, the number of listings in Africa’s stock markets is lower than comparable regions, with just over 1,000 listings in Sub-Saharan Africa (a third of them being listed in the Johannesburg Stock Exchange), compares poorly to about 3,500 companies that are listed in India or 1,700 firms listed in China.

Despite these structural and cultural impediments, however, high financial costs associated with going public, such as initial and annual listing fees, as well as the direct and indirect costs that come with meeting exchange reporting deadlines and disclosures are some of the excuses given by enterprises. In relation to these, governments’ support via providing fiscal incentives and amnesties for both issuers and investors continues to be vital. However, what’s more, a lack of information on the advantages of listing and concerns about losing control have made many entrepreneurs wary of disclosing business details and ceding control. Therefore, supporting any efforts by Exchanges in public education efforts and awareness creation to the society is key.

After all being said, the limited number of listings in various African markets means that more needs to be done. Undoubtedly, fund managers and other such investors in the continent have a small number of promising shares to invest in. This leads to a lack of diversification of portfolios, and regional and sector concentration of assets. In addition, we have seen price distortions on liquid securities given the dearth of investable stocks.

Because of this imbalance in the supply and demand of new issues, IPOs present a good opportunity for African entrepreneurs and for the growth of the stock exchanges on the continent. Statistically, most new listings in Africa perform well and are heavily over-subscribed, as investors continue to flock to the few listings made. Thus, it may prove crucial to change practices in African stock exchanges to attract foreign investors.

In conclusion, there is strong evidence that stock markets can be an essential part of a developing economies. Studies by the IMF concluded that, supported by the right policies and reforms, stock markets can help African companies expand operations, contributing to economic growth. There is therefore need to ensure that there exists organised, efficient market where the governance standard and permission requirements are on par with international standards. In this respect, fostering better grounds for more listings in the African market will boost capital inflows into the region’s economies. For instance, raising equity finance via the capital market is often considered more profitable than capital raising in private market groups. As such, African entrepreneurs could be motivated to list their businesses if they were made aware of the access to capital – this again would boost the economy.

Enterprises are the backbone of economic growth as they drive industrial output and create jobs. Hence, the ability of companies to access growth capital is paramount for increasing employment, domestic spending and investment, resulting in increased GDP.

What’s more, listings enhance transparency and promote good governance, as IPOs subject companies to scrutiny and exposure. Luckily, environments favourable to the growth and improvement of bourses are beginning to take root in Africa. Political stability is increasing inside many countries, while sound economic policies and accountable institutions are slowly but surely being implemented. What needs to tip off an explosive growth we all anticipate in these markets is a bit of more governments taking interest in the growth of local stock markets.

Financing our Infrastructure via Capital Markets

Improving infrastructure is not only critical for economic growth in Africa but essential for ensuring the improved wellbeing of its people. Empirical researches shows that there is a strong link between infrastructure development and economic growth, not only in the continent, but elsewhere.

According to the African Development Bank (AfDB) reports, road access in Africa is only 34 percent as compared to 50 percent in other developing regions. In agriculture, just about 5 percent of agriculture in the Africa is under irrigation, compare to 37 in Asia or 14 percent in Latin America.

Africa’s average national electrification rate of 43 percent, is poorly compared to 81 percent in developing countries in Asia and 98 percent recorded in Latin America. The total electricity generated by Africa’s 52 countries for its billion people is equivalent to what is being produced and consumed by a single nation in Europe, Italy, as an example. There are cases where the total electricity generated in an African country, such as ours, with almost 50 million people, is not enough to power even a single airport in some other countries, the Schiphol’s Amsterdam Airport, as an example, etc.

According to AfDB, the amount of capital required to close the infrastructure gap in Africa is estimated to be in the region of US$93 billion annually for the next five years to 2020.

Will China stepping in and funding economic infrastructure, or the BRICS Development Bank or the Asia Infrastructure Investment Bank or some other foreign financial institutions fill this funding gap? The answer is no. We have been through this kind cycle and experience again and again. What Africa needs is to look into and develop its capital markets to finance its infrastructure development.

Sourcing funds to finance a sizeable infrastructure project in Africa has always been fraught with difficulties. One major challenge is that the multilateral development finance institutions, which are dominated by the western developed countries, often impose stringent policy conditions to loans, and they are rightly so. But it also appears that the funding required to close the infrastructure gaps in a timely fashion is simply not easily in existence on these institutions’ balance sheets, even our own African Development Bank.

Another issue is that the major lenders have historically been more active in financing social infrastructure such as health and education. Their approach to development in Africa has by and large been related to “poverty alleviation”. As it turns out, financing social infrastructure for poverty alleviation objectives isn’t the same as financing economic infrastructure which plays a critical role in spurring economic growth, which in this moment in time, has not been accorded serious attention in this region. While social infrastructure is important for economic development, however, economic infrastructure is even more urgent. Wealth creation and capital accumulation are facilitated more by investments in economic infrastructure.

The fact is, the old approach of countries relying heavily on multilateral and regional development finance institutions to fund infrastructure has proved to be unworkable. It is also incapable of closing the financing gap of this size. In fact, neither the old nor the new institutions have the risk appetite for the kind of investments needed. If African countries continue to rely on these organisations and institutions, then the pace for closing the infrastructure gap will be very slow.

The current move for geo-economic relationships based on trade and investment as well as encouraging African countries towards looking inwardly for solutions related to financing our development, instead of the historical aid and assistance model, looks like the better way to go. Furthermore, recent economic challenges in most developed and frontier countries have made traditional development finance institutions hesitate to provide resources for the huge but critical infrastructure investment required in Africa.

Given such experience, the game-changing infrastructure projects that can make a dent in the infrastructure deficit and move economies to a higher growth path need to come from Africans’ own resources, and in some cases be supplemented by what we can be accessed from international financial markets. And, the place to start would be the the debt (bonds) market where domestic savings will be intermediated and be able finance our significant economic infrastructure projects.

As indicated above, the truth is, our domestic markets are still relatively small, however needs to be developed slowly by central governments, municipals, government parastatals issuing bonds in local markets where both domestic and international players can freely access, then we can as well supplementing these efforts with pots to international markets issuances for Eurobonds. What has been happening, recently, for some African countries is accessing international markets with total disregard of the local market. For instance, in the past seven years, more than ten African countries have raised considerable amounts from the international capital market in the form of Eurobonds.

Traditionally, most African countries, with the exception of South Africa, have not consciously seen the capital markets as a critical source of finance. Yet raising debt financing in the capital market is one of the most potent sources of finance for rapid infrastructure development. This is because countries are able to raise funds for earmarked projects without policy conditionalities. And the cost of the funds, while relatively expensive compared with concessional loans from the International Financial Institutions and other multilateral development finance institutions, is often cheaper than loans from international banks.

It is on these basis, that countries have to be encouraged to go to capital markets (both domestic and international) to raise funds for infrastructure projects. However, these funds should not be used to finance consumption or get misused and abused (like recent cases for some countries) but should be channelled directly into the financing of the much-needed economic infrastructure.

The railways and canals in America, and Europe, were largely financed with capital raised through bonds. From records of history, huge infrastructure projects have been financed with funds from the capital market. This is because national budgets are often unable to support the required infrastructure expenditure. Country’s balance sheets in often cases lacks the fiscal space to accommodate the substantial financial outlays required for infrastructure development.

Any suggestion that traditional finance institutions or development finance institutions would be willingly able and capable to fund any substantial infrastructure projects required in Africa requires rethinking. Governments must turn to the market to raise capital.

Financial Market Diversification – A Wish List for 2016

For one thing, market liquidity, 2015 was a historical year for the local exchange (note, liquidity is one of the key parameters for stock exchange’s performance measurement, it measures how rapid and efficiently shares can move between investors). In 2015, trading activities reached Shs. 1,073 billion, more than 20 folds compared to the historical average turnover of about Shs. 50 billion per annum. Inspire of this achievement, however, like many African markets, the exchange had a tough and challenging year when measured on investors’ returns, as prices in most counters plummeted and indices spiralled downward eating into companies and markets capitalisation.

So, as measured in our local currency, our market capitalisation was down by seven percent year-on-year. However, when measured in US Dollar the loss in investors’  returns was about 25 percent — largely due to the depreciation of the shilling. The Shilling lost by almost 20 percent during 2015, this fall in value of our local currency relative to the U.S dollar reduced investors return (especially those whose investment originates from the U.S dollar) by the same rate, both on paper valuations and trading activities.

Again, as it applies in most African economies, over-reliance on raw commodity exports, coupled by an environment where following China’s manufacturing and economic growth decline, resulted into deterioration in demand for commodity and hence lower prices. This phenomenon crashed many African currencies and spillover into economic growth and investment returns. Furthermore, hampered by over-reliance in imports for most of their development and consumer goods, ranging from infrastructure related equipments and materials to domestic consumables, added fuel into the deterioration fire. And so, a combination of these factors — and the lesser than expected economic growth, affected investors returns in fundamental terms and pushing them into the bearish sentiments — hence most African stock markets lost investors value in billion of U.S dollars. As for our local market, investors loss was in the magnitude of Shs. 397 billion (about US$ 200 million) for the 15 domestic listed companies and Shs. 1,595 billion (about US$ 800 million) for all 22 listed companies — including cross-listed companies.

Estimates from various sources indicates that 2016 will still be another challenging year, economies are expected to grow at a slower pace than initially anticipated and this might affect markets performances. Therefore, as economies slows down, as commodities demand dwindles and becomes even more cheaper, as African economies continues to rely on imports for almost everything used and consumed, and as economies continue to rely on Foreign Direct Investments (FDI) and Overseas Development Assistance (ODA) to finance most of their development and growth related projects and objectives — is there a possibility to predict bullish markets for 2016 in such a pictorial environment?. The obvious response to such a question is NO; unless something gets done in the way we model and execute our own growth and development programs i.e. responses to questions such as: how can we increase our non-commodity exports?, how can we internally be able to produce more of what we consume?, how can we efficiently and diligently finance our long term development projects and enterprises from local resources? how can we grow the capacity of our domestic markets so they can be more vibrant as channels of finance intermediation for long term investments? etc.

A combination of recent efforts by our government to address the fiscal discipline while at the same measure increases tax revenue is something significantly positive. Not in rhetoric, but in practical terms this increases the possibility of financing our growth and development using local money. However, as is, for sustainable inclusive growth, the fiscal aspect needs to be combined with clear monetary policies that can potentially unlock our local resources (such as savings) so that they can be better and efficiently used for financing some of our long term projects. Currently, we have about Shs. 20 trillion of savings and deposits within our commercial banks, however, savings within the economy that are not yet within the banking systems can be relatively larger than what has cumulatively been mobilised by the banking system. The question is, how can these other untapped savings resources be unlocked for formal productive investments? A vibrant bonds market can be one of the tools to unlock this potential. Unfortunately, our current interest rate regime does largely encourage savers, investors and intermediaries to increase their lending activities to the government, and performs relatively lesser in supporting private sector business enterprises financing.

Where treasuries in the primary market attracts funds at yields ranging between 15 percent to almost 20 percent, depends on maturity, it is tough to motivate the growth of a vibrant bonds market. It is practically challenging for corporate entities to mobilise long term investment financing via issuance of tern notes or corporate bonds.

If we can imagine an environment and a situation where interest rates will be commercially and economically viable, if interest rates can come down to reasonable levels — two things might happen: (i) there will be increased business enterprises activities, as funding for them could be affordably accessed from the local market; and (ii) entities will have an option to either borrow from commercial banks or borrow directly from the public via issuance of commercial papers (i.e. corporates term notes and corporate bonds). The action of corporates accessing public money by issuance of notes and bonds will: (i) enhance pricing competition among lenders (commercial banks) and (ii) will further unlock idle savings which are not yet tapped into the banking system — these will then-on be used for productive investment activities within the economy.

In a normal financial market environment, whenever certain asset classes, such as equity (shares) slows down, investors normally switches to other asset classes, such as treasuries or other fixed income instruments or gold, etc. That is what we currently observing where global equity markets have not been performing so well in these past few days following fears related to China’s economic slow down trajectory and the geo-political challenges related to deterioration diplomatic relationship between Saudi Arabia and Iran. Global Investors quickly sold off on the equity space, switching their investments into treasuries and gold. For things like these to happen and take shape at the local level, it is necessary that there has to be a vibrant organised market for such other instruments where investors can switch into. And so, if we can strategise and execute programs that will enable existence of a vibrant markets for various long term financial instruments (shares, bonds, commodities, derivatives), despite global challenges, we can, in some cases increase the level of financing our enterprises growth and development projects using local money. And, going by the details above, funds are somehow available, relative to our economic size, it requires the means to unlock them for productive use.

2015 – Was A Year of Challenges and Opportunities for Stock Markets

For one measure — market capitalisation and stock indices — stock markets across the world have had mixed results for the year just ended, 2015. In our region, for example, the performance was dismal for most exchanges, particularly when measured on the basis of U.S Dollar wealth creation or price performance of listed companies or market capitalisation; this performance during the year was largely a result of continued strengthen of the United States economy and its currency, the U.S Dollar when measured against many other currencies in the region. And so, when measured in U.S Dollar-Adjusted Stock Market Returns for 2015 for a selected number of stock market, below was the performance.

STOCK MARKET % Change in 2015 in US$
Botswana Stock Exchange -6%
Bourse Régionale des Valeurs Mobilières SA (BVRM) 6%
Dar es Salaam Stock Exchange -25%
Ghana Stock Exchange -27%
Johannesburg Stock Exchange -28%
Lusaka Stock Exchange -46%
Malawi Stock Exchange -25%
Nairobi Securities Exchange -22%
Namibian Stock Exchange -4%
Nigerian Stock Exchange -24%
Rwanda Stock Exchange -43%
Stock Exchange of Mauritius -22%
Uganda Securities Exchange -22%
Zimbabwe Stock Exchange -29%

As to our local environment, when we exclude the U.S Dollar effect to our local currency depreciation, our total market capitalisation and indices lost by just 7 percent in Tanzania Shillings terms, while the domestic market capitalisation lost by 4 percent — indicating that cross-listed companies in our market lost more ground compared to our domestic listed companies. One should remember that out of the 22 listed companies in our market, seven (7) companies are cross-listed from other Exchanges. Six (6) from the Nairobi Securities Exchange and one (1) from London Stock Exchange.

Indicator                                                 Jan-15            Dec-15       % Change
DSEI Index (Points)                             2,519.64      2,333.76         -7%
TSI Index (Points)                                4,672.57      4,478.13         -4%
Total Market Cap (TZS billion)        22,090.39  20,494.69        -7%
Domestic Market Cap (TZS Billion)  9,925.45  9,527.89           -4%

Market capitalisation measures how deep the stock market is, that is, it measures the number of companies listed in the stock market, their size in term of number of volume of shares issued and held by shareholders as well as the price performance of these shares in the stock market. When such performance are measured and aggregated for all listed companies, one gets the total market capitalisation. Market capitalization also measure how the stock market performs within the economy, it measures how the stock market contributes into the economic growth and in wealth generation to those invested in listed companies. With our economy size at about TZS 70 trillion, with our total market capitalisation of TZS 20.5 trillion, this was about 30 percent of the Gross Domestic Product (GDP) while the domestic market capitalisation at TZS 9.5 trillion — was about 14 percent of the GDP.

The other important measure of stock exchanges performance is the ability of the stock market to facilitate trades and enable as many shares to exchanges hands between and among investors as many times as possible. This measures the so called liquidity of the stock exchange — that is, it measures how liquid the market is. On this measure — our local stock exchange witnessed a relatively very good year. Just three years ago, our trading turnover used to be an average of TZS 50 billion per annum, which when compared and benchmark to the leading Exchange in our region, Nairobi Securities Exchange (NSE), our liquidity performance used to be just about 3 percent of the NSE’s trading size; in 2015 our trading turnover was TZS 1,073 billion (a growth of more than 21 times or 2,146 percent) which was slightly about 25 percent of the NSE’s performance during the year 2015.

On market valuation — another ket measure of stock market performance, even though we lost 4 percent on domestic listed companies, we ended the year trading at the trailing Price Earning (PE) Ratio of 16 times, similar to other leading regional market. PE ratio measures the value of companies in the stock market by comparing the companies earnings to their trading prices in the market. It is an important measure to both listed companies and investors. The measure is also keenly looked by potential issuers of shares in the market because it measured how valuable their company will be given investors fundamental companies’ performance and investors sentiments about the economy and the market. Few years ago our market PE ratio was less than 10 times, with companies in the banking sector and manufacturing sector performing poorly relative to similar companies listed in other regional exchanges. That is now no longer the case — therefore, it has become arguably correct to motivate potential issuers to consider listing in the local market either for capital raising purposes or for cashing-out (divesture) purposes.

What else happened in our local exchange in 2015?

  • We were the first Exchange in Africa to introduce mobile trading platform in our trading, settlement and securities depository system — investors are now able and capable to buy and sell their shares using their mobile phones while in remote locations;
  • We had three listings — two for equity segment our our market and one for corporate bonds segment — these are in addition to listings of government bonds
  • We have successfully conducted the practical knowledge enhancement on savings and investment activities to higher learning students (via the DSE Scholar Investment Challenge) – through this initiative, higher learning students learned practically on how to invest and trade in listed shares using a combination of actual data from the DSE and a virtual trading platform
  • We initiated DSE demutualisation (converting the Exchange from a mutual entity limited by guarantee to a limited company limited by shares), which is now at its final stage where upon approval by the Regulator we intend to perform the Initial Public Offering (IPO) and self-listing before end of first quarter 2016. Demutualisation aims to strengthen our governance as well as our operational and financial capability. Despite these achievements, encouraging the government to implement laws and policies meant to increase the vibrancy and grow our local capital market is still a key challenge. Encouraging the private sector to consider DSE as a potential long term capital raising platform is also still a challenge – cultural business practices related to transparency and good governance are hard to crack and requires sometime. So, in 2016 — these will be our focus areas:
  • We will enhance our efforts for public awareness and public education to inform the business community, existing and potential investors, the government (its agents and local governments) and policy makers on the role of stock market to facilitate financing of business enterprises and government programs and projects using the local financial market.
  • We will improve our bonds trading support services to key market participants so that to enhance our bonds liquidity and depth;
  • We will improve, integrate and/or consolidate the Bank of Tanzania (BOT) and DSE CSD and Registry activities for government bonds;
  • We will make the necessary preparations (i.e. conducting feasibility studies) for potential listing of closed ended collective investment funds and second generation financial products i.e. long term financial derivatives.