Capital markets play an important role in promoting economic activity by facilitating and diversifying enterprises’ access to capital. At the macro level, deepening capital markets, which have ample liquidity and development of secondary markets have the opportunity to reshape developing world’s access to development finance, facilitate driving wealth creation and anchor the emergence of powerful regional trading blocs.
In emerging and frontier economies, benefits that accrue to national economies as a result of capital markets growth and the subsequent deepening of these markets are potentially greater, but such developments are also particularly sensitive to a host of institutional variables, including competition, protection of minority investors and the overall business productivity. Because of this, supporting development of capital markets requires a broad and ambitious program of reform which can better be championed from the policy making level filtered downward to enhancement of key institutions and the regulatory framework.
Nonetheless these issues are not unique to emerging or frontier capital markets, they are rather the general “rules of the game” interpreted from the point of view of each economy and markets. However, there are also specific issues that are much more significant in emerging markets and merit some consideration – all of them related to how policy makers can jump start a vicious cycle of market depth, liquidity, confidence and contribution to economic growth. Some of the key issues in the development of capital markets in a country include: the role of foreign capital in market development; the role of privatisation of state enterprises as a tool of market growth; as well as the potential for tapping into growing pool of pension funds in facilitating growth of domestic capital markets. These three factors informs our discussion today — read on:
The first key issue – Foreign investments: owing to the crucial role of liquidity in the development of capital markets, foreign capital is a development worth welcoming. Encouraged by the strong growth prospects of emerging economies, foreign investors have in recent decades sought out both short and long-term opportunities in emerging economies capital markets, often making investments that are relatively substantial compared with the market capitalisation of individual firms and indeed the market as a whole. Actually, this is self-evident even in our local market where foreign investors hold more than 50 percent of total market value and over 70 percent of trading liquidity at the DSE.
Inspite of the potential side effects of over-dependence on foreign investment (i.e their temporal nature), a great deal of foreign capital flow contribute significantly in the development of capital markets in terms of its depth, breadth and liquidity. Whether foreign direct investment (FDI)/strategic ownerships or foreign portfolio ownership (where foreign owners do not exercise any control on the investable company) they both play a crucial role in facilitating sources of development finance in a country — what would be key for to our consideration is how do we utilise such foreign capital?
The second key issue – Privatisation: in many emerging economies, the creation of capital markets, especially stock exchanges, has gone hand-in-hand with programs for the privatisation of state-owned-entities (SOEs), this has its origin in the history of these economies; as a result the development of capital markets in developing countries has been driven to a great extent by such offering, with large-scale privatisation programmes typically being followed by substantial increases in market capitalisation and trading volumes as well as strengthening of regulatory and corporate governance frameworks. Studies indicate that as at the end of the 20th century, 30 out of 35 largest share offerings has been by way of privatisations (Megginson and Netter 2001). This has been the case even here at home, almost all domestic large market cap companies that are listed in the DSE are a result of privatisation, you name them: TBL, TCC, NMB, Twiga Cement, Tanga Cement, Swissport, TOL — one could only wish that many more of such would have been privatised via the stock market, we probably could have Mutex, Mwatex, Mbeya Cement, Tanelec, Morogoro Shoes Co. Ltd, etc successfully listed in our stock exchange while making quality garments, shoes, etc for our domestic consumption, for exporting while at the same time provide an efficient and ready market for our cotton farmers and cattle keepers.
To reinforce this point, the 2009 World Bank Report, revealed that between 2000 and 2008, developing countries used equity markets to raise about US$ 193 billion by selling stakes in SOEs. According to this report, the largest such transaction were China’s sale of shares in the Industrial and Commercial Bank of China (ICBC) and the Bank of China, as well as the floating of Russia’s Rosneft — in total between them China and Russia accounted for about 83 percent of total value of equity-market-led privatisations over the 2000-8 period.
The third key issue – Pension Funds as Investors: pension funds are a key tool of injecting liquidity into capital markets. In essence pension funds sources helps countries to avoid the over-dependence in temporary model-based (“hot money”) foreign capital. Pension funds sources are somehow consistence with most domestic policy objectives in developing countries, where pension funds encourages or at least allow retail investors to invest, albeit, indirectly into securities listed in the local market. For pension funds to play an envisaged role in the development of domestic capital markets, reform becomes a necessity, and if well executed it have the opportunity to positively impact the development of capital markets. In our country, this is not yet the case, pension funds contributes less than 5 percent of the total market capitalisation of the DSE listed companies.
As I elaborated in my previous articles, the country of Chile chose a few decades ago to use the pension funds route to facilitate growth of their capital markets and finance various enterprises in their economy, they have done this with success. And according to a study by Niggerman and Rocholl (2010), pension funds reforms have contributed to the building of larger, though not necessarily deeper, capital markets (because in most cases pension funds pursue a conservative investment philosophy, hence their activity in most cases are confined in the primary market, during IPOs). However, despite this, still the effect of pension funds investment activities is significant and incremental to the benefits from other pro-market reforms, i.e. markets in less financially developed markets have benefited the most, as have less developed markets at the country level.
I wish to stress that it is the quality, not the relative size, of pension funds’ activities that is associated with the capital markets growth. In most cases, the growth of pension funds’ assets tends to promote capital markets development only in countries with otherwise high level of financial development. Elsewhere, restrictions on the type of assets funds are allowed to invest in, small pension sizes, political interference and efforts to enlist funds in financing government decifits make it difficult for markets to build on pension fund activity. Furthermore, the problem of investment restrictions is ubiquitous because pension funds are often either state-owned or at least strongly regulated and are investing money that, as a rule, beneficiaries cannot afford to lose. Hence, the funds’ soundness and performance are highly political and hence in many developing economies the rapid liberalisation may be undesirable.