Diaspora Bonds for financing Industrialization

This is the third in a series of articles discussing the concept of bonds, and how their various forms and diverse (treasury bonds, infrastructure bonds, industrial bonds, corporate bonds, municipal bonds, diaspora bonds, sovereign bonds, green bonds, etc) can be used as tools for financing our development. As you may recall, I started writing these series by stating the obvious fact:  that in order to succeed, our development visions, policies, plans and strategies must be underpinned by an equivalent transformative change in the financial system, i.e. there must be the financial infrastructure, structures, products and the necessary intermediation agencies that would bring the capital formation idea into fruition.

I further stated that, there can be many financial products that could be developed to facilitate the financing of our development, either in industrialisation or other such development plans — the idea of enhancing and diversifying development of our capital markets via bonds issuances, may seriously need further consideration, given its potential. I said that our bonds market is largely underutilised both by the public and private sector; i.e. to-date our bonds market is worth only Tsh. 6.2 trillion (i.e. just 5 percent of the Gross Domestic Product – GDP, which is far on the lower end), to gravitate this problem 98.5 percent of our bonds market is made of government bonds, there are only four outstanding listed corporate bonds (worth about Tsh. 100 billion), there are absolutely no municipal bonds or infrastructure bonds, or industrial bonds, or any other form of bonds. And so as a matter of sensitization and probably in efforts to make us think deeper, I have discussed industrial development bonds and infrastructure development bonds, today I will cover diaspora bonds.

As is, upon right conditions and circumstances, diaspora communities are eager to support the fortunes of the people who have remained in homelands. They normally demonstrate this desire via remittances – as a result, remittances have become a vital part of the safety net, cushioning millions of families in developing nations and keeping families from momentous financial difficulties (note, as of 2016 developing countries received remittances of US$ 401 billion which was 3-times larger than official development assistance – ODA and two-third of total global remittances of US$ 601 billion). However, despite high volumes and frequencies of remittances, these funds are largely treated as immediacy expenditure measures, with a bit of developmental aspects, dealt at individual levels hinged on the idea of emotional and personal attachments as well as patriotism. However, for the lack of coordination, this has not been executed in the broader nation building level. And so, while remittances offer evidence that members of the diaspora care about their home countries — even if for a primary intent of keeping their loved ones funded – these funds do not offer a path to financing sustainable development at the national level. In current conditions, governments does little to harness the flow of incoming foreign money from diaspora except by making such transactions cheaper and easier as they make their way to individual families. Thus, much as communities in developing countries continues to rely heavily on remittances, as source of funding – remittances end up only helping friends and families in times of need and to some extent help the diaspora populations acquire assets back home.

Yet, there is an opportunity for cash-strapped developing nations to gain access to the hard-earned savings of their sons and daughters living abroad – an opportunity that have been tried and tested by some other countries. Israel and India comes to mind easily – over the years these countries have made significant uses of their famously large and industrious diaspora populations to finance local development. Israel and India have had successful issued diaspora bonds, with expatriates from each country investing billions of dollars. From early 1950s, the Development Corporation of Israel has implemented several diaspora bonds issuance program seeking finances from its diaspora with the objective of raising foreign exchange for building the state infrastructure – annual sales of such bonds fluctuating depend on the needs, i.e there were significant increases during the 1973 Yom Kippur War (US$ 150 million), similarly during the 2009/11 terrorist attacks (US$ 500 million). In the other hand, on three separate occasions, India has issued bonds to its expatriates in order to balance their payment deficit and also finance infrastructure projects raising millions of dollars from its diaspora population. What is, and how does diaspora bonds works?

Diaspora bonds are essentially a form of government debt that targets members of the national community living abroad, based on the presumption that their emotional ties to a country make investing in such products worthwhile. It is a fact that, bolstered by advances in transportation and communication and an increasingly mobile workforce, globalisation is contributing to the rise of interconnected societies and communities that needs to be taped. As a result, developing countries in need of financing can consider expatriates working in wealthy countries for development financing support back home. This is the idea behind issuing diaspora bonds, in which diasporas receive discounts on government debt from home countries.

This financing tool has gained its traction in developing countries in recent years – so for developing nations with sizable diaspora populations, diaspora bonds provide an opportunity to tap into a capital market beyond international investors, foreign direct investments, or external loans. After all, some governments (given their geo-political, political and socio-economic challenges) find it difficult raising money on international markets or attracting foreign investments, in such cases, diaspora bonds are thought as attractive alternative source of financing. Much as emotional forces has rarely been applied to finance, but attachments to home and patriotism could yet prove as effective fundraising mechanisms for such economies, that are struggling to raise money on the standard international capital markets or in attracting foreign investments or accessing funds but with prohibitively high interest rates demanded by mainstream investors. Despite the patriotism aspect, policy makers and governments should not mistaken this financing tool to a quick and easy route to access the stockpile of savings that diaspora population might have built — to succeed in raising capital through this mechanism it requires some painful changes to the way economies manage their finances and how they would like to build trust and develop a sustainable a s well as a responsible relationship with our diaspora populations as considerations for diversifying development finance.

In conclusion, as is, well-planned infrastructure and development projects improve people’s lives and spur economic growth, but with competing financial needs and little to mobilise from, either by way of taxes or borrowing or development assistance – it is difficult to pay for that new road, or a standard railway gauge, or a power generating plant, etc all at once, so government might choose to supplement its domestic bonds issuance program with diaspora bonds. What has been the experience closer to home? – Ethiopia, is one of the countries that have made some tangible success in this aspect, started with the first diaspora bond (“Millennium Corporate bond”) in 2008, targeted raising funds for Ethiopian Electric Power Corporation from the diaspora, however, this issuance did not meet expectations. Then, despite this first experience, Ethiopia launched the second diaspora bond: “Renaissance Dam Bond” which turned out to be a success. And so, other countries with significant remittances from diaspora such as Nigeria (which receives remittances to the tune of US$ 20 billion per year) issued a diaspora bond of US$ 100 million; Ghana with average remittances of US$ 2 billion a year and Kenya at US$ 1.6 billion, have also considered this idea. I clearly understand that with our average remittance, which is currently less than US$ 0.1 billion per annum, diaspora bonds issuance might not seem as an attractive consideration. However, it may be that with more coordination and existence of products such as diaspora bonds, might unlock the potential.

Advertisements

Infrastructure Development Bonds for financing Industrialization

In my last week’s article, I wrote about Industrial Development Bonds (their relevance in industrialization and how this financing concept works/might work in our environment). In this piece, I cover the Infrastructure Development Bonds. Larger part of this article is dedicated into emphasizing the relevance of infrastructure development to a society, in the later part of the article I will explain the concept of infrastructure development bonds. As it is, infrastructure remains the dominant challenge for Tanzania (like in many other African countries) as we seek to enhance the pace of development and economic growth and as we pursue further growth via the Five-Year Development Plan (FYDP-II) whose main theme is industrialization – now, it is difficult to industrialize without the supporting infrastructure.

The infrastructure challenge remains significant and somehow daunting; however, it is possible to identify specific areas that need to be prioritized. Indeed, it is important to priorities, in order to ensure that resources are allocated efficiently and that the most pressing needs are met. In the mix of all this, financing remains a key constraint; and it seems to me that there is no single solution to our infrastructure financing gap. For citizens, policy makers and development partners, the most effective approach in addressing the existing infrastructure financing gap lies in creating a series of initiatives which help to catalyze a response from a broad spectrum of players in the financial markets. The truth is that infrastructure financing gap cannot be tackled by the public or private sectors in isolation. What is needed is an effective collaboration of the public and private markets.

Building a 21st-century infrastructure is a critical component of the country’s efforts to accelerate economic growth, expand opportunity, create jobs and improve the competitiveness of our economy. Investment in infrastructure is vital for sustained economic growth.  Energy, transport, water and information technology services remain well below international standard, and this creates serious bottlenecks as we try to achieve the transformational rates of growth that have been witnessed in other emerging markets.  The need is particularly stark in the light of rising populations, and rapid urbanization.

It is therefore necessary for the government and its agencies to work to bring private sectors capital and expertise to bear in finding new financing ways to increase investment in ports, airports, roads, bridges, communication networks, drinking water and sewer systems and other projects by facilitating partnerships between the government and private sector investors.

Investing in a 21st-century infrastructure is an important part of the FYDP to build on the progress our economy is making by creating jobs and expanding opportunity for all hardworking citizens. Infrastructure like roads, bridges, ports, water purification plants and reservoirs provide critical services to consumers and businesses while protecting public health and the environment.

Traditional tools of financing infrastructure i.e.  international development financial institutions, development aid, fiscal mechanisms, and domestic capital markets (via issuance of general purpose bonds) needs a re-thinking and re-strategizing because the current level of infrastructure investment is far too low, for them only, and as a result too many worthwhile infrastructure projects go unfunded. However, the government’s initiatives and activities (such as those depicted in the FYDP-II) might help interested parties to build more of infrastructure projects by bringing together the public and private sector to identify challenges and explore creative financing strategies–in water, transportation, energy, communication, etc. Proposals in this (and others) echo into a growing push to make infrastructure financing more accessible to a wider range of institutions and individuals, provide more flexibility for the government, and offer more opportunities for the private sector to take an active role in financing, designing, building, maintaining, and operating public infrastructure assets. As a country, we should be poised to take significant steps in mobilizing new sources of funding to finance our infrastructure development.  There is thus an urgent need in developing a financing strategy for infrastructure that aims to increase the resources available for investment such large and complex projects which requires us to mobilize different sources of capital through a variety of financial instruments, vehicles and markets. As is, our financial sector development has been hampered by the lack of liquid, longer-term, domestic investment instruments.  This has made it difficult to address the vast and growing infrastructure needs.  However, the current declining access to external funding highlights the urgent need for the government to mobilize resources from domestic capital markets to meet our development needs. This is where ideas such as infrastructure development bonds gains their traction.

In addition to funding, new structures are required to channel resources for our development. Given the nature of physical infrastructure projects that normally require large-scale and long-term financing in a mix of local and foreign currencies, attention has recently been paid to “infrastructure development bonds”.  We do not have to invest the wheel, we can draw useful lessons from emerging countries in terms of infrastructure development. Countries, like Malaysia, Korea, Hong Kong, Chile, Brazil, even Kenya have already begun to do this (Kenya’s infrastructure bonds market is currently worth about Ksh. 155 billion, equivalent Tsh. 2.6 trillion). These countries have positioned their own private sector to play a role in infrastructure projects, and also to engage in strategic partnerships with foreign companies.  They have also created an enabling environment for effective Public-Private Partnerships (PPPs).  Since a major challenge in our country is a weak and fledgling private sector, it is clear that lessons need to be learned from these countries as to how to nurture the private sector.

Infrastructure bonds can be a more efficient form of financing as they reflect the long-term nature of infrastructure financing, which is often not available from the banking system.  They also bring more transparency to the transaction, and to the financial market as a whole.  To convince the private sector to increase its involvement in infrastructure financing, our government need to continue financial market reforms, targeting institutional capacity, market structures, product mix (in line with specific needs), etc. This will develop efficient markets for infrastructure bond financing, and foster an investment environment suitable for private sector activities.

I will end up by defining infrastructure bonds – these are bonds issued either by governments or by private entities for the purpose of financing infrastructure related projects, be it physical infrastructure such as in transportation, communication, sewage, water, electric systems, etc or social infrastructure such as hospitals, schools, parks and conventional centers, etc.

Industrial Development Bonds for financing Industrialization

In order to succeed, the 5-Year Development Plan, our national industrialization plan and strategy must be underpinned by an equivalent transformative change in our financial systems, i.e. the creation of local/domestic system of capital formation should go hand in hand with efforts to industrialize, to create a local/domestic capital formation system there has to be a set of institutional factors and policy tools that will encourage and enable the culture of savings and capital formation. On the other hand, there must be the financial infrastructure, structures, financial products and the necessary intermediation agencies that would bring the local capital formation idea into fruitation.

In between, there can be many financial products that could be developed to facilitate the financing of our industrialisation, some of which I elaborated in my previous articles. Today, I want to re-emphasis on the idea of bonds, for a purpose – first of all it is an essential product for financing development; second of all this product is significantly underutilised in our economy i.e. to-date bonds worth only Tsh. 6.2 trillion (only about 5 percent of the Gross Domestic Product – GDP) are listed at the DSE, and 98.4 percent of these are government bonds, there are only four corporate bonds listed (worth about Tsh. 100 billion, all issued by banks), there are absolutely no municipal bonds or infrastructure bonds, or any other form of bonds. Specifically, in this article, I discuss the concept of industrial development bonds, the next piece will cover Infrastructure development bonds, in later articles we will also cover diaspora bonds, sovereign bonds, etc.

An industrial development bond is a unique type of a revenue bond normally organized and sponsored by the government (central or a local) to develop industrial parks, or export processing zones or special economic zones — i.e. proceeds from the issued bonds are used for a variety of such facility development purposes, including land acquisition, construction, purchase of machinery and equipment, real estate development fees, the cost of bond issuance, etc. So, let us assume perhaps you, an entrepreneur or an industrialist, need to purchase or construct a new industrial facility, or there is a need to improve or refinance an existing facility, or acquire new equipment — capital expenditures related to what you intend to achieve can be financed by using industrial development bonds. How does this work, and what role does the government play?

In enabling the above to happen, a governmental authority or agency would act as the issuer or a sponsor of the bond but the proceeds are directed to the activities of the private enterprise, in a way the whole process becomes like a collective financing scheme where entrepreneurs and industrialists in their collectiveness benefits and leverages from the expertise, strength, tax exemptions and other assistance that the government has the power and capacity to do in order to access industrial funding from the public. This way, the government facilitate the financing of industrialization by providing small and mid-sized businesses who want to construct or furnish manufacturing facilities which can be used in the manufacturing or production of tangible goods; including facilities, which are directly related to and ancillary to a manufacturing facility. Then the revenue fees collected from users of the facility are specifically used to repay bond holders/ultimate financiers of the manufacturing or industrial facility – the public.

In order to access these funds from investors/financiers the manufacturing or industrial facilities and companies imbedded into it must meet certain criteria such as: companies in this facility must be manufacturers of tangible goods, or engage in the process that must add value or alter raw materials; or that a significant percentage of the bond proceeds must be used for expenditures directly related to the manufacturing processes (part to it may be used to finance ancillary facilities such as warehouse or office space); or that funds mobilized can only be used to acquire the necessary land and build a manufacturing plant; or that funds can be used to acquire an existing manufacturing plant or rehabilitate old structures; or that funds mobilized should be used to acquire new equipment used in the manufacturing process; or revenue stream from users of the facility should be blocked and set aside to repay bonds coupons and principal back to investors/financiers, etc.

Having understood the operability of the idea, let us delve a bit into the background to this type of financial instrument: Industrial Development Bonds has their genesis in the 1930s in America. For instance, through a 1936 Mississippi industrial development program termed “Balance Agriculture with Industry”, the state of Mississippi authorized the first U.S. industrial bonds. These bonds were issued by the city of Durant for the construction of a Realsilk Hosiery Mill factory. This financing model was designed to draw, attract or retain industry into communities, for the purpose of employment/job creation, and other embedded economic benefits.

Up to this point, one may rightly raise a question – if these bonds are issued or sponsored by the Government, what then is the difference between them and the existing general purpose bonds currently issued by the Government? I will explain. An industrial development bond differs from traditional government revenue bonds as these bonds are issued on behalf of a private sector businesses. These bonds are typically used to support specific project(s), as indicated above. Meaning, the bond issue is created and organized by a sponsoring government (or government agency), with the proceeds used by the private sector to develop industrial facilities. The businesses in the facility are then responsible for bond repayments. The sponsoring government (or agency) holds title to the underlying collateral until the bonds are paid in full. The sponsoring government (or agency) is not responsible for bond repayment.

The next question will be, why then doesn’t the private enterprises issue corporate bonds to finance the same development objectives? I will respond — Industrial development bonds are more desired than corporate bonds as the private business pays a lower interest rate. Under Industrial Development Bond financing technique, apart from the benefits that comes from being backed by the government, but additionally governments allow private enterprises, to benefit from the government’s status as a tax-exempt entity and its ability to issue debt obligations at tax-exempt rates. In most cases, this arrangement provides tax exemption status to the bonds (just like the case for general purpose bonds issued by the government). As the ultimate recipient of the proceeds of the bonds, the private user, benefits because the interest on the obligations is tax-exempt and therefore bears a lower interest rate than comparable taxable financing. For example, given the tax incentives Industrial Development Bonds are issued at rates below taxable alternatives.

Measuring the Value of a Company, and its Shares

In recent days, with regard to some concluded and ongoing Initial Public Offering (IPOs) the public have been caught up in some level of education (and in most cases miseducation) by some people in the society – probably well-meaning individuals or people with bad intent, in often cases using the social media platform as a tool to dispense their knowledge in a topic as complex as – VALUATION. I know for sure that even a piece such as this posted in the mainstream media would not perfectly educate the person who wants to make an informed investment decision, that is why it is advised that a prospective investor should consult licensed investors advisers, stockbrokers, accountants and lawyers prior to make such a commitment. But I will try.

Now, let me emphasize this one point from the onset, because it is important. That, valuation of companies, businesses, shares or other such assets and securities is not a precise science and whenever the valuation is conducted, the conclusions arrived at in many cases, with necessity, are subjective and dependent on the exercise of individual’s judgement, their understanding and sentiments. So, even the staunch stock investment traditionalist and value-based investors like Warren Buffet will form their judgement about a valuation and the business or share price separate from other individuals – why? because business and share valuations are matters of individual’s perception, judgment and sentiments. As long as there is an exercise or activity of valuation, there is no indisputable single value of the business or its shares and normally credible and knowledgeable valuers of businesses and shares will express their opinion on the value as falling within a likely range.

Whilst valuers does insist that they consider their range of values to be both reasonable and defensible based on the information availed to them by those providing them with data and information to inform their assumptions, their projections, and their conclusion on the business and share valuation but they also will insist that it is true and possible that some other credible business and shares valuers, if given the same assignment with the same information, may place a different value on the business and its shares. Why? as I said earlier valuation is not a precise science.

The second important point to note is that business and share value is not the same as business and share price. Value and Price are two different concepts when it comes to making an investment decision. Therefore, the actual price that a transaction can be concluded or achieved can be higher or lower than the estimated value provided by valuers depending upon the circumstances of the transaction and the nature of the business, for example there might be perception of potential synergies once the transaction is concluded, and this will inform the understanding and negotiated price of shares or the business on the basis of the valuation carried out. Furthermore, as is in such transactions, the knowledge, negotiating ability and motivation of the buyers and sellers and the applicability of a premium or discount, is in most cases affect, the actual market price achieved for any such transaction.

Accordingly, the valuation conclusion in often cases — be it in a private placement transaction or a public offering (IPO) transaction — does not necessarily have to form the price at which any agreement proceeds. The transaction price is something on which the parties themselves have to agree; and so by buying the shares sold during the IPO you basically agree on the price that is set, which do not necessarily have to be the share value, and as a rational investor you should expect that, unless the company is on a forced sales value mode, or is under liquidation. The ones who set the price (the issuer’s of shares and their advisers) do not have to take the business value or share value as the actual price of shares, as some people have been informing the public in recent days. There are other factors beyond the valuation that will inform the price of a share or business.  Read on:

The process of a company, business  and share valuation is typically based not on historical results, but on its capacity to generate positive future cash flows. This capability is a function of the internal capacity of an entity supported by the trend of the industry and the business environment in which the company operates. Therefore, anyone who indicates and insist that the Net Asset Value (which is a historical value) of a “going concern” business should be the ultimate basis of a business or share valuation and therefore share price is somehow mis-educating and mis-leading the public, despite the well-meaning aspect of the advise.

As part of the valuation work, credible valuers will in most cases conduct an analysis of the business performance over the past period of years using audited accounts and then they will as well review and analyse financial projections prepared by the company that intend to issue its shares or sell their business. Upon being comfortable and confident that the historical data are credible and authentic and upon challenging the assumptions used by the company to form their projections, then valuers will in principal use three valuation methods to value the company, business or shares: Discounted Cash Flow; Comparable Market Multiples (this includes Price Earnings Ratio, Enterprise Value to EBITDA, Enterprise Value to Sales Revenue, etc) and also the Net Assets Value (based on the market value of its assets and liabilities).

The Discounted Cash Flow method is generally recognized as the most comprehensive and renowned going concern valuation technique. This method is based on the premise that the value of a company is a function of the future cash flows generated by the business, discounted at a risk-adjusted cost of capital.

On the other hand, the comparable market multiple valuation technique is appropriate for assessing the value of shares of companies that are not listed in the stock exchange by comparing the commonly used multiples of similar actively traded public companies so as to extrapolate the market value of a company and/or its shares. For example if you are valuing a bank or a telecommunication company, you use data and information of similar companies that are listed in the local and/or foreign stock markets to derive at the value of the bank or telecommunication company being valued – it also provide the benchmarking confidence to the DCF valuation method.

However, it is important to note that the value obtained using market multiples approach is also largely a function of the type of guideline information used. For example, when recent revenues are used as a basis of the transaction value, the value derived using this approach will generally represent a controlling (acquisition of entire company), non-marketable value; while in most cases the value obtained using publicly traded companies often is considered a non-controlling marketable value – therefore it is important that issues like controlling stake, country risk, maturity of the sector the comparable business is operating, comparable company’s market share in its sector in a particular economy, should be keenly considered.

All in all, the idea behind the market multiples approach is that the value of a business (often privately held firm) can be determined by reference to “reasonably comparable guideline companies” for which values are known. Such guidelines may be based on the fundamental of the company’s performance i.e. sales revenue, assets and earnings.

In conclusion – this article meant to provide some more insight to the public, probably help to educate where there has been a miseducation, but it does not in any way provide a conscience advise on how to value business or companies or shares. Valuation is a complex topic that will be fairly covered in such a piece of article in a newspaper.

Explaining the Ups and Downs of a Stock Market

Anyone who has ever had money at play a role in the stock market as an investor, or a just keen observer, or a stock market analyst knows that stock prices fluctuate from time to time, for good and sometimes not so good, reasons creating temporary moments of “highs” and “lows”. For many, especially stock analysts and active investors, these fluctuations can potentially be very stressful. The fundamental aspect to this, however, remains true, in that the success in the stock market investment requires patience and a willingness to see past fluctuations to study the larger picture over a period of time. With time, you gain the experience to better interpret these fluctuations; with time, history tells us, stocks are always in the upward trajectory.

From the month of May 2013 – a reference to the point I joined the Dar es Salaam Stock Exchange, to-date, the domestic listed companies have combined returned a total of 160 percent in the form of capital gains to investors – this is equivalent to Tsh. 1,539 billion of wealth creation/increment to investors; and if combined with an average of 7 per cent per annum return in the form of dividend, it makes up a combined compounded equity return of about 200 per cent in a period of close to four years. One key aspect to note, is that despite the overall growth in market wealth creation to investors over this four-year period, however, in the last twelve months, i.e. since April of 2016 to date the market has lost close to 11 percent of investors’ wealth, which in monetary terms this is a combined loss of Tsh. 961 billion of domestic market capitalization; while from January 2017 to-date there has been a loss of about 3 percent, about of Tsh. 220 billion loss on investors’ wealth. If only there were no these losses, investors could have increased their paper wealth by Tsh. 2,500 billion (Tsh. 2. Trillion) in these four years. However, the wish of if the losses could not happen makes us irrational! And so, this is story about the nature and behavior of a stock market – there are highs and ups, as well as the lows and downs. A rational investor should expect either, with a hindsight that in the overall, equity investment provides positive returns to its investors, as long as the economy keeps growing, the business environment is conducive and that the investment is well managed.

However, as it is with human nature, rational investors are not as many out there, that’s why lows and downs moments are highly highlighted to extent of, in some cases, eliminating altogether the memories related to sweet moments when we enjoyed the highs and ups. I have just mentioned “human nature”, and to bring my point even closer to our “human nature” – one might say, the stock market can quite tell a story closer to a love story, somehow complete with break-ups (and make-ups). And as it is with such relationships, split-up doesn’t always mean a relationship is dead, sometimes an “end” could just be a set up for a new beginning, with reconciliations and re-corrections. And therefore, much as we have seen the downward trend in the past one year for the reasons I partly explained in my quarterly note, will the coming months before end of year 2017 prove to be a period of reconciliation and re-correction? Probably yes, probably no. The answer to this sometimes goes into the fundamentals of investments and stock markets theories. Theories that have been tested by history and proven in most cases to be something meaningful to make reference into. In reference to our piece today, I would like to make reference into the “Dow Theory”.

Charles Dow, the founder of the Wall Street Journal and inventor of the world’s first stock market index, was the first financial analyst to scrutinize stock market fluctuations and interpret its bigger picture. He studied the ups and downs of the market and developed the so-called “Dow Theory” which, among other things, defines a “trend.” All stocks move up and down over time, creating temporary “highs” and “lows.” When a stock creates a sequence of “higher highs and higher lows,” it is trending. This suggests that the motivations of market participants are in favor of price moves in one direction, either up or down. Either the trend is up, and demand for stock is high, or the trend is down, and more investors wish to sell stock than buy it. And, so – this boils down into the fundamental matters of demand and supply as well as investors’ sentiments, which then determine the efficiency in how stock prices are determined and in which the market behaves.

So, how does this work? Let us start with the supply side — for any stock, most of the time there are a set number of shares outstanding. When you want to purchase shares, you must compete with other buyers for the limited supply available in the market. Where does this supply come from? Shares are only available to buyers if their current owners who choose to sell them. Thus, supply in the stock market consists of stock being sold. If few or no traders want to sell their stock, then there is no supply and buyers can have difficulty opening positions.

Demand — when you want to sell stock, it can only be liquidated if someone else wants to purchase those shares from you. Thus, your supply must be met by demand in the marketplace. In the stock market, demand equates to buyer interest. If no one is interested in buying the stock you wish to sell, then you may have difficulty getting rid of it. In such a case, sellers are competing with each other for the few buyers that are present.

The goal of any stock market is to facilitate the trade of securities. Stock market ups and downs are directly caused by an imbalance in supply and demand emanating from both fundamental and sentimental based factors. Prices remain consistent or “flat” if supply and demand are approximately equal. If there is more supply than demand, then sellers must accept lower and lower prices as they compete with each other for buyers’ interest, and the stock drops in price. Likewise, when a stock is in high demand, buyers must pay higher and higher prices to compete with each other for the few shares available, and the stock increase in price.

As indicated above, demand and supply which are determinant of stock prices have fundamental and sentimental origins, I will dedicate the next two paragraph on the sentimental element. The relationship between supply and demand in the stock market is often called “sentiment.” When stocks are in high demand and prices are rising, the sentiment is mostly positive which leads to fewer stock owners wishing to sell and more investors wishing to buy. Extremes in sentiment ironically precipitate major market fluctuations. When sentiment reaches a positive extreme, a stock market drop is often imminent. “Contrarian” investors, the like of Warren Buffet, monitor market sentiment and trade opposite the prevailing attitude. The cause for this is simple. When most participants in the market have a similar opinion, then there is more room for some of them to change their minds. When sentiment is more balanced, there is more room for skeptical investors to eventually join the prevailing attitudes and start a trend. Strong opinions in the masses rarely last for long, as more balanced sentiment is healthy.

In wrapping up, despite the up and down swings of the stock market, in order to maximize your equity investment return potential, apply some pro-active investment management philosophy. This is imperative –particularly in stock selection that is informed by a view on the market cycles, company returns and diversification as you try to ignore the rumors you hear about how stocks are valued or the stock market behaviors. Try to resist the naysayers and their model-driven predictions about how the market can go, in most cases their forecasts have proven to be not more valuable than a coin toss. In all these, it is good to try and maintain your cool head and handle well your emotions. Yes there are seasons that are not so good, but if only you have the patience, the growth trajectory is always there.

Strategic Reconfiguration of Financial Resources for Industrialisation

Financial year 2016/17 is the first year of implementing our Five Year Development Plan (FYDP-II) themed: “Nurturing Industrialisation for Economic Transformation and Human Development”. As it is, in order to succeed, the national industrialization and economic transformation strategy must be underpinned by transformative changes in the country’s financial institutions whereby the creation of indigenous systems of capital formation goes hand in hand with efforts to industrialize. So far there has not been strong indications that we are pursuing efforts to transform our financial markets ready for industrialisation. I am of the opinion that our focus on creating a set of institutional factors and policy tools that will encourage and enable the culture of savings and capital formation in our country is very fundamental.

As I opine, I clearly understand that there are multiple challenges and opportunities in financing our industrialisation. It is also obvious that there are several factors that should be taken into consideration in order to elaborate on how the country can transition and galvanize further support for promoting the financing of its industrialisation, i.e. we need to: (i) encourage and motivate adequate flow of FDIs into industrial sector, diverting from the tradition where most of the FDI were directed towards natural resource; (ii) enhance our domestic financial resources mobilisation for sustainable capital formation as well as the allocation of capital sourced; (iii) enhance our ability to finance infrastructure that is critical to industrial development; (iv) improve our business environment conduciveness in order to attract more flow of domestic and external finances into productive sectors of the economy; (v) increase our coordination capacity so that resources from individuals, pensions funds, and other institutional investors can be intermediated better for sustainable financing of industrial sectors and its embedded infrastructure requirements; and (vi) strength our public policies and develop financial products that can leverage remittances from Tanzanians in the diaspora.

Hence, the second obvious: the process of capital formation requires us to consider key reforms and transformations in the banking sector (i.e., a good mix of commercial, investment and development banks) and capital markets. Today, Tanzania has over 50 banks and non-banking financial institutions with combined balance sheets size closer to 27 per cent of Gross Domestic Product (GDP). However, the majority of these are commercial banks mainly focusing on providing short to medium term working capital funding to businesses. Lending activities are highly geared towards supporting trading activities and personal loans. A mix of banks including banks that will provide financing to industries is therefore urgently required, and the government has to champion this by way of an appropriate ownership and governance model, as suggested below.

The government and private sector should champion introduction of financial instruments that will be used as investment platforms and vehicles for mobilization of investable funds i.e., common stock (for common ownership), specialist instruments and institutions (e.g. real estate investment schemes [REITs] for real estates; industrial development banks for industries; infrastructure bonds for infrastructure projects; municipal revenue bonds for local government projects; etc.); micro savings bonds etc. Such financial instruments should be linked to practical industrialization projects and entities that will be in need of such funding. This will require a strong coordination among various ministries, agencies and private sector and other supporting institutions.

Commercial banks should be encouraged and motivated to get heavily involved and align themselves with the country’s industrialisation and transformation goals. By building their capacity to finance long-term projects and enterprises under the industrialization and infrastructure development program, banks should be able to extend their credit tenor to long term, especially if they can also match their long term lending activities with capital finances that can be sourced via capital markets (i.e. by issuance of long term debt instruments and shares). Banks should be able to match their lending with sources of capital that can be obtained from the capital markets via issuance of corporate bonds.

The Government should create a conducive regulatory framework that will motivate commercial banks to participate in the investment banking space, providing deal sourcing transactions and corporate financing advisory services as well as arranging syndicated credits.

Banks have to be motivated to participate in the risky industrialization programs – this can be in the form of credit guarantee by the central government (or other institutions created for such mandates), interest rate subsidy, etc. Banks should also be encouraged to build their capacity to provide long term soft loan schemes for pre-selected industries such as textile and garments, constructions and furniture, cement, sugar, special engineering industries, etc. With proper incentive and motives, banks can also be instruments for financing modernization, replacements and renovation of industries necessary to achieve economic level of production as envisaged in the FYDP-II.

We should also think of establishing specialist banks/financial institutions such as: (i) industrial development bank (targeting the manufacturing component of industrialization with mandates to also coordinate and integrate activities of various financial institutions providing finance to industries i.e. arranging syndication lending for industrial projects, etc.); (ii) infrastructure development bank, as is the case with Tanzania Agricultural Development Bank (TADB) that provides wholesale lending for agricultural projects; (iii) Construction industry focused banks lending to building materials manufacturers; (iv) Banks lending to small and medium (SME) industries, etc.

These specialist banks/institutions should be tailored to support industry-led projects and enterprises. Ownership and governance of such financial institutions should be strategic so as to enable accountability and efficiency. They should be public-private owned with clear mandates, among others, to provide direct and indirect financing to industrialization projects. These financing facilities and mandates will include seed capital, long-term credits at subsidized financing costs for pre-selected projects as identified in the FYDP II, rediscounting bills, providing guarantees, underwriting of and direct investment to industries issuing financial securities, etc. The government and private sector should see this as a backbone of the modern industrial economy. In this undertaking, the government should be willing and ready to take risks that cautious entrepreneurs would tend to avoid by providing heavy capital investments in pre-selected priority industrial sectors.

To facilitate establishment of these institutions, the government can provide seed capital, while private sector (local and foreign) could participate via a combination of private placement and Initial Public Offerings (IPOs). With IPOs and listing, these institutions will be able to efficiently raise future capital by way of rights issues and/or bonds issuances.

It is therefore recommended that in addition to the government’s equity financing, banks such TIB Development Bank and TADB should consider to pro-actively access other sources of funds i.e., public funds from the local capital markets as well as strategic partnerships with international financial institutions that have shared interest like AfDB, IDC and PIC of South Africa, EIB of Europe, China Industrial Development Bank, etc. This will allow these banks to continuously access public money and other such sources whenever substantial funds are required, via rights issuances, issuing of corporate, infrastructure, industrial, or revenue bonds at competitive and efficient cost of funding set by market forces. Furthermore, this will increase these bank’s (or other established specialist financial institution’s) institutional capability to lead or arrange syndications with both local and international financial institutions.

Non-availability of credit and other forms of financing on easy terms has been one of the major handicaps of small industries in Tanzania. At different moments and capacities, the government and other financial institutions have conducted various schemes to assist industries in this sector by obtaining credit facilities, SME Credit Guarantee scheme is among these efforts. As it is, these efforts have not resulted into meaningful results, therefore, the need for the economy to have financial institutions that will finance small industries on comparatively liberalized terms with long term repayment periods i.e. 5-15 years and long term moratorium 12-18 months cannot be emphasized.  With the view of providing speedy flow of institutional finance to this sector, institutions such as those providing insurance and credit guarantees to cover major part of the risk on such schemes will be necessary.

To fast track the process, there can also be Small Industries Development Bank(s) – such bank(s)’ role will be to promote, finance and develop industries in small scale sector as well as coordinating activities of agencies which provide finance to small enterprises. Such financing and assistance can be in the form of equity type assistance by way of seed capital, can be via direct discount and rediscount of bills arising out of sale of capital equipment in small scale sector, etc.

The government may also consider to provide capital subsidy to a certain percentage of fixed investments (such as land, building, machinery, equipment, etc.) units for expansion, diversification and modernization programs and expansion in order to promote small scale industries – industries such as furniture making, sports goods, writing materials, etc. can be reserved specifically for small industries.

A good mix of banks, sometimes sourcing their finances from the capital market provides an opportunity to finance our industrial development, as we continue to attract and motivate FDIs and other sources of foreign capital as well.

SMEs Financing via Capital Markets

When the Dar es Salaam Stock Exchange (DSE) in collaboration with the capital markets regulator and other stakeholders established the second tier segment in its listing platform (the Enterprise Growth Market – EGM) for the objective of facilitating the financing needs of Small and Medium Enterprises (SMEs), new ventures and loss making entities (with clear plans to turn into profitability upon accessing efficiently priced source of capital) — our hopes were high. We approached this initiative with an understanding that access to finance, especially of the long-term and sustainable nature was one of the most mentioned hindrance for SMEs growth and expansion. However, since its establishment in the last quarter of 2013 the EGM has been able to attract only 5 companies – mostly from one sector — the financial sector. There is so far not a single listing from real productive sectors of our economy, sectors such as agriculture, manufacturing, mining, tourism or even trade are totally unrepresented. As I say this, I want us to understand that it is good to have companies from the financial sector seeking equity source of financing, particularly given their operating model, i.e. accessing public money for onward-lending to real sectors of the economy and hence the multiplier effect, but I further want us to understand also that having a diverse of sectors represented in the stock exchange’s EGM segment has its own positive impact in various forms.

In spite of the slow growth in the EGM, relative to the size and quantum of the SMEs in our economy, access to capital remains a major hindrance to most SMEs –this is not only for our case, the situation applies in many other economies. It is because of this that multilateral institutions, governments, policymakers and private sector actors across developed and developing markets remain focused on addressing this key barrier to growth of SMEs. It is a fact that access to external finance (or lack thereof) remains a specific area of concern for SMEs, a 2016 OECD report on the topic of SMEs access to financing, notes that “despite recent improvements in SME lending…many SMEs continue to face credit constraints.”

In addressing this challenge, much of the focus, mostly (and in actual fact appropriately), has been and still is on the area of enhancing lending to SMEs; until recently, where we observe growing emphasis on the need to diversify the range of financing options that are available to SMEs beyond bank borrowings, and consequently the potential role of capital markets in SME financing has emerged.  This phenomenon is partly a consequence of the retreat in bank lending post the 2008 financial crisis, but also a recognition of the impact that an over-reliance on debt finance can have on the ability of firms to withstand economic downturns, this is according to the recent report by the World Federation of Exchanges (WFE). Furthermore, the 2015 OECD report to G20 Finance Ministers and Central Bank Governors notes that “although full disintermediation of SME financing is neither achievable nor desirable, there is a wider need for use of the capital markets by SMEs.”

Efforts to address SMEs comes from many fronts, for example in Europe, the Capital Markets Union Action Plan makes special mention of the need to address barriers to SME access to capital market financing options; and in Canada, the TMX Group (owners of the Toronto Stock Exchange) have established an independent working group, to identify mechanisms for increasing company access to growth capital. Central to this enthusiasm for SME-enablement is the fact that SMEs globally are significant employers and potential contributors to economic growth. These themes are particularly salient in the low growth, post 2008 financial crisis world of the developed markets but resonate equally in developing economies. According to the European Bank for Reconstruction and Development, “SMEs make up over 99% of the total number of businesses”  in the markets in which they operate; the International Chamber of Commerce states that SMEs represent “around 60% of private sector jobs”;  the European Commission estimates that SMEs represented “99.8% of all enterprises in the non-financial business sector” in the EU, accounting for “67% of total employment”10; and the US Small Business Administration suggests that “small businesses provide 55% of all jobs and 66% of all net new jobs since the 1970s” in the United States, according to the WFE 2016 report.

Given their relevance to the economic growth, to employment, to entrepreneurial development and innovation, facilitating SMEs access to diverse sources of funding, especially long term source of funding that are also efficiently priced by the market, increases the ability of SMEs to play a growing sustainable role the growth and development of both enterprises and economies. Therefore, the idea of alternative markets in stock exchanges, or establishing stock exchanges for SMEs is well placed and probably overdue. Why? Overall, companies that in the last few years have made use of informal (trade credit) and formal (bank funding) sources of funding declared that they also faced borrowing constraints, defined as being unable to access some or all the funds they needed, according to WFE.

In encouraging SMEs to access public money by way of Initial Public Offering and the subsequent listing into the stock exchange, it is important for us to state the fact that listed companies are less likely to be borrowing constrained than unlisted companies. Listed companies are normally perceived by banks as carrying lower level of risks, given the governance and control requirements instituted to listed companies by regulators, compared to unlisted companies whose transparency and governance mechanisms are not controlled, therefore much as listed companies are not constrained to borrowing compared to unlisted but also their cost of borrowing is relatively lower compared to unlisted companies.

Furthermore, the constraint around borrowing and high cost of borrowing could be because borrowing constrained’ companies (i.e. unlisted companies) decide not to, or are unable, to list, but also because the very fact of listing makes them less likely to be constrained as they have more financing options to tap into. Because listing gives companies access to an additional source of funding, it reduces their likelihood of facing financial constraints. Consistently, empirical studies indicate further that listed companies also tend to use less internally generated funding (retained earnings) for their expansion and growth compared to unlisted companies – meaning investors in listed companies tends to enjoy real cash returns more often relative to unlisted companies, again it is on the basis of their easy access to various sources of financing.  In conclusion therefore, for those companies that comply with listing requirements, accessing public equity finance is a way to reduce their financing constraints.

One major issue remains very relevant in this discussion, and it is worth mentioning as I conclude – liquidity in the EGM listed companies is key in efforts to attract investors to invest in listed SMEs. Investors, both retail and institutional investors put emphasize on more liquidity in SME stocks in order to increase their confidence in investing in listed SMEs. So far liquidity in the 5 companies listed in the DSE’s EGM hasn’t been as vibrant. What could possibly be done to enhance liquidity? One of the mechanisms to address the liquidity issue is to increase the availability of good quality information about SMEs, which can be achieved via listed SMEs research activities by market intermediaries. Other mechanisms that may help to increase liquidity may involve introducing dedicated market makers for SMEs; the exchange and intermediaries profiling/showcasing SMEs to relevant investors, this could take the form of traditional in-person events or via seminars and workshops; other tools may include expanding and diversifying the exchange’s  investor base — in smaller markets like ours, crowd-in institutional investment funds may be a desirable mechanism where we can create listed investment vehicles that focus on investing in listed SMEs or on unlisted SMEs with the intention that the target companies are then listed in due course. While this may not have a direct impact on liquidity, it could increase the availability of funds for SMEs and the quality of companies when they eventually come to market. And lastly, to crowd-in retail investors, policy makers should consider to sustain the use of current tax incentives to attract more investors.