How to achieve financial inclusion via capital markets

In recent times, financial inclusion have caught our diverse understanding, and we may fairly question: is registering for mobile accounts (wallets) or the practice of money transfer via mobile phone a significant achievement for “true” financial inclusion? If not, what could be the ideal measure of financial inclusion? According to the Alliance for Financial Inclusion (AFI), the first dimension to measure financial inclusion is access to the financial services and products that formal institutions offer. To achieve meaningful access, we have to consider other aspects of the financial market’s ecosystem – i.e. deposits, borrowing, investing, insurance, retirement funds, trading electronic funds, etc. I will dwell on how “true” financial inclusion can be achieved via capital markets products and services using this idea of electronic funds.
Although the economy has made significant strides in recent years along with higher savings and investment rates, inclusive growth continues to be a challenge. We are, not only lagging many emerging economies, but also, we have a comparatively lesser degree of “true” financial inclusion as compared to some countries in frontier markets. By financial inclusion here we mean ease of access, convenience and low-cost availability of financial products and services to all sections of the population. Meaning, faster and more inclusive growth prompts inclusion of diverse economic activities and geographical regions in the financial system.
The role of capital markets is vital for inclusive growth in wealth distribution and making capital available to investors. Capital markets can create greater financial inclusion by introducing new products and services tailored to suit investors’ preference for risk and return as well as borrowers’ enterprise needs and risk appetite. Innovation, investment advisory, financial education and proper segmentation of financial users constitute the possible strategies to achieve this. A well-developed capital market creates a sustainable low-cost distribution mechanism for distributing multiple financial products and services across the country.
With a long-term growth trajectory, considerable financial deepening, increasing foreign cash-flows and increase in credit, deposits and bank assets as a percentage of GDP, rapid financial inclusion appears a reality if it can be coordinated by various financial institutions and with the application of technology. Lack of institutional co-ordination, competition, technology and financial literacy are cause of lower market penetration. Alongside these, the capital markets also have challenges of excessive concentration of trading at member level, company level and also geographically. The market also needs fair amount of development work on the bond market (especially micro-savings bonds, municipal bonds), interest rate futures, SME segment in the stock market and in the cash market.
Financial deepening also implies a larger focus on the debt and equity markets than physical assets and as a country we lag behind on this front. We, in the capital markets need to cast off the conventional notion that financial inclusion is a part of social responsibility and should realize that it can foster profitable business. We need to see into it that we facilitate domestic and international investments, not only into money transfers, for the people without a bank account. We can enhance savings by households or can encourage our society to be that among highest savers in the region, which currently is a challenge given that less than 1 per cent of the population participates in capital markets. Given a savings rate of about 30 per cent and the fact that more than 50 per cent of household savings continue to be in relatively unproductive assets, prospects lie in driving these savings into the financial system (especially the capital markets) and channelizing them into productive investments. Through financial inclusion, capital markets can generate productive investments.
True financial inclusion would need financial literacy and matching technology to enhance accessibility besides adequate competition to cause more substantial marketing. The agency model can be replicated for increasing financial literacy and thereby increasing direct participation of masses in the financial system.
Capital markets entities and intermediaries could adopt innovative practices and work with banks and non-banking bodies (agents) like post offices, etc., that can provide distribution outlets for these products. Financial service providers in the capital markets can foster financial literacy on the lines of initiative such as brokers creating association with public entities such as the Post Office to provide price information and investment based-inputs to savers who could potentially be converted to investors. The postal network can also be used for distribution of financial products and services.
Financial inclusion also demands greater integration of network of banks, the exchange, insurance companies, and other financial bodies to facilitate and benefit from cross selling. Banks have a larger role to play given that over 10 million account holders and over 500 branches with about 40 per cent and 25 per cent branches in semi-urban and rural areas respectively. Nearly 50 per cent of the country’s total savings go into bank fixed deposits which could easily be converted to capital markets products. Banks can, thus, play a key role in fostering financial inclusion using capital markets products and services.
The regulator has permitted banks to enter into agreements with stock brokers and mutual funds for marketing and distributing of capital markets securities and mutual fund products. Some stock brokers are also permitted to offer discretionary portfolio management and investment advisory services. This aspect of business has the great potential to constitute more of the financial market sector products in relation to financial inclusion but has not yet been fully explored. Capital markets products, such as mutual funds play an important role in mobilizing the household savings and bringing them to capital markets.
Going forward, the regulator may consider approval of online distribution of capital markets products and services through the stock exchanges and pursue efforts to encourage retail investors to invest in such financial products. The network of brokering companies spread is only in Dar es Salaam, they are yet to outreach other urban centers or semi-urban areas, such online access could increase brokers’ focus on retail investors. Such cross-selling facilities creates enough products and services for each intermediary to have economies of scale and also promotes financial inclusion.
Mobile and internet are likely to trigger faster growth in our capital markets. Internet stock trading is popular among retailers in other parts of the World. In Tanzania, where there are about 20 million internet users, such internet penetration rate is about 35 per cent of the population, this signifies the great potential for internet trading of capital markets products. Currently, mobile telephony serves the people’s need for information access. The penetration of mobiles is more than internet, with over 40 million subscribers. In the near future, a mobile trading revolution is likely to generate financial inclusion faster.
Greater financial inclusion is required for growth and development of SMEs, which contribute heavily to our GDP and in generating large scale employment opportunities. Special focus should be given to the Enterprise Growth Market (EGM) segment of the DSE which targets to empower SME to access funds from capital markets, helping the SME sector grow by assisting them in raising risk capital and, thereby, contributing to diversification of their sources of finance. The EGM is also meant to provide an exit route by building bridge between SMEs and the private equity and venture capital. Capital markets can play a significant role in creating financial inclusion by making available multiple financial products and services to the masses. This requires conscious efforts to identify the respective target segments and enhance the penetration through financial education, product innovation, diversification, customization and simplification. The experience of mobile money informed us that we have the sophistication and professionals with vast business potential and what is needed is proper financial integration and efforts by capital market players to tap into this potential and assume new roles and responsibilities.

On the Disliking of Debt-Related External Financing

In recent days there has been discussions, both in the mainstream as well as social media platforms, with regard to how we Africans finance (and intend to finance) our economic development. China seems to be at the center of these discussions, particularly in the context of lending/borrowing. If we step back and relook on the current state of matters as to how most of developing nations finance their economic activities from the external sources’ paradigm – can we see a better option? According to the 2018 World Investment Report, issued by the United Nations Conference on Trade and Development (UNCTAD) — developing economies draws on a few external sources of finance, these mainly include Foreign Direct Investment (FDI), Portfolio equity, Long-term and Short-term loans (private and public), Overseas Development Assistance (ODA), as well as Diaspora Remittances. FDI has been the largest source of external finance over the past decade, and probably the most resilient to economic and financial shocks. To be precise, sources of external financing to Africa stands as follows: ODA & other official flows (36 percent); Diaspora Remittances (28 percent); FDIs (21 percent), Loans and other related investments (14 percent) as well as Portfolio Investment (1 percent). As data indicates, loans are yet to become the main source of external finances to Africa, rather FDIs and Remittances are gaining impact.
The good news here is that the growth of ODA has stagnated over the past decade, currently it amounts to about a quarter of FDI inflows to developing economies. On average, between 2013 and 2017 FDI accounted for 39 per cent of external finance for developing economies.
The other good news is that FDI, being the major source of such financing, does exhibit lower volatility than other sources. Debt-related flows on the other hand are susceptible to sudden stops and reversals – good that it is yet to become major. And to date, portfolio equity flows account for a low share of external finance to developing economies, especially where capital markets are less developed, like in our case, which is not a good sign, but like debt-related flows, portfolio equity are also considered as relatively unstable because of the speed at which positions can be unwound.
Now, under circumstances where many African countries expresses their desire to pursue socio-economic development propelled by industrialization and its imbedded structure – if we assume for a minute that we are serious with our intent this time around — if we think external debt-related finance has some dirty attached into it, where will the financial resources for infrastructure development and industrialization come from? How can we sustainably finance these industrialization drives? Yes, we know for a fact that any successful and sustainable industrialization policy needs to be preceded and/or accompanied by important development/transformation in the financial sector – but while we are developing the financial sector and its institutions, while we are enhancing national capacities to mobilize financial resources, both domestically and externally, what needs to happen?
If we so much dislike debt-related flows, should it come down to FDIs, Yes? but when it comes to FDIs, wouldn’t it be fair for us then if we seriously consider diverting from resource-seeking FDIs into both “market and efficiency-seeking FDIs”. Here, history could be a good teacher, that focusing on “resource-seeking FDIs” without strategic diversification seems like not a sensible approach worth pursuing. Currently the stock of FDIs in Africa is estimated at US$ 867 billion; about US$ 83 billion allocated to the East Africa nations and US$ 20 billion of this is in Tanzania. We know that a significant portion of these FDIs investments are resource and/or commodity-based – actually the decline in FDIs inflows to only about US$ 7.6 billion for the whole of East Africa and US$ 1.2 billion for Tanzania in 2017 relates to this. That’s why the recent challenge in both demand and pricing of commodity quickly got reflected to the reduction in annual FDI inflows to Africa. Much as there are expectations FDIs inflows renewals in 2018, but reasons underpinned such hope for recovery are in tied to better commodity prices. Again, a sensible approach is to create conducive climates to attract such investors from the usual top-10 sources of FDIs for Africa (i.e. US, UK, France, Italy, China, South Africa, Singapole, India, Turkey, etc) to bring their efficiency and market-seeking manufacturing FDIs into textile, automobile, ICT, industrial parks, etc.
If we are hesitant to the market and efficiency seeking FDIs route as well, then a little over a year ago my friends – Ali Mufuruki, Gilman Kasiga, Rahim Mawji and I wrote a book, titled: Tanzania’s Industrialization Journey 2016-2056, under the resource mobilization section of the book, we offered some other proposals we thought to practical given our circumstances. In a relatively lengthy way we labored to explain why we entertained and actually encouraged the idea that we need to proactively and aggressively encourage domestic resources mobilization, basically by strengthen our financial institutions (especially those with long term financing mandates) by enhancing the legal/regulatory and other infrastructure aspects as well as the accompanied financial instruments that will be linked to the practical resource mobilization for industrialization projects and entities that requires such funding. We also indicated the need for introduction of institutions such as industrial development bank(s) and banks to be more involved and align themselves in the country’s industrialization goals. We proposed the need for a combination of ownership (between the state, strategic/industrial investors and the public (via IPOs) and management of entities and projects that execute the industrialization programs. As well as the need to engage the Diaspora in our industrialization not only in financing (through remittances) but also leveraging from their knowledge, skills and experiences.

The Stock Markets and the Financing our Industrialization and Economic Transformation

In my last week’s article, I tried to indicate, picking from other country’s industrial revolutions and transformations perspectives, how they financed their transformation and how necessity it is for a country to transform its domestic financial resources mobilisation as it aims to transform its economy through industrialisation — like we intend to do. Today, I will focus on the need for a vibrancy stock market, as part of the tools economies normally utilise in financing their economic transformation.

History tells us, most successful industrialisation and economic transformation policies were preceded and/or accompanied by important development in the country’s savings and capital formation. The lesson in front of us is somehow clear in the sense that the process of capital formation go hand in hand with efforts to industrialise and transform. In my reading of the National Five Year Development Plan (FYDP-II) 2016/17 – 2020/21, which carries the theme: “Nurturing Industrialisation for Economic Transformation and Human Development”, the almost 400 pages document, the word Dar es Salaam Stock Exchange has been mentioned only once — the DSE mentioning came under the context of trying to explain why FYDP-I didn’t achieve some of its intended objectives. One of the reasons given being the lack of capital and funds to implement some of the key priorities, and DSE underdeveloped being one of the reasons. Other than that, DSE (or the capital market in that matter) has not been mentioned in the FYDP-II and its proposed financing strategies. And I think this is a mistake, similar to the one we made in FYDP-I.

FYDP-II is right — our local stock market is relatively underdevelopment. After almost 20 years of existence, the DSE is still narrow and thin, domestic market capitalisation (Tshs. 8.5 trillion) ratio to GDP is only about 10 percent, liquidity/turnover ratio (averaging about Tshs. 800 billion p.a) to market capitalisation is also about 10 percent. Only 17 domestic listed companies (23 inclusive of cross listings) are listed, and three currently outstanding corporate bonds. Government’s listed bonds worth about Tsh. 4.8 trillion are also listed, less than 5 percent of our current GDP; and the total number of investors at the Exchange is only about 450,000 — closer to only one percent of total investable population.

In my opinion, the upside potential is high, but only if we consciously decide to create and pursue the right policies under this context. Previously (& currently), the stock market has not been part of the country’s development plans (the same seems to apply under FYDP-II). DSE has not been treated as the primary national engine of capital formation and economic development by the Government or the donors. For instance, instead of driving most privatisations through the DSE and creating a tax efficient structure for companies listed on the exchange and investors in listed securities, different policies are normally chosen. The consequences of these policies are an economically weak stock market (as rightly stated in the FYDP-II), without a vastly adequate supply of securities in the market place. This is a big lost opportunity for financial inclusion, domestic capital formation and broad-based economic empowerment.

To avoid repeating similar mistakes, FYDP-II should specifically aim to revolutionise the growth and vibrancy of the stock market in the process of sustainable domestic capital formation as we strategies to finance our future. FYDP-II should have made DSE as one of the tenets of financing the envisaged industrial programs and its related infrastructure programs. How can the government facilitate growth and development of the stock markets? — there are several tools that can be deployed to achieve this objective. I will mention a few:

Out of hundreds of privatised state-owned entities, only seven (7) were privatised via listing into the exchange. These are TOL Gases, TBL, TCC, Swissport, Tanga Cement, Twiga Cement, and NMB. Hundreds of others were privatised via private sales, large part of these didn’t bring the financing, skills, technology or job creation, as was envisaged and most of these entities are no longer in operations. Comparably, entities that were privatised through the stock market on an efficient combination of ownership, by: the government, strategic/industrial investors and the public (by way of IPOs); have been more impactful, both socially and economically compared to entities that were privatised through private sales. The 7 mentioned companies are some of the largest tax payers, they provide some of most quality jobs — propelling their employees to middle income earners, being listed entities, they are relatively more effective for tax administration purpose. I therefore, urge the government to learn from this experience; the remaining SOEs should be conducted across the DSE. With the vibrant stock market (brought by, among others, privatisation of SOEs through the DSE), entrepreneurs, industrialist and business owners from the private sector will be attracted to use the capital market for their enterprises growth and development as well as an exit mechanism. This is how consideration to use the stock market for funding industrialisation would be meaningful.

Apart from privatisation, the government should also implement policies and legislative actions whose spirit was to facilitate growth of the local stock market, a wider economic empowerment and an inclusive growth i.e. policies such the economic empowerment; financial inclusion; local content; privatisation, etc. Furthermore, the Mining Act of 2010 as well as the Electronic and Postal Communications Act (EPOCA) of 2010 (amended in 2011) are some of the legislative actions meant to economically empower local citizens by way of ownership in such key sectors of our economy, however, provisions of these laws in the context of ownership distribution hasn’t been implemented, or for the case of EPOCA, the 2015 regulation provided an option. Were these laws implemented, we would have increased the depth, liquidity and the number of local investors in our stock market; that’s how we will encourage more savings and domestic capital formation.

Additionally, we should proactively and aggressively encourage domestic savings by pursuing programs that will introducing other financial instruments that can then be used as investment platforms for many. Financial instruments such as, common stock (for common ownership), micro savings bonds, infrastructure bonds, municipals revenue bonds, real estate investment schemes, collective investment schemes, etc must be championed by both the government and private sector using existing and potential financial institutions. These financial instruments should be linked to the practical industrialisation projects and enterprises that requires such funding.

As we pursue this approach, we need to be mindful of the fact that our current savings rate as a proportion of our GDP is about 20 percent while the country’s investment rate per annum is about 30 percent of the GDP, the gap is financed using foreign funds and capital. We need to gradually reduce this gap by way of developing our domestic capability to raise the rate of domestic savings and capital formation.

Blending private domestic and foreign investment through shareholding on the state-owned enterprises is vital for creating a vibrant local capital market. In relation to FYDP-II financing, a combination of government’s substantial ownership in existing (and new industries) via financial interests/commitments, combined with large number of shares trading publicly in the stock market, plus joint ventures between strategic/industrial investors on one hand and small investors (via IPOs) on the other hand, plus debt instruments i.e. syndicated trade credits, project finance will encourage the financing of the envisaged industrial program, enterprises and projects.

The FYDP-II has mentioned many strategies of financing identified priority sectors and projects; i.e. increase tax revenue by broadening our base; establishment or enhancement of specialist banks; foreign direct investments (FDIs); domestic borrowing; issuance of sovereign bonds, etc. What is clearly missing is the intent to grow the stock market so it can facilitate capital raising, encourage savings and capital formation — which is vital for the envisaged industrialisation program and for economic transformation. We shouldn’t continuously avoid this opportunity.

Lessons from the Existence of Stock Markets

What do you think is the most important thing that investors in the stock markets do? Keep their expenses low? Hire good fund managers? Avoid paying taxes? Have perfect investment timing? Well, these are all important, but arguably the very most important decision is choosing what kinds of things to invest in. In other words, a good selection of asset class to invest in. The action of setting aside some money to invest in the first place is the absolute most essential step. But then, if you don’t do that, you are not even an investor in the first place.
In the stock market, you can invest in popular growth stocks or the unloved value stocks – it depends. You can invest in big companies (commonly known as “large-cap”) with years of existence or small companies (“small-cap”). You can invest in domestic listed stocks or in international stocks, etc.
According to the experts, more than 90 percent of your ultimate investment return depends on your choices of asset classes. But then, this assumes that you invest money and leave it invested. If you move in and out of your investments, then your results are totally unpredictable.
If one was observing stock performance for the DSE over a period of 10 years, by the way the reason I say 10 years is because of a famous maxim from Warren Buffett, who says: don’t buy something unless you would be willing to hold on to it if the market were shut down for 10 years. So, the performance of DSE listed stocks for these past 10 years indicates there has been both significant growth in value and dividend elements.
On the other side of the coin, some people perceive and compare stock exchanges to casinos or betting joints or places to make quick money. Some of these sentiments are partly informed by news report that show frantic traders speculating on where prices would go next, almost becoming euphoric if the shares have had a good run up (also called a bull market), or thoroughly depressed if the market is down (a bearish market).
The image portrayed by the media is somehow unfortunate because alongside speculative traders and investors are millions of value-based investors, representing retirements savers, pensions funds, insurance funds, who genuinely try to understand the long term prospects for a company, calculate intrinsic values, deciding allocations of money to companies — facilitating their growth and expansion, or building new factory, make new invents, go into new frontiers, etc.
Through the actions of these genuine investors, societies access new products, new industries, employments, wealth creation, economic empowerment, etc as money is taken from idle and inefficient activities and re-allocated to new frontiers and efficient use. That way everyone benefits: from businesses ideas in need of funds, to those with savings in a pension schemes, to those with life insurance covers, to those with idle held cash, to those with investments in lower returns assets, etc.
As it is, economies need diversified investors and investment avenues to facilitate business growth, especially long-term enterprises and projects — many investors would prefer the liquidity and vibrancy offered by stock markets compared to the difficulty of alternative avenues.
In the same vein, societies need people willing to take risks — either in establishing new business ventures, or expanding current businesses into other new territories, or innovations based on ideas or people with the willingness to provide risky funds to new ventures and ideas. Some financial institutions, by their nature, or business model and mandates are not willing to accept such risks. Institutions, such as banks — would like to strike deals with companies whereby even if the profit is small or when the company makes losses, they are still paid their money in agreed terms. Also, they usually require collateral so that if business plans turnout to be not as expected, the bank can recoup its money by selling off property or other assets under collateral. Holders of other forms of debt capital such as bonds, take similar low-risk (but also low-returns) deals.
Imagine if debts were the only form of capital available for businesses. In such case, few businesses would be established or flourished, it would be rare for entrepreneurs and business managers to come-up with investment projects that would offer lenders the security they need or the certainty and predictable returns they require. Part of the reason why businesses flourish in various uncertain environment, is because they are also financed by capital whose source recognize that uncertainty and risk taking is part of the business and investment environment. Such fund providers factors-in such situations in their capital and investment pricing.
Now, consider a company whose business is continuously cyclical, or whose sustainability depends on its customers sentiments, or weather, or other external factors — can such a business be purely financed by debt? Probably no — such a business would require part of its finance be partly equity. That way non-risk takers can finance part of the business and risk takers can finance it partly — naturally risk takers will want high reward for putting their hard-earned savings in such an exposure. In exchange to such risk taking they would want to have their views on who should be on the board, they would want the power to vote down major moves proposed by the managers. They would also want regular information on the progress of the company. One important aspect to note is that these holders of shares, in the success or failure of the enterprise, they do act as shock-absorbers so that other parties contributing to the company, from suppliers and creditors to bankers, do not have to bear the shock of a surprise recession, a loss of market share. That’s why it is important for any society to appreciate the relevance of a stock market.