Exchanges are important contributors to the growth and development of domestic economies. They help funnel domestic savings towards long-run investment, thus sustaining household consumption through additional returns and contributing to the accumulation of domestic wealth. At the same time, well-functioning exchanges enhance the ability of young growing companies, as well as more established corporations with expansion plans, to access the capital they need to grow their businesses.
Exchanges also provide information, offering direction, acting like benchmarks to the real economy. The development and sophistication of local capital markets can be measured along several dimensions (returns, volatility, size), with liquidity and price efficiency being perhaps the most important indicators of capital markets development.
The role of exchanges is particularly important in the case of markets like ours i.e. markets that have not yet attained the performance of developed markets and are in low/middle income country. Our kind of markets typically underperform when compared to developed markets: we are less liquid, less efficient, more volatile, and are sometimes characterized by lower corporate governance standards. Understanding what factors are constraining the development of our market is therefore of paramount importance to sustain our growth and to bridge the performance gap with developed markets.
Such understanding becomes more urgent given the impact of COVID-19 pandemic in the economy. We predict our economy to grow at estimated less of 5.6 percent, which is almost 1.5 percent of our pre-COVID projections. While, like other emerging markets, we will suffer less than developed economies, but there is an impact. As the pandemic slows down the growth prospects of some aspects of our market, it is of even more crucial importance to reignite the engine of our economic growth, by allowing capital markets to perform its activity by facilitating the allocation of funds to where they are most needed.
Capital market development and economic growth
There has been a substantial amount of research documenting how capital market development is positively related to economic growth, both in developed and in developing markets. Different channels through which capital markets affect economic development have been identified: well-functioning capital markets increase domestic savings rates as well as the quantity and the quality of investments, they help growing companies to raise capital at a lower cost, making them less dependent on bank financing; they also encourage financial discipline and reduce the costs of information, which contributes to a better allocation of resources.
Therefore, nurturing capital markets development in a middle-income economy can be seen as an indirect way of enhancing the underlying economic conditions of a country, a task which has become even more urgent after the impact of COVID-19. Even, the most recent studies in countries such as South Africa (Khetsi and Mogale, 2015), Malaysia (Nordin and Nordin,2016), or Turkey (Coskun et al.2017), to mention just a few, have also confirmed the positive relation between stock markets and economic growth.
Against this background, some questions naturally arise: how can an exchange identify those elements that may be withholding it from further development? What changes to the ecosystem can have the greatest positive impact on the exchange’s performance? How can the exchange most efficiently stimulate the market in a way that is optimal? How can the exchange strengthen its role in rebuilding the economy in an inclusive and socially responsible way?
Each of these questions will have a different interpretation and may result in a different set of conclusions and recommendations. But regardless of the differences, it is useful for the economy to promote a general framework linking the characteristics of a market and of its ecosystem with the attributes of a well-functioning market. For example, various research shows that international investors are attracted by better stock market conditions, that is, by better liquidity, lower volatility, or higher corporate governance standards.
Research has also found that higher foreign participation and trading are in turn associated with better stock market characteristics, that is, with lower stock market volatility, an improvement of corporate governance standards and better competitiveness and profitability of domestic listed companies. This suggests international investors are attracted to better markets and, at the same time, exert a beneficial influence on them, generating a virtuous circle. Therefore, making middle-income markets, like ours, more attractive for international investors is a way to further stimulate stock market development, and, indirectly, economic growth.
However, other than that, stimulating financial inclusion on the demand side (investors), i.e. via the use of fintech as a tool to stimulate retail participation in the stock markets is recommended. As we know it, financial technology has made access to financial services easier, for companies and households alike. While this is a global trend, we, like other emerging markets face a more challenging environment than developed economies, in terms of existing infrastructure, attitude towards financial services, legal framework and overall level of technological developments. Success stories like that of mobile payments show that Fintech broadening financial inclusion need to develop tailored solutions for capital markets as well.
The element of enhancing the role of stock market in a middle-income economy would be to innovate financial products that enable retail participation in markets. As noted above, markets like ours have a challenging environment — financial institutions wishing to attract local savings need to consider that the local infrastructure, the attitude towards financial services, the overall level of financial literacy and the legal framework might not be as supportive as in developed markets. To attract domestic savings, especially from rural areas, stakeholders in the capital markets need to develop tailored and innovative solutions.
To stimulate financial inclusion on the supply side (issuers), financial literacy as a way to stimulate participation, by potential issuers, and especially small businesses is highly recommended. As it is, private companies often rely on traditional sources of finance (such as bank lending) because they are unaware of or do not have the necessary preparation to tap into alternative sources of finance. Supportive private companies with financial literacy programs can have a positive effect on listings.