Thursday, August 5, 2021

Weak stock markets cripple economic development, impair productive projects

Established in 1989, the Botswana Stock Exchange (BSE) is the third largest stock exchange in the Southern African Stock Exchanges (SADC exchanges). Botswana presents a perfect, optimistic and fertile ground for effectively developing and utilizing the capital market for industrial financing.

In a 2019 research study article titled “The Impact of Stock Market Development on Economic Growth: The Case of Botswana”, acknowledges that the BSE “continues to be pivotal to Botswana’s financial system, and in particular the capital market, as an avenue on which government, quasi-government and the private sector can raise debt and equity capital”.

Using a decade long data from 2006 to 2016, the research study, undertaken by Ishmael Radikoko, Shadreck A. Mutobo and Mphoeng Mphoeng showed that “the value of shares traded has a strong positive correlation with economic growth. This result implies that liquidity has propensity to stimulate economic growth in Botswana”. The results of the study also show that there exists no causality relationship between stock market development and economic growth.

It is generally accepted that the stock market has become one of the important ingredients of firms’ expansion and in turn economic growth. Stock markets serve as a veritable tool in mobilizing and allocating savings among competing uses which are critical to the growth and efficiency of the economy. The efficiency of the stock market performs an allocative functions of capital; allocating savings to firms with relatively high prospects as indicated by their rate of returns and level of risk.

According to the research study, financial intermediation assembles household and foreign savings for investment process by firms. For sustainable growth and development, funds must be effectively mobilized and allocated to enable business and the economy to harness their human, material and management resources for optimal output.

“The result of this empirically study show the existence of a long run relationship between stock market development and economic growth. The empirically study found that the value of shares traded is the major determinant of stock market indicators that promoted economic growth in Botswana, because there is a long positive relationship between stock market value of shares traded and real gross domestic product (GDP) growth, and at the same time the indicator is robust and statistically significant”, states the research study.

The study in conclusion recommends that policy makers and opinion formers should gear efforts towards fine-tuning the indices that can result in a long-term pessimism in the stock market like unpaid dividend, delay in dividend payments and transfer of stocks. This is pertinent to encourage and cajole greater population of the citizenry into investing in the stock market.

“This way, activities in a stock market will grow, capital accumulation increased and national productivity may be improved accordingly. Initiatives that educate the public about the importance of the stock market to the economy, and how participation by individuals in the stock market can improve the stock exchange and boost the economy should be encouraged “, the study recommends adding that “such initiatives are already in place such as the Fortune 500”.

In yet another 2012 research study titled “Testing Weak-form Market Efficiency in Emerging Markets: Evidence from The Botswana Stock Exchange”, the author, Sabur Mollah observed that most of the researches conducted on the stock returns in emerging and less developed markets are characterized by high volatility and predictability.

It is argued that the key forces by which markets are supposed to attain efficiency, such as arbitrage and investors’ rationality is contradicted with the psychological and institutional evidence in the real world. For instance, arbitrage is limited as it relies crucially on the availability of close substitutes.

According to the research study, BSE was one of the representatives of emerging markets during the period 1989 -2005 with rapid growth in terms of market capitalization, trade volume and the number of listed companies.

It is further observed that in Botswana the pace of industrialization has suffered in the past due to factors like import oriented country, lack of entrepreneurs, and low levels of productivity. Botswana however presents an optimistic ground for effectively developing and utilizing the capital market for industrial financing.

According to the research, though it is generally believed that the emerging markets are less efficient, the empirical evidence does not always support the thought. The evidence on weak-form inefficiency is controversial especially in developing and less developed countries’ market.

Most of the studies conducted in less developed markets points to the existence of weak form inefficiency and market inefficiency results from barriers to dissemination of information, which depends positively on the real cost of capital to speculators and negatively on the speed of information dissemination.

It is further noted that “a lower degree of efficiency in less developed countries markets might be due to common characteristics of loose disclosure requirements, thinness and discontinuity in trading and less developed nature of the markets”. Clearly, conditions in less developed countries are further away from idealized vision of the world than in major developing countries markets.

It is acknowledged that institutional factors contributing to market inefficiency include illiquidity, market fragmentation, trading and reporting delays and the absence of official market makers.

Yet another 2020 research study by Loyd Sungirirai and Abba Sungirirai titled “Botswana Stock Exchange Listed Companies as an Alternative Indirect Real Estate Investment in Botswana” came to the conclusion that “Botswana real estate investors purchase BSE listed property shares as an alternative to direct real estate investment”.

It is posited that access to the investment characteristics of real estate without necessary capital outlay required for direct real estate investment proved to be the greatest motivator for indirect real estate investment whilst the greatest hindrance to indirect real estate investment was indicated as the high discount between market value of the property shares and the net asset value of the underlying portfolio.

“Investors are therefore recommended to include real estate in their portfolios for diversification and hedging purposes and to indirectly invest in real estate through the purchase of property companies’ shares as this provides access to the investment characteristics of real estate without the necessary capital outlay required for real estate investment”, the study advises.

The research study concluded that the current asset allocation revealed a bias towards listed companies and bonds, indicating that Botswana investors have a fair share of exposure in real estate given that in Europe only about 10.4 percent are invested in real estate.

The other conclusion is that “though the market is wash with liquidity, the fact that most of the funds are from government, government agencies and quasi government entities with regimented investment preferences”.

The risk tolerance level appears at odds with the current assets allocation that exhibit a high proportion of risky assets (shares). It is concluded that investors are going to significantly reduce their exposure in shares (risky assets) into safer assets like real estate and or bond securities.

“Real estate is considered a more stable investment option whilst the fixed income market is less risky than shares and as such should witness a growth in preference by investors” states the research study, adding that “whilst some investors prefer to invest in discounted assets, others view the discount as an undervaluation of the investments they will be making and thus shun such investments. However, other salient factors might be that property holding counters on the BSE are tightly held hence rarely change hands and this is attributable to the fact that all companies are generally held by single controlling shareholders, mostly families”.

Another research study titled “The Role of Stock Market on Economic Development of Rwanda: A Case Study of Rwanda Stock Exchange” acknowledges that recent empirical research linking stock market and economic development suggests that stock markets enhances economic development. Countries with well developed stock markets experience higher economic development than countries without.

Evidence indicates that, while most stock markets in African countries are relatively underdeveloped, those countries which introduced reforms that are geared towards development of stock markets have been able to grow at relatively higher and sustainable rates .

A study in 2011 showed that South Africa, the country whose stock market is the largest and most developed in Africa, in terms of market capitalization and trading volume, “has been growing significantly since 2000”.

Countries like Egypt, Ghana, Tanzania, Botswana and Mauritius, whose stock markets have been developing recently, “were able to realize average per capita growth rates of more than 2.8 percent for the past eight years.

However, some countries that did not have formal or effective stock market like Lesotho, Seychelles and Ethiopia could not manage to realize average per capita growth rates above 2.7 percent over the past eight years.

Even those countries with small and less developed stock markets like Swaziland and Uganda did not manage to realize average per capita growth rates above 2.7 percent during the past years as reposited in the CBL Economic Review of 2009.

The research study notes that stock market promotes public-private sector partnerships to encourage participation in productive investments. “The need to shift economic development from public to private sector to enhance economic productivity has become more inevitable as resources continue to diminish.

“It assists the public sector to close the resource gap, and complement its effort in financing essential economic development, through raising long-term project based capital. It also attracts foreign portfolio investors who are critical in supplementing the domestic savings levels. It facilitates inflows of foreign financial resources into the domestic economy”, submits the research study paper adding that “the well functioning stock market increases economic efficiency, investment and growth”.

The study concluded that stock market also help finance the public sector borrowing requirement while reducing fiscal pressure of debt redemption if maturities of securities are lengthened. Governments can also raise long term funds through the stock market and enhance the creation of a robust yield curve.

The World Federation of Stock Exchanges and the United Nations Conference on Trade and Development (UNCTAD) in a paper titled “The Role of Stock Exchanges in Fostering Economic Growth and Sustainable Development” stated the number of countries with a stock exchange has grown dramatically over the last 40 years – from just over 50 in 1975 to over 160 in 2015.

This increase is partly attributable to a growing consensus about the role of stock exchanges in promoting economic development. However, despite this growth in the number of exchanges, the link between exchanges and economic development is not widely understood or appreciated.

According to the paper, as at the end of 2016, there were nearly 50 000 companies listed on 81 exchange groups around the world. The combined market capitalization of these companies was approximately US$70 trillion.

The report also highlights that while many people think of stock markets as representing large companies, the companies listed on these markets (which in many instances include dedicated markets for small and medium-sized companies) range in size from a market capitalization of less than $10 million to well over $100 billion.

The companies listed on the stock exchanges come from all economic sectors, services, manufacturing, mining and services from other companies. They generate revenues that pay salaries, buy goods and services and return dividends to shareholders. They are also significant employers”, according to the WFE whose estimates suggest that the 24 000 companies across just over 26 of the 55 WFE’s equity market exchanges employ over 127 million people.

The paper further observes that despite the significant growth in stock exchanges and SME platforms worldwide, low income countries have significantly fewer SME platforms than high income countries.

Stock exchanges in smaller developing countries have a more difficult time supporting companies, and in particular supporting SME growth. A lack of foreign investors, lack of investment in domestic industries, lack of domestic savings, and low availability of liquid capital all make it the more difficult to establish thriving stock exchanges.

“Additionally, businesses in these markets often choose to list on larger, more developed exchanges rather than list on their own country’s exchanges. These factors, together with the relatively smaller size of companies in these markets, make it even more challenging for exchanges in these markets to offer variable exchange-based offering for SMEs”, states the paper.

The paper concludes that the mobilizing of finance is central to what exchanges do and the existence of well-functioning exchanges can therefore contribute to economic growth and development.

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