The Horse and the Cart of Capital Markets

Apr 30 , 2021
By Zelalem Bezabih

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Ethiopia is in the process of establishing a capital market to round out its broad-based economic reforms. It can offer as many advantages as it carries clear risks, writes Zelalem Bezabih (zolalede@gmail.com), a business development and social researcher.

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Part of the ongoing macroeconomic and structural reforms in Ethiopia will be the establishment of a capital market. Both government and private investment initiatives often fall short of one critical factor of production - capital. Ideally, with abundant labour and ample natural resources, availing capital completes the missing link in expanding economic growth. Shortage of capital is one of the most repeatedly mentioned complaints to speed up investments and solve some of the country's pressing problems.

Ethiopia does not have a capital market to transact stocks (equity) and bonds (debt instruments) in the secondary market. Not implementing such an advantageous platform is costly and limits investor’s ability to earn better returns as an alternative to saving it in banks. In recent years, the financial market debates have moved from “we don’t need such markets,” to “is now the time?”

There are several reasons to believe that, yes, now is the time. Capital markets are a source of funding that encourages private investments. The government will be able to source funding from the economy itself, through a treasury bills market, and not by printing money from the central bank. Also, more people will be encouraged to invest in shares and collect money from the market. This eliminates the biggest contributing factor to inflation. The expected increase in the purchasing power of money will improve the livelihood of low-income households. Such markets increase mobilisation of savings and improve efficiency and the volume of investments, economic growth, and development.

Capital markets will also minimise the entry and exit barriers for businesses. Entrepreneurs will be better off in getting their ideas running and commence their business ventures. Unnecessary brokers profiting from withholding information will be put out of business as the cost of information is diminished. Meanwhile, the risk factor in owning a business is also expected to be reduced as people could easily register their shares in the market and transfer ownership if things do go according to plan. And should capital markets be open to foreign investors, it will provide an added source of foreign currency.

No less critical is that, as part of the government’s efforts to privatise public-owned enterprises and liberalise the large portion of the economy, the last piece of the jigsaw would be a capital market to close the gap with modernised economies. At least, these are the advantages proponents of capital markets say accrue. The reality could be different.

With strict regulations in financial markets still in place and an adequate skill set missing, the lingering question is: are we ready for it?

Indeed, establishing a capital market may not be an end in itself. Ethiopia is desperately attempting to join the global market. It is in the middle of World Trade Organisation (WTO) accession meetings and is also implementing an International Monetary Fund (IMF) programme, all of which come with pre-requisites.

But checks have to be in place as we cannot do things with our rapid pace of enthusiasm. This massive measure of establishing the market should be carefully planned not to place the cart before the horse. There is a need to address the reasons which reduce the sought-out gains of the capital market.

To start with, our banks are not familiar with secondary financial services and much of their extravagant profits are gained from basic bank transactions of money transfers and loan interest. More often than not, capital markets are carried out through computer-based electronic trading platforms, underlying the need for strong and sophisticated cybersecurity.

There are also no investment banks in Ethiopia, critical for informing potential investors on the movement of the markets. There would also need to be a well-established, accredited and professional class of brokers and dealers that can provide market information in real-time. These are the sorts of necessary improvements that need to be put in place to ensure investors and small-time savers have confidence in the stock market platform.

Since the financial regulator in Ethiopia is the National Bank of Ethiopia (NBE), its performance under such a complex environment will also be put under the limelight. Failure to address the above pitfalls has disastrous calamities of loss and fraud. The synergy has to be put in place by focusing on the availability of capital, the availability of investment opportunities, macro-environment factors, and the institutional capacity of NBE to regulate flexibly and actively.

Another reason for skepticism surrounding a capital market is the fear of creating unbalanced business ownership leading up to fewer people owning many companies. This skews the market into a cartel-like supply chain leaving the consumer at the mercy of conglomerates. Both the government and the low-income consumer will end up being powerless. Under such circumstances, it would pay to make the capital market broad-based instead of relying on few players. The government could act on behalf of the population and reserve some shares to protect public interest and put in place a stringent share company regulatory environment that protects small shareholders.

Potential calamities from wrongly implementing the capital market may include lack of control over the fair disclosure of financial information, poor growth in the secondary market, the prevalence of insider trading and front running, and manipulation of security prices. Economic failure following too much dependency and trust in capital markets is not a far-fetched possibility, as was made clear by the speculations that led to the Great Depression and the financial crisis of the late 2000s. Unless carefully regulated, leaving the trades to market forces could be volatile and catastrophic.

Financial laws on capital movements and trades should be stringent in boosting competitiveness to avoid monopoly and fragility of the economy. For instance, there should be incentives for the reinvestment of profits in product differentiation, cost reduction, expanded capacity and product development.

Laws against the concentration of shares in a single individual, company or “trusts” should also remain in place. Otherwise, there would be an epidemic of hoarding of financial resources, leading to the assumption of excessive risks by the few. The collapse of such ventures brings the investors to their knees and has the power to cripple the entire economy.

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PUBLISHED ON Apr 30,2021 [ VOL 22 , NO 1096]

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