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Africa's struggling stock exchanges

Boost to economic development or "costly irrelevance"?

By Jacqueline Irving in Abidjan, Accra and Lagos

Further development of Africa's stock markets will top the agenda of the African Stock Exchanges Association conference to be held in Abuja, Nigeria, in late October. Already, the number of exchanges in Africa has grown considerably, with 13 new ones formed since 1989, bringing the total to 19. Meanwhile, moves are under way to better link them with each other. For instance, the host of the Abuja conference, the Nigerian Stock Exchange, is working with other West African stock markets on plans to eventually integrate the exchanges in the region, with the aim of making them more viable instruments for private-sector activity.

The proliferation of stock exchanges in Africa indicates that a number of countries now consider them one facet of a wider strategy for developing national, and even regional, economies. According to Mr. Alan Kyerematen, director of the Enterprise Africa programme of the UN Development Programme (UNDP), stock markets, along with other sources of financing, can promote private enterprise expansion and thus stronger national economic growth. "If you have stronger companies that have greater access to capital for their growing businesses ... then there is the potential for creating more sustainable jobs, which can also lead to a reduction in poverty," he told Africa Recovery.

Others, however, consider the links between stock exchanges and overall socio-economic development to be tenuous, nonexistent or even harmful. They advise African countries not to devote further scarce resources and efforts to promoting them at this point, since there are many weightier problems to address in Africa: high poverty levels, inadequate social services and undeveloped infrastructure. Even if the resources were available, some add, stock markets could expose already fragile developing economies to the destabilizing effects of short-term, speculative capital inflows.

Developing thin markets

Most African capital markets are still tiny and fledgling -- especially in comparison with their counterparts in other regions. In sub-Saharan Africa, the Johannesburg Stock Exchange accounts for nearly 90 percent of the total value of the region's market capitalization (listed shares). Even the Nigerian exchange, ranked second among sub-Saharan exchanges in 1999, had a market capitalization of just $2.94 bn (equivalent to 6.9 per cent of gross domestic product). In the case of West Africa's other exchanges -- the eight-country regional exchange in Côte d'Ivoire and the Ghana Stock Exchange -- the amounts were just $1.5 bn (5.5 per cent) and $916 mn (12.1 per cent), respectively.

Except for the Johannesburg exchange, most African exchanges share other impediments to their growth and development: too few indigenous companies, small average company size, and low liquidity levels (the value of shares traded in relation to total market capitalization). The number of companies listing shares generally is low, and trading in one or just a few stocks often dominates total trading activity.

In studies of stock markets in developing countries, Mr. Ajit Singh, an economist at Cambridge University in the UK, found that while such exchanges may have positive benefits for the corporate sector by providing them access to additional capital, the economies as a whole "gained little." In Africa, indigenous companies, which tend to be small and medium-sized, so far have made relatively little use of stock exchanges, in part because they lack experience and resources for issuing shares, but also because their managers fear losing control after going public.

Mrs. Ndi Okereke-Onyiuke, managing-director of the Nigerian Stock Exchange, told Africa Recovery that many investors prefer to buy shares in small-to-medium-sized companies because they often have higher growth potential than larger firms. She urges smaller companies to overcome their tendency to associate share issues with loss of control and to recognize the role of stock markets in helping companies grow. UNDP's Mr. Kyerematen urges exchanges throughout Africa to lower barriers to the entry of indigenous, small and medium-sized firms.

In West Africa, all three exchanges have been trying to attract more such companies by setting up "over the counter" markets and secondary and tertiary markets with less strict listing requirements. They also have been giving increasing attention in the last year or so to educational and promotional programmes to attract more investors. For example, the Ghana Stock Exchange has been participating in local and regional business fairs, and offers courses and seminars on market investing and personal finance. In addition to advertisements in the local press, radio and television and the maintenance of a Web site, the Ghana exchange sponsors a radio programme. The broadcasts aim to generate public interest in the stock exchange by explaining investment topics to listeners and holding a weekly quiz which awards a 200,000 cedi prize to be invested in shares of the quiz winner's choice.

Because the vast majority of Africa's enterprises are not large, Mr. Kyerematen's Enterprise Africa programme is developing an additional way for these companies to raise funds outside the traditional exchanges. This "private placement initiative" will enable well-managed, solid, smaller companies in strategic sectors to issue shares or notes to investors with the help of financial intermediaries. Mr. Kyerematen stresses that this initiative should ultimately benefit African exchanges by providing smaller firms with capital until they become large enough to be listed.

Some, however, believe that an emphasis on promoting stock markets in Africa is premature. Mr. Singh, the Cambridge economist, has noted the sheer scarcity of economic development resources in Africa and recommends that countries therefore concentrate on improving their banking systems before further developing their stock exchanges. Setting up or expanding stock markets at this stage would be a "costly irrelevance" and only add to the woes of Africa's already fragile financial structures, which tend to have undeveloped and poorly regulated banking systems, he argued in a 1999 paper.

Uncertainties of foreign investment

Mrs. Okereke-Onyiuke notes that floating major enterprises on stock markets can help develop otherwise thin markets by attracting foreign capital. This in turn could encourage more indigenous companies to list. Given the large size of the enterprises slated for the second phase of Nigeria's privatization programme, such flotations could potentially deepen the country's capital markets enough to accommodate foreign investors, thereby supplementing domestic savings.

Foreign ownership of securities and assets remains controversial. In addition, some financial experts point out, as a country integrates its financial markets more tightly with world markets, it becomes more and more susceptible to global volatility. Large cross-border movements of capital invested in portfolio securities -- rather than "brick and mortar" direct investment -- tend to accompany and fuel financial instability.

Mr. Singh recommends that African countries focus on encouraging foreign direct investment rather than on developing exchanges that attract short-term investment flows. Because stock exchanges in developing countries are generally less well regulated and more poorly organized than their counterparts in developed countries, they are more prone to high volatility, he says. Recalling the financial crises of many Asian and Latin American countries over the last decade, Mr. Singh argues that large amounts of portfolio investment in Africa would greatly increase vulnerability to domestic and international shocks.

This is not a problem in West Africa at the moment, however. Foreign portfolio investors over the past year have shied away from the subregion, which they perceive as politically and economically unstable. The main market indices of the Bourse Régionale des Valeurs Mobilières (BRVM) in Abidjan, Côte d'Ivoire, and the Ghana Stock Exchange fell 15.8 per cent and 32.9 per cent, respectively, in US dollar terms in the first half of 2000. Only the Nigerian Stock Exchange escaped negative investor perceptions. Its index rose nearly 16 per cent in US dollar terms in the first half of 2000, largely due to renewed confidence in the Nigerian economy following the return to civilian rule and signs of increased privatization activity.

"Some people out there are inclined to think that Sierra Leone, for instance, is next door to Ghana," laments Mr. Ernest Abankroh, company secretary of Ghana's Ashanti Goldfields mining company. "Even the Democratic Republic of Congo is seen [by foreign investors] as close to Ghana. An incident in any African country sends shock waves among investors."

While acknowledging that short-term foreign capital flows can be potentially destabilizing, Mr. Kyerematen says countries can guard against such risks by bolstering their financial market regulations, improving governance in general, and promoting the listing of solid, well-managed and competitive local companies. "Logically, if companies are performing well, one would not expect people to withdraw their funds and invest them in other markets," he argues.

The head of Mr. Kyerematen's agency, UNDP Administrator Mark Malloch Brown, recently cited the development of bond and equity markets in Africa as among the key steps to build domestic capital, develop private sectors and reverse capital flight. At the same time, Mr. Malloch Brown underlined the role of domestic capital formation and investment in helping economies improve their growth -- generally recognized as an important (although insufficient) element in the reduction of widespread poverty.

Vehicles for privatization

Many of those who extol the virtues of foreign investment also see great potential for African exchanges as vehicles for selling off state-owned firms. Privatization, they argue, can help build nascent private sectors and promote a culture of savings and investment.

So far, however, few privatizations actually have been carried out through stock exchange flotations in Africa. The exchanges in West Africa have functioned more as "political and economic lobbying platforms" to open up the subregion's economies, than as vehicles for actually raising capital, notes Mr. Mengistu Alemayehu, a senior investment officer with the World Bank's private-sector lending arm, the International Finance Corporation.

Although he sees the potential of the Nigerian exchange in particular as "enormous," Mr. Alemayehu observes that the role of West African exchanges in private sector development has been limited so far. Among the constraints, he cites unfavourable macroeconomic conditions in the countries served by the exchanges, the small size of the exchanges themselves and low liquidity (low trading levels relative to the total value of listed shares).

"Transferring ownership to the public through the stock exchange could be a very useful tool of, not only disempowering [former state managers], but also expanding the liquidity of these markets, developing the culture of investment, and expanding the horizon of investment opportunities that are available," says Mr. Alemayehu. For example, privatization of shares in large state utilities in Nigeria through the stock exchange would "provide not only a boost for the exchange in terms of size and market capitalization, but also in terms of getting thousands and thousands of [local] people to become shareholders."

According to Mrs. Okereke-Onyiuke, the Nigerian Stock Exchange (NSE) has promoted Nigeria's privatization programme. It was instrumental in convincing the former government of General Ibrahim Babangida to carry out the first sell-offs of state-owned firms back in the 1980s, she recalls. The exchange now is "working hand-in-hand" with the elected government of President Olusegun Obasanjo, which has launched a second phase of the privatization programme as a centerpiece of its plans to restructure the economy. The NSE recently held a workshop to advise more than 500 local government officials from throughout Nigeria on how to privatize state enterprises and issue revenue bonds tied to specific development projects.

Similarly, Mr. Niamkey Tanoe, head of operations at the BRVM -- the world's first regional stock market -- told Africa Recovery that the Abidjan-based exchange is encouraging all eight member countries (Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo) to make use of it in their privatization programmes. Moreover, the BRVM has been working with Côte d'Ivoire's Privatization Committee to advise the other seven countries on some of the technical aspects of carrying out privatizations through public offerings.

Public flotation through stock markets is the "easiest and most efficient way" of broadening local ownership in former state-owned enterprises, according to a 1999 working paper of the UN Economic Commission for Africa. By offering shares to local people, stock market flotations can help make otherwise unpopular privatization programmes somewhat more politically palatable. Such programmes nevertheless remain controversial. Unions point to the frequent loss of jobs and benefits once firms are privatized, while intellectuals and business groups often decry the increase in foreign ownership of national assets (see Africa Recovery, April 2000).

Seeking to counter such negative perceptions, privatization advocates note that governments can invest the revenues earned from state enterprise sales in industrial research and development, health, education, and roads, communications and other infrastructure. At a privatization conference in July, Mrs. Okereke-Onyiuke cited as an example the government's use of some of its privatization proceeds to revive the Nigerian Railway Corporation. Because the government no longer subsidizes the privatized companies, she added, more public funds become available for socioeconomic development.

Sometimes, stock exchanges can be used for dispersing newly privatized shares geographically, preventing the concentration of shares in one or more regions. The Nigerian exchange, for example, uses regional quotas in order to allocate shares more equitably. Prospective investors are asked to indicate their state of origin on the exchange's application forms because "the government and the NSE want a wide geographical spread, to enable as many Nigerians as possible to benefit," explains Mrs. Okereke-Onyiuke. "We also encourage government-owned development finance institutions in those states that are a little backwards with regards to investment to buy shares for later sale to individuals of those states," she adds.

Stock exchanges and savings rates

Of course, extremely low income levels keep share ownership beyond the reach of most people in Africa. More than 40 per cent of the continent's inhabitants live on less than $1 a day. In West Africa, reckons Mr. Alemayehu, a maximum of 5-15 per cent of the population has access to conventional financial institutions and the number of people within that group who have access to shares traded on exchanges is extremely limited.

Savings rates in the region are by far the lowest worldwide, averaging around 13 per cent of GDP for the typical African country in the 1990s. Africa is the only world region in which both per capita savings and investment rates have fallen over the last 30 years.

According to economic theorists, stock markets can potentially raise savings and investment rates by introducing new instruments that might better meet savers' needs and by pooling the small savings of many individuals to fund investment in large-scale projects that otherwise might not be undertaken. In Africa, there is little sign of this happening so far.

In Ghana, for example, total savings were just 12 per cent of GDP in 1995, down from 17 per cent in 1960. Even those Ghanaians with income levels high enough to have access to conventional financial institutions and investing opportunities are more likely to invest their savings in government securities.

The government has been issuing Treasury bills in ever increasing quantities, Mr. Yeboa Amoa, managing director of the Ghana Stock Exchange and deputy chairman of the African Stock Exchanges Association, told Africa Recovery. The reason for their popularity is obvious: in a country where bank lending and deposit rates are quite high, the interest income on these bills was around 44 per cent at mid-year, compared with shares which generally paid dividends of only around 5-10 per cent. "So if I'm a rational investor," remarked Mr. Amoa, "it's obvious what I should do."

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BOX 1:

Integrating West African stock markets?

Since its foundation in 1993, the African Stock Exchanges Association (ASEA) has promoted not only the development of stock exchanges, but also cooperation among them within four main regions: in East Africa among the exchanges in Kenya, Tanzania and Uganda; among the Johannesburg Stock Exchange and smaller Southern African Development Community exchanges; in North Africa, led by the Cairo and Alexandria exchanges; and in West Africa among the Nigerian and Ghanaian exchanges and the Bourse Régionale des Valeurs Mobilières, the francophone regional exchange.

In West Africa, the idea of working towards further integration of stock exchanges is part of a wider push within the region toward lowering barriers to the free movement of people, goods, services and capital. This has long been a goal of the 16-member Economic Community of West African States (ECOWAS), which celebrated its 25th anniversary this year.

In April, six ECOWAS members, led by Ghana and Nigeria, decided to "fast-track" plans to set up a second monetary union and common currency in the subregion by 2003, alongside the eight-member West African Economic and Monetary Union, which uses the CFA franc (pegged to the French franc). Some analysts and local officials believe that further integration of capital markets could help reinforce such plans. Others feel that the lack of a common currency, along with the need for further harmonization of regulatory, tax and policy frameworks, will hamper any rapid regionalization of West African stock markets. While there are differences over how long it actually will take to link West Africa's exchanges, many involved in the process agree that pooling the resources of these small and fragmented capital markets could boost their ability to mobilize local and international capital for private-sector and infrastructure development.

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BOX 2:

Development finance bonds

African stock market advocates see some scope for the continent's exchanges to mobilize resources for development through the issuance of bonds to fund specific industrial and social projects. Officials of the BRVM, the regional exchange in Abidjan, believe that their bond market has great potential for raising such funds. The West African Development Bank (BOAD), which helps finance regional development projects, has four separate bond issues on the Abidjan market, making it the BRVM's single biggest bond issuer, says Mr. Niamkey Tanoe, head of operations for the exchange.

In Nigeria, the Securities and Exchange Commission (SEC) is stepping up efforts to promote the bond market to state and local governments as a means of raising funds for development projects. As with equity markets, lack of public awareness has hindered development of Nigeria's bond market. To try to counter this, the commission has held a series of public information sessions in recent months. SEC Director-General Mallam Suleiman Ndanusa recently urged state governments to follow the example of the Edo state government, which earlier this year issued a 500 mn naira ($5 mn) revenue bond to fund low-income housing construction.

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BOX 3:

Enticing small investors

Financial institutions in some African countries have been trying to attract more small investors with limited means by offering ways for them to pool their funds and lower the risk of investments in shares traded on exchanges. Mr. Yinka Sanni, general manager of the asset management arm of International Banking and Trust Company, a top merchant bank in Nigeria, argues that unit trusts (mutual funds) hold "tremendous opportunity" for Nigerians. "As Nigeria makes further progress economically and there is more disposable income in people's hands, there would definitely be more savings," he told Africa Recovery. "Unit trusts would enable investors -- no matter how small they may be -- to pool funds together for investment purposes."

In Ghana, Parliament is currently considering an amendment to the securities law allowing the creation of unit trusts. Already, according to Mr. Yeboa Amoa, managing director of the Ghana Stock Exchange, members of the Ghana Cocoa, Coffee and Sheanut Farmers Association (GCCSFA) have grouped together to purchase stakes in two of the six companies that have publicly divested shares on the exchange. Back in 1994, some 160,000 small investors under the GCCSFA umbrella bought shares in Ashanti Goldfields, Ghana's largest gold mining concern. And in May 2000, the association's farmers collectively bought 20 per cent of the shares on offer in the Produce Buying Company, Ghana's largest domestic buyer of cocoa. Company employees themselves purchased another 5 per cent, while the general public bought 4 per cent.

The Nigerian exchange is encouraging companies to allot shares on a preferential basis to organized groups of small investors, such as market associations, cooperative societies and cooperative farmers. It also recommends that the Nigerian Labour Congress participate through the national pension fund. This echoed the suggestion by Mr. Ernest Abankroh, company secretary of Ashanti Goldfields, that Ghana's national pension fund invest some of the assets that it holds for workers in the stock market, rather than just fixed-income securities.

The BRVM in Abidjan urges companies to "offer their shares in smaller values," says Mr. Diouf Birahim, head of the Central Depository at the regional exchange. "In fact, a main goal of the BRVM is to mobilize domestic savings in the eight member countries by appealing to the small investor," he adds.

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