Ebook Capital Market Development in Africa: Selected Topics
One of the newest developments in Africa’s financial landscape is the ever increasing role of stock exchanges. In 1993, the first African Capital Markets conference was held in Nairobi, Kenya. At that time, there were 10 stock exchanges. Today, there are 19 stock exchanges in Africa ranging from giant Johannesburg to start-ups like Uganda and Mozambique. In this overview chapter, we establish the reasons for the growth of stock exchanges in Africa and examine their record of success against the expectations that led to their creation. Finally, we identify developmental constraints and propose some recommendations for policymakers, regulators and market operators.
The potential role of financial markets in economic growth has been well documented. Capital markets are mechanisms for raising and trading long-term capital and thus represent the long end of the maturity spectrum of financial instruments. In general, financial markets provide four important economic functions. The first is that markets determine the prices of assets traded through the interaction of buyers and sellers. This is the process of price discovery. Second, financial markets provide a mechanism for an investor to sell a financial asset. Thus, markets offer liquidity or the ability to convert a financial asset into cash. Thirdly, financial markets reduce the cost of financial transactions. By bringing sellers and buyers of financial assets together, explicit search costs, such as the cost that would be spent to identify a seller or buyer of an asset are eliminated. Information costs, which are incurred in assessing the investment merits of a financial asset, are also reduced because specialized institutions emerge to produce information more efficiently. Finally, financial markets provide facilities for transferring risk. In so doing, they ensure that risks are borne by those most willing to bear them. In performing all these functions, financial markets serve to mobilize savings from the public and channel them to firms undertaking productive investments, generating even more savings and investment in a virtuous growth cycle. Inactive markets are weak in terms of liquidity production and information production. An inefficient market becomes a barrier to raising capital in the primary market, and reduces the volume of trading in secondary markets.
Capital market institutions, such as stock exchanges, stockbrokerage and investment banking firms, deliver several secondary economic benefits. Capital markets facilitate corporate governance and serve as markets for corporate control. Inefficient management is typically thrown out of office through takeovers, which allow unfriendly raiders to accumulate shares in the open market and take control of the firm. The very threat of such takeovers is actually a powerful mechanism for disciplining management. The stock market also serves as a thermometer for corporate performance. Management gets signals from the stock price behavior to judge performance and take corrective action. In short, the stock market votes on corporate performance.
The Savings and Loan Associations’ crises in the United States during the late 1980s, the financial crisis in Asia in the late 1990s and several instances of banking crises around the world have drawn attention another critical role of financial markets. Nobel economist, Professor Merton Miller (1998) has argued that a well-fleshed out set of financial markets and associated institutions mean that a country can reduce its dependence on the banking system, which is the dominant institution for financing economic growth in the developing countries. Even though banking plays a significant intermediation role, it remains fragile and crisis-prone because of inherent maturity mismatches and the instability of deposit obligations.
The fragility of banking systems is a reality, despite elaborate national and international rules on capital adequacy and other prudential requirements. Well-developed financial markets bring diversification benefits. Having a wide spectrum of financial markets available keeps a country from being overdependent on crisis-prone banking systems. It is argued that countries such as the United States have made themselves less vulnerable than in the past to credit crunches and have substantially increased the capital allocation process by substituting dispersed and decentralized financial markets for banking. In such decentralized markets, substitutes and supplements reduce reliance on the banking system. Examples of such substitutes and supplements include mutual funds, which have proven to be a viable substitute for bank accounts as a source of liquidity for the public. In much the same vein, high yield bonds (“junk bonds”) have turned out to be an effective financial market supplement and substitute for long-term commercial loans by banks. For the above reasons, a greater role for securitized finance using stock markets, bond markets and derivative markets is essential. Miller supports his thesis by citing the economic problems of Southeast Asia, which can be attributed not to too much reliance on financial, markets not to too little. Like the U.S. economy a century ago, emerging Asian economies do not have well-developed capital markets and so remain heavily dependent on banking systems to finance growth.
Contents
LIST OF ACRONYMS AND ABBREVIATIONS
CHAPTER 1
OVERVIEW OF AFRICAN CAPITAL MARKETS
- Executive Summary
Introduction
The Objectives of Securities Market Development in Africa
What is Africa’s record?
What Accounts for the Less than Expected Performance?
Policy Recommendations
References
CHAPTER 2
THE ESSENTIALS OF AN EFFICIENT MARKET
- Executive Summary
What is Market Efficiency?
The Theory of Rational Expectations
Efficient Markets Theory: Rational Expectations In Financial Markets
Implications of the EMH for Capital Markets
A Note on Technical Analysis
A Note on Fundamental Analysis
References
CHAPTER 3
EVIDENCE ON MARKET EFFICIENCY
- Executive Summary
Testable Implications of the EMH
Tests of Market Efficiency in Developed Markets
A Survey of Stock Market Seasonalities
Active Versus Passive Portfolio Management
The Efficiency of African Stock Markets
Concluding Comments
References
CHAPTER 4
IMPLICATIONS OF EFFICIENT MARKETS HYPOTHESIS FOR FIRMS, INVESTORS AND REGULATORS
- Executive Summary
Corporate Finance
Implications of Efficient Market Hypothesis for Firms
Implications of Efficient Market Hypothesis for Investors
Implications of Efficient Market Hypothesis for Regulators
References
CHAPTER 5
AN OVERVIEW OF MARKET LIQUIDITY
- Executive Summary
Defining Liquidity
Selected Liquidity Measures
Implications for Capital Markets
References
CHAPTER 6
STRATEGIES FOR IMPROVING LIQUIDITY
- Executive Summary
Factors Affecting Liquidity
Market Structures
African Trading Systems
Policy Implications
References
CHAPTER 7
AFRICAN CAPITAL MARKETS AND GLOBAL FLOWS
- Executive Summary
The Economic Rationale for Capital Flows
Global Flows and Africa
Why Does So Little Capital Flow from the Rich Countries to the Poor?
CHAPTER 8
HOW TO ATTRACT FOREIGN INVESTORS
- Executive Summary
Understanding Emerging Market Risks
Tapping the Benefits of Financial Integration
Recommended Strategies
Policy Implications
References
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