Emmanuelle Moors de Giorgio examines the role African governments can play in fostering the growth of their national stock exchanges.
In Africa, where market returns are often correlated with world-wide commodity prices and rain, what role can the governments play in fostering the growth of their stock exchange?
To begin with, governments can strive to provide a sound macroeconomic environment. This has proven instrumental to attracting long-term portfolio investments. Governments can also establish a reliable and reasonable regulatory and tax regime. Kenya, for instance, introduced a favourable tax regime with non-residents paying a 10% withholding tax on dividends (locals paid 5%), but no capital gains, stamp duty or value added tax.
Liberalising foreign exchange controls is ultimately beneficial but always delicate. Before asset swaps were introduced a couple of years ago, the fact that South African domestic investors could not invest abroad diminished their incentive to sell their current holdings and thus created an illiquid market. Liberalising exchange controls will, in the short term, encourage domestic investors to move part of their investment out of domestic stock exchanges and into off-shore stock markets. This is what happened when in 1996 Botswana allowed life insurance companies and pension funds to invest up to 65% of their assets outside the country. In the long run however, this measure will also attract those foreign investors who do not feel comfortable if they cannot get their capital out of a market freely.
Minimising restrictions on foreign portfolio investment is another key measure which has helped the growth of African stock exchanges. This has generally taken place recently (e.g. in 1995 for the Nairobi stock exchange (NSE)) and progressively. Today, the shares ceiling for institutional investors ranges from 40% (Zimbabwe), 74% (Ghana), to 100% (Egypt).
The 40% limit in effect prevents foreigners from investing in most subsidiaries of multinational companies and, in Kenya for instance, fewer than 20 of the 58 listed companies are available to foreigners. Some countries (e.g. Tunisia and Zambia) have in the past prevented foreigners from investing in primary but not successive offers.
Another way of promoting local investors may be to allocate them a portion of new issues, possibly at more attractive conditions. Foreign portfolio investment directly increases liquidity, which is ultimately beneficial also for domestic investors. The ZSE chief-executive reckons that the net inflow of foreign investors since their inception in November 1993 has been more than Z$1.65bn, higher than the turnover of 1996 alone.
While restrictions on foreign investment reduce liquidity, they can protect the country from the effects of massive sales by foreign investors during sudden bearish moods. Another way of alleviating such effects is by promoting domestic savings. This can be done, for instance, with regulations that encourage private pension funds and economic policies that foster real interest rates. The dominance of domestic over foreign investment funds helped the Casablanca stock exchange to successfully weather the recent world-wide market turbulence.
Opening government securities to foreign investors is a tempting method of financing budget deficits but, unfortunately, it draws liquidity away from the stock exchange. High interest rates also raise companies' borrowing costs and tend to slow down business activity, resulting in lower earning growth which mutatis mutandis depress stock prices. Interest rates above 25% were yet another reason for the poor performance in 1997 of the stock exchanges of Kenya and Zimbabwe.
Deregulating and opening brokerage activities to foreign entities and local companies should also be encouraged. The role of stockbrokers is to buy and sell stocks on behalf of their clients and, less frequently in Africa, to produce research and make recommendations. …