Zambia : Capital Market Development in Africa: key Enablers and Inhibitors

Mussie Delelegn Arega (PhD)

The debates on the relationships between financial systems and economic growth remain inconclusive. Questions such as what level of capital flows are optimal for developing economies and whether free movement of capital in and out of the economy (capital account liberalization) is desirable remain unanswered or controversial. The same goes for capital markets and their role in the effective mobilization and efficient allocation of resources. However, there is an emerging consensus that sound financial systems are engines and locomotives of economic growth and development although these relationships are not straightforward.

Despite the difficulty of determining causality, the relationships between finance and real economic sectors are intricate and systematically interdependent. While macroeconomic stability and sustained economic growth depend on modern, dynamic, prudent, and sound financial systems, the latter also needs a stable macroeconomic environment and efficient production, distribution, and consumption of goods and services. The financial systems are also key to making markets and institutions as well as regulatory and supervisory mechanisms tandemly function, and responsive to changing circumstances. Conversely, if financial systems are underdeveloped and persistently vulnerable to shocks with no functioning institutions and efficient regulatory regimes, the macroeconomic fundamentals will display instability, and markets and institutions will become dysfunctional. In other words, the malfunction on one side of the equation causes bifurcated risks and uncertainties in the economy, market mechanisms, and financial systems. Such risks heighten particularly during unforeseen shocks-be they endogenous or exogenous to the economy. A further challenge is the lack of a universally accepted blueprint to guide policies on capital markets development or financial liberalization. Nor is there a “one size fits all” approach to minimize risks from volatility in capital flows and advance economic growth, capital accumulation, and sustainable development. However, from the empirical evidence to date, economies that maximized development gains from financial liberalization, while containing the risks are those that had addressed their structural rigidities and macroeconomic imbalances, fostered industrialization, and developed sound institutions before embarking on capital accounts liberalization.

As with any financial market, the functioning of capital markets requires the prevalence of key enablers. These include effective corporate governance, robust monitoring and supervisory mechanisms, transparent rules and regulations, symmetrical market information, financial literacy and numeracy (knowledge of traders), and the ability to manage risks that arise from price fluctuations, exchange rate volatility, instability of interest rates and unpredictable weather conditions, among others.

According to the Capital Market Factbook (2024), the total market capitalization of the global equity market hit US$115 trillion in 2023, with the total equity insurance reaching US$422.2 billion in the same year. Although growing in importance, Africa’s share remains negligible at about 1.7% (about US$ 2 trillion) with 1400 listed companies. Africa’s market capitalization is also heavily dominated by a few countries such as Egypt, Kenya, Nigeria, and South Africa. The most dominant player in the continent is South Africa, with the Johannesburg Securities Exchange (JSE) ranking 19^th in the world, boasting more than 800 listed companies with close to US$ 1trillion total capitalization. The Mauritian stock exchange market has shown tremendous growth in a relatively short period from about 3 % of the country’s nominal GDP in 2008 to 66.27% in 2022 with 100 listed companies.

Regionally, available data (www.theglobaleconomy.com) shows that advanced developing economies of Asia account for nearly 30 % of the global capitalization of the equities market, followed by Latin America. In developing Asia, in 2022, the average share of total equity market capitalization in GDP exceeded 110 % in top-performing economies. Whereas, for Latin America, the average share of the 5 top performing countries was 38.33% during the same year. A relatively higher share in selected African countries than those in Latin America shows a lower level of GDP than higher market capitalization. This can be seen from the lower total share of Africa in global market capitalization.

Africa’s low and marginal share in the total capitalization of the equities and securities market is against the continent’s long history of capital markets and an increasing number of countries establishing such markets. Currently, the African Securities Exchange Association (ASEA) boasts 32 Securities Markets, stock exchanges, and market infrastructure from 37 countries. What primarily characterizes Africa’s pre-independence securities markets is that they are shaped by the legal and institutional setup of the colonial era and are crafted to promote and maintain “exploitative relationships” between the African nations and their colonial masters. Dominant in securities trading during the colonial era were precious stones, notably gold and diamonds, as well as metallurgy, other industrial minerals, oil, and gas, and agricultural commodities of industrial or commercial significance. Some historians also link the 19^th-century expansion of plantations in the USA and Latin America and the emergence of capitalism to the slave trade where Africans were sold and exchanged in the US banks of southern states and the United Kingdom.

Ethiopia is a latecomer to capital markets except for the unsuccessful efforts of emperors Menelik (1889-1993) and Haile Selassie (1930-1974). Authoritative historians of the Ethiopian economy chronicled Menelik’s efforts to monetize the Ethiopian economy including the introduction of the silver coin and the establishment of the Development Bank of Ethiopia in 1908-with shareholders being the emperor, his wife (Empress Taitu), his lieutenants, and loyal chiefs. Only in 1965, under the reign of Haile Selassie, and after the second Ethio-Italian war (1928-1933) was the first formal Ethiopian Securities Exchange market established, which was dissolved by the Military regime in 1974. After 5 decades, the current Ethiopian Government reintroduced the Ethiopian Capital Market and established the Ethiopian Capital Market Authority (ECMA) under proclamation number 1248/2021. The key objectives were to “foster a vibrant capital market ecosystem that promotes innovation, financial inclusion and drives economic growth” of the country.

Empirical evidence, challenges, and inhibitors

It is evident, that the origin of capital markets in most African countries predate Structural Adjustment Programmes (SAPs) of the 1980s undertaken as part of the economic liberalization mantra. In Ethiopia, the newly established capital market is part of the ongoing reform of the country’s economy and integral to IMF/World Bank-sponsored financial liberalization, including free-floating of the exchange rate, privatizing state-owned enterprises (SOEs), allowing entry of foreign banks, and deepening financial liberalization.

Empirical evidence shows that, unlike the Asian economies, financial liberalization & the establishment of capital markets in Africa have not led to inclusive and sustained economic growth. This is due to the combination of the above-mentioned history of Africa’s capital markets and the underlying structural rigidities of the continent’s economies. Weak institutional and regulatory frameworks as well as inadequate supervisory mechanisms further undermined the realization of gains from capital markets. Consequently, African capital markets remain underdeveloped with limited services, and their economies remain commodity-driven and underdeveloped with little or no industrialization. Africa’s capital Markets also suffer from a series of shortcomings (inhibitors) and inherent weaknesses. These include market concentration (few SEOs or foreign firms dominating market capitalization); inadequate market structure (low supply, low demand, and inadequate liquidity); asymmetrical market information and insider trading; high cost and complex processes of issuing securities; high level of informality and a limited number of participating firms; poor access to finance and volatile retail financing; lack of data and poor policy coordination; high macroeconomic instabilities and risky investment opportunities; lack of experience and knowledge of domestic investors to mitigate risky investment strategies; and weak income-savings-pension relationships.

Unlike Africa, Asian economies maximized the developmental gains from financial liberalization and capital markets development. They became the dominant source of global capital, output, investment, and exports. Excluding Asian developed economies, Singapore, China, India, Malaysia, and Thailand became among the top performers in cross-border capital flows and global market capitalization. In 2024, the Shanghai Securities Exchange with a US$ 6 trillion total market capitalization, emerged as the world’s third largest, after the New York Stock Exchange and Japan’s Exchange Groups. The Asian “emerging markets” have become the global powerhouses for manufacturing exports-accelerating overall socioeconomic development and deepening structural economic transformation.

What made Asian economies uniquely successful is their pragmatic policies and strategic integration into the global market by fostering industrialization and beefing up institutions with a “Developmental State” model. That is Asia’s pragmatism, careful and cogent policy sequencing, and gradual liberalization of their financial systems are among the key success factors. This in effect means that macroeconomic stability and proactive states are more important in driving the development processes than financial liberalization or open capital markets. More specifically, direct and preferential credit to the domestic private sector and “infant industry protection” widely exercised by the Asian economies are foundational for the development of a vibrant, dynamic, and innovation-driven domestic private sector. It also means that the neoliberal assumptions that market forces are agile and flexible to correct structural imbalances and that protectionist policies are disastrous to the economy are more myth than reality. Particularly, in weaker economies of SSA, financial liberalization and the establishment of capital markets rarely mediate savings-investment rates and are unable to mobilize and allocate capital efficiently to key sectors. Even in a carefully sequenced policy environment, unmanaged capital flows are not desirable. Nor are they without adverse consequences. As was observed during the Asian financial crises of 1997-1998, unfettered capital account liberalization caused havoc in the region, wiping out hard-won development gains of the preceding decades. It is important to underscore that the main problem in Africa and other developing countries is not financial liberalization or the establishment of capital markets. Rather it is the lack of serious thoughts about pre-existing socioeconomic conditions (macroeconomic imbalances), erroneous policy sequencing, and the lack of strong and dynamic institutions that are capable of enforcing policies, regulations, and supervision mechanisms in the financial systems. These are further compounded by increased negative externalities and structural (binding) constraints to development which must be addressed before financial liberalization and capital market formation.

Ethiopia has “latecomers” advantages.

Ethiopia and other latecomers to financial liberalization and capital markets development have the advantage of learning from the pitfalls and success stories of frontrunners. That is, drawing policy lessons from regional and international best practices, standards, and successful and less successful experiences is critically important for latecomers. This helps to avoid mistakes or failures, minimize risks and uncertainties, and tap the potential of capital markets for industrialization, structural economic transformation, and overall socioeconomic development. This is particularly important given that developing sound and efficient financial systems (including well-functioning capital markets) involves long, complex, and arduous processes. It particularly requires developed financial instruments and enhanced liquidity in the economy to boost employment, incomes, and savings before capital account liberalization. It also calls for managing supply and demand for diversified financial products, and putting in place robust institutional, regulatory, and legal frameworks. This notwithstanding, the speed, scope, and extent of the current Ethiopian policy reform process are alarming and raise questions about whether serious thoughts were given to the country’s key fundamentals and if policies are appropriately sequenced or effectively implemented.

The key lesson from the Asian “emerging economies” is that success depends largely on key policy approaches (pragmatism and careful sequencing), and the objectives of financial systems. Generally, economies that minimized the hazards of information asymmetry and enhanced the participation of the domestic private sector and investors in their financial systems managed to advance their development objectives. These economies also fostered modern and efficient regulatory and supervisory capabilities together with vibrant and dynamic institutions (that interpret market signals, tame exuberance and manage expectations). These countries are also the ones that fostered industrialization, diversified economic and export bases, achieved macroeconomic stability, and relieved economy-wide structural constraints.

More specifically, Ethiopia and other latecomers need to have, at least, the following mix of policies as a “toolbox” to benefit from liberalized financial systems, including capital markets.

• Avoiding monopoly and heavy market concentration: Excessive dominance of the listing on the capital market by SOEs or foreign investors, may lead to heavy market concentration which crowds out domestic firms, which in turn, may constrain the fostering of competitive, innovative, and dynamic firms in the economy. Foreign direct investment is good, but it should not be at the expense of domestic investors. The key to success is to have diversified investors and players together with enlarged investment opportunities that enhance the sustainability and functionality of capital markets. The most recent study conducted in several middle-income countries shows that less than 10 largest companies, (usually SOEs and foreign-owned) dominate 50 % of the market capitalization. In Zimbabwe, out of 63 listed companies, three large companies account for more than 45 % of the market capitalization. In some countries such as Botswana, there is heavy sectoral concentration in listed companies where mining represents the biggest share (85.2%) of total market capitalization, followed by financial services (6.2%) and banking (3.2%).

• Maximizing key enablers and minimizing inhibitors: Ethiopia’s large and youthful population has the potential to serve as a pull for foreign capital provided that the knowledge and skill mix is enhanced, and the education sector is aligned with the needs of the economy or the labor market. Financial literacy and numeracy as well as building the skills and knowledge base of the population is key to managing risks and uncertainties as well as creating critical mass in expanding trading in equities and bonds. Real GDP growth may also play an important role in motivating the flow of foreign capital. However, these basic indicators may not be enough to help Ethiopia to attract and benefit from both domestic and foreign capital. Other key factors that should be at the heart of domestic policies include macroeconomic stability (stable exchange and interest rates, low inflation, and a balanced budget), dynamic institutions as well as peace and political stability. As part of the overall macroeconomic stability, it is vital for Ethiopia to ensure monetary policy autonomy and enlarge its development policy space. What is more important is to foster and nurture new financial institutions such as organized associations of financial dealers or brokers as well as financial infrastructure through which payments are made, securities are settled, transactions are handled, etc. It is equally vital for Ethiopia to clearly define and delineate the roles and responsibilities of the Ethiopian Capital Market Authority (ECMA) and other financial institutions such as banks, pension funds, and insurance operators. Along with this, and if this has not been already done, the Government of Ethiopia may consider instituting a time-bound and performance-based monitoring mechanism for the ECMA. What should be the share of total capitalization of equities and securities market in the country’s GDP in the next 5, 10, 15, or 20 years? How will this compare with frontrunners in Africa and elsewhere? Such benchmarking is vital for correcting the courses and ensuring efficient allocation of capital particularly to the productive sectors of the economy.

• Addressing sectoral rigidities and structural imbalances: Fostering industrialization and economic diversification with value-addition as well as promoting exports is key to expanding capital markets, instruments, and innovative financial products. Export diversification and value addition are particularly important to reduce the trade deficit, keep external debts manageable, enable the economy to reduce dependency on external finance and manage systemic risks and uncertainties that deter private investment flows. As part of financial infrastructure, building technological capabilities including Information and Communication Technologies (ICTs), beefing up cyber security, creating a technology-savvy population, and facilitating innovative solutions in the financial systems should not be ignored.

• Data, statistics, and better policy coordination: Data-driven and evidence-based policymaking and coordination is important for countries such as Ethiopia given that data in capital markets tends to remain opaque compared to national and international banking and insurance operators. Quality data is vital not only for monitoring the functioning of financial markets, but it is also critical to bridging asymmetry in market information and enhancing transparency. These are foundational in enhancing better regulation and supervision with clear mechanisms to enforce financial deals, contracts, and transactions as well as improved payment settlement /clearing processes for cross-border transactions.

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