How to deepen Africa’s financial markets
Africa has some of the World’s fastest growing economies and one of the key drivers of economic growth has been the financial markets.As a person familiar with the continent, I know that stability in financial markets is a must. The continent’s financial market are considered shallow compared with the Western World. Africa’s stock market capitalisation to GDP ratio is less than 30 percent, which is very low in comparison with other regions. Africa’s interbank lending to GDP ratio also shows how shallow financial markets are compared with developed world.Similar with equity and money markets, Africa’s bond market also lags behind. Both government bond market to GDP ratio and corporate bond to GDP ratio score lowest. Shallow financial markets possess a high risk of volatility at the event of sudden capital reversal. In South Africa, key players face several obstacles in deepening it’s financial markets. Both supply and demand sides face a similar problem which is the limited number of issuers as well as a low investor base. Lack of product diversification in the market also plays significant role creating an illiquid financial market. These conditions are exacerbated by low infrastructure and policy support from the government.
One notable cause of Africa failure to depend the financial markets is the perception of a higher tax burden as a result of greater disclosure and higher listing costs in some of the markets like Johannesburg Securities Exchange and Nairobi Securities Exchange.The bond market is equally facing similar challenges of a limited and slow-growth issuer base. The bond markets in countries like Nigeria, South Africa, Egypt and Kenya are dominated by government bonds, which contribute up to 70 percent of total bonds outstanding. Government bond market is relatively more developed than the corporate bond market. The share of corporate bonds remains weak due to the lengthy issuance process for corporate bonds which takes up to 12 months. This lengthy process also plays a significant role in increasing costs for the company. Reluctance to list bonds by big companies causes African countries to lack a high volume of credible bond issuances. African countries also face similar problems on the demand side. The equity markets in Kenya and South Africa, retail investors in January 2016 only amounted to only 0.003 percent of the total population. This number is low compared to Australia and Finland with more than 16 percent of their total population. In the bond market, there is one important thing that Africa lacks which is the absence of market-makers especially in the corporate bond market.
Institutional investors like pension funds or asset managements are often forced to buy and hold bonds until their due date because there are no market activities available for different products, especially for corporate bonds. The situation is worsened because retail investors rarely buy corporate bonds due to high ticket size. Investors also face several regulations that limit the ability of foreigners to directly invest in Africa’s capital market.In fact, only few countries allows foreign investors to own business up to 100% as of February 2016 data released by an international research firm.In order to improve the issuers’ base, African countries must simplify their issuance regulations, especially in the bond market. As mentioned above, normally it takes up to 12 months to issue a bond in most countries. International markets tend to gradually reduce approval times for all classes of debt issuers, mostly as part of a concerted attempt to streamline the issuance process.In order to increase the number of retail investors, African countries could design some sort of incentive. The tax incentives vary depending on the investment made. The incentive can be given in the form of a tax deduction as long as they keep their investments. Africa’s population of more than 1 billion signifies huge potential for retail investors. They might not be big capital investors, but they constitute a sizeable amount in the number of investors. The transaction volume will make the market more active and their capital will surely help maintain the market in a liquid condition.
In order to improve domestic institutional investor participation,countries like Kenya, South Africa, Ghana, Tanzania and Nigeria should shift their investment behaviour. Up to 50 percent of institutional investors’ funds are invested in cash and money market instruments, which are considered short term instruments. This trend is significantly higher compared to developed markets. At the moment, institutional investors, especially pension funds, measure their performance annually using short term benchmarks. Another factor is that there are no penalties for investors to withdraw their money before retirement time. Shifting the mindset of the pension industry would promote development of long-term funding in Africa and help stabilise the financial market.The challenges in Africa’s financial markets do not reside only on the supply and demand side. African countries still have much homework to do in order to improve other aspects, such as product gaps, infrastructure gaps and a cumbersome regulatory climate. Sound financial markets will enhance resilience and the capacity to cope with shocks, improve the effectiveness of macroeconomic policy, as well as support solid and inclusive growth.
One notable cause of Africa failure to depend the financial markets is the perception of a higher tax burden as a result of greater disclosure and higher listing costs in some of the markets like Johannesburg Securities Exchange and Nairobi Securities Exchange.The bond market is equally facing similar challenges of a limited and slow-growth issuer base. The bond markets in countries like Nigeria, South Africa, Egypt and Kenya are dominated by government bonds, which contribute up to 70 percent of total bonds outstanding. Government bond market is relatively more developed than the corporate bond market. The share of corporate bonds remains weak due to the lengthy issuance process for corporate bonds which takes up to 12 months. This lengthy process also plays a significant role in increasing costs for the company. Reluctance to list bonds by big companies causes African countries to lack a high volume of credible bond issuances. African countries also face similar problems on the demand side. The equity markets in Kenya and South Africa, retail investors in January 2016 only amounted to only 0.003 percent of the total population. This number is low compared to Australia and Finland with more than 16 percent of their total population. In the bond market, there is one important thing that Africa lacks which is the absence of market-makers especially in the corporate bond market.
Institutional investors like pension funds or asset managements are often forced to buy and hold bonds until their due date because there are no market activities available for different products, especially for corporate bonds. The situation is worsened because retail investors rarely buy corporate bonds due to high ticket size. Investors also face several regulations that limit the ability of foreigners to directly invest in Africa’s capital market.In fact, only few countries allows foreign investors to own business up to 100% as of February 2016 data released by an international research firm.In order to improve the issuers’ base, African countries must simplify their issuance regulations, especially in the bond market. As mentioned above, normally it takes up to 12 months to issue a bond in most countries. International markets tend to gradually reduce approval times for all classes of debt issuers, mostly as part of a concerted attempt to streamline the issuance process.In order to increase the number of retail investors, African countries could design some sort of incentive. The tax incentives vary depending on the investment made. The incentive can be given in the form of a tax deduction as long as they keep their investments. Africa’s population of more than 1 billion signifies huge potential for retail investors. They might not be big capital investors, but they constitute a sizeable amount in the number of investors. The transaction volume will make the market more active and their capital will surely help maintain the market in a liquid condition.
In order to improve domestic institutional investor participation,countries like Kenya, South Africa, Ghana, Tanzania and Nigeria should shift their investment behaviour. Up to 50 percent of institutional investors’ funds are invested in cash and money market instruments, which are considered short term instruments. This trend is significantly higher compared to developed markets. At the moment, institutional investors, especially pension funds, measure their performance annually using short term benchmarks. Another factor is that there are no penalties for investors to withdraw their money before retirement time. Shifting the mindset of the pension industry would promote development of long-term funding in Africa and help stabilise the financial market.The challenges in Africa’s financial markets do not reside only on the supply and demand side. African countries still have much homework to do in order to improve other aspects, such as product gaps, infrastructure gaps and a cumbersome regulatory climate. Sound financial markets will enhance resilience and the capacity to cope with shocks, improve the effectiveness of macroeconomic policy, as well as support solid and inclusive growth.
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