Some crucial reforms have become the need of the hour
Anybody who has visited our capital market regulators recently, came back energized with optimism -- perhaps the days of inaction are behind us. There is an incoming positive shift in a market previously characterized by “manipulation,” which harmed small investors and often even jeopardized the government’s reputation.
Some positive developments
It goes without saying that augmenting investment requires access to affordable and long-term capital. But a financial system shackled by a weak banking sector cannot do that.
If banks lend long-term with relatively short-term deposits, they will find themselves in an asset-liability mismatch, making them vulnerable in moments of crisis. Hence, the need for a vibrant capital market. One that can raise long-term capital for private and government projects in a way the banks cannot.
There have been some positive developments in the market, especially the demutualization of the bourses, where this writer played a significant role. We hoped demutualization would create a governance structure that increased market flexibility to change economic dynamics and reduce the concentration of ownership power.
Another reform which aimed to bring transparency was the Financial Reporting Act, which came into effect in 2015.
The Bangladesh market has long suffered from crafty accounting manipulations that artificially inflated a firm’s value.
Local, small, and novice investors were the first victims of such financial engineering or “Chinese accounting” as they say.
The combined effects of these two reforms can go a long way in rebuilding investor-confidence, especially after the infamous 2010 crash.
But regulators will have to convince people that they can ensure compliance and impose penalties on detractors of best financial practices. Shanghai and Shenzhen Stock Exchanges’ 25% stake in DSE has strengthened DSE’s muscle power to pursue further streamlining and welcoming regional investments.
Though many are investing, investor confidence remains low. While we saw the occasional rally, there was never any discernible upward trend in the general market index for a while -- especially one that we could tag to positive economic developments like increased industrial production.
A false hope
Some will argue we saw a big rally last year. Make no mistake; that had little to do with sound economic fundamentals. Stock prices soared to unprecedented heights, driven primarily by banks even when banks were battling soaring bad loans.
Many felt that the Bank Companies (Amendment) Act 2017 was the reason, which allowed more directors from a single family in a bank’s board and increased their tenure.
Naturally, sponsor-directors of banks heavily invested, anticipating the amendment, while small investors got caught up in the rally and simply followed suit. Speculation on dividends added fuel to the fire.
Incidentally, genuine investors still lack confidence and rely on rumours instead of careful analysis of a company’s financials, business model, and management integrity. Most chase short-term investments.
The market is severely under-represented by hundreds of big companies which have ignited economic activity in Bangladesh for the last decade. Foreign institutional investment remains too small to have any sizeable impact on our market; if it did, then we would have seen fewer episodes of unexplainable spikes and corrections.
Better policy coordination
There is also serious lack of coordination between major regulatory authorities: Bangladesh Securities and Exchange Commission (BSEC), Bangladesh Bank, and the finance ministry. This had a role in the 2010 crash that wiped out the savings of millions of retail investors. And that is precisely where the reform agenda must start: Better policy coordination.
Regulators, and professionals in the market, must work towards cautioning retail investors about the hazards of relying on rumours. Carrying out minimum due diligence before investing is not an option, but a must.
Surprisingly many investors believe that the capital market index should only increase and BSEC’s primary objective should be to drive stock prices upward. Otherwise, they are of no good.
If regulators are serious about raising confidence, they must ensure that large local and foreign firms, with strong fundamentals, go public. Pushing the bucks only to the foreign multi-nationals will not hold water.
Reforms in tax policy
That brings us to the need for substantial reforms in tax policy. Grameenphone, despite tremendous eagerness from Grameen Bank founder and Telenor headquarters, would at least have delayed their listing, if not for the tax break for listing.
Ultimately, these firms need to be given the right incentives. Regulators should consider further reductions in corporate tax rates for listed companies, though tax rate reduction alone so far didn’t play any significant role to attract companies to go through the listing route.
Further incentives can be offered to corporations consistently offering attractive dividends and/or offload a large share of stocks, instead of just the minimum required to go public. These rates should be consistent for all sectors, including banks and telecom.
Easier said than done
Globally, capital markets comprise both stocks and bonds. A foreign fund manager interested in Bangladesh will only divert substantial capital here if he can create a hedge between stocks -- which have inherent risks and bonds. Developing a market for corporate bonds is vital here.
Given the lack of public confidence and awareness about the benefits of investing in debt instruments, this is a lot easier said than done. A reform agenda on this front will require an enabling regulatory environment with tax incentives, issuing benchmark bonds, seriously pursuing a rating system, establishing effective trading platforms, and finally establishing a derivatives market with instruments of long maturities to hedge against interest rate, exchange rate, and default risks.
Another disappointment is the complexity of regulations that govern the overall process of raising funds from the market. This complexity, together with lower financial incentives, led to only a few IPOs in the past years.
Then again, market participants would generally agree that even simple matters like purchasing treasury bills are a tedious task, let alone IPOs.
A lack of professionalism
There is also the alleged lack of professionalism among mutual fund managers which played a role in the unhappy state of the market. Several quarters alleged that these funds lack professional expertise and are mostly politically sheltered, which stagnated investor confidence.
On the contrary, this is also true -- in a market characterized by a lack of quality stocks, and little variety of asset classes, where will the mutual fund managers go? On the other hand, regulators need to educate the public about the benefits of routing their investments through professional fund managers.
Simultaneously, fund managers must be given more diversity and flexibility in terms of where they can invest. With the bond market still in infancy, one option could be to allow a small portion of these funds to be invested in overseas financial assets.
Of course, this should be considered only after due diligence and accurate reporting of investment dynamics to the capital market and money market regulators.
We also must remember that the success of these reforms depends on the extent of political will regulators or BSEC can generate. It is sometimes said that recognizing the problem is winning half the battle. Sadly though, that is not the case for capital market reform in Bangladesh.
We can see a lot of energy in our new BSEC or capital market leadership. Before this stamina wanes, we must prepare an actionable laundry list and drive this towards a possible destination, and fast.
Mamun Rashid is an economic analyst.