The Development of African Capital Markets

A Legal and Institutional Approach

Boniface Chimpango

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781315408965
• Edition: 1
• Topic: Economics
• Subtopic: Commercial Policy
• Index: Economics

Most capital markets that have been established in developing economies like Africa have struggled to make progress over two decades down the line. Development of African Capital Markets explores why these markets have remained underdeveloped and discusses a possible development theory that can be used in designing and implementing legal and institutional reforms to reinvigorate capital markets in African and other developing countries.

Boniface Chimpango analyses the weaknesses of capital markets in developing countries, and argues that legal and institutional framework for capital markets in developing countries should be tailored to the unique informal rules prevalent in each country rather than being transplanted from developed countries.

This book will be of interest to scholars, students and policy makers in the fields of economic development, African Studies, law, development and regulatory policy.

1
Introduction

The increasing appetite for capital markets in developing economies

The role and place of capital markets in economic development have received increasing attention in recent times. It is believed that there is a strong correlation between the level of development of capital markets and the level of economic development of their respective country or economic region.¹ Roth² succinctly summarised this view as follows:

A well-developed capital market facilitates the capital formation that is essential to economic growth. Effective use of domestic savings allows many domestic enterprises that are unable to attract foreign capital to obtain needed capital from domestic sources. Moreover, foreign companies that find it possible to raise capital in the local market of a developing country are encouraged to establish new or expand existing operations in that country thereby making their products available without expenditures of foreign exchange.

A number of empirical studies have found that stock markets are an important source of finance for funding the growth of large corporations in some African countries.³ For example, it was found that, in Ghana, the stock market financed about 12 per cent of the total asset growth of listed companies in the period from 1995 to 2002.⁴

Consequently, the development of capital markets has become a common item on the development agenda of most developing economies, including African economies. However, in Africa, an effective solution to develop its capital markets continues to elude policy makers. Despite various efforts and strategies⁵ to develop the markets by African state and economic authorities, African capital markets remain underdeveloped. Professor Nicholas Biekpe⁶ defined this problem in the following terms:

The basic question facing many policy makers in Africa is the identification of factors that constrain the development of successful and viable capital markets on the continent. Many African countries have embarked on economic reform programmes; in most cases with the support of the World Bank and the International Monetary Fund. These programmes have often included the liberalisation and restructuring of the financial sector. However, financial sector reforms have been least successful in many of these countries. The basic question, therefore, is why such reforms have not succeeded, despite the fact that they are an essential element in the development of efficient capital markets. For the further development of capital markets in Africa, useful lessons may be drawn from the experience of Asian and Latin American countries, as well as certain other African countries that have been able to promote the development of such markets successfully.

The above observation perfectly sets out the point of departure for this study, which seeks to engage in a holistic diagnosis of the current malaise of capital markets in most developing countries, including in Africa, and to provide possible alternative solutions for capital market growth in such countries.

Table 1.1 Comparison of some stock exchanges in the SADC region

Country	Year founded	Stock exchange	No of listed companies (as at 2009)	Market capitalisation (US$-BLN) (as at 2009)
Bostwana	1989	Botswana Stock Exchange	31	4.26
Malawi	1995	Malawi Stock Exchange	15	1.48
Mauritius	1988	The Stock Exchange of Mauritius	40	4.82
Mozambique	1999	Maputo Stock Exchange	6	–
Namibia	1992	Namibia Stock Exchange	29	0.96
South Africa	1887	Johannesburg Stock Exchange	396	799.02
Swaziland	1990	Swaziland Stock Exchange	5	–
Tanzania	1998	Dar es Salaam Stock Exchange	15	3.57
Zambia	1994	Lusaka Stock Exchange	21	5.27
Zimbabwe	1993	Zimbabwe Stock Exchange	96	–

Source: extracted from the Capital Markets Authority, A Comparative Analysis of The Performance of African Stock Markets For The Period 2008–2009, Volume II, June 2010.

This study seeks to explore legal and institutional constraints that may be responsible for the slow capital market growth in developing countries, particularly in Africa. Policy makers in Africa need to be properly guided in order to have the right focus for their resources in their bid to develop African financial markets. This study is therefore part of the overall economic development agenda in Africa. Several development programs have been initiated in Africa aimed at implementing legal and institutional reforms in an attempt to orchestrate economic growth across the continent. Such programs have been based on different theoretical underpinnings but little progress has been registered so far, as depicted in Table 1.1 below which gives a picture of the state of the development of stock exchanges in the SADC (South African Development Community) region. It is for this reason that this research seeks to develop a theory of development that may help in the implementation of the current development agenda generally and the development of strong capital markets specifically.

The role of capital markets

The upsurge in the popularity of the capital market idea has been attributed to a number of global as well as market factors. Global factors that have generated interest in capital markets include intellectual conversion of political elites to the power of markets as instruments of economic change, privatisation of public assets and the sustained recovery in equity markets and the technology revolution. Market factors include innovation in financial products and markets, the advent of institutional investors, the development of derivative markets and the liberalisation and internalisation of markets.⁷

The relevant question for this study is: what is the role of capital markets in overall economic development? It is necessary to examine the role of capital markets in national economies, as the need to develop capital markets in emerging markets would only be justified if markets play a significant role in economic development. Before we do that, however, we need to look at the relevant terminology which will give this study a proper perspective.

The term capital market has a wider definitional scope as it embraces the whole complex of institutions and arrangements through which capital may be raised.⁸ Capital markets channel the money provided by savers and depository institutions such as banks, credit unions and insurance companies to borrowers and investors through a variety of financial instruments including bonds, notes and stocks, which are collectively called securities.⁹ The capital market system is therefore made up of three major parts: (1) stock market, (2) bond market, and (3) money market. The capital market is sometimes referred to as the securities market.

This work will, however, mainly focus on the stock markets because trading of stock is more common in developing countries than other exchange traded products such as bonds, forex and commodities. Stock markets are also called stock exchanges or equity markets. A stock exchange is defined as a market for the sale and purchase of shares, stock and other securities.¹⁰ Stock exchanges are usually organised and regulated and securities are bought and sold at prices governed by the forces of demand and supply. Stock exchanges basically serve either as primary markets or as secondary markets of stocks. In its role as a primary market, a stock exchange allows new issues of equity or debt to be arranged in the form of an entirely new floatation or in the form of an offer to existing investors.¹¹ The primary market therefore enables corporations, governments, municipalities and other incorporated bodies to raise capital by channelling the savings of the investors into productive ventures.¹² On the other hand, the secondary market allows investors to sell their securities to other investors for cash, thereby reducing the risk of investment and maintaining liquidity in the system. The existence of a secondary market therefore makes the primary market operate more effectively.¹³

Apart from the formal stock exchanges, equity or debt is also traded on the Over the Counter market (OTC). This market deals mainly in securities which are not traded on an exchange, usually due to an inability to meet listing requirements. The market is operated by brokers/dealers who negotiate directly with one another over computer networks and by phone. Securities acquired in the OTC market are riskier than those quoted on the stock exchange for several reasons, including lack of sufficient statutory protection to investors and lack of liquidity.¹⁴ The role of OTC markets has now been significantly reduced following introduction of alternative markets where trading of most unlisted shares take place.¹⁵

Function of capital markets

In order to understand the role of stock markets in economic growth, it is important to look at the distinct functions of the markets themselves. Generally the functions of capital markets may be summarised as follows:

• Capital markets maintain a free market by providing a meeting place and facilities for trading which in turn brings together a constant stream of buyers and sellers of stocks.¹⁶ In this way capital markets facilitate the flow of funds generated within the economy to be made available to those who need...