The Potential of the Bangladesh Capital Market
Mamun Rashid runs an expert eye over our financial future
The capital market is the engine of growth for an economy, and performs a critical role in acting as an intermediary between savers and companies seeking additional financing for business expansion. Vibrant capital is likely to support a robust economy. While lending by commercial banks provides valuable initial support for corporate growth, a developed stock-market is an important pre-requisite for moving into a more mature growth phase with more sophisticated conglomerates. Today, with a $67 billion economy and per capita income of roughly $500, Bangladesh should really focus on improving governance and developing advanced market products, such as derivatives, swaps etc.
Despite a challenging political environment and widespread poverty, Bangladesh has achieved significant milestones on the social development side. With growth reaching 7 percent in 2006, the economy has accelerated to an impressive level. It is noteworthy that the leading global investment banks, Citi, Goldman Sachs, JP Morgan and Merrill Lynch have all identified Bangladesh as a key investment opportunity. The Dhaka Stock Exchange Index is at a 10-year high, however, the capital market in Bangladesh is still underdeveloped, and its development is imperative for full realisation of the country's development potential.
It is encouraging to see that the capital market of Bangladesh is growing, albeit at a slower pace than many would like, with market development still at a nascent stage. The market has seen a lot of developments since the inception of the Securities and Exchange Commission (SEC) in 1993. After the bubble burst of 1996, the capital market has attracted a lot more attention, importance and awareness, that has led to the infrastructure we have in the market today.
Reasons behind the underdevelopment
Access to high quality and credible corporate information remains a major problem in the market. While a handful of institutional investors may enjoy certain benefits since they have an investment unit manned with qualified officers, nothing exists for retail investors. And, in the absence of independent research houses, retail investors primarily focus on advice given by their brokers, which often consists of market rumours. This is not acceptable, and it often leads to enormous losses for small investors who are vital for a low-income and emerging market like Bangladesh. Filtering of information among different types of investors may leave scope for manipulation; this assumption had been proved right in the 1996 market meltdown at the cost of many individuals and households.
The market does not have an adequate number of fundamentally sound scrips. The authorities should not force major corporations to come into the market, without creating an enabling environment. The focus should be on the privatisation of state owned enterprises through public offerings in the bourses. The market has to reach such a stage of development that companies will take it as a serious alternative to bank financing.
The government has reduced the interest rates on savings instru-ments, however this particular market is still limited to the commercial banks, and individual investors do not have access to these instruments. These savings instruments are considered risk-free, and since they are not present in the capital market, the overall risk of investment for an investor remains very high. A portfolio investor does not have the option of reducing his average portfolio risk by adding these risk-free opportunities.
An estimate suggests that the ratio of institutional-to-retail investors is still low in Bangladesh, even relative to other emerging markets. Institutional investors bring long-term commitment and a greater focus on fundamentals and, hence, stability in the market. The presence of institutional investors is also expected to ensure better valuation levels due to their specialised analytical skills. While we do have public sector as well as private sector institutional investors in the economy, proprietary investment from these institutions is not significant -- other than the Investment Corporation of Bangladesh that was created in 1976 and currently manages several mutual funds.
Corporate governance of international standard is still lacking. Multinational corporations and institutions operating in Bangladesh often adhere to a very high international standard compliance regime. Parent companies of most of these corporations and institutions have their scrips listed in developed markets. Unless the local market adheres to, and effectively enforces, a standard corporate governance system, there will not be a level-playing ground for international business houses vis-a-vis local operators.
An important aspect for capital market is reflection of fair value of scrips. This is not adequately present in the current scenario, and due to this reason the market is not receiving the attention of an important segment of investors, both foreign and local. Investors are perhaps depending more on speculative analysis, resulting in volatility in the market, as opposed to fundamental analysis, which could attract more stable long-term investors who are sure about their investment tenure and expectations.
1996 and now
The bull-run that took place in 1996 has left a number of positives for the market. A lot of investment-friendly regulatory reforms have been implemented by the SEC. We now have stronger surveillance and improved rules relating to public issue, rights issue, acquisition, mergers and so on. All these fundamental developments, which were well overdue, followed the 1996 bull-run. It was a learning experience for Bangladesh, and the desired level of changes was initiated by the market watchdog subsequently.
In the secondary market, surveillance is more active and particular than before. These developments, that are widely appreciated, are actually the fundamental requirements that are in place today resulting from the continuous efforts of the government and multilateral agencies.
Trading has now become automated, led by the Chittagong Stock Exchange through the central depository. In the present automated trading environment, bids/offers, depth, and required broker particulars are all recorded and can be retrieved for future reference. The Central Depository Bangladesh Limited (CDBL) was created in August 2000 to operate and maintain the Central Depository System (CDS) of Electronic Book Entry, recording and maintaining securities accounts and registering transfers of securities; changing the ownership without any physical movement or endorsement of certificates and execution of transfer instruments, as well as various other investor services including providing a platform for the secondary market trading of Treasury Bills and Government Bonds issued by the Bangladesh Bank.
The stock market surveillance mechanics in place at present has no resemblance to that of 1996. There are strict rules and guidelines, trading circuit breakers and international standard surveillance to protect investor rights and ensure fair play. The disclosure requirements and its timing for both listed scrips and IPOs as devised by the SEC are now more reflective of international practices. The SEC is also adopting new valuation methods that result in fair pricing of new issues. While there is still a lack of credible research organisations, a few firms like Asset and Investment Management Services of Bangladesh Ltd. (Aims) have come up, and they are investing in research and building up stock market related credentials.
The recent surge in the stock market
The Dhaka Stock Exchange Index was at a 10-year high in the 2007 year end (up 66 percent), which made it Asia's top performer after China. The steady investment atmosphere prevailing throughout 2007 is considered to be one of the main reasons behind this surge. Good return prospects, stable market growth, and uninterrupted trading as a result of political stability attracted foreign investors to local securities. In 2007, foreign investors bought shares worth $205.7 million, while the amount of selling was $78.6 million, according to a DSE statistic. According to the DSE, in 2007, net foreign or portfolio investment on the Dhaka Stock Exchange surged 8.3x to $129 million. The banking sector, followed by the power, pharmaceutical and cement sectors, received the most foreign investment.
The caretaker government has also attracted investors by pledging to sell state enterprises. The state-owned companies -- Jamuna Oil Company Ltd. and Meghna Petroleum Ltd. -- debuted in the bourses early this month. Some analysts think that the market had been undervalued before the surge, and the uphill trend, therefore, played the role of an upward correction of the market.
The P/E ratio now stands at 20x as compared to 14.1x for emerging markets. It seems sustainable if the planned big IPOs of a few SOEs and the top telecom companies take place. More such large issues are required, which can emerge out of the energy, infrastructure and public sectors.
The capital markets in Asia are getting more and more focus with the growing corporatisation of the Asian economies. Eastern Asia has progressed a lot with respect to attracting western companies to get listed in Asian bourses as well as supporting innovative instruments, and Southeast Asia is also coming up with India leading the way. Comparing the local market scenario with that of the rest of the region, Bangladesh is in pretty good shape as we have most of the infrastructure in place. Our market capitalisation is relatively smaller and it currently stands at $9.3 billion, which is just over 13 percent of GDP. Higher liquidity is skewed towards a handful of scrips, while a stagnant situation exists for few less profitable issuers.
At present, the government is heavily focusing on developing a debt capital market. Such measures are certainly welcome as Bangladesh lacks a proper secondary market for bonds. The market is yet to support short-term capital requirements of corporations. Commercial Paper (CP) has not yet been tried primarily due to interest rate volatility and illiquid risk-free instruments that can be used as benchmark neither for short-term and hardly for long-term financing. It can, therefore, be said that we have a somewhat flat yield curve in Bangladesh at the moment.
Debut trading of state-owned oil companies like Jamuna Oil Company Ltd and Meghna Petroleum Limited on the local bourses in January 2008 has spurred a lot of encouragement among investors. This initiative taken by the government to list SOEs will increase market capitalisation and improved liquidity.
SEC is also contemplating the introduction of the book-building method in the valuation of IPOs in order to ensure a fair price within this year. This will encourage companies with sound financial health to come into the market.
Regulatory pressures are mounting on telecom companies to get listed. It is estimated that the listing of the top telecom companies will attract more foreign investment, increase the market capitalisation by few folds, and bring about higher standards of corporate governance.
There is still huge potential in the market for securitisation and other debt instruments like commercial papers and corporate bonds, and derivatives, which will help foreign investors hedge their exposure.
The market needs more and more good scrips. The process would be easier if we could draw attention of good issuers by improving the market governance system and eliminating scope for manipulation. There are only limited instances, such as in commercial banks/leasing companies, where regulators can impose guidelines relating to capital structure. Hence, it may be difficult to force a corporate house to list unless it agrees at the time of licensing or registration. Inadequate disclosure requirement, and a culture of family-owned conglomerates deter the expansion of corporate governance into the local industry. The regulators need to play an active role in removing the bureaucratic bottlenecks, and promote rules that provide incentives to these groups of companies to list.
To expedite the market development process, it may be a good idea to decide on certain milestones and link them to the disbursement of Development Credit Support of the World Bank. The government is making good progress in other sectors, including monetary management, corporatisation of public-sector banks and others through this linkage.
The missing link between the SEC, Bangladesh Bank, Bangladesh Telecom Regulatory Commission and other regulatory bodies is now getting established. Individually, they were not serving each others' interests, and there was no effective coordination among them, hence the country was deprived of great initiatives. A dedicated financial market cell at the Ministry of Finance could be formed to coordinate with these regulators as well as other ministries.
In terms of creating market depth, more profitable state-owned-enterprises should be listed. The supply of securities can be increased if the SOEs are allowed to operate through the stock exchanges. Floatation of SOE scrips is expected to expand the market by couple of times. Corporatisation of SOEs will bring in transparency as well as confidence on the government financial system.
Incentive for private sector entrepreneurs to access the capital market should be more noticeable. Tax gap between listed and non-listed companies could be increased. Infrastructure projects should access capital market to raise financing through bonds and corporations should raise short term financing through commercial papers. Securitizations should be encouraged. We need to be proactive and take initiatives to promote new products in the market.
In a more developed market, institutional investors such as merchant banks, commercial banks, insurance companies, are major traders of securities. We need enforceable and more effective laws and rules to attract foreign institutional investors.
Equity research is not yet very popular in Bangladesh, quality of brokerages houses should be assessed by the quality of research produced by their independent research departments. SEC is expected to take an educational role in the process by bringing in international resources and creating investors awareness through television and other media. Local TV channels focus on business but we also need education for the young generation financial education for the college and university students, irrespective of their discipline, should be promoted. Young people have every right to learn the mechanisms of saving, investing and the importance of personal financial management.
Quality analysis needs to address this valuation issue in a more pro-active manner. The independent analysts should raise the flag when a scrip is overvalued or undervalued, the intrinsic value of a traded security should be covered in the research paper. Investors are perhaps depending much on speculative analysis resulting into volatility in the market as opposed to fundamental analysis, which could attract more stable long-term investors who are sure about their investment tenure and expectations. It is observed that whenever there is a downturn in the market, individual investors go on rampage. However, these investors should understand that downturns, bearish trends and market corrections are an integral part of stock markets.
The Bangladesh capital market still has a long way to go. The recent measures taken by the transitional government have already begun to positively impact the markets. If more investor-friendly policy reforms were to be implemented, the capital market will undoubtedly play a critical role in leading Bangladesh towards being the next Asian tiger with growth comparable to India, Vietnam and the other most dynamic economies in the region.
Mamun Rashid is a banker and economic analyst