## _wp07209

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### I. INTRODUCTION
- Purpose: examine the economic importance and future of African stock markets; analyze link between stock market and economic growth from corporate finance and macroeconomic perspectives; discuss policy options for promoting stock market development in Africa.
- Recent developments:
  - Prior to 1989 there were just five stock markets in sub-Saharan Africa and three in North Africa; today there are 19 stock exchanges.
  - New stock markets established in Ghana, Malawi, Swaziland, Uganda, and Zambia.
  - Stock market development has been central to domestic financial liberalization programs in most African countries.
- Central policy questions:
  - What benefits does a country gain from having a stock market?
  - Are stock markets playing an important role in allocating capital to industry?
  - What is the relationship between stock market development and economic growth?
  - What determines stock market development?
  - How to make the stock market more functional to African countries?

### II. THEORETICAL MECHANISMS AND AMBIGUITIES
- Mechanisms by which stock markets may promote growth:
  - Encourage savings by providing new financial instruments (Levine and Zervos, 1998).
  - Provide avenues for firms to raise capital at lower cost and reduce dependence on bank financing.
  - Takeover mechanism provides managerial discipline and efficient use of assets (Kumar, 1984).
  - Reduce information costs through generation and dissemination of firm-specific information; efficient prices incorporate available information.
  - Improve financing of long-term projects via liquidity (Bencivenga and Smith, 1991).
- Theoretical ambiguities and potential negative effects:
  - Increased liquidity may reduce precautionary savings, possibly adversely affecting growth.
  - Speculative bubbles can disconnect prices from fundamentals (Binswanger, 1999).
  - High liquidity may encourage investor myopia and weaken corporate governance (Bhide, 1994).
  - Pricing and takeover dynamics may encourage short-termism and financial engineering over organic growth (Singh, 1997); takeover discipline may favor size over performance (Singh, 1971).
  - Limitations are magnified in developing countries with weaker regulatory institutions and greater macroeconomic volatility, increasing price volatility and reducing efficiency of price signals.

### III. TRENDS, STRUCTURE AND PERFORMANCE OF AFRICAN STOCK MARKETS
- Overall trends:
  - Number of exchanges increased to 19 across Africa.
  - With the exception of South Africa, most African stock markets doubled their market capitalization between 1992 and 2002.
  - Total market capitalization for African markets increased from US$113,423 million to US$ 244,672 million between 1992 and 2002.
- Structural characteristics and challenges:
  - Trading concentrated in a few stocks accounting for a large share of total market capitalization.
  - Serious informational and disclosure deficiencies for many stocks; supervision by regulatory authorities often inadequate.
- Performance despite limitations:
  - Ghana Stock Exchange: year return of 144 percent in US dollar terms at end of 2004; compared with 30 percent return by Morgan Stanley Capital International Global Index (Databank Group, 2004).
  - Other strong performers in the year: Uganda, Kenya, Egypt, Mauritius and Nigeria.
- Notable point:
  - Johannesburg Securities Exchange accounts for about 90 percent of the combined market capitalization of the entire continent.

### IV. KEY STATISTICS ON AFRICAN STOCK MARKETS (Indicators, 2004)
- Number of Listed Companies; Market Capitalization (percent of GDP); Value Traded (percent of GDP); Turnover (percent)
  - Botswana: 18; 29.4; 0.6; 2.1
  - Egypt: 792; 51.3; 7.5; 17.1
  - Cote d’Ivoire (BRVM): 39; 13.6; 0.3; 2.5
  - Ghana: 29; 30.7; 0.8; 3.2
  - Kenya: 47; 24.9; 2.1; 8.0
  - Malawi: 8; 9; 1.0; 11.1
  - Mauritius: 41; 39.3; 1.6; 4.4
  - Namibia: 13; 8.1; 0.3; 4.7
  - Nigeria: 207; 20.1; 2.3; 13.9
  - South Africa: 403; 214.1; 76.5; 45.0
  - Swaziland: 6; 9.3; 0.0; 0.0
  - Tanzania: 6; 6.2; 0.2; 2.5
  - Uganda: 5; 1.4; 0.0; 0.2
  - Zambia: 11; 8.0; 0.1; 1.1
  - Zimbabwe: 79; 87.9; 14.0; 3.9
  - Average Africa: 113.6; 36.9; 7.2; 8.0
  - Average SSA* (Excluding South Africa): 39.2; 22.1; 1.8; 4.4
  - Comparative markets:
    - Malaysia: 962; 161.3; 50.8; 33.4
    - Mexico: 152; 25.4; 6.3; 29.1
    - Thailand: 465; 70.6; 66.7; 93.8
- Additional notable statistics:
  - Market capitalization as a percentage of GDP as low as 1.4 in Uganda.
  - Turnover as low as 0.02 percent in Swaziland (noted earlier in text) versus about 29 percent in Mexico.

### V. INSTITUTIONAL & INFRASTRUCTURAL INDICATORS (selected findings)
- Eleven indicators considered: existence of a market regulator; a governing law; nature of clearing & settlement; settlement cycle; existence of an international custodian; foreign participation; exchange control; nature of trading systems; existence of a central depository; number of trading days; accounting and auditing reporting system.
- Selected country summaries (existence denoted by √ in source; selected settlement cycles and reporting systems preserved as reported):
  - Algeria: Market regulator √; Governing law √; Electronic clearing & settlement; Settlement cycle 4; International custodian None; Foreign participation √; Exchange control None; Trading system Electronic; Central depository None; Trading days 1; Reporting system Local S.
  - Botswana: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation √; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Local S.
  - BRVM: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5***; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository None***; Trading days 3; Reporting system Local S.
  - Egypt: Market regulator √; Governing law None; Manual*** clearing; Settlement cycle 4; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - Ghana: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5*; Reporting system Local S.
  - Kenya: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
  - Mauritius: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - Nigeria: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - South Africa: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 5**; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Local S.
  - Uganda: Market regulator √; Governing law None; Manual clearing; Settlement cycle 5; International custodian None; Foreign participation √; Exchange control √; Trading system Manual; Central depository None; Trading days 2; Reporting system Intern. S.
  - Zimbabwe: Market regulator √; Governing law √; Manual clearing; Settlement cycle 7; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
- Main infrastructural bottlenecks:
  - Use of slow manual systems; many markets continue to trade manually and use manual clearing and settlement.
  - Most markets lack central depository systems.
  - Some markets still have restricted foreign participation.
  - Namibia and South Africa now use a common depository system SAFICAS and this has enabled the move to standard T+3 settlement cycle.
  - BRVM and Egypt now have electronic systems.
- Result: These bottlenecks slow trading and induce inactivity.

### VI. STOCK MARKET CONTRIBUTION TO CORPORATE FINANCING (selected empirical shares)
- Data sources for corporate financing patterns: national flow of funds statements and company accounts (strengths and limitations noted in source).
- Country evidence and mean financing shares (percent):
  - Ghana: stock market financed about 12 percent of total asset growth of listed companies between 1995-2002.
  - South Africa (1996–2000): liabilities accounted for 61 percent of total financing; retained earnings 21 percent; external equity 18 percent of total assets growth (Glen and Singh, 2003).
  - Zimbabwe (1990–1999): external finance contributed 75.4 percent of total funds; internal finance provided the remaining 25 percent; equity financing 7.8 percent of total (Mutenheri and Green, 2003).
  - Mauritius (1992–1999): stock market financed about 9 percent of total asset growth; retained earnings 30 percent; external debt 61 percent (Lalchand, 2001).
  - Global comparison (Glen and Singh, 2003, 1996–2000): liabilities 49 percent of total financing; internal equity 29 percent; external equity 22 percent.
- Selected rows from Table 3 (mean values, percent):
  - Korea: Retentions 23.10; External Finance 76.90; External Equity 31.20; Total Debt 43.30
  - India: Retentions 25.30; External Finance 74.70; External Equity 14.60; Total Debt 51
  - Malaysia: Retentions 13.30; External Finance 86.70; External Equity 9.60; Total Debt 70.80
  - Thailand: Retentions 5.70; External Finance 94.30; External Equity 16.10; Total Debt 80.60
  - Ghana: Retentions 22.50; External Finance 77.50; External Equity 12.20; Total Debt 48.40
  - Mauritius: Retentions 30; External Finance 70; External Equity 9; Total Debt 61
  - South Africa: Retentions 21; External Finance 79; External Equity 18; Total Debt 61
  - Zimbabwe: Retentions 24.60; External Finance 75.40; External Equity 7.80; Total Debt 67.60

### Box: Financing corporate growth in Ghana (detailed)
- Sample period: growth in balance sheet over 1995 to 2002.
- Mean financing shares (percent of change in total assets, means sum to 100):
  - Internal sources (retentions): average quoted Ghanaian firm finances 11.45 percent of growth of total assets from internal sources.
  - External debt: 47.86 percent of growth of total assets.
  - New issues of equity: 40.69 percent of growth of total assets.
- Debt maturity: about 84 percent of total debt is short term.
- Measurement caveat: indirect (residual) method of measuring equity finance may have upward bias (revaluations and reserves included).
- Direct (alternative) method following Whittington, Saporta and Singh (1997):
  - Contribution of equity to total assets growth for the median listed Ghanaian firm reduced to 12.20 (percent).
  - Comparison indicates the indirect method overstated equity contribution by 20.85 percentage points (33.05 - 12.20).

### VII. MACROECONOMIC GROWTH CHANNEL — EMPIRICAL METHODOLOGY
- Objective: assess economy-wide effect of stock market development on sub-Saharan African GDP growth.
- Stock market indicators used (separately): market capitalization/GDP; value of shares traded/GDP; turnover ratio (value traded/market capitalization).
- Estimation approach: Arellano and Bond (1991) Difference GMM dynamic IV approach to control country/time effects and endogeneity.
- Data: unbalanced panel of 14 African countries; stock data from Reuters Services and Emerging Stock Markets Fact Book; macro data from IMF International Financial Statistics.
- Stock-flow timing issue addressed following Beck, Demirgüç-Kunt and Levine (1999).

### VIII. EMPIRICAL RESULTS (Difference GMM — exact coefficients and statistics)
- Equation 1 (Market Size = market capitalization/GDP):
  - Lagged growth: 0.0652 {0.049}
  - Investment: 0.0256 {0.022}
  - Market Size: -0.0386 {0.581}
  - Observations: 189
  - Sargan: 0.89
  - AR(1): 0.06
  - AR(2): 0.56
- Equation 2 (Value of Shares Traded/GDP):
  - Lagged growth: 0.0757 {0.012}
  - Investment: 0.0227 {0.056}
  - Value of Shares Traded: 0.0379 {0.082}
  - Observations: 183
  - Sargan: 0.81
  - AR(1): 0.10
  - AR(2): 0.66
- Equation 3 (Turnover Ratio):
  - Lagged growth: 0.0790 {0.012}
  - Investment: 0.0269 {0.021}
  - Turnover Ratio: -0.0037 {0.769}
  - Observations: 181
  - Sargan: 0.82
  - AR(1): 0.08
  - AR(2): 0.53
- Interpretation and caveat:
  - The ratio of value of shares traded to GDP is the significant stock-market driver of economic growth in the sample.
  - An increase in stock market activity via higher liquidity (value traded/GDP) augments GDP growth by 3.7 percentage points (coefficient 0.0379 interpreted as 3.79 percentage points in the text).
  - Market capitalization/GDP and turnover ratio were not significant in these specifications.
  - Sargan and AR tests support instrument validity and absence of second-order serial correlation.
  - Caveat: inclusion of South Africa may bias results heavily toward this finding.

### IX. DETERMINANTS OF STOCK MARKET DEVELOPMENT (policy-relevant factors and empirical findings)
- Key preconditions identified:
  - Macroeconomic stability:
    - Low and predictable inflation supports stock market development and reduces informational asymmetries.
    - Sound macroeconomic environments and sufficiently high income levels (GDP per capita), domestic savings, and domestic investments are important determinants.
  - Banking sector development:
    - Stock markets at early stages complement rather than substitute the banking sector.
    - A well-developed banking/financial intermediary sector and liquid inter-bank markets promote stock market development.
    - Weak banking systems can constrain stock market development.
    - Empirical evidence (Demirguc-Kunt and Levine, 1996) shows high correlation between stock market indicators and banking sector development.
    - Yartey (2007b) finds that a percentage point increase in banking sector development increases stock market development in Africa by [text cuts off at this point in source].
  - Institutional Quality:
    - Institutional quality (law and order, democratic accountability, bureaucratic quality) reduces political risk and enhances the viability of external finance.
    - Yartey (2007a) finds these institutional measures important determinants of stock market development in Africa.
    - Bekaert (1995) and Erb et al (1996a) provide evidence that higher political risk is associated with market segmentation and higher required returns.
  - Shareholder Protection:
    - Level of shareholder protection in securities or company laws is a key determinant (Shleifer and Vishny, 1997).
    - La Porta et al (1999) show quality of shareholder protection correlates with capitalization and liquidity.
    - Demirguc-Kunt and Maksimovic (1998) show firms in countries with high legal system effectiveness grow faster relying more on external finance.
- Quantified empirical finding:
  - Yartey (2007b): a percentage point increase in financial intermediary sector development increases stock market development in Africa by 0.597 percentage points controlling for macroeconomic stability, level of economic development, and quality of legal and political institutions.

### X. POLICY OPTIONS TO PROMOTE STOCK MARKET DEVELOPMENT IN AFRICA
- Overview: markets are small, illiquid, with infrastructural bottlenecks and weak regulatory institutions; policy options examined include automation, demutualization, regional integration, promotion of institutional investors, regulatory and supervisory improvements, involvement of foreign investors, and educational programs.

- A. Automation
  - Expected benefits:
    - Reduce costs and inefficiencies, increase trading activity and liquidity.
    - Speed up operations and reduce costs associated with manual systems.
    - Facilitate extension of trading days and hours.
    - Eliminate need for trade intermediation—investors can log onto systems to monitor markets and trade, bypassing brokers.
  - Central Depository System (CDS) eliminates risks of loss, mutilation and theft of certificates and reduces errors and delays associated with paper-based securities.
  - Constraints:
    - Automation is an expensive venture with huge budgetary implications for African governments.
    - Proliferation of electronic communication networks (ECNs) and alternative trading systems (ATS) is gradually reducing the cost of automation.
  - Example/model:
    - Namibian model: NSX of Namibia uses the trading system of the JSE of South Africa; markets could adopt CDS systems similarly.
  - Strategic importance:
    - Automation is particularly important for regional integration.

- B. Demutualization
  - Definition: change in legal status, structure and governance of an exchange from a non-profit, protected interest one to a profit oriented entity.
  - Expected benefits:
    - Opens up trading rights, broadens ownership, reduces monopoly power of traders and brokers, introduces "vote per share" governance and separation of ownership from trade intermediation.
    - Can reduce undue governmental influence and increase access to exchange services.
  - Risks and mitigation:
    - Conflict of interest and regulatory oversight risks; mitigation includes self-listing arrangements (example cited: Singapore arrangement among SGX, SGX-ST and the Monetary Authority).
  - Applicability to African exchanges:
    - Not an immediate priority for most African exchanges; recommended as medium- to long-term step after improving liquidity and strengthening cooperation.

- C. Regional Integration
  - Rationale:
    - Merging stock exchanges can multiply volumes with potentially the same overhead costs and address fragmentation.
    - Integration promotes cost efficiency, improves liquidity and price discovery, harmonizes trading/clearing/settlement systems, and enhances surveillance and access to information.
  - Challenges:
    - High institutional and financial costs; nationalistic politics; fears of domination by larger economies.
  - BRVM case study:
    - BRVM is a regional exchange for eight WAEMU countries; computerized with satellite links; trades three days a week with a daily fixing; dominated by Ivorian companies.
  - Preconditions and technical necessities:
    - Legal harmonization, automated systems, currency convertibility considerations (monetary unions help preclude convertibility problems).
  - Lessons:
    - It can take a very long time to build a regionally integrated exchange; sustainability and private sector incentives are critical.

- D. Promote Institutional Investors
  - Rationale: pension funds, insurance houses and other institutional investors promote transparency, market integrity, lower transaction costs, and efficient trading and settlement.
  - Benefit: act as countervailing forces to commercial and investment banks, forcing greater competitiveness and efficiency.

- E. Strengthen Regulation and Supervision
  - Objectives:
    - Protect investors from opportunistic insider behavior; solve agency problems and information asymmetry.
    - Need for clear rule of law and an efficient judicial system.
  - Key components:
    - Regular disclosure, transparency and enforcement; disclosure of transactions, accounting and identity of ultimate beneficial owners.
    - Presence of a securities regulator and effective private laws on contracts and dispute resolution.
  - Practical considerations:
    - Develop strict ethical and conduct-of-business rules reflecting international best practices and local needs.
    - Implement “necessary” rules rather than merely “nice” ones.
  - Main challenge: shortage of experienced supervisors and absence of a strong tradition favoring compliance and discouraging regulatory forbearance.

- F. Attract Capital Flows and Encourage Foreign Participation
  - Current facts:
    - Portfolio investment accounted for a meager share of 0.15 percent of the total capital flows to Africa in 2003 (excluding South Africa).
    - Portfolio flows dominate total capital flows to South Africa, increasing liquidity on the JSE.
  - Policy drivers to attract capital flows:
    - Sustained economic growth, quality public institutions and infrastructure, trade liberalization, and efficient capital markets.
  - Capital account restrictions:
    - Many African countries maintain capital account restrictions limiting cross-border investments; risks of liberalization include potential for capital flights and financial crises.
    - Recommendation: lift capital account restrictions to attract portfolio investment, preceded by trade liberalization and domestic financial liberalization.
  - Foreign participation and ownership ceilings:
    - Examples of existing ceilings: foreign ownership cannot exceed 40% in Kenya and Zimbabwe and 74% in Ghana.
  - Fragmentation issue:
    - Portfolio capital typically targets large and growing markets, creating further argument for de-fragmentation.

- G. Strengthen Education
  - Need and approach:
    - Increase public knowledge about stock market functioning through regular and intensive education programs at firm and individual levels.
    - Firm level: allay fears of listing (example: Ghana Stock Exchange study found 33 percent of firms surveyed unwilling to list because of fear of losing control).
    - Individual level: tapping financial wealth outside the financial system via educational campaigns.
  - Existing initiative:
    - JSE/Liberty Life Investment Challenge in South Africa introduces youth to economics and finance and has been running for three decades.

### XI. SUMMARY AND CONCLUSIONS
- New markets established in Ghana, Malawi, Swaziland, Uganda, and Zambia.
- Common market shortcomings:
  - Trading often concentrated in a few stocks that account for a considerable part of total market capitalization.
  - Low liquidity hampers support for local market infrastructure (trading systems, market analysis, brokers).
- Empirical contributions of stock markets to corporate finance (selected figures preserved):
  - Ghana: stock market financed about 12 percent of total assets growth of listed companies between 1995 and 2002.
  - South Africa: new equity issues accounted for 18 percent of total assets growth between 1996 and 2000; external debt contributed 61 percent of total financing, and retained earnings financed the remaining 21 percent.
  - Zimbabwe: equity finance contributed 8 percent to the funding of listed corporations between 1990 and 1999.
  - In these countries, the stock market is the most important source of long term external finance.
- Broader questions:
  - Little systematic evidence exists on whether stock market development has increased aggregate savings, investment, or productivity of investment in African countries.
  - Some econometric evidence indicates the stock market (through value of shares traded) is positively associated with economic growth in Africa, though results may reflect the dominance of the price effect and may be biased by inclusion of South Africa.
- Determinants of stock market development:
  - Macroeconomic stability, robust economic growth, well developed banking sector, and good quality institutions.
  - Garcia and Liu (1999): income level, banking sector development, domestic savings and investment, and stock market liquidity are important determinants.
  - Yartey (2007b): a percentage point increase in financial intermediary sector development increases stock market development in Africa by 0.597 percentage points controlling for macroeconomic stability, level of economic development, and quality of legal and political institutions.
- Key challenges ahead:
  - Stock market integration (harmonization of bankruptcy and accounting laws and trade liberalization).
  - Demutualization to address governance and profitability issues (more relevant after consolidation of technological and regulatory reforms).
  - Eliminate impediments to institutional development: wider dissemination of information, robust electronic trading systems, adoption of central depository systems, sound legal and accounting frameworks, private sector credit evaluation capabilities, and strengthened public sector regulatory oversight.

*Source document content from _wp07209 - References..............................................................................................................*

### References..............................................................................................................

### _wp07209 - References..............................................................................................................

### I. INTRODUCTION
- Purpose: examine the economic importance and future of African stock markets; analyze link between stock market and economic growth from corporate finance and macroeconomic perspectives; discuss policy options for promoting stock market development in Africa.
- Recent developments:
  - Prior to 1989 there were just five stock markets in sub-Saharan Africa and three in North Africa; today there are 19 stock exchanges.
  - New stock markets established in Ghana, Malawi, Swaziland, Uganda, and Zambia.
  - Stock market development has been central to domestic financial liberalization programs in most African countries.
- Global drivers cited (Cosh, Hughes, and Singh, 1992):
  - the progressive deregulation of financial markets both internally and externally in leading economies;
  - the internationalization of these markets;
  - the introduction of a number of financial products allowing riskier and bigger financial investments; and
  - the emergence and the increasing role of new actors in the financial markets particularly, institutional investors.
- Central policy questions addressed:
  - What benefits does a country gain from having a stock market?
  - Are stock markets playing an important role in allocating capital to industry?
  - What is the relationship between stock market development and economic growth?
  - What determines stock market development?
  - How to make the stock market more functional to African countries?

### II. STOCK MARKET AND ECONOMIC GROWTH: THEORETICAL AND ANALYTICAL ISSUES
- Mechanisms by which stock markets may promote growth:
  - Encourage savings by providing new financial instruments (Levine and Zervos, 1998).
  - Provide avenues for firms to raise capital at lower cost and reduce dependence on bank financing.
  - Takeover mechanism provides managerial discipline and efficient use of assets (Kumar, 1984).
  - Reduce information costs through generation and dissemination of firm-specific information; efficient prices incorporate available information.
  - Improve financing of long-term projects via liquidity (Bencivenga and Smith, 1991).
- Theoretical ambiguities and potential negative effects:
  - Increased liquidity may reduce precautionary savings, possibly adversely affecting growth.
  - Speculative bubbles can disconnect prices from fundamentals (Binswanger, 1999).
  - High liquidity may encourage investor myopia and weaken corporate governance (Bhide, 1994).
  - Pricing and takeover dynamics may encourage short-termism and financial engineering over organic growth (Singh, 1997); takeover discipline may favor size over performance (Singh, 1971).
  - Limitations are magnified in developing countries with weaker regulatory institutions and greater macroeconomic volatility, increasing price volatility and reducing efficiency of price signals.

### III. STOCK MARKET DEVELOPMENT IN SUB-SAHARAN AFRICA: TRENDS AND CHARACTERISTICS
- Overall trends:
  - Number of exchanges increased from a handful to 19 across Africa.
  - With the exception of South Africa, most African stock markets doubled their market capitalization between 1992 and 2002.
  - Total market capitalization for African markets increased from US$113,423 million to US$ 244,672 million between 1992 and 2002.
- Structural characteristics and challenges:
  - Trading concentrated in a few stocks accounting for a large share of total market capitalization.
  - Serious informational and disclosure deficiencies for many stocks; supervision by regulatory authorities often inadequate.
- Performance despite limitations:
  - Ghana Stock Exchange: year return of 144 percent in US dollar terms at end of 2004; compared with 30 percent return by Morgan Stanley Capital International Global Index (Databank Group, 2004).
  - Other strong performers in the year: Uganda, Kenya, Egypt, Mauritius and Nigeria.

### IV. KEY STATISTICS ON AFRICAN STOCK MARKETS (Table 1: Indicators of Stock Market Development in Africa, 2004)
- Number of Listed Companies; Market Capitalization (percent of GDP); Value Traded (percent of GDP); Turnover (percent)
  - Botswana: 18; 29.4; 0.6; 2.1
  - Egypt: 792; 51.3; 7.5; 17.1
  - Cote d’Ivoire (BRVM): 39; 13.6; 0.3; 2.5
  - Ghana: 29; 30.7; 0.8; 3.2
  - Kenya: 47; 24.9; 2.1; 8.0
  - Malawi: 8; 9; 1.0; 11.1
  - Mauritius: 41; 39.3; 1.6; 4.4
  - Namibia: 13; 8.1; 0.3; 4.7
  - Nigeria: 207; 20.1; 2.3; 13.9
  - South Africa: 403; 214.1; 76.5; 45.0
  - Swaziland: 6; 9.3; 0.0; 0.0
  - Tanzania: 6; 6.2; 0.2; 2.5
  - Uganda: 5; 1.4; 0.0; 0.2
  - Zambia: 11; 8.0; 0.1; 1.1
  - Zimbabwe: 79; 87.9; 14.0; 3.9
  - Average Africa: 113.6; 36.9; 7.2; 8.0
  - Average SSA* (Excluding South Africa): 39.2; 22.1; 1.8; 4.4
  - Comparative markets:
    - Malaysia: 962; 161.3; 50.8; 33.4
    - Mexico: 152; 25.4; 6.3; 29.1
    - Thailand: 465; 70.6; 66.7; 93.8
- Notable points:
  - Johannesburg Securities Exchange accounts for about 90 percent of the combined market capitalization of the entire continent.
  - Market capitalization as a percentage of GDP as low as 1.4 in Uganda.
  - Turnover as low as 0.02 percent in Swaziland (noted earlier in text) versus about 29 percent in Mexico.

### V. INSTITUTIONAL & INFRASTRUCTURAL INDICATORS (Table 2 highlights)
- Eleven indicators considered: existence of a market regulator; a governing law; nature of clearing & settlement; settlement cycle; existence of an international custodian; foreign participation; exchange control; nature of trading systems; existence of a central depository; number of trading days; accounting and auditing reporting system.
- Selected country summaries (existence denoted by √ in source):
  - Algeria: Market regulator √; Governing law √; Electronic clearing & settlement; Settlement cycle 4; International custodian None; Foreign participation √; Exchange control None; Trading system Electronic; Central depository None; Trading days 1; Reporting system Local S.
  - Botswana: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation √; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Local S.
  - BRVM: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5***; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository None***; Trading days 3; Reporting system Local S.
  - Egypt: Market regulator √; Governing law None; Manual*** clearing; Settlement cycle 4; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - Ghana: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5*; Reporting system Local S.
  - Kenya: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
  - Malawi: Market regulator √; Governing law √; Manual clearing; Settlement cycle 7; International custodian None; Foreign participation None; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
  - Mauritius: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - Morocco: Market regulator √; Governing law None; Manual clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - Namibia: Market regulator None; Governing law None; Manual** clearing; Settlement cycle 5**; International custodian None; Foreign participation None; Exchange control None; Trading system Electronic; Central depository None**; Trading days 5; Reporting system Local S.
  - Nigeria: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Intern. S.
  - South Africa: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 5**; International custodian √; Foreign participation √; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Local S.
  - Swaziland: Market regulator √; Governing law √; Manual clearing; Settlement cycle 5; International custodian √; Foreign participation √; Exchange control √; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
  - Tanzania: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 5; International custodian None; Foreign participation None; Exchange control None; Trading system Manual; Central depository √; Trading days 3; Reporting system Intern. S.
  - Tunisia: Market regulator √; Governing law None; Electronic clearing; Settlement cycle 5; International custodian None; Foreign participation None; Exchange control None; Trading system Electronic; Central depository √; Trading days 5; Reporting system Local S.
  - Uganda: Market regulator √; Governing law None; Manual clearing; Settlement cycle 5; International custodian None; Foreign participation √; Exchange control √; Trading system Manual; Central depository None; Trading days 2; Reporting system Intern. S.
  - Zambia: Market regulator √; Governing law √; Electronic clearing; Settlement cycle 3; International custodian √; Foreign participation √; Exchange control √; Trading system Manual; Central depository √; Trading days 5; Reporting system Local S.
  - Zimbabwe: Market regulator √; Governing law √; Manual clearing; Settlement cycle 7; International custodian √; Foreign participation None*; Exchange control None; Trading system Manual; Central depository None; Trading days 5; Reporting system Intern. S.
- Notes from source:
  - √ denotes the existence of related indicator.
  - Local S: local accounting and auditing reporting system.
  - Intern. S: international accounting and auditing reporting system.
  - Source: UNDP African Stock Markets Handbook, 2003.
  - *Ghana exchange started daily trading in [table note truncated in source].

*Italic: Source document content from _wp07209 - References..............................................................................................................*

### 2006. Ghana, Kenya and Zimbabwe now allow some level of foreign participation

### _wp07209 - 2006. Ghana, Kenya and Zimbabwe now allow some level of foreign participation

### Institutional and infrastructural bottlenecks on African stock markets
- Main bottleneck: use of slow manual systems; many markets continue to trade manually and use manual clearing and settlement.
- Most markets lack central depository systems.
- Some markets still have restricted foreign participation.
- Namibia and South Africa now use a common depository system SAFICAS and this has enabled the move to standard T+3 settlement cycle.
- BRVM and Egypt now have electronic systems.
- These bottlenecks slow trading and induce inactivity.

### Stock market contribution to financing corporate growth (overview)
- Two data sources for corporate financing patterns: national flow of funds statements and company accounts; each has strengths and limitations.
  - Flow of funds: comprehensive cross-sector coverage, comparable across countries, but excludes intra-sector flows and may require statistical adjustments.
  - Company accounts: often more reliable but available for only a sample of firms; constructed on a worldwide basis including foreign subsidiaries.
- Conclusion: stock markets have contributed to financing growth of large corporations in certain African countries; stock markets were the single most important source of long-term external finance for listed firms in several cases.

### Country evidence and exact financing shares (mean values, percent)
- Ghana: stock market financed about 12 percent of total asset growth of listed companies between 1995-2002.
- South Africa (1996–2000): liabilities accounted for 61 percent of total financing; retained earnings 21 percent; external equity 18 percent of total assets growth (Glen and Singh, 2003).
- Zimbabwe (1990–1999): external finance contributed 75.4 percent of total funds; internal finance provided the remaining 25 percent; equity financing 7.8 percent of total (Mutenheri and Green, 2003).
- Mauritius (1992–1999): stock market financed about 9 percent of total asset growth; retained earnings 30 percent; external debt 61 percent (Lalchand, 2001).
- Global comparison (Glen and Singh, 2003, 1996–2000): liabilities 49 percent of total financing; internal equity 29 percent; external equity 22 percent.

Table 3 (selected rows reproduced as reported, mean values in percent)
- Korea: Retentions 23.10; External Finance 76.90; External Equity 31.20; Total Debt 43.30
- India: Retentions 25.30; External Finance 74.70; External Equity 14.60; Total Debt 51
- Malaysia: Retentions 13.30; External Finance 86.70; External Equity 9.60; Total Debt 70.80
- Thailand: Retentions 5.70; External Finance 94.30; External Equity 16.10; Total Debt 80.60
- Ghana: Retentions 22.50; External Finance 77.50; External Equity 12.20; Total Debt 48.40
- Mauritius: Retentions 30; External Finance 70; External Equity 9; Total Debt 61
- South Africa: Retentions 21; External Finance 79; External Equity 18; Total Debt 61
- Zimbabwe: Retentions 24.60; External Finance 75.40; External Equity 7.80; Total Debt 67.60

### Box: Financing corporate growth in Ghana (detailed findings)
- Sample period: growth in balance sheet over 1995 to 2002.
- Mean financing shares (percent of change in total assets, means sum to 100):
  - Internal sources (retentions): average quoted Ghanaian firm finances 11.45 percent of growth of total assets from internal sources.
  - External debt: 47.86 percent of growth of total assets.
  - New issues of equity: 40.69 percent of growth of total assets.
- Debt maturity: about 84 percent of total debt is short term.
- Measurement caveat: indirect (residual) method of measuring equity finance may have upward bias (revaluations and reserves included).
- Direct (alternative) method following Whittington, Saporta and Singh (1997):
  - Contribution of equity to total assets growth for the median listed Ghanaian firm reduced to 12.20 (percent).
  - Comparison indicates the indirect method overstated equity contribution by 20.85 percentage points (33.05 - 12.20).

### Cross-country comparison and implications
- Listed corporations in Ghana, Mauritius, South Africa, and Zimbabwe rely much less on external finance for asset growth than corporations in other emerging markets:
  - External finance ratios: Ghana 77.5 percent; Mauritius 70 percent; South Africa 79 percent; Zimbabwe 75.4 percent.
  - Other emerging markets: Korea 76.90 percent; India 74.70 percent; Malaysia 86.70 percent; Thailand 94.30 percent.
- New equity issues for quoted African corporations range from 7.8 percent in Zimbabwe to about 19 percent in South Africa; median for Ghanaian corporations is 12 percent.
- Conclusion: stock market has played a major role in financing large African corporations; need to examine economy-wide benefits (savings, investment productivity) — evidence is sparse.

### Stock markets and macroeconomic growth channel: methodology
- Objective: assess economy-wide effect of stock market development on sub-Saharan African GDP growth.
- Stock market indicators used (separately): market capitalization/GDP; value of shares traded/GDP; turnover ratio (value traded/market capitalization).
- Estimation approach: Arellano and Bond (1991) Difference GMM dynamic IV approach to control country/time effects and endogeneity.
- Data: unbalanced panel of 14 African countries; stock data from Reuters Services and Emerging Stock Markets Fact Book; macro data from IMF International Financial Statistics.
- Stock-flow timing issue addressed following Beck, Demirgüç-Kunt and Levine (1999).

### Empirical results (Difference GMM summary and exact coefficients)
- Equation 1 (Market Size = market capitalization/GDP):
  - Lagged growth: 0.0652 {0.049}
  - Investment: 0.0256 {0.022}
  - Market Size: -0.0386 {0.581}
  - Observations: 189
  - Sargan: 0.89
  - AR(1): 0.06
  - AR(2): 0.56
- Equation 2 (Value of Shares Traded/GDP):
  - Lagged growth: 0.0757 {0.012}
  - Investment: 0.0227 {0.056}
  - Value of Shares Traded: 0.0379 {0.082}
  - Observations: 183
  - Sargan: 0.81
  - AR(1): 0.10
  - AR(2): 0.66
- Equation 3 (Turnover Ratio):
  - Lagged growth: 0.0790 {0.012}
  - Investment: 0.0269 {0.021}
  - Turnover Ratio: -0.0037 {0.769}
  - Observations: 181
  - Sargan: 0.82
  - AR(1): 0.08
  - AR(2): 0.53
- Interpretation:
  - The ratio of value of shares traded to GDP is the significant stock-market driver of economic growth in the sample.
  - An increase in stock market activity via higher liquidity (value traded/GDP) augments GDP growth by 3.7 percentage points (coefficient 0.0379 interpreted as 3.79 percentage points in the text summary as "3.7 percentage points").
  - Market capitalization/GDP and turnover ratio were not significant in these specifications.
  - Robustness: Sargan and AR tests support instrument validity and absence of second-order serial correlation.
- Caveat: inclusion of South Africa may bias results heavily toward this finding.

### Determinants of stock market development in Africa (policy-relevant factors)
- Key preconditions identified:
  - Macroeconomic stability:
    - Low and predictable inflation supports stock market development and reduces informational asymmetries.
    - Sound macroeconomic environments and sufficiently high income levels (GDP per capita), domestic savings, and domestic investments are important determinants.
  - Banking sector development:
    - Stock markets at early stages complement rather than substitute the banking sector.
    - A well-developed banking/financial intermediary sector and liquid inter-bank markets promote stock market development.
    - Weak banking systems can constrain stock market development.
    - Empirical evidence (Demirguc-Kunt and Levine, 1996) shows high correlation between stock market indicators and banking sector development.
    - Yartey (2007b) finds that a percentage point increase in banking sector development increases stock market development in Africa by [text cuts off at this point in source].

*Source: _wp07209 - 2006. Ghana, Kenya and Zimbabwe now allow some level of foreign participation*

### 0.59 percentage point controlling for  macroeconomic stability, economic development and

### _wp07209 - 0.59 percentage point controlling for  macroeconomic stability, economic development and

### Institutional Quality
- Institutional quality is important for stock market development because efficient and accountable institutions tend broaden appeal and confidence in equity investment.
- Equity investment becomes gradually more attractive as political risk is resolved over time; development of good quality institutions can affect the attractiveness of equity investment and lead to stock market development.
- Empirical findings cited:
  - Yartey (2007a) finds law and order, democratic accountability, bureaucratic quality as important determinants of stock market development in Africa because they reduce political risk and enhance the viability of external finance.
  - Bekaert (1995) provides evidence that higher levels of political risk are related to higher degrees of market segmentation and consequently low level of stock market development.
  - Erb et al (1996a) show that expected returns are related to the magnitude of political risk; in both developing and developed countries, the lower the level of political risk, the lower is required returns.
- Policy implication:
  - Political risk is a priced factor that strongly affects the local cost of equity, with important implications for stock market development.

### Shareholder Protection
- Level of shareholder protection in securities or company laws is a key determinant of stock market development (Shleifer and Vishny, 1997).
- Strong shareholder protection:
  - Reduces fears of expropriation for investors.
  - Allows ownership to be relatively dispersed, providing liquidity to the market.
- Empirical findings cited:
  - La Porta et al (1999) show the quality of shareholder protection (as written in laws) is correlated with capitalization and liquidity of stock markets in 49 countries.
  - La Porta et al (1997) find countries with lower quality of legal rules and law enforcement have smaller and narrower capital markets and more concentrated ownership among listed firms.
  - Demirguc-Kunt and Maksimovic (1998) show firms in countries with high ratings for legal system effectiveness grow faster by relying more on external finance.

### Promoting Stock Market Development in Africa — Overview
- Current characterization: African stock markets are small, illiquid, with infrastructural bottlenecks and weak regulatory institutions.
- Despite problems, stock markets in Africa have helped finance growth of large corporations but there is little evidence of broader economic benefits.
- Proposed policy options (examined below) include: increase automation, demutualization of exchanges, regional integration of exchanges, promotion of institutional investors, regulatory and supervisory improvements, involvement of foreign investors, and educational programs.

### A. Automation
- Expected benefits:
  - Reduce costs and inefficiencies, increase trading activity and liquidity.
  - Speed up operations and reduce costs associated with manual systems.
  - Facilitate extension of trading days and hours.
  - Eliminate need for trade intermediation—investors can log onto systems to monitor markets and trade, bypassing brokers.
- Central Depository System (CDS):
  - Usually accompanies automation; eliminates risks of loss, mutilation and theft of certificates and reduces errors and delays associated with paper-based securities.
- Constraints:
  - Automation is an expensive venture with huge budgetary implications for African governments; many African stock markets have found it difficult to fully automate their systems.
  - Proliferation of electronic communication networks (ECNs) and alternative trading systems (ATS) is gradually reducing the cost of automation.
- Example / model:
  - Namibian model: NSX of Namibia uses the trading system of the JSE of South Africa; markets could adopt CDS systems similarly.
  - Operational difficulties include currency convertibility issues and lack of harmonized financial systems.
- Strategic importance:
  - Automation is particularly important for regional integration; without automation, benefits of integration are likely to be lost.
- Footnote definition:
  - "Automation involves the implementation of computerized and electronic systems for trading, clearing and settlement purposes. In automated exchanges, the placement and matching of buy and sell orders are computerized and not constrained by location."

### B. Demutualization
- Definition:
  - Change in legal status, structure and governance of an exchange from a non-profit, protected interest one to a profit oriented entity.
  - Process involves monetizing members’ seats, assigning values per seat, allowing members to keep or sell shares, and changing legal/organizational form into a company limited by shares.
- Context and trend:
  - Gained popularity in the 1990s due to competition among exchanges, need for increased capital, need for good corporate governance, and opening ownership to public investors (Pirrong, 2000).
  - Between 1999 and 2003, the number of demutualized and public exchanges in the world increased from 10 to 25 (IOSCO, 2005).
- Expected benefits:
  - Solves mutual structure problems by opening up trading rights, admitting new trading partners, and broadening ownership so the public can invest in exchanges.
  - Reduces monopoly power of traders and brokers present in mutual exchanges; introduces "vote per share" governance and separation of ownership from trade intermediation.
  - Reduces undue governmental influence (appointment of government officials becomes unnecessary).
  - Increases access to exchange services and can remove "soft commissions" or "bundled commissions" for fund holders by allowing direct access to information.
  - Instills efficiency and better structures; potential commercial gains for exchanges.
- Risks and mitigation:
  - Conflict of interest and regulatory oversight: exchanges may avoid enforcement against their own customers; commercialization of services and compromised listing standards/oversight.
  - Mitigation example: self-listing arrangements (footnote example: Singapore arrangement among SGX, SGX-ST and the Monetary Authority).
- Applicability to African exchanges:
  - Demutualization should not be immediate priority for most African exchanges given many have existed barely three decades and face teething issues of poor infrastructure and illiquidity.
  - Recommended as a medium- to long-term step after improving liquidity and strengthening cooperation.
  - African markets can study the JSE experience; JSE stance poses challenges for advocacy of a regional SADC exchange because a future regional exchange is expected to be demutualized given the JSE’s stance.

### C. Regional Integration
- Rationale:
  - Merging stock exchanges can multiply volumes with potentially the same overhead costs (Claessens, Klingebiel and Schmukler, 2002).
  - Integration aims to solve fragmentation, reduce number of national exchanges, promote cost efficiency, improve liquidity and price discovery, and harness pooled economic and human capital skills.
  - Integration fosters synergies in risk management, harmonizes trading/operations/clearing/settlement systems, and improves surveillance and access to information across market segments.
- Challenges:
  - Merging into a single regional exchange is ambitious and daunting due to institutional and financial cost complexities.
  - Nationalistic politics: African governments view exchanges as national assets and resist transformations that reduce national touch.
  - Smaller economies fear domination by bigger economies and potential capital diversion to larger markets (example: Botswana officials were uncomfortable with South Africa’s virtual African exchange proposal due to fear of capital flight towards JSE).
- Case study — BRVM (Box 2):
  - The only regional exchange in Africa, BRVM in Cote d’Ivoire, consists of eight French speaking West African countries of the West African Economic and Monetary Union (WAEMU): Benin, Burkina Faso, Cote d’Ivoire, Guinea Bissau, Mali, Niger, Senegal and Togo.
  - Opened in 1998 with branches in each WAEMU country.
  - Ownership: majority private sector; member states own 13.4 percent of the capital.
  - Trading: computerized with satellite links; brokers and agents transmit orders and consult/edit quotation results to the central site in Abidjan from national branch offices.
  - Market structure: 15 brokerage firms; trading takes place on three days of the week and all orders are filled at a price set at a fixing once a day.
  - Clearing and settlement: Trades are cleared and settled at the Depositaire Central/Banque de Reglement SA.
  - Problem: Exchange is dominated by Ivorian companies; corporations in remaining member countries have not fully embraced the exchange.

*Source: Excerpt from the provided IMF working paper content*

### Box 3. Progress on Stock Market Integration in Africa

### Box 3. Progress on Stock Market Integration in Africa

### Integration initiatives and regional developments
- In SADC, the Committee of SADC Stock Exchanges (COSSE) set up a strategy to develop an integrated real-time network of securities markets requiring each national exchange to automate trading through a single accessible regional system and to harmonize listing rules.
- As at 2000, all SADC exchanges had harmonized listing requirements in accordance with the JSE system.
- The Johannesburg Securities Exchange (JSE) and the Namibian Stock Exchange (NSX):
  - NSX uses the trading and settlement systems of the JSE.
  - NSX rules and requirements are based on that of the JSE.
  - Majority of the shares listed on Namibia Stock Exchange (NSX) also have primary listings on the JSE.
- Memoranda of Understanding (MoUs) on collaborative programs:
  - JSE has signed MoUs with Egypt, Ghana, Kenya, Nigeria and Uganda.
  - Nairobi Stock Exchange has signed MoUs with Nigeria and Ghana.
  - South Africa proposed a virtual African exchange in 2003 to enable qualifying companies to simultaneously list on all member exchanges (simultaneous listing rather than a single integrated exchange).
- East Africa:
  - East African Member states Securities Regulatory Authority under an MoU between Kenya, Tanzania and Uganda seeks to promote integration.
  - Kenya is the anchoring market; Nairobi Stock Exchange and the Kenya Capital Markets Authority are fostering regional exchange promotion by harmonizing rules and regulations.
  - Ugandan Securities Exchange has harmonized its listing rules with that of the Nairobi Stock Exchange.

### Preconditions and technical necessities for integration
- Important preconditions:
  - Legal harmonization (trading laws and accounting standards) and a liberalized trade regime.
  - Harmonized legislation, rules, listings, trading days, settlement, and reporting standards.
- Accounting and reporting standards:
  - Standards tend to be based on national systems influenced by colonial history (example: BRVM countries adopted common standards following their common colonial past).
- Automation:
  - Integration cannot be successful without automated systems enabling investors and traders to log on and trade from other stations.
- Currency convertibility:
  - An integrated exchange with many inconvertible currencies increases administrative costs.
  - Advantages of monetary unions (example: WAEMU in the case of the BRVM) help preclude convertibility problems.
  - SADC progressing quickly toward a regional stock exchange due to convertibility of most regional currencies.
  - Africa has many currencies, few convertible within the continent; currency convertibility depends more on trade density and cannot be forced, creating hurdles for regional exchange integration efforts.

### Lessons from BRVM and regional projects
- From BRVM experience (Asea, 2004):
  - It can take a very long time to build a regionally integrated exchange.
  - Establishing a regionally integrated exchange does not guarantee effective use or market integration.
  - Sustainability and success of regional projects must be carefully assessed before undertaking them.
  - Private sector participation (vs. only regulators, central banks, and public institutions) typically has the best incentives to determine whether expenditure on integration schemes is worthwhile.

### D. Promote Institutional Investors
- Rationale:
  - Institutional investors promote efficient market practices and financial innovation.
  - They favor greater transparency, market integrity, lower transaction costs, and efficient trading and settlement.
- Roles and benefits:
  - Pension funds, insurance houses and other institutional investors can act as countervailing forces to commercial and investment banks, forcing greater competitiveness and efficiency.
  - African exchanges stand to gain from increased institutional investor involvement.

### E. Strengthen Regulation and Supervision
- Objectives:
  - Protect investors from opportunistic insider behavior; solve agency problems and information asymmetry.
  - Need for a well structured and clear rule of law and an efficient judicial system to address contract repudiation and expropriation risk.
- Key components:
  - Regular disclosure, transparency and enforcement.
  - Important disclosure requirements: transactions, accounting and the identity of ultimate beneficial owners; disclosures must be simple and supportive of legal and accounting frameworks.
  - Enforcement requires compliance and prosecutorial capability; presence of a securities regulator is important.
  - Effective private laws on contracts and dispute resolution complement enforcement.
  - Strong corporate governance mechanisms boost investor confidence.
- Practical considerations:
  - Develop strict ethical and conduct-of-business rules for exchange members reflecting international best practices and local needs.
  - Implement “necessary” rules rather than merely “nice” ones (Friedman and Grose, 2006).
  - Key challenge in Africa: shortage of experienced supervisors and absence of a strong tradition favoring compliance and discouraging regulatory forbearance (Vittas, 1998).

### F. Attract Capital Flows and Encourage Foreign Participation
- Current facts:
  - Portfolio investment accounted for a meager share of 0.15 percent of the total capital flows to Africa in 2003 (excluding South Africa).
  - Portfolio flows dominate total capital flows to South Africa, increasing liquidity on the JSE.
- Policy drivers to attract capital flows:
  - Sustained economic growth, quality public institutions and infrastructure, trade liberalization, and efficient capital markets (Asiedu, 2006).
  - Enabling business climate: low costs of doing business, property rights, effective regulations and legal institutions, and some capital account liberalization.
- Capital account restrictions:
  - Many African countries still maintain capital account restrictions limiting cross-border investments and exchange capabilities.
  - Risks of liberalization: potential for capital flights and financial crises depending on the nature of incoming capital (Henry, 2000).
  - Debt-based flows pose higher crisis risk; equity or bond-based flows share risk between parties.
  - Recommendation: lift capital account restrictions to attract portfolio investment, preceded by trade liberalization and domestic financial liberalization.
- Foreign participation and ownership ceilings:
  - Increasingly African markets are opening to foreign participation with little or no ceilings.
  - Examples of existing ceilings: foreign ownership cannot exceed 40% in Kenya and Zimbabwe and 74% in Ghana.
- Fragmentation issue:
  - Portfolio capital typically targets large and growing markets, creating further argument for de-fragmentation of African markets.
  - Opening markets to foreign participants increases trading and liquidity as well as injects fresh capital.

### G. Strengthen Education
- Need and approach:
  - Increase public knowledge about stock market functioning through regular and intensive education programs.
  - Educate both firms and individuals:
    - Firm level: allay fears of listing (high listing requirements, fear of losing control of family businesses).
      - Ghana Stock Exchange study (Yartey, 2005): 33 percent of firms surveyed were unwilling to list because of fear of losing control.
    - Individual level: tap financial wealth outside the financial system via consistent educational campaigns at various societal levels.
- Existing initiatives:
  - JSE/Liberty Life Investment Challenge in South Africa introduces youth to economics and finance and its application to investing and trading on the JSE; has been running for three decades.

### Summary and conclusion — stock market contributions and challenges
- New markets established in Ghana, Malawi, Swaziland, Uganda, and Zambia.
- Common market shortcomings:
  - Trading often concentrated in a few stocks that account for a considerable part of total market capitalization.
  - Low liquidity hampers support for local market infrastructure (trading systems, market analysis, brokers).
- Empirical contributions of stock markets to corporate finance:
  - Ghana: stock market financed about 12 percent of total assets growth of listed companies between 1995 and 2002.
  - South Africa: new equity issues accounted for 18 percent of total assets growth between 1996 and 2000; external debt contributed 61 percent of total financing, and retained earnings financed the remaining 21 percent.
  - Zimbabwe: equity finance contributed 8 percent to the funding of listed corporations between 1990 and 1999.
  - In these countries, the stock market is the most important source of long term external finance.
- Broader questions:
  - Little systematic evidence exists on whether stock market development has increased aggregate savings, investment, or productivity of investment in African countries.
  - Some econometric evidence indicates the stock market (through value of shares traded) is positively associated with economic growth in Africa, though results may reflect the dominance of the price effect.
- Determinants of stock market development (empirical findings):
  - Macroeconomic stability, robust economic growth, well developed banking sector, and good quality institutions.
  - Garcia and Liu (1999): income level, banking sector development, domestic savings and investment, and stock market liquidity are important determinants.
  - Yartey (2007b): a percentage point increase in financial intermediary sector development increases stock market development in Africa by 0.597 percentage points controlling for macroeconomic stability, level of economic development, and quality of legal and political institutions.
  - Good quality institutions (law and order, democratic accountability and limited corruption) reduce political risk and enhance viability of external finance.
- Key challenges ahead:
  - Stock market integration (harmonization of bankruptcy and accounting laws and trade liberalization).
  - Demutualization to address governance and profitability issues (more relevant after consolidation of technological and regulatory reforms).
  - Eliminate impediments to institutional development: wider dissemination of information, robust electronic trading systems, adoption of central depository systems, sound legal and accounting frameworks, private sector credit evaluation capabilities, and strengthened public sector regulatory oversight.

*Source: Irving (2005).*

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