General economic theory tells us that well-functioning markets produce efficient outcomes for the ultimate benefit of consumers.
The domestic player’s ability to drive market activity needs to be encouraged as well as facilitated.
General economic theory tells us that well-functioning markets produce efficient outcomes for the ultimate benefit of consumers.
However when these conditions are absent, various impediments to trade can thwart process of price discovery and can impair the ability of markets to function optimally.
Absa Africa Financial Markets Index (2021) report shows that, on average, the score on market depth of African stock marts dropped by one point compared to last year. This as equity market turnover as a proportion of market capitalisation fell in the year to June 2021.
A key question raised by this report is how sanguine market players should be about this current state of affairs. Should they care? The short answer is yes and the reason is volatility - the flipside of the liquidity coin - and the foreign investor fact.
For starters, what is market liquidity? It generally refers to the ability to execute large transactions with limited price impact and is measured by the speed with which large purchases and sales can be executed.
It tends to be associated with low transaction costs. A reduction in liquidity, therefore, introduces frictions and costs to end users of those markets (such as companies seeking to raise capital to invest and manage their risk).
And why is liquidity important? As markets become global, an accompanying threat to small and less developed markets is the drying up of liquidity with a concurrent transfer of that liquidity to other major markets in the region.
Foreign investors piling in and out of emerging markets at the hint of a crisis, leaving especially smaller markets depressed for extended periods of time, is a wake up call on the need to re-focus on local investors. This reality is set to “bite” again sometime next year when the US Fed raises its policy rate.
Domestic market
Are we going to witness markets suffer again from high spikes in volatility and watch the exodus of foreign investors? Most likely, yes. This is why the weak potential on the part of domestic market players to drive local market activity needs to be encouraged and facilitated.
Need to ensure that local investors have sufficient resources for capacity building should always be constant, especially as these young African markets grow.
What are the possible remedies? Capacity building of local investors, Introduction of market makers, regulatory reforms (especially around costs and access) are some but most crucial is regionalisation. Most local capital markets in Africa are clearly very small in size.
For instance, excluding South Africa (348 per cent of the GDP), the highest stock market capitalisation in Africa was in Mauritius (56.4 per cent of GDP) in 2020.
To put this in context, the capitalisation of Mauritius stock exchange was well below the average market capitalisation in South East Asia (102.8 per cent of GDP) and in high income countries (145 per cent of GDP).
In my opinion, regionalisation is not only an important route to deepening African financial markets, with countries coordinating to pool their strengths, but it could also help unlock Pan-African investment flows.
Mr Mwanyasi is managing director at Canaan Capital
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