Role of capital markets in developing economies
Capital markets are key drives of economic growth as they help facilitate the demand and supply of credit. Through the capital markets governments and the private sector can access funding for infrastructure financing or large capital expenditures in the case of large corporations. Capital markets can also be looked as a platform whereby those in need for capital go to find those with available capital that they are willing to give out.
For developing economies capital markets are crucial as they allow the producers of goods and services and those tasked with infrastructure development to access both long and short-term capital. For example, the Growth Enterprise Market Segment (GEMS) of the Kenyan capital market allows small and medium enterprises to raise capital by listing their shares on the market. The listing requirements placed on these businesses tend to be flexible and less stringent on the firm taking into consideration the growth phase that these SMEs tend to be in. The opportunity created by capital markets to SMEs is beneficial to the economy as a whole as these businesses provide goods and services contributing to the GDP of the country. Additionally, these products and services can also be exported decreasing the reliance of imports, improving the trade deficit and strengthening the currency of the country.
Capital markets also promote a saving and investment culture among the general public. They provide an opportunity for savers to reap a reward from their capital through investments. The market helps in matching long-term savings from the contractual savings industry to long-term investments in exchange for a greater purchasing power in the future. It also helps in diffusing stress on the banking sector by matching long-term investments to long-term capital as well as providing an opportunity for small scale savers to benefit from the ownership of large-scale productive assets.
Additionally, capital markets build economic confidence. A well function capital market is a sign of economic growth. Large economies around the world have functioning capital markets that facilitate the channeling of capital from those with surplus to those in need. Consideration for foreign direct investment tend to be affected by the health of the local capital market and for an economy such as Ethiopia a well-functioning market could attract more foreign investment.
History of the capital markets of Ethiopia
Share trading in Ethiopia has existed from 1957. Between 1959 to 1963 close to 61 Million Birr was moved as investment in shares of numerous companies that were issuing them. Of this 41 Million Birr was invested in foreign companies. In 1960 the National bank of Ethiopia (at the time the State Bank of Ethiopia) formed the share exchange department that played the role of underwriter and provided over-the-counter services. Prices were posted regularly at the bank’s main office and prices were set using trial and error method with third parties willing to buy and sell shares encouraged to quote their own bid and ask prices.
As new companies were formed, the resources of the shares exchange department became more strained. This led to the formation of the Share Dealing Group formed by the National Bank of Ethiopia and it consisted of six institutions. The share dealing group met frequently and it succeed in its objectives of creating confidence in the market, educating the general public on investing in shares and laid the groundwork for the eventual creation of a full-blown stock exchange. Some of the instruments that were traded under the Share Dealing group included forward and option transactions and in 1966 there were around 17 companies being traded and four government bonds. The share dealing group operated until 1975 when financial and other large institutions were nationalized and moved into government ownership.
Author: David Kageenu