For nearly two decades the sub-Saharan nation of Mozambique had one of the world’s fastest-growing economies, averaging GDP growth of 7 percent a year from 1998 to 2015. But the recent decline in the prices of commodities like aluminum and coal, and a reduction in foreign direct investment, have combined to slow Mozambique’s annual GDP growth to just 3.3 percent last year — worrisome for a country with 26 million people, two thirds of whom are under the age of 25.
The government of Mozambique has tried to boost economic growth through its capital markets. For more than 17 years, Mozambican authorities have been addressing key components that have the potential to foster capital markets development, including regulatory, operational and technological infrastructure. Nevertheless, the country’s markets remain small, with shallow activity, and its society fails to enjoy the benefits of well-functioning capital markets.
Liquidity shortages deter the development of early-stage capital markets across sub-Saharan Africa, limiting market participation and hindering economic growth. This article aims to highlight the extreme importance of liquidity as a lever for overhauling underdeveloped capital markets. It also proposes a potential course of action for Mozambique, which can be viewed as a proxy for other sub-Saharan African countries with underdeveloped capital markets, given structural similarities related to the landscape of informal economies, small and medium-size enterprises (SMEs), and saving and investing patterns.
“Mozambican institutional investors — in particular, insurance companies and pension funds — could play an important role in solving their country’s liquidity conundrum.”
Despite the recent economic slowdown, immense investment opportunities abound for Mozambique. The country has one of the largest infrastructure deficits in Africa, less than half of its arable land is used for agriculture, and it currently ranks 14th in the world for natural gas reserves. Investment in these areas could accelerate economic performance, but it would require adequate financial infrastructure, including well-functioning capital markets.
The Mozambique Stock Exchange was created in 1998 and is responsible for ensuring the normal functioning of the nation’s capital markets, which are regulated by the Bank of Mozambique. Trading, clearing and settlement are carried out electronically, and the main market participants include the government, commercial banks, large companies, pension funds and insurance firms. Foreign investors can engage in the stock exchange through an authorized participant; both principal and realized returns are repatriable. Participation by retail investors and the private sector remains subdued, and even though there is currently a regulatory and operational framework to encourage investment funds and independent brokers, these actors are still nonexistent. At the end of last year, the Mozambique Stock Exchange had four listed stocks, 22 government securities, 17 corporate bonds and three companies that had issued commercial paper. Its total market capitalization was $867 million, with annual turnover of just 4 percent.
Liquidity can be described as the ability of buyers and sellers to meet their investing, financing and hedging requirements in a timely and cost-efficient manner. It is a feature highly valued in financial markets. Liquidity is crucial for capital markets development, resulting in the orderly flow of information, capital accumulation, productive investments and positive benefits to society.
In Mozambique the government sought to increase market participation — and improve liquidity — by passing the Public-Private Partnership law, which requires that all megaprojects list 5 to 20 percent of their shares on the country’s stock exchange. But even though there have been a number of megaprojects, the 2011 law has had little impact so far, largely because of a lack of clarity regarding both the operational steps required by companies to do a listing and the enforcement of the new rules.
Not Banking on Change
In 2013, Mozambique established a primary dealer system to try to increase participation in the country’s government bond market and form a benchmark for its fixed-income securities. Primary dealers’ responsibilities include supporting the secondary market by setting aside a percentage of their primary market holdings for retail investors. Currently, this requirement is not being explicitly enforced; the reason could be insufficient coordination among authorities. It is worth mentioning that the primary dealer system is made up entirely of commercial banks, which compete structurally with capital markets and may not feel naturally compelled or sufficiently motivated to nurture the secondary markets. If more and more companies relied on capital markets to fund their activities and projects, at the expense of bank loans, that could be viewed as a potential threat to the banks’ margins.
Mozambican institutional investors — in particular, insurance companies and pension funds — could play an important role in solving their country’s liquidity conundrum. Premiums underwritten by Mozambique’s insurance industry, for example, represented just 2 percent of GDP in 2015, compared with 8.8 percent for insurance companies in OECD nations. As the insurance industry grows, it will have more assets to invest in financial instruments. But currently the balance sheets of insurers in Mozambique are dominated by real assets, cash and equivalents, representing more than 60 percent of assets. Mozambican pension funds, for their part, held more than 86 percent of their assets in government securities, cash and unsecured bank term deposits as of 2015 – a reflection of investment guidelines that favor capital preservation. Investment guidelines for pension funds and insurers would need to be updated to allow them to invest in more flexible financial instruments and focus on portfolio diversification and risk awareness.
Importance of Intermediaries
Capital markets need a diverse group of intermediaries — both in nature and in reach — to nurture participation. Mozambique has a framework for capital markets intermediation, but that function is still restricted to commercial banks, which seem comfortable with a status quo where the banking sector holds a monopoly on the function of financing the economy. The government can encourage brokerage firms and other intermediaries to get involved by offering incentives in the form of tax exemptions or reductions, or stock exchange fee exemptions or reductions. Without a broad group of intermediaries, efforts by Mozambique’s authorities to attract the interest of retail investors and deepen the penetration of local institutional investors will be challenging.
“The process of overhauling underdeveloped capital markets is demanding, but the effort is worth it.”
Throughout the world SMEs foster entrepreneurship, employment and job creation. In sub-Saharan Africa, the private sector is made up largely of SMEs that operate in an environment of expensive and limited credit access. Mozambique is no exception. SMEs there have struggled to tap into bank lending to develop their business prospects; their presence in financial markets is still a mirage. For Mozambique and the other predominantly cash-based economies of sub-Saharan countries to truly grow their capital markets, SMEs need to be able to list and trade on local stock exchanges. At the same time, regulators must reduce information asymmetry by disclosure enforcement, so that investors can assess their risks and borrowers can benefit from fair pricing and be held accountable to deliver what was promised in the marketplace. Mozambique and other sub-Saharan countries can look to the likes of the National Stock Exchange of India and Brazil’s BM&F Bovespa for relevant examples of emerging market exchanges that successfully list and trade SMEs.
The process of overhauling underdeveloped capital markets is demanding, but the effort is worth it given the positive correlation between capital markets development and economic growth. Research suggests a number of preconditions for a well-functioning capital market, including sound macroeconomic policy, a strong institutional and legal setting, and robust financial and technological infrastructure. All preconditions are necessarily designed and implemented to achieve adequate market liquidity.
Mozambique is currently pursuing ideal macroeconomic, regulatory and operational policies, with relevant technical assistance and cooperation from bilateral and multilateral international institutions. As a result, financial education, pension system reforms, savings awareness programs and many other actions that aim to develop the nation’s capital markets are under way and in some cases nearing completion. But there is still little or nothing concrete on the liquidity front per se, while the market remains underdeveloped. A new approach should be adopted in which authorities periodically set specific goals pertaining to liquidity measures and develop actions around those goals that can be objectively assessed by the end of the period. It is time to explicitly target liquidity.
Eden Mabilana is an IFC–Milken Institute Fellow, born in Mozambique. He works for the Bank of Mozambique as a trader; his responsibilities include open market operations and portfolio management. As part of the IFC–Milken Institute Capital Markets Program, he is a business development intern at World Quant, LLC. He holds a Dealing Certificate from ACI–the Financial Markets Association and is currently involved in the implementation of FIRST Initiative’s debt markets development in Mozambique, which also seeks to develop the local capital market.
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