Stimulating the capital market

After the boom and bust of the stock market in 2010-2011, the impression of the capital market has changed dramatically. Wrong concepts are responsible for impeding further developments in the share market. However, in a growing economy such as ours, the role of the stock market must be revived to remain at the cutting edge of competition with other emerging nations. Just bank-led financing for development is inadequate and risky. A balanced diet of both the banking sector and the capital market is essential to ensure the rapid expansion of businesses and industry, thus leading to a healthy economy for Bangladesh.

The crash of 2010-2011 is responsible for three negative impacts: 1) abnormal gains for a few while enormous losses for many; 2) repulsion and negative image of the stock market and; 3) discouragement of foreign portfolio investment. On the other hand, at least two positive effects were achieved: 1) the market has corrected to reflect companies' potential to a great extent; and 2) excessive craziness for ballooning stock gains has plummeted. As a result, whatever growth we are recently witnessing in the stock market, is more resilient and linked with economic fundamentals. The collapse has left behind a lesson for us: if you are getting an abnormal rate of return, something wrong lies inside the stock. We need to consider this abnormal growth as a bubble developing phase. The bubble will burst soon and you need to sell the stock before you thrash your fortune.  

The question of how to judge a normal rate of return has always been hard to answer even in an efficient market. The 2010-2011 crash warranted a greater role of regulators who should investigate whether huge manipulation is going on inside a stock that has skyrocketed of late.  There must be something suspicious about the traders of the company.  Even an erudite person like Alan Greenspan, the longest serving chair of the US Federal Reserve, went wrong in assessing the Wall Street in the mid-2010s. He claimed that US economic fundamentals were sound. Later on, he tried to justify his blunder in a testimony to the US Congress by arguing that the American collapse was a once-in-a-century credit tsunami. While Greenspan can afford going wrong, our shareholders cannot. Hence, we need to develop stricter rules and punish the wrongdoers to protect our shareholders, thereby developing a healthy capital market.  

The best way to create the most congenial climate for the stock market is to create an ambience of transparency and governance, and secondly, to ensure a uniform and consolidated low interest regime. If the risk-free deposit rate is greater than or even closer to the rate of return from the risky stock market, dreaming for a healthy capital market is sheer absurdity.

A sensible person will never go to the stock market for a 12 percent return, if he can easily earn similar returns from national saving certificates or sanchaypatra, which is 100 percent risk free. The risk premium is derived by deducting the risk free rates from returns on risky assets such as stocks. A high risk premium above 10 percent is needed to attract investors toward the stock market. The earlier volatility in the Dhaka Stock Index (DSI) has set the stage for expecting higher risk premiums in Bangladesh. The DSI peaked almost close to 9000 and then cascaded down to 2600 within a short time, torpedoing stockholders' confidence and creating enough justification for expecting high risk premiums in the future. Since we have little control over stock market returns, the only way to stimulate the capital market is to lower all sorts of deposit rates. Before doing this, we need to first reduce the huge disparity among deposit rates.  

The reverse repo rate is 5.25 percent, which is essentially commercial banks' deposit rate with the central bank. The average deposit rate available for customers in the banking system is about 7 percent. But the sanchaypatra rate is close to 12 percent. This type of yawning disparity does not reflect a notion of uniformity or consolidation in the deposit rate structure.  This fatty band of deposit rates is detrimental to the growth of the stock market. The upper line of the band has already made stock market investments unattractive.  

The risk free rate (12 percent) plus risk premium (say, 10 percent) requires well above 20 percent rate returns from the stock market. And this ambitious rate of return is hard to achieve. A potential stock buyer will naturally be discouraged to make his foray into the capital market. Not considering this threshold effect of the deposit rate on the survival of stocks exposes our conscientious ignorance to the capital market.

The central bank has been successful in motivating commercial banks to reduce all sorts of interest rates. Combating inflation by the central bank has paved the way for interest rates to slide. Inflation would have been much lower had the government adjusted our domestic fuel prices to the incredibly low global oil prices. A lower inflation would give a lower deposit rate, which would again invigorate the stock market.      

Despite imperfections, we must do our best to empower the stock market. Neglecting this market will be self-defeating. It will eventually slow down the pace of growth in manufacturing and services. The rational mindset in an emerging economy should vouch that the stock market is our responsibility and we all need to take care of it with integrity and by adopting the best practices from around the world.    

The writer is chief economist of Bangladesh Bank.