Faruq Ahmad Siddiqi
The stock market is passing through a recession for about two years now. Apparently, there is no indication of recovery yet. Government and the regulators seem to have given up hopes of any early recovery and there is not much talk about it any more. Investors are perhaps too frustrated to hold the usual protest rallies in front of the exchanges. Thousands of them are back home quietly after losing every thing they had. This is not unexpected. Stock market crash of this magnitude naturally shook confidence of most of the investors. Government failed utterly to perk up the situation through policy measures and restore confidence of the investors.
While stock market index started declining sharply at the end of 2010 and the process was still continuing, a crisis was developing in the money market too by the middle of 2011. Inflation reached a double digit figure and other macro-economic indicators looked threatening. As a result the central bank had no choice other than adopting a stringent monetary policy and control excess liquidity. This restricted the scope of fund flow from money market to capital market. Some banks, overexposed to capital market, had significant loss due to sharp fall of stock prices. Most of the banks and financial institutions were not in a position to make any fresh investments in the stock market. This worsened liquidity crisis in the stock market. Irresponsible remarks were made by persons holding high position which did not help improving investors confidence. Under this kind of scenario, it became increasingly clear that stock market recovery was not likely any time soon.
Lingering slump in the secondary market inescapably had its consequence on the primary market. Some IPOs with relatively high premium faced problem when trading started as secondary market was not ready for that kind of pricing under the existing circumstances. Therefore initial public offering (IPO) pricing has become a critical concern. Good companies with satisfactory track record would not feel encouraged to be listed without attractive IPO pricing policy. But the Securities and Exchange Commission (SEC) may be hesitant to approve an acceptable premium in a depressed market condition. This dilemma may deter the process of bringing good companies to the market. New companies or companies without good track record may be more willing to come to the market since they would not expect high premium. Therefore, SEC may have to be more careful about new companies.
In cases of good companies, the Commission needs to balance pricing so that they do not feel discouraged to come to the market and at the same time the pricing is acceptable in the secondary market. This is a delicate and challenging job in an erratic market situation. SEC also needs to be careful about timing of granting IPOs. Current market turnover is very low and participation appears to be mostly by small traders. These investors have limited financial capacity. When they apply for primary shares, their fund is blocked for few weeks. As a result, if there are quite a few offers at a time, it may cause liquidity crunch in the secondary market. IPO application needs to be invited with reasonable time pacing so that it does not divert fund from secondary market significantly. These small details may become important when the market is in a negative mood.
Negative news about the banking sector has recently been a cause of concern. Massive swindle in Sonali Bank and negative news about some other banks both in public and private sectors have eroded investors confidence significantly. New provisioning policy of the central bank has also its negative impact on profitability of the banks at least in the short term. This has further influenced the declining stock price in the banking sector. Our stock exchanges are dominated by banking sector. Performance of this sector has an overall effect on the whole market and that seems to have been the case in last few weeks. Restoring confidence in the banking system has become a challenge not only for the capital market but for the economy as a whole.
It is now more than a year since the government declared an incentive package for the small investors. This included waiver of a part of interest on margin loan taken from merchant banks and brokerage houses. Perhaps the scheme was taken without proper assessment of its consequences. However, since the scheme was adopted with the initiative of the government, its proper execution has to be ensured by the government. But this has been implemented only by Investment Corporation of Bangladesh (ICB) which is owned by the government. Prospect of its implementation by others appears to be uncertain. This naturally added to the frustration of small investors and eroded credibility of the government and regulators. Proper implementation of this scheme is now a major challenge.
Incentive package also included a 20% quota of new IPOs for the affected small investors. This also does not seem to be of much benefit to the investors for number of reasons. In a bearish market, difference of price between issue price and subsequent trading price has narrowed down. Therefore, primary shares are not as profitable now as it was before.
Secondly, in view of large number of affected investors, quota of 20% does not help much in getting primary shares.
Thirdly, when application is made from an affected BO account, allotted shares are credited there. Since the applicant has margin loan in that organization, any profit from sale proceeds of the allotted shares is adjusted against unpaid loan and the applicant does not gain from it. The scheme therefore helps broker houses or merchant banks rather than the affected investors.
Institutional investors are not very active in the market for quite some time. We can not expect a vibrant market without their participation. Banks and financial institutions have been constrained by liquidity crunch. They do not have the surplus fund that can be diverted from core business to capital market for long term investment. Most of the large broker houses and merchant banks are subsidiaries of banks and financial institutions. Similarly, most of the mutual funds are sponsored by them. So, if there is liquidity problem in banks, significant institutional investment can not be expected. Merchant banks and broker houses owned by the banks and financial institutions were very active throughout 2010. It was very naive of the institutional investors to assume that stock market boom would continue. Yet, they did think so. They invested substantial money in setting up large expensive offices and hiring additional staff. In expectation of hefty profit some of these organizations advanced margin loan in an aggressive manner. Some banks and their subsidiaries built up their own investment portfolio.
After the stock market collapse, the scenario was completely reversed. In the course of last two years, market index came down from nearly 9000 points to around 4000. Many of these investors had to make provision in their profit and loss account due to reduced market price of their stock. A substantial portion of the margin loan could not be recovered by the merchant banks and broker houses from their clients. Expenses for the offices and staff continued putting pressure on cash flow. They were obliged to pay interest on borrowed fund to banks. At the top of that, decision was taken at government level to waive part of the due interest of small investors.
As a result of all these factors, institutions that offered excessive margin loan to their clients are at the verge of ruins. They have no fund to offer fresh loan and even if they have, there are not many prospective clients willing to take it. In a depressed market like this, it is obviously hazardous to invest in shares with borrowed fund. Some market intermediaries are in shambles and finding it difficult to maintain their operational capability. As a measure of cost cutting, they are likely to retrench their staff and perhaps at least in some cases they have done it already. This is likely to retard the process of developing stock market professionals which is important for efficient management of the market. The government or the regulators do not seem to be addressing these problems at all. However the regulators need to appreciate that role of institutional investors and market intermediaries is crucial in the process of market recovery and their problems call for serious attention.
SEC has taken some good steps for development of the market. It takes time to get benefit of reform measures and hopefully these measures will bring long term benefit. But more attention is required to the immediate problems. Many reform measures were taken after 1996 disaster but it took many years to get benefit from those reforms. It should not take that long this time. Market is more developed now and at least some investors are likely to be active again once there is semblance of stability in the market. Let every body work for that stability and confidence rebuilding. After all it is only a question of time. The stock market will surely rebound and take its rightful place in contributing to the national effort for long term financing of trade, commerce and industry.
The writer is a former chairman of Securities and Exchange Commission.