Morbidities in Bangladesh stock market: Are they curable?

In relative terms, the overall Bangladesh economy is faring well as compared to many developing countries during the period of ongoing severe global recession. Thanks to a low extent of international financial interconnectedness. But the economy is not completely immune to foreign shocks. Eventually, they may yet travel to Bangladesh economy with some intensity if there is a double-dip global recession in the offing. Good agricultural harvest uptrend in low-end RMG exports and increased inflows of remittances with some counter-cyclicality help the economy still remain afloat.

Progress in social sectors, such as, education and healthcare services will bring long-run tangible benefits. Give credit where it is due and be constructively critical with possible remedial measures to help overcome weaknesses. Successes are overshadowed by failures due to massive communication failures of the government. The overall economy is not in crisis, but appears fragile on some fronts. The fragility comes from the financial sector. It has been inherently weak and now in a disarray posing systematic risk for banks, corporate sector and SMEs, in particular. The overall situation calls for careful corrective measures to forestall further deteriorations. Cumbersome cross-ownership structure, like Japanese keiretsu, in financial institutions and industrial conglomerates by a few families (like Birala and Tata in India) also contribute to the systematic risk.

Growing problems in one part of this ownership will spill over to the other part.  Any joint negative events thus put the economy at high risk.  The job-creating bank-based financed engines (SMEs) also do not remain untouched as banks go through undercapitalization.  Such heavy concentration of cross-ownership in a handful of super rich families makes them politically powerful and financially influential in the economy. Japan has been in an economic contraction mode since late 1980s to date.  One of the reasons is the keiretsu. Thus, the question arises:  Are we following Japanese model or India model of state patronage for economic development? We should draw lessons from Japan from the late 1980s into the 21^st century. We can draw other lessons from Japan that low-wage cost advantage that Japan enjoyed for a while after the Second World War does not last forever.  Japan managed to succeed by steering its export-dependent economy from low-wage advantaged products to value-added industrial products through industrial restructuring. In short, we have to anticipate changes, manage changes, adapt to market dynamics and be proactive to gain global competitiveness. Otherwise, doom days are ahead.

At the same time, we have to keep the economy on right track by a combination of good fiscal and monetary policies. Imprudent monetary policies, self-created financial regulatory strangulation, conflicting market signals and radar-less commercial banking will create financial chaos leading to financial crisis in the capital market of which stock market is an important part. The other part is our embryonic treasury bond market with no development of a corporate bond market.

In the backdrops of the foregoing paragraphs let us now devote attention to the current sordid state of the cancerous part of the Bangladesh economy, that is, the stock market and its grim future. A sound and vibrant stock market plays an important role in enhancing economic growth. The extent of its importance in this respect remains in disputes both in anecdotal volumes of theoretical and empirical finance literature for correct pricing of equities and rational allocations of investible funds among competing productive economic activities. Empirical evidences on this issue are illusive and they vary across countries.

True, equity prices are unpredictable on the premise of the so-called market efficiency hypothesis.  But the price changes ought to occur with some continuity. Any abrupt and large declines and rises in prices are indicators of gross market inefficiency. An inefficient market also occasionally overreacts and underreacts to rumors. No one, on average, can beat the efficient market and earn abnormal return. To beat the market, powerful, influential and well-connected players are tempted to engage in insider trading (a conceptual and legal gray area) by pre-empting private information before it goes into the public domain. They are also capable of manipulating or hijacking the market. They are the ones who enjoy cross-ownership of financial and industrial conglomerates at government patronages through bribing in many shades and forms.  They are of dual/changing political colors. Needless to identify their personal identities in this write-up. People know who they are as identified in recent report that remained silent on the mishandlings of the Bangladesh Bank.

In its current state, the Bangladesh stock market is in paralysis suffering from confidence crisis. They lost faith in the commitment and ability of policymakers and regulators (FM, BB and SEC) because of the main actors' incompetence, inexperience, vacillations, conflicting and sporadic imprudent comments, to mention a few.  Rational people in their own minds realize their deficiencies. Only the morons cannot understand. Giving some benefit of rationality, why did they lobby for the jobs, in the first place, which they will not be able to handle? Why are they still hanging in there? Should they not exit gracefully? Today, these are the questions in many minds. The elders had their days in the past. This is not their time in the age of globalization and the era of rapidly evolving cutting-edge information technologies.

The 3.3 million small investors' pressing demand is to bring the perceived culprits under judicial inquiries. This will partially restore investors' confidence in the market showing a resolve of the government. Any incentives package short of this bold step is hollow to them. The head of the government (PM) needs to apply her political capital boldly and wisely in this case with no further delay. Otherwise, the political capital will fade away through time to these small investors, their family members and well-wishers. Inaction on it will be both bad economics and bad politics.

Maybe, the frontier stock market in Bangladesh is thin, shallow, less liquid and inefficient. In market capitalization, it is very tiny and currently a negligible percent of GDP after the crash. One may, thus, question its overriding importance in the $100 billion-economy.  The size is peripheral to its negative psychological effects on the economy with huge pains and sufferings of so many losing small investors and their families.

Stock market is not just index numbers. It has its own anatomy and biology that quacks will not understand. It is connected to investors' sentiments. At the same time, it has its own emotions with ebbs and flows. Investors' sentiments are now nearing the lowest point drowning the market emotions. So, the market is now in a moribund state. Its revival is no longer a policy and numerical game. Rather it is psychological.  To break this negative psychosis of small investors, the bold step, as stated earlier, must be taken now.

Apart from the aforementioned, so many things went wrong over time to culminate into this severe confidence crisis. To name a few, dissipation of deceptive information (rumors) to the market, fraudulent corporate accounting practices, lack of policy coordination, prolonged loose and confusing monetary policy, imprudent fiscal policy, lack of effective monitoring and surveillance, policy inaction, etc. led to this situation. Free stock market is good in concept and theory. But it cannot always take care of itself. It may be vulnerable to accounting manipulation to entice small investors thereby artificially inflating the stock prices out of line with underlying macroeconomic fundamentals. Once the small investors enter the stock market in herds and engage in momentum trading, the manipulators exit the market with windfall gains. Not necessarily, the tainted colossal gains stay at home.  In fear of security, capital takes flight abroad. This, in turn, erodes the value of Taka against some key foreign currencies depending on overseas destinations. Any incentive to whiten black money for revitalizing the stock market is thus unlikely to work. Rather, it creates moral hazards for another bout of market debacle.

The stock market follows a simple natural law by rising and falling, and vice versa:  a rapid rise in prices are to be followed by a rapid fall out of panic. Simply put, stock market is risky. A recent press briefing by the BB that investment in stock market is not risky is grossly misleading and insane. Risk is like a piece of cloud that changes shape and darkness as it moves. It is an inherent truth that one must take higher risk for higher reward on stock investing. This market is not a place to make money without risking financial loss. In other words, this market is not normally meant for the financially illiterate and the people of small means. So, small investors are at fault too for their losses. In fact, they behaved irrationally out of exuberance and ignorance. As a result, promotion of financial literacy must gain national prominence in academic curricula across all disciplines at all levels of education. Otherwise, they will be the willing victims of deceptions, again and again.

Stock prices eventually respond to macroeconomic fundamentals like per capita real GDP growth, price and exchange rate stability, stable money supply growth, low and stable real interest rate, reasonable size of budget deficit, developments in trade balance, acceptable rate of unemployment, etc. Any off-balances in these variables will destabilize the stock market. Today, how many of them look favorable? Virtually none. So the market (DSE index) had no reason to peak at 8,918 on December 5, 2010 from 2,941 in August, 2009 when the overall macroeconomic environment was relatively stable with some exceptions. As of February 9, 2012, the DSE Index at 3,369 declined 62% from its immediate previous peak. From August, 2009 the steep ascent to the peak was 203%.  Again, prior to the stock market crash in 1996, the rise to the peak was 220% with a smaller base. The subsequent plunge was 70%. This suggests that history repeats itself with the same actors in play. This shows excessive abnormality in the market and the frothy market was ripe for a free fall.  If we accept DSE Index in August, 2009 as benchmark, the market appears yet to have some room for further falls in absolute term from the February 9, 2012 level.  In percentage term, the market has potential to fall even farther to hit the bottom, if left alone for self-correction. Nifty 20 or blue chip 20 stocks in DSE before preceding peak had P/E ratios at 100 or more while the average P/E ratio of the DSE general index was 30.  This shows how much was the overvaluation of each of these 20 blue chip stocks.  In fact, they drove and drowned the market.  By now, the financial picture of these companies and their ownership structures must be clear as a connecting thread is traced in the beginning of this write-up.  Thus, their blue chip rating was highly exaggerated suggesting that the stock raters were at faults as well.  Concomitant unusually high turnover ratios also enticed small investors giving false hopes for each blue chip company efficiency and growth prospects.

Then, where is the bottom of the Bangladesh stock market?  It is any body's guess until the suggested bold measure is taken against the identified hijackers of the market.  The conclusions deem dry and dreadful.  But facts remain as they are and history repeats itself.  The stock market has morbidities in its current state, but they are curable through proper institutional rearrangements, putting right people at right places who can take bold and correct steps, regulatory clarity and so on.

In closing, the situation did not evolve overnight.  Hostile attitude of the past Caretaker Government (CG) toward business community and euphoric public optimism also partly contributed to inflating stock market and large metropolitan real estate market.  Collapse of the latter will crack the bottom.  We should learn lessons from USA and Japan in this respect.  On a historical note, the US stock market took 10 years to recover after the 1929 crash, despite a sequel of bold and monumental regulatory steps. All the dooms and glooms are around.  Bad days and good days do not last forever.  Let us now hope for future blooms and blossoms.

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Matiur Rahman is the MBA Director and JP Morgan Chase Endowed Professor of finance at McNeese State University, USA.