photo:bdnews24.com

A number of newspapers recently reported that in the past few days, nationalised commercial banks and financial institutions have been actively buying in the stock market in order to “bring normalcy” to the market. I guess the definition of normalcy is price appreciation every week in the magnitude of 2-3 percent, for an annual return of over 100 percent. Otherwise, in a market that has a price to earning (PE) ratio of over 30, how does the fall of stock prices by a mere 15 percent in total can be construed anything but normal?

Even after recent corrections, the PE ratio is over 25. Putting in perspective, if investors depend only on earnings of the invested companies for return OF their capital (let alone any return ON capital), they would have to wait a long 25 years. No other comparable stock markets have a PE ratio over 20. In the past 10 years, even Bangladesh stock market traded at a long-term average PE of 20. If such is the case, why a market that is overvalued by at least 25 percent needs state support? When correction in the market is overdue and is actually a healthy development, why the state is pouring good money into a flawed system, and to whose benefit?

What bothers me most is the mode of the intervention. The news reports state that the Investment Corporation of Bangladesh (ICB) received Tk 2.0 billion (200 crore) “financial assistance” from the central bank to intervene in the market. ICB used this money, along with its own funds as well as funds from its mutual fund portfolios to purchase stocks whose prices were falling. I guess the same is true for other state-owned banks and financial institutions, as well as some private financial institutions.

The whole process is wrong, offensive, foul and reckless in a number of ways. First, this is a clear transfer of state funds to speculators without any accountability. Bangladesh capital market is nowhere near to being an important contributor to national growth that it would have to be propped up by transferring public wealth to rowdy speculators.

Second, there seems to be no accountability or policy direction by the government for ICB or others as to what securities should be purchased with this “financial assistance”. It means these parastatals can use this fund to purchase any stocks they wish to please any group of investors they want.

Third, ICB is reported to have used cash from their mutual fund portfolios to purchase stocks whose prices were falling. The assets and the cash in the mutual fund portfolios do not belong to the ICB, to the ministry of finance or to the government. They belong to the mutual fund investors. What right does the ICB have to use their money and hurt their interests while implementing government’s policy decisions? This is a gross violation of investors’ constitutional right to own assets without government meddling.

Finally, what is a normal state of the market where such intervention stops, at a PE ratio of 100? By a process called “reversion to mean”, the market shall and must come down to a realistic level, no matter what the size of the intervention. In this case, normalcy may mean a historical PE ratio of 20 or lower. By postponing the day of reckoning, what does the government achieve?

It is understandable that a political government would not want another stock market crash on its watch, and it would do everything to avoid such embarrassment. However, such embarrassment could be nipped in the bud many months ago. The whole affair started with banks’ excessive venture in the stock market. As soon as the market PE surpassed the historical average, the central bank should have slowly limited banks’ exposure. Instead, platitude substituted for sound policies. When the horse left the burn, the central bank has been forced to take (or withdraw) measures, which are ignominious to the prestige of the institution.

Instead of banks having to adjust by January 15 their loans diverted from industrial accounts to stock market, they now have unlimited time. A time-tested safeguard such as single borrower exposure limit has been relaxed. Finally, it is reported that the central bank has been asking banks not to sell their shares in a depressed market. Since when is it the job of the central bank to maintain the level of stock prices? Sooner or later the market would adjust downward and the banks would be left with losses from these investments. Is a weaker banking system more desirable than a weaker stock market? It appears that the discipline achieved through the Banking System Reform of the last decade could be lost while trying to defend a weak capital market.

The knee-jerk, reactive policymaking that is the hallmark of the Securities and Exchange Commission (SEC) seems to have spread upwind. I would also put the blame squarely on the media that unnecessarily magnified the stock market and its subsequent fall. Robert Shiller in his book “Irrational Exuberance” attributes excessive media coverage of the stock market as one of the causes for speculative bubbles. That surely was the case in our market. The recent market correction should have been ignored and viewed as what it was — a necessary lesson for foolhardy speculators. Instead, we are wasting valuable time, resources and political capital to remedy a make-believe crisis.

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ANM Hamidullah is a retired banker and can be reached at hamidullah1972@hotmail.com

Disgruntled investors after record fall in stock market.

The rot started many months ago; on Sunday the market finally started crumbling. Between Sunday and Monday, Bangladesh stock market lost more than 15 percent. For a small economy, a loss of wealth of almost $7.5 billion, even on paper, is remarkable. Given the fact that many small investors flocked to the market lured by easy profit, the ripple effects would be widespread.

In 2010 alone, the market appreciated by 100 percent. In the three years (207-2010), the average return was over 50 percent. The market appreciated so fast lately that the inactivity during the first part of the decade was overshadowed by the performance of the last three years, resulting in an average annual return of over 30 percent during this decade. Despite the current corrections, the magnitude of the return is still stupendous. In other words, nothing to feel sorry about the last two days’ loss. After all in a market based laissez-faire economy, nobody has the right to determine how others invest on their own free will.

However, last two years have brought in clueless investors in the market. These are investors with limited capital, limited knowledge and limited risk-taking capacity. Most diverted their funds from essential or productive activities. Most left their day jobs to ponder on the market. In other words, these people had no business partaking in this risky game. We shall keep hearing about the plight of the retired government official in the days to come.

In other places, I have tried to explain how the speculative bubble started in the first place. It was a confluence of factors, including lack of investment opportunities in the real sector, excessive supply of money and proliferation of trading facilities. Finally, banks’ reckless participation in the market exacerbated the situation. What is pathetic is the role or lack thereof of the central bank. In keeping exchange rates fixed and favourable to exporters, it increased money supply without any care for inflation or asset price bubbles. What is more irresponsible is to let banks leave their traditional business and frolic freely in the stock market. Only in the last six months did the central bank notice that something was amiss. Only in the last three months did it actively enforce the rules limiting stock market participation by banks. The last central bank governor was too timid to enforce these rules against the veiled threat and the current one proved too populist to do the same. Would anyone care to comment why margin lending is regulated by the SEC and not by the central bank?

I think the point is not missed by the current government that the stock market crash of 1996 was considered one of the failures of the then government, which precipitated its fall. I would expect them, rightly, to look for the sources of this crash. I would ask them to look at the right places, and not target phantoms such as “speculators” or “rumour mongers”. Rather look for the SEC officials that changed rules (especially on margin rules) every few minutes either not knowing what to do or knowing too well how inside information works. Also, it is worth knowing what SEC officials in connivance with the culprits of the last crash were involved in overpricing IPOs, especially mutual funds. Also why and who randomly changed rules regarding mutual funds trading to protect their own investments but misguided the rest of the market. It is easy to find out, with available trade records of the DSE, who bought in one name and sold in another name, thus manipulating the market. Look for names such as Chittagong Vegetable and CMC Kamal, and determine what factors contributed their meteoric rise (5000 percent) despite those being crappy businesses.

In order to achieve double digit growth, we needed to raise our savings/investment rates by at least 10 percent of the GDP, from 25 percent to 35 percent. Capital markets could be a very good source for that.

It appears as in everything else, we killed the golden goose.

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ANM Hamdullah is a retired banker.