Promoting capital market in Ethiopia is a rather recent economic and financial activity. The contributor of this article intends to throw some light on the meaning of capital market, the legal framework, opportunities and challenges the sector would bring forth for Ethiopia.
A capital market is a financial market where individuals, institutions, and governments can buy and sell financial securities, including stocks, bonds, derivatives, and other long-term investments. The primary function of a capital market is to facilitate the flow of funds between investors who have capital to invest and entities (such as corporations or governments) that require capital to finance their operations, projects, or investments.
Major components of capital market include primary market in which new securities are issued and sold directly by the issuing entity to investors. This process is known as an Initial Public Offering (IPO) in the case of stocks or bonds. The funds raised from the sale of securities in the primary market provide capital to the issuing entity for investment purposes.
Secondary market is where previously issued securities are bought and sold among investors without involvement from the issuing entity. Stock exchanges and over-the-counter (OTC) markets are examples of secondary markets where investors can trade stocks, bonds, and other financial instruments based on supply and demand dynamics.
Capital markets provide liquidity to investors by offering a platform to buy and sell securities easily and efficiently. Liquidity allows investors to convert their investments into cash quickly without significantly affecting the market price of the securities.
Capital markets offer investors the opportunity to diversify their investment portfolios and manage risk by investing in a variety of asset classes, sectors, and geographic regions. Diversification helps spread risk and reduce the impact of adverse market movements on investment returns.
Capital markets play a crucial role in determining the fair market value of securities through the process of price discovery. The interaction of buyers and sellers in the market determines the prevailing market prices of securities, reflecting factors such as supply and demand, investor sentiment, economic conditions, and corporate performance.
Capital markets facilitate the mobilization of savings and investment capital from investors to fund productive activities, projects, and ventures that contribute to economic growth, job creation, and innovation. By providing access to capital, capital markets support entrepreneurship, business expansion, and infrastructure development.
Capital markets are subject to regulatory oversight by government authorities, financial regulators, and securities exchanges to ensure transparency, fairness, and investor protection. Regulatory frameworks establish rules and standards governing the issuance, trading, disclosure, and conduct of participants in the capital markets.
The formation of capital market in Ethiopia dates back to the 1950s whereby the first share company in Ethiopia was established by the Ethiopian Abattoirs in 1956. Similarly, the Bottling Company of Ethiopia started to sell shares in 1957 followed by Indo Ethiopian Textile Share Company in 1958, HVA Ethiopia Sugar Factory Share Company in 1959 and the Tendaho Plantation Share Company in1961. In 1963 Addis Ababa Bank was established.
Earlier in 1960 former State Bank of Ethiopia was established. This was the first step in institutional approach to share markets. It established a share exchange department to regulate shares in those days. The promulgation of the Commercial Code of the Imperial Ethiopian Government also provided for the legal requirements for instituting and handling of shares. Share companies expanded further after 1965 allowing more financial grounds for the formation of share based market transactions.
The Proclamation that provided for the Establishment of Ethiopian Capital Market Authority Proclamation no.1248| 2021 define capital market as “ a market where securities such as shares or equities, bonds, derivatives or other related securities are bought and sold.
The main purpose for the establishment of the Authority is to the national economy of the country, to establish a legal framework for regulation of capital market and to legislate uniform requirements and to monitor the transactions with securities. Provide fair, efficient and transparent financial trade transactions.
This year the Authority issued a Licensing and Supervision Directives to streamline the development of capital market in Ethiopia. According to the Directives, those legible or obtaining operational license from the Authority include securities brokers, Securitas dealers, securities digital sub brokers, investment banks, securities investment advisers, securities Sharia advisers, securities Robo advisers, collective investment schemes operators, crowed funding intermediaries, security market makers, securities custodians, securities portfolio managers, credit rating agencies, securities appraisal firms and appointed representatives. The Directives also prescribes licensing requirements and documents to be presented to the Agency.
The writer of this contribution believes that over the last 30 years, the establishment of a number of private banks and insurance companies as well as growing FDI will provide a more meaningful condition for the expansion of share companies and the nascent capital market in the country.
Ethiopia’s growing agriculture output and modernization of the sector along with diversification of export commodities and their increment in quality and quantity could give a better financial backing for the capital market that could kick off in the country between this and next year. Moreover, the expansion of industrial and agro industrial parks in the country would provide the necessary financial backing for capital market.
Along with these positive tendencies, the formation of capital market in Ethiopia will certainly face several challenges that are directly related to the nature of the economy of the country.
Ethnic based conflicts, economic destabilization that could affect investors’ confidence, multiple changes in financial and monitory polices by the National Bank and the effects of inflation could frustrate the genuine initiatives of capital market.
The acute foreign exchange shortage, largely the result of weak export performance and high demand for foreign currency, remains the leading challenge for U.S. suppliers and for which there is no quick fix. When foreign currency is available, banks prioritize certain sectors over others. Businesses can usually expect delays in acquiring foreign currency extending up to a year. Significant payment delays for delivery of imported goods and services, or cancellation of government tenders for lack of funds are another side effect. Further, forex controls make it difficult for investors to repatriate profits.
Other challenges include bureaucratic barriers to investment, inconsistent interpretation of the investment regulations, logistical bottlenecks, corruption, expensive land transportation, and delays affecting importing products and shipping exports. Land rights issues and an unpredictable tax regime may add another layer of complexity for foreign investors and operators. Private sector expansion is hampered by a lack of a capital market.
The Ethiopian economy has grown at a rapid pace over past decade until 2019, but in addition to foreign exchange scarcities, the economy remains vulnerable to internal conflicts, periodic droughts and commodity price volatility that impacts the demand and price of Ethiopia’s primary export commodities. The price of coffee, one-third of Ethiopia’s exports, has a pronounced impact on Ethiopia’s export earnings.
The fact that Ethiopia has now joined BRICS will help the nation to have access to hitherto impossible foreign capital markets. The nation needs to exploit this opportunity over time.
The question now is what should Ethiopia accomplish to accelerate the pace of formation of capital market in the country? The writer wishes to forward some suggestions.
In the first place, the Commercial Code of Ethiopia needs to be revised so that the legal provisions could facilitate smooth and legitimate capital market for nation in the country.
On the other hand, extensive and detailed capacity building and training programs need to be conducted for potential participants in the capital market. Similarly, the struggle against contraband trade, money laundering and printing of counterfeit local and foreign currencies must be intensified in a more organized manner with the participation of all concerned stakeholders.
The digitalization of fiscal and financial services is of critical importance to allow foreign investors to conduct one stop business ventures and to conduct more frequent monitoring on the activities of licensed organizations.
Capital market could be vulnerable to highly skilled corruption activities at all levels and this requires close monitoring and implementation of the rule of law in the financial sector.
At the end of the day, what advantages can Ethiopia expect from a well developed capital market?
A capital market provides businesses, government entities, and other institutions with access to long-term financing by issuing stocks, bonds, and other securities to investors. By raising capital through the capital market, Ethiopian companies can fund expansion projects, infrastructure development, and strategic investments to spur economic growth.
Developing a capital market allows Ethiopian entities to diversify their sources of financing beyond traditional bank loans and government grants. Access to equity and debt financing through the capital market enables businesses to manage their capital structure, reduce reliance on bank borrowing, and mitigate financial risks.
A vibrant capital market can catalyze economic growth by channeling savings into productive investments, fostering entrepreneurship, and promoting innovation and job creation. By mobilizing domestic and foreign investment capital, Ethiopia can stimulate economic activity, enhance productivity, and capitalize on emerging opportunities in key sectors of the economy.
Listing on a stock exchange and accessing capital market financing often requires companies to adhere to stringent corporate governance standards and transparency requirements. By promoting good corporate governance practices, the capital market can improve accountability, investor confidence, and management effectiveness within Ethiopian companies, leading to sustainable business growth and value creation.
A well-regulated capital market attracts domestic and international investors seeking investment opportunities and portfolio diversification. By offering a range of investment instruments such as stocks, bonds, mutual funds, and Exchange- Traded Funds (ETFs), Ethiopia can attract capital inflows, deepen liquidity, and expand investor participation in its financial markets.
Capital raised through the capital market can be directed toward financing critical infrastructure projects, including transportation networks, energy facilities, telecommunications systems, and urban development initiatives. Infrastructure investment enhances Ethiopia’s competitiveness, connectivity, and resilience, laying the foundation for sustainable economic development.
BY SOLOMON DIBABA
THE ETHIOPIAN HERALD THURSDAY 7 MARCH 2024
