The Challenges Of Developing Financial Markets
BMI View: Afghanistan's plans to establish a stock market in 2014 are ambitious, and even if the exchange is created on schedule, it will face considerable challenges attracting investors. Nevertheless, it is a necessary step towards financial market reform, which will benefit the economy, assuming that the country doesn't return to all-out civil war after NATO withdraws in 2015 .
Afghanistan plans to establish a stock market in 2014 as part of a broader attempt to modernise its economy, which is almost entirely dependent on international aid. Afghanistan is following in the footsteps of other Asian 'frontier markets' such as Vietnam, which opened a stock exchange in 2000, and Laos and Cambodia, which set up bourses in 2011 . Myanmar meanwhile plans to inaugurate its own equity market in 2015. Plans for the Kabul Stock Exchange are being spearheaded by two young Afghans who worked in the US at Morgan Stanley and Merrill Lynch.
Proponents of the stock exchange argue that Afghanistan's companies need a means of raising capital, and that domestic investors need a formally sanctioned place to put their money. At present, there is a vast grey economy and Afghanistan's wealthy individuals put considerable capital in to local property market development or spirit their money out of the country to Dubai (where they often buy property) , bypassing Afghanistan's currency withdrawal restrictions . Indeed, capital flight has been a major problem for the economy, amounting to an estimated US$4.6bn in FY2011-2012 (March-March).
The creation of a bourse would mean that ownership of private companies could change hands in a relatively transparent manner. Critics say that when President Hamid Karzai privatised Afghanistan's state-owned enterprises (SOEs) in the 2000s, the absence of capital market infrastructure meant that f irms were sold directly to well- connected individuals, a phenomenon that has also occurred in post-communist transitional economies around the world . The establishment of a stock market should theoretically bring about greater transparency in the business sphere , and require the development of more robust legal architecture, in terms of institutions and practices. Industries that could benefit from equity market development include mining (potentially the most lucrative sector , given Afghanistan's vast mineral reserves), construction, and textiles.
Obstacles To Stock Market Development
Unsurprisingly, there are major obstacles to the development of the Afghan stock market. The first is the possibility that Afghanistan's business elites will flee the country, or at least evacuate more of their money, as the US and its NATO allies press ahead with withdrawing the vast majority of their troops by 2015. Although the US seems set to retain at least several thousand troops in Afghanistan beyond that date, there is a possibility that the country could return to outright civil war, similar to the situation following the collapse of the Soviet-backed Najibullah regime in 1992.
The second challenge is that not enough companies may list on the market, and the ones that do will not attract significant investor interest, due to political uncertainty stemming from the April 2014 presidential election (which will see President Karzai step down due to term limits) and the Western withdrawal. The third problem is that investors will be deterred by the high degree of corruption in Afghanistan. Memories are still fresh of the collapse of Kabul Bank (the country's biggest bank) in 2010 due to corrupt insider lending practices. This is likely to keep even the bravest foreign investors at bay, assuming that they would even be allowed to own significant stakes in listed companies.
The fourth obstacle is that Afghanistan is one of the poorest countries in the world, with a per capita GDP of less than US$600. It thus lacks a sizeable middle class that could become retail investors.
Nonetheless, assuming that the Kabul Stock Exchange is launched on schedule, it would still be a significant first step on the road to capital market development. We assume that initially only a few firms would list, and that the market could enjoy a 'novelty' -induced surge, similar to that experienced by Vietnam's and Laos' equity indices initially after their opening.
Afghan Stocks As Alternative To Property?
Afghanistan's planned stock exchange could also benefit from a switch by wealthy Afg hans from property to equities - assuming of course that they do not move more money out of the country before 2015. Kabul experienced a major property boom in the 2000s, as the fall of the Taliban prompted an influx of foreign aid workers and advisers, exiled Afghans returned home , and rural Afghans moved to the capital en masse to benefit from new job opportunities . This created demand for quality housing and offices (as well as makeshift homes for rural migrants) , and spurred new businesses. However, with NATO planning to withdraw most of its troops over the coming year , aid workers , international development advisers , and some former exiles are already leaving, c ausing 30-6 0% falls in rents in some districts over the past two years, according to anecdotal reports. This has left many properties vacant, as they are no longer in demand by foreigners, but are still far too expensive for ordinary Afghans.
Bond Market In Need Of Further Development
A second element of financial market development is the bond market . Afghanistan has a very limited treasury bill market, with the longest maturity being 364 days, but Da Afghanistan Bank (DAB, the central bank) wants to extend maturities eventually. The development of the bond market will be all the more important as Afghanistan struggles to find new sources of financing after 2014, w hen Western countries will slash development assistance further . The DAB is currently planning to issue Islamic bonds ( sukuk ), possibly before the end of 2013, to offer investors secure assets. The authorities presumably hope to tap into the vast capital controlled by Gulf investors, although given the political uncertainty facing Afghanistan, the country will remain peripheral to most investors for the foreseeable future.
Better Than Nothing
Although the challenges to developing Afghanistan's financial markets are great, the government's and central bank's plans are better than doing nothing. Whether they succeed very much depends on whether Afghanistan's next president will retain Karzai's economic policies, and whether the country will succumb to renewed civil war once most NATO troops have gone . However, we caution that even if Afghanistan remains reasonably stable, its low level of development will relegate it to frontier market status indefinitely . Arguably , Myanmar, Asia's latest 'hot' emerging market, has much better economic prospects than Afghanistan, and considerably fewer risks.