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Capital markets for financing economic development - II

Thursday December 24 2020
BOT PIC

As we stated last week, one of the primary objectives of any nation is ensuring sustainable, all-inclusive socioeconomic development for its citizens. In the light of the investment requirement to achieve such objective, financing for growth and development from various sources has to be considered - and one of those sources is capital markets. However, for domestic capital markets to be used effectively as one of the fundamental platforms for financial resource mobilization, there is a greater need to develop and strengthen it in order to be used to mobilise domestic savings for commercial and development financing.

The role that capital markets have in financing infrastructure development, large agricultural and industrial enterprises, services industry, and Small and Medium Enterprises (SMEs), and the links with economic growth, are increasingly being highlighted. As to where, a vibrant and well-functioning capital market, as part of the financial system, permits an economy to fully exploit its growth potential, as it ensures that the best investment opportunities receive the necessary funding, while the inferior opportunities are either denied capital or access lesser and expensive sources of capital.

The fundamental channels through which capital markets are connected to the economy, economic growth and development are outlined as follows:

(a) Creating a bridge between suppliers of capital and users: The contact between agents with a monetary deficit (government development projects, economic and business enterprises, individual with housing and other socioeconomic needs, etc.) and the ones with monetary surplus (fund managers for pensions, contractual savings, insurance companies, mid-to-high net worth individuals, etc.) can take place directly through direct financing, but also through a financial intermediary in form of indirect financing, which is a situation whereby specific operators facilitate the connection between the real economy and the financial market. In this case, the financial intermediaries could be banks, investment funds, pension funds, insurance companies, or other non-bank financial institutions.

(b) Promoting saving and investments: Capital markets increase the proportion of long-term savings (pensions, life insurance covers, etc) that is channelled to long-term investment. Capital markets also enables the contractual savings (pension and provident funds, insurance companies, medical insurance schemes, collective investment schemes, etc.) to mobilize long-term savings from small individual household and channel them into long-term investments. It fulfils the transfer of current purchasing power, in monetary form, from surplus sectors to deficit sectors, in exchange for reimbursing a greater purchasing power in the future. This way, the capital markets enable corporations to raise funds to finance their investments in production activities.

The implication will be an increase in productivity within the economy leading to more employment, increase in aggregate consumption and hence growth and development. It also helps in diffusing stress on the banking system by matching long-term investments with long-term capital. It encourages broader ownership of productive assets by small savers and hence facilitate implementation of inclusive economic empowerment and financial inclusion policies.

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It enables citizens to benefit from economic growth and wealth distribution and provides avenues for investment opportunities that encourage a thrift culture critical in increasing domestic savings and investments that translate to economic growth.

(c) Facilitating efficient allocation of scarce financial resources: the capital markets facilitate the efficient allocation of scarce financial resources within the economy by offering a large variety of financial instruments with different risk-and-return characteristics. This competitive pricing of securities (e.g. equity and debt instruments: various forms of bonds for infrastructure, environment impact, local government development, etc.) and large range of financial instruments allows investors to better allocate their funds according to their respective risk and return appetites, thereby supporting economic growth.

(d) Financing utility and infrastructure development: The capital markets also provide equity capital, debt capital and infrastructure development capital that have strong socioeconomic benefits through development of essential utilities such as roads, water and sewer systems, housing, energy, telecommunications, public transport, etc.

These projects are ideal for financing through the capital markets via long dated bonds and asset backed securities. Infrastructure development is a necessary condition for long-term sustainable growth and development. In addition, capital markets increase the efficiency of capital allocation by ensuring that only projects that are deemed profitable can successfully attract funds. This will, in turn, improve competitiveness of domestic industries and enhance ability of domestic industries to compete globally, given the current momentum towards global integration. The result will be an increase in domestic productivity which may spill over into an increase in exports and, therefore, economic growth and development

(e) Financing Private-Public Partnerships: Capital markets are in often cases used as platforms to promote P-PP projects, thereby encouraging participation of private sector in productive investments. The need to shift economic development from public to private sector to enhance economic productivity has become inevitable as resources continue to diminish.

It assists the public sector to close the resource gap, and complement its effort in financing essential socioeconomic development, through raising long-term project-based capital. It also attracts foreign portfolio investors who are critical in supplementing the domestic savings levels and who facilitate inflows of foreign financial resources into the domestic economy, thereby supporting economic growth. (To be continued)

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Moremi Marwa is chief executive officer of the Dar es Salaam Stock Exchange Email: [email protected]

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