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Bangladesh’s Capital Market: A Need For Policies to Regain Investors’ Confidence

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LightCastle Analytics Wing
July 7, 2020
Bangladesh’s Capital Market: A Need For Policies to Regain Investors’ Confidence

Capital markets have a huge role to play in the economic development of the country. An efficient capital market helps allocate capital to businesses efficiently. Businesses in turn use the capital to grow, generate new ideas, and spread novel technologies. As a result, productivity improves, and the overall economy benefits.

Bangladesh’s capital market, however, has greatly lost the confidence of its investors due to negative performance in the previous two years and the COVID-19 pandemic crisis. Yet, the country’s capital market needs these investors now more than ever in order to revitalize the nation’s economic recovery.

Policymakers, in particular, the Bangladesh Securities and Exchange Commission (BSEC) can play an important role in bringing back investor confidence in the country’s capital market. Confident investors can then invest in good quality businesses that can improve the latter and the nation’s economy as a whole. 


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Declining Performance in the Past Leading to Reduced Confidence in the Present

Bangladesh’s capital market has failed to keep up with the country’s economic growth. Among its regional peers, the market capitalization-to-GDP ratio is the lowest. The ratio has been decreasing over the years suggesting a lack of listing of large corporations in the market. 

Consequently, investors are losing confidence to invest in the country’s capital market as large corporations are more likely to provide regular dividends and coupon payments.

Figure: Market Capitalization-to-GDP ratio (in percentage) of selected Asian countries / Source: IDLC Monthly Review

Two Consecutive Years of Negative Growth Affected Investors’ Optimism

In the past two years, Bangladesh’s capital market has undergone negative growth. The major index DSEX fell 28.7% during this period. After posting a stellar return of 24% in 2017, the broad index DSEX declined by 13.8% in 2018, wiping out USD 4.3 billion of market capitalization. [1] In the year 2019, the key market index fell 17.3% to 4,452; hitting a 42-month low and the total turnover fell 14.6% to BDT 1.14 trillion.[2]

Figure: Daily Average Turnover at the Dhaka Stock Exchange (in BDT billion) from 2012-2019 / Source: City Bank Capital Resources Limited

Macroeconomic issues such as the liquidity crisis in the banking sector, aggressive bank borrowing by the government, and depreciation of the Bangladesh Taka against the US Dollar have contributed to the downfall.

Besides, issues such as the clash of Grameenphone with BTRC over default payments, liquidation of People’s Leasing and Financial Service Limited, poor payout ratio of listed companies, and reduction in the price of large-cap companies like BATBC, Square Pharma, and United Power have also worsened the situation. The capital market of Bangladesh and its investors entered 2020 amidst such negative economic outcomes.

Figure: Month-end DSE Broad Index (DSEX) points from January 2019 to February 2020/Source: Bangladesh Bank

COVID-19 Worsening the Already Worsened Mood of Investors

The first COVID-19 case in Bangladesh was announced on March 8. The announcement caused a huge drop in investors’ confidence as they became uncertain about the country’s economy. The key index of the Dhaka Stock Exchange (DSE), DSEX, fell to its lowest level since January 2013.

On the other hand, the Chittagong Stock Exchange (CSE) also registered a loss that day. The selected index, CSCX, and All Share Price Index, CASPI declined by 466.9 and 769.3 points respectively.[3]

Figure: DSEX Closing Points from March 1 to March 9 / Source: Dhaka Tribune

To avoid the free-fall, Bangladesh Securities and Exchange Commission (BSEC) issued a circular that the opening price of the listed security will be set on the average closing price of the preceding five trading days and the average price will be considered as the floor price and lower limit of the circuit breaker.[4] 

Instead of encouraging further investment, the move discouraged investors from investing. The floor price was higher than the price at which investors were interested to buy. As a result, the liquidity of the market and its appeal to foreign and sophisticated investors were reduced.

Later at the end of the month, the government announced a public holiday from March 25 that extended till May 30. Considered “Non-essential,” the two stock markets were also closed down. Bangladesh remained the only country where the stock markets were closed for two months due to the coronavirus pandemic.

The New York Stock Exchange shifted to electronic trading after two traders tested positive while regional markets remained open and rebounded. The sudden move to close down the stock markets has mainly affected small retail investors as they could not sell their shares to access emergency funds.

Finally, the stock markets opened on May 31 after a 66-day hiatus. However, the trade volume was very low due to the floor price. Most buyers were not interested in buying stocks at the floor price, which was higher than the last five days’ average price.

The benchmark index, DSEX closed at 1.37% points down compared to the previous week’s index value. [5]

DateDSEXDS30
May 314,060.451,365.37
June 013999.491,347.18
June 023969.581,330.51
June 033,963.411,328.51
June 043,953.391,321.49
Table: Closing points of DSEX and DS30 indices of the Dhaka Stock Exchange in the first week after reopening / Source: Dhaka Stock Exchange

Rescission of Floor Price Setting, Digitalization of Transactions, and Luring Foreign Investors to Retrieve Investor Confidence

The last two years and the current pandemic crisis have greatly hurt investors’ confidence in the country’s capital market. On the other hand, capital markets elsewhere stumbled a bit but reached record-high levels as investors remain hopeful for an economic recovery. Therefore, policymakers, particularly Bangladesh Securities and Exchange Commission (BSEC), should take steps to regain investors’ confidence so that the latter can aid in the country’s economic recovery.

Some policies BSEC can take to improve investors’ confidence include:

Remove Floor Price-Setting Scheme to Encourage Investment

The floor price-setting scheme was meant to prevent investors from facing further losses due to the stock markets going negative. But the scheme has discouraged investment in the first place. 301 companies listed in the Dhaka Stock Exchange could not find buyers as their floor price was higher than the average price.[6] 

The price-setting scheme goes against the basic economic principles of supply-demand equilibrium. Such a floor pricing setting was adopted by the Karachi Stock Exchange during the 2008 Global Recession. The action not only froze trading but also eroded investors’ confidence even after the removal of floor pricing. BSEC should take note of this matter and take steps to gradually rescind the floor price-setting scheme. 

Fortunately, BSEC lifted the floor price restrictions for transactions in the block market on June 15.[7] This is a good sign, although the move will not impact small investors as they do not participate in the block market where the minimum allowed transaction is BDT 5 lakhs.

BSEC should also remove the restriction on the main market so that small investors can benefit as well.

Adopt Widespread Electronic Trading for Continuous Transaction

The Dhaka Stock Exchange (DSE) uses Flextrade – a real-time trading platform that allows remote trading from any suitable device. But only 5% of trades of the bourse are executed online. As a result, trading could not have taken place during public holidays. There are concerns about lockdowns as the number of COVID-19 cases is increasing which might lead to the closure of the stock markets again. 

BSEC should, therefore, provide incentives for traders and brokers to adopt electronic trading. 

Electronic trading will also support the need for physical distancing as market participants do not need to be physically present in the market. This measure will support small retail investors who might need emergency liquidity if the economy faces a further downturn.

Bringing in Foreign Investors Can Be a Key to Raising Investor Confidence

Foreign investors tend to invest for the long term. Thus, they bring stability to the market that will encourage large-cap companies, and consequently, sophisticated investors to participate. Overall investor confidence can, therefore, be improved by bringing in foreign investors. 

However, foreign investment faced a downturn last year due to currency depreciation and other negative economic outlooks. There was a record of net sales by foreign investors while purchases reduced. Total foreign turnover at DSE stood at BDT 80.3 billion which was 10.7% lower on a Year-on-Year basis.[2]

Figure: Year Wise Total Foreign Buy and Sell (in BDT billion) in Dhaka Stock Exchange from 2011 to 2019/Source: City Bank Capital Resources Limited

There were already initiatives taken to attract foreign investors in the capital market earlier by the country’s primary bourse Dhaka Stock Exchange. It collaborated in a strategic partnership with the Shenzhen Stock Exchange to launch the CNI-DSE Select Index (CDSET) comprising 40 companies. There are also plans to launch Size-Based Indices like CNI-DSE Large-Cap Index, CNI-DSE Mid-Cap Index, and CNI-DSE Small-Cap in the coming days.[8]

The country’s two stock exchanges should, therefore, undertake more such strategic partnerships to attract more foreign investors. The technical support provided by these strategic partners can build a strong foundation for the markets required for foreign investments. 

In addition, policymakers can consider “tax-loss harvesting” in order to improve the country’s capital market image for foreign investors. Under tax-loss harvesting, investors are taxed at an aggregate level instead of each trade. Such a facility is allowed in India and Pakistan and can be adopted in Bangladesh as well.[9]

Boosting Investor Confidence for the Long-Term: Development of a Vibrant Bond Market

Bangladesh’s capital market lacks a fully developed bond market. This fact has been acknowledged even by the newly appointed commissioners of the Bangladesh Securities and Exchange Commission (BSEC).[10] However, the issuance of a Taka-denominated bond by Pran Group in the international market and that of Ashuganj Power Limited in the local market shows promise for the country’s bond market.

Figure: Bond Market Development in selected Asian countries (in USD billion), November 2019/Source: Asia Bond Monitor November 2019, Asian Development Bank

A vibrant bond market can provide investors with a less risky asset. This can increase participation in the country’s capital market. Moreover, the fixed coupon payment of bonds can increase investors’ confidence in the market. On the other hand, corporations will have a low-cost alternative to banks for funding.

Currently, corporations seek funds for long-term investments from banks that mainly focus on short-term financing. Thus, a vibrant bond market can help businesses raise much-needed funds for long-term capital projects and provide respite for banks that need to bear the burden of providing the former with funding.

A developed bond market can also help the government as well. Instead of going for foreign funds, the government would be able to mobilize local funding for large infrastructure and development projects. The need is more acute at the current moment as the government will need to allocate most of its current budget for healthcare and social security measures due to the pandemic crisis.

However, bottlenecks exist. Bond issuance in Bangladesh is a lengthy process that contradicts the fast-paced dynamic nature of businesses. To adapt to the fast-paced dynamism, Indian regulators require only notification of regulatory compliance for businesses after bond issuance.[1] 

BSEC can also replace its lengthy bond issuance process with a process similar to that of the Indian market in order to allow the country’s investors, businesses, and even the government to reap the rewards of a thriving bond market. 

Bangladesh’s capital market has gone through a lot of downturns in the past two years. As a result, investor confidence went down as well. The situation went further south with the COVID-19 pandemic.

Now, as the country’s two stock exchanges have reopened, it is time for policymakers to diversify the market so that investors, businesses, and even the government can benefit and help on the path to economic recovery.

Farhan Uddin, Content Writer at LightCastle Partners, has prepared the write-up. For further clarifications, contact here: [email protected].

References


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WRITTEN BY: LightCastle Analytics Wing

At LightCastle, we take a systemic and data-driven approach to create opportunities for growth and impact. We are an international management consulting firm which creates systemic and data-driven opportunities for growth and impact in emerging markets. By collaborating with development partners and leveraging the power of the private sector, we strive to boost economies, inspire businesses, and change lives at scale.

For further clarifications, contact here: [email protected]

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