Stock Exchanges of small countries

The Stock Exchanges (SE) in small countries of the Balkan region are not operating successfully. The comment is only for the countries where the SE is open, because Albania does not have yet the own SE.

What’s wrong with them?

The monthly money volume has not seen an increase in latest years and the number of transactions are so small to be considered as a real stock exchange. A stock exchange is a very important financial market. It is a highly efficient and visible instrument of financing. In the countries that have a tradition regarding to the stock exchanges it is used to finance most of the needs of corporations, way above financing available from banks. Individuals and firms save some of their income and invest it. The stock exchange is meeting grounds for savers wishing to invest their savings – and firms looking for investments.

Another function of stock exchanges is to assist governments in financing their internal borrowing requirements. Governments sell obligations (called bonds) to investors through the stock exchanges in their countries. A stock exchange is, therefore, an indispensable tool for re-financing national debt.

But a few conditions must prevail before a stock exchange functions properly.

The most important condition is the existence of a healthy, growing economy in the stock exchange’s country. Investors flock to robust economies and shy away from sickly ones.

On the face of it, the economy of Balkan region suffers from the illness of stagnation and lack of big and competitive market. On the other hand, the high unemployment, low savings, low level of growth, a trade balance deficit and payments deficits are the macro panorama of the economy as a whole.

It is fact that the economy is growing, but the black economy is still big and has a share almost of half of official GDP. The deficits are covered by enormous capital infusions from donor countries.

When an economy is growing the profits of companies (including those listed in the SE) will grow with it. This makes the shares of these companies an interesting buy. Since no one is buying we must look for the problem elsewhere.

A prospering stock exchange is linked to the existence of the right micro and macroeconomic management. Balkan has more than its share of problems in this respect. The process of transformation of businesses with social capital had four basic defects:

(a) it introduced no new management, ideas or capital to the beleaguered firms which were “transformed”. The market simply does not believe that they were transformed. The same people run the same shows under a different hat.

(b) such transformation violates the concept of Hierarchy, a chain of command. It blurs the distinction between labor (workers) and capital (owners). What is wrong with that is that a ship must have a captain – and only one. Someone must have the authority and the responsibility. Collective management is no management at all. Moreover, innovation change and revitalization are all prevented.

What change could come from the same set of worn out managers? How can thousands of owners decide to worsen the conditions of the workforce – if owners and laborers are one and the same? So, management is polluted by irrelevant, non-economic considerations: power struggles amongst groups of workers, social considerations and political ones.

The other one is high (real) interest rates. When interest rates are high, three effects prevent the resuscitation of the stock exchange:

First, firms have high financing expenses (interest payments) – which reduces their profits.

Second, it is not worthwhile to borrow money and to invest in shares.

Third, it is more tempting to invest money in bank deposits, yielding high interest rates – than in shares. High interest rates are the poison of stock exchanges.

The same is true for low savings rates. If people and firms do not save there is no capital available for investment in stocks.

This, exactly, is the current situation in Balkans. The impossibly high interest rates coupled with exceedingly low savings is happening now in the region. There is basic mistrust between clients and their banks. They prefer other ways of keeping their money.

But all the above is far from exhausting the list of pre-conditions for the proper functioning of a stock exchange.

Investors must have timely, accurate and full information about the firms that they invest in. This will allow them to respond in real time to developments in the company and to prevent losses. This will also make it difficult to cheat them which is where we come to the question of accounting standards.

The accounting rules in Balkans are under revise continuously to have a conformity with International Accounting Standards and International Reporting Financial System.

But the big issue it is that Balkan region firms maintain a double accounting system. One set of books is tax-driven. It is intended to show losses or profits at the whim of the management. An elaborate scheme of hidden reserves lies at the heart of the typical financial statements of the businesses in this region. The other accounting books, even they are in opposition with informality, reflects reality. This is a huge barrier to foreign investment and foreign investors are the driving force in every modern stock exchange.

The trust of investors in the stock exchange is based on legislation to protect their property rights against the firm’s management’ against the authorities and against other investors who might wish to rig the market or manipulate the prices of stocks.

But legislation without an effective judicial and law enforcement systems is like a stock exchange without money. To enforce property rights in Macedonia takes ages and even then, the outcome is not certain. Laws, regulations are in their embryonic stage and some of them seem to have had an abortion: they were hastily and unwisely copied verbatim from legal codices of other countries.

Last is the presence of a fair, transparent and non-corrupt marketplace. The stock exchange, the banks, the regulatory authorities, the police and the courts have to be above suspicion. For the market to be utterly efficient it must be utterly free of any ulterior considerations and motives. Corruption distorts the market’s allocative mechanisms and powers. It is easily discernible in dealings in the stock exchange for all to see. A stock exchange is, after all, the showcase of the local economy.

But there is a problem which helps to explain much of the predicament of the stock exchange in Balkan. It is the fact that the market is missing its most important player: the public sector.

Investors, both foreign and domestic look for the public sector to be active in the local stock exchange. Governments throughout the world use their stock exchanges to sell shares of state-owned enterprises to their populace. The stock exchange becomes a mechanism for the distribution of the national wealth – as embodied by the state-owned enterprises to all the citizens. As we said before, governments also use the stock exchange to borrow money from their citizens.

The public sector in Balkans is not part in most of the stock exchange transactions. Not one company is privatized through the SE. A government’s activity in the stock exchange is proof that the government believes in it. Therefore, if it does not operate in the stock exchange it proves that it does not believe in it. If the government does not believe in the stock exchange in its own country why should the investors believe in it?

A stock exchange must be liquid so that investors would be able to convert their shares into cash easily and expediently. It must include many investment options – professionally put, it must be diversified. This will allow the investors to choose from a variety of investments and also to reduce their risks by dividing their money among a few types of investments.