Ethiopia’s maiden organized securities exchange, the Ethiopian Securities Exchange (ESX), officially launched its operations a fortnight ago with a lot of hype and widespread international acclaim. The ESX officials hailed the occasion as a critical step towards fostering a culture of investment and financial inclusivity in Ethiopia. Meanwhile, the Director General of the Ethiopian Capital Market Authority (ECMA), Hana Tehelku, said that this accomplishment will “enable businesses to access sustainable financing and provide investors with new opportunities to grow their wealth.” More particularly, public officials as well as some financial and economic pundits have espoused the view that capital markets like the ESX will have good distributional implications. They argue that ordinary people can invest in corporate securities according to their financial capacity and thus benefit from the wealth that will be created.
The question then is: Is this claim legitimate, or is it a purely rhetorical exercise?
The economic impact of capital markets can be direct or indirect, creating winners and losers in the process. Direct impacts operate through access to funding for businesses and the government, profitable opportunities to invest in marketable securities, and the storage of financial wealth. Indirect impacts mainly work through a growth dividend.
The access-to-finance argument is evidently compelling. Domestic firms have been overly dependent on credit from commercial banks, which have been extracting rents from borrowers due to lack of alternative finance providers. Bank-centered loans have also been biased against long-term private sector investments. The ESX thus gives listed firms the option of tapping larger volumes of funding through equity and debt markets, lowering their cost of capital while also being able to think long term.
The government, too, can henceforth meet its long-term financing needs in a non-distortionary way. Traditionally, it has had to sell illiquid Treasury bills and bonds, crowd out private sector bank loans, rely upon central bank direct advances, or secure external loans. Moreover, the government will have more policy instruments in its macroeconomic stabilization toolkit.
However, individual investor participation in capital markets is determined both by individual savings and also by a certain level of financial sophistication. Only the wealthy, and to a lesser extent upper-middle-income people, can respond to capital market signals to earn higher returns on funds that are not needed immediately. Likewise, only they can store wealth in financial-market products to protect or build it over time. This means that the bulk of the Ethiopian population is taken out of the equation.
According to the Ethiopian Economics Association, one-third of Ethiopians live in absolute poverty with increasing depth. More than 70% of the population is engaged in mostly rain-fed agriculture. Unemployment levels are alarmingly high, and those who work pay unjustifiably high personal income taxes with the top marginal rate set at 35%. Thus, savings at the household level are minuscule. To make matters worse, escalating inflation has further eroded living standards. Thinking about a securities investment is, therefore a luxury for most households.
Even in wealthier countries, the great majority of retail investment in capital markets is controlled by a small number of wealthy households. For instance, the overwhelming number of American and European families holds no direct investments in stock markets at all. Most families have indirect investments through institutional investors, especially pension funds, which aggregate retirement savings to invest in long-term securities for adequate and sustainable income in old age. But even after taking into account these indirect holdings, most people have modest stake in capital markets. In citizens’ everyday lives, jobs, cost of living, and real earnings matter much more than the prices of stocks and bonds.
But then, advocates of the ESX also laud the indirect benefits to citizens. Specifically, investment in corporate securities can promote capital formation and thereby economic growth. The supposition here is that growth would then trickle down to the citizenry in the form of jobs and real-wage growth. Nonetheless, this argument ignores two facts. First, the ESX’s contribution to economic growth depends critically not on its mere establishment but rather on its functional and operational efficiencies, which have been lacking in many African stock markets. Second, what is good for the economy at a macro level is not necessarily good at a micro level. Whether or not growth reaches the masses is conditional on its source and deliberate interventions such as social policies and anti-poverty programs. Otherwise, as Nobel Prize-winning economist Joseph Stiglitz demonstrated a decade ago, trickle-down economics is untenable: growth could just trickle up to the rich and worsen income inequality and poverty.
It is also worth noting the well-documented disconnect between stock markets and the real economy. In the United States, home to the world’s largest equity exchange – the New York Stock Exchange (NYSE), the relationship between stock performance and real economic growth is tenuous. The link between capital market development and poverty is also indirect and gradual. An empirical study published in 2023 shows that stock market development has no significant impact on poverty alleviation in a sample of six Sub-Saharan African countries, including those with the more progressive stock markets (South Africa, Nigeria, and Kenya). And there is no reason why these results should be different in the case of Ethiopia.
True, the ESX has a fundraising platform for small and medium-sized enterprises (SMEs), which in theory can expand and create more jobs. However, most Ethiopian SMEs, except perhaps some innovative businesses in the tech sector, are characterized by relatively low productivity, competitiveness, and management skills, which constrain their ability to grow to become large. In fact, exit rates are high among the smaller firms. This implies that local SMEs seem especially unlikely to take full advantage of the access to capital offered by a securities exchange.
With these considerations in mind, different measures can be adopted to bridge the gap between capital markets such as the ESX and the average Ethiopian household.
First, the government should set a minimum wage, reduce the number of personal income tax brackets and the corresponding tax rates, and control inflation or implement cost-of-living allowances, so that the working class might achieve savings from improved disposable income.
Second, assuming healthy household savings, the capital market authorities may consider creating basic, simple, and low-cost investment products for individual investors with elementary knowledge and investment needs.
Third, there may be a way to link informal financial systems to the ESX. For example, the savings of mutual assistance associations such as edir might be consolidated and then invested in the capital market to earn higher benefit for the members.
Fourth, the government can establish and enforce property rights for tangible rural assets like livestock, which may then be converted into marketable securities (with possible guarantees by the regional governments) to raise capital for an association of owners.
Fifth, microfinance institutions are well known for their outreach to the poorer segments of society, so the pool of their loans can be securitized to increase their return and funding capacity.
Finally, the government or its development partners could issue bonds in the capital market and use the proceeds to support the poor’s cause through, for example, development of affordable and social housing or slum upgrading.
To conclude, none of this is to argue that capital markets in Ethiopia are undesirable. But one should not appeal to benefits to the common man as a reason for their establishment. The direct individual beneficiaries will be predominantly the rich and a few financially educated elites. The supposed indirect benefits to the masses are, at best, uncertain.
Matias Assefa is an economic and business analyst based in Addis Ababa. You can reach him via matias.assefa@gmail.com
