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Time to strengthen our capital markets to tame forex risks

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Time to strengthen our capital markets to tame forex risks


savings

Out of the six pillars that make up the Absa Africa Financial Markets Index; access to foreign exchange, market transparency, tax and regulatory environment, legal standards, capacity of local investors and market depth, the last two are most crucial.

It is therefore a little disappointing that, from Absa’s latest research, they are the only pillars that Kenya has scored below average. That raises plenty of concerns.

With China’s bilateral lending and outbound foreign direct investment decreasing, how will a weak local market plug this hole? Is the new administration raising its hopes too high leaning on local markets?

How will we fund our infrastructure projects when our savings rate (12per cent) are some of the lowest in the world?

To start with, let’s look at why we need a well-functioning local capital market. One; it increases access to local currency financing and thereby helps manage foreign exchange risk and inflation better. This is a valuable benefit especially in the current high-inflationary, strong-dollar environment.

Two; a vibrant local market will help provide greater financial market stability. Lessons learnt from the 1998 Asia crisis when sudden capital outflows caused a lot of misery. Good to note that World Bank research shows that emerging markets were better able to manage the 2008 global financial crisis, averting major economic dislocations. Three; it provides benefits at the macroeconomic level by supporting monetary policy transmission, which is facilitated through liquid securities markets.

For us to gain these benefits, we will need to urgently accelerate from where we currently stand. First is to increase our savings rates. Foreign savings can never be a good substitute for domestic savings. They cannot be a basis for our domestic investments. Such an arrangement does not end well in the long run (think Sri Lanka). We can borrow a leaf from our neighbours too.

Tanzania and Uganda savings rates stand at above 20 percent, Africa stands at 17 per cent while the average for the world is 24 per cent. Two is to embrace innovation. How about introducing local currency bonds or bonds indexed to the exchange rate? There’s plenty of international investors with hundreds of billions of dollars looking for higher yields. Three is to create an inviting economic environment. If foreign investors see reckless fiscal and/or monetary policies, they would vote with their money. Sound economic policies tend to attract more portfolio inflows into a country.

Achieving these goals is crucial to the economy too. Research from the World Bank shows a high correlation between fundamentals (read: gross domestic capital markets and per capita income) and the level of development of the local capital markets. This explains in large part why, in general, capital markets are at an embryonic stage in smaller and low-income countries.

One more thing, as the development of capital markets is best done gradually, it, therefore, means that in the near term, tapping international markets will remain the feasible option for the foreseeable future for Kenya. That door has to remain open for now.



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