THE GLOBAL ECONOMIC DOWNTURN – OUTLOOK FOR THE NIGERIAN CAPITAL MARKET

by
Mustapha Muktar, Ph.D
Department of Economics
Bayero University, Kano-Nigeria
Introduction

The reign bearing of the ‘bull’ and ‘bear’ that is the alternating expectations of stock price rise or drop is a common feature of any capital market throughout the world. In Nigeria in the past couple of years, the bullish trend has persisted so much so that normal swings in price movements that should characterize a stock market is discounted. The Nigerian stock market has blossomed so much these past few years that it was being rated globally as among the bourses that offer the highest return on investment. The number of quoted companies and share holder size has grown exponentially including all manner of persons: speculators, jobber’s ordinary traders and money grubbers. By the second quarter of 2008 some investors took the easiest route out off-loading their stock holdings as speculations of the global economic down turn and policy signals were unleashed on the market. This paper will examine the factors that are behind the crises in the Nigerian capital Market under the current economic downturn; however emphasis will be made on the domestic factors that have contributed to the crises in the market.

Some long-standing market players, having been hit by enormous losses in recent times are already considering alternative investment options, much less those who only discovered the goldmine in stock investment, at the outset of the banking sector consolidation.

This first major bear season since the consolidation in the banking sector saw the market capitalisation of the Nigerian Stock Exchange, which represents the aggregate value of companies or stocks, dipping from N13tn in March to N10.87tn on Friday.

Although it is normal for stock prices to go up or down with the interplay of the forces of demand supply, investors were alarmed by the persistent decline in the prices of stocks, which has lasted for over three months.

The causes of the economic downturn in 2008

• Falling House prices.
• Credit crunch.
• Contraction of Credit following demise of Lehman Brothers and other Financial Giants.
• Fall in Confidence affecting consumer spending and investment.
• Global downturn in economic growth.
• Cost Push inflation of early 2008, causing a squeeze in living standards.

·         Massive job loss due to problems in the financial sector.

·         Global rise in the price of Foodstuffs and other goods.

·         excessively loose monetary policy which lead to crash in the global capital markets

·         Downward fall in the world Price of crude oil.

Causes of the Crises in the Nigerian Capital market

·         Significant disinvestment by foreign investors

·         Lingering liquidity tightness; waning public confidence;

·         Panic selling by domestic investors;

·         Possible second round effects on the balance sheet of banks through increased provisioning for bad debts and lower profitability.

·         Huge Margin Trading Losses

·         Lagged Contagion from the Global Financial Crisis

Domestic Factors that Lead to the Crash of Nigerian Capital Market

Commercial Banks’ Margin Loans,   It is a practice in all markets of the world, be it New York or London; players take margin loans from their banks to trade. There are rules (relating to this loan), basically, the person, who approaches the bank to a margin loan, will be instructed by the bank to deposit cash or shares equivalent to about 30 or 40 per cent of the loan he wants to take. For example, if you want to take N100 loan, the bank will ask you to bring N30 in cash or equivalent, in the credit process of the bank, the bank is saying that because the market is liquid and shares quoted on the stock market are near cash, I am willing to accept that as additional security.

The reality that happens in Nigeria is that the banks themselves scavenge for people to come and collect margin loans at cheaper rate some investors even got the loan without depositing the 30% or 40% and indirectly it is not the performance of some companies that determines the marketability of their shares but rather some arrangement have taken place giving the public a false impression on the performance some companies.

Anywhere in the world, margin loans are used for stock market and that is what makes the market grow. Like has been explained, every kobo that the bank has given to a broker was used to pay for shares bought on behalf of the bank. When you have a margin account, it is a joint venture business (but) it is the broker that takes the maximum risk. You are saying, 'I am willing to loss up to 30 per cent' and when it goes down, the bank immediately realises the shares. If you look at all the documentations signed in the banks, they would put the clause there that the bank would sell without recourse to you. Most of them chose not to sell at that time (when the meltdown started), hoping that this was a minor correction, unfortunately, it wasn't, it had become a major depression in the market.

Performance, changes in government or regulators, bad publicity, is some contributors to price fluctuations. In the recent stock market scenario, the relative ease for accessing these margin loans created a huge demand on just about any quoted company, with the result of prolonged periods of upward price movements. This unnatural push led to several shares trading at prices way beyond levels justified by market fundamentals calibrated by the company’s historical and near term performance. The immediate jumbo profits from these transactions dulled the sensitivity to the prevailing risks of a reverse trend.

The banks were said to be owed more than 388 billion naira margin debt by stock broking firms who have found it difficult to pay back the loan. In order to minimize loss, banks went ahead to aggressively dispose of the equities held by the broking firms. This singular action led to the massive offloading of shares by other investors who saw the banks action as loss of confidence in the market. The public has grown confidence in the strong capital base of the banks since post consolidation. Seeing the banks exiting the market was a signal of doom to other investors who have continued to mount pressure on their brokers to sell off their shares. Confidence is now at its lowest ebb. No one really knows when the bulls will return. However, one thing is sure- the lessons learnt from the price crash cannot be forgotten in a hurry.

Nigerian financial institutions found themselves overexposed in non-performing loans, which leads to liquidity crunch. The institution may find it really difficult to meet regular day-to-day transactions. This forced some of them to borrow from other banks at exorbitant rates which worsened the already bad situation.

Loss of customer confidence and patronage, unhealthy competition for rapid growth leads to focus away from core customers to stock market and investment analysts who are constantly watching out for year-end profit numbers which become pivots for share price appreciation and public demonstration of profitability. Consequently, the risk management system of some Nigerian financial institutions that should be based on sound governance, stability, customer relations, transparent finances, security of customer and shareholder funds become eroded. This further reduces the chances of attracting potential future investors and new customers. Customers will naturally keep faith with a stable, customer friendly bank with moderate profits than a high risk institution with astronomical profits.

Another cause is the faults in  domestic monetary and financial policies such as the untimely reversal of the margin trading policy which halted the fuelling of the bull market as well as the consequent increased pressure on banks a few months from the halt of the policy to start recalling their funds; the increase in MPR from 9.50% to 10.5% in a bid to curb the seeming excess liquidity which was also part of the underlying reason for halting the margin facility; the rumours of a CBN policy on the harmonization of banks' year end which triggered a desperation in the industry for fund mobilization which equally bid up the interest rates and made the money market even more attractive. The response of the international investment community to the developments within the domestic financial market environment their reaction to developments in their own financial landscape is another causes that is worthy of mentioning. When the global economy started to operate at the borderline of recession, investors and entrepreneurs generally scouted in desperate panic for alternative investment outlets and opportunities for better returns and minimization of losses.

The Nigerian market which at the time was being driven by excessive bank credits following heavily engineered recapitalization became the coveted bride. For many of the banks with heavily skewed ownership structure the battle for maintenance of the existing ownership structure resulted in shades of financial engineering through the use of re-labelled customer funds and credits from colluding banks to finance the acquisition of trillions of shares. And through a second level of share price engineering at the stock market, ballooned and manipulated prices created enough funds to repay creditors. And to further cover the trail, there was need for second and third rounds of capital raising exercises. Prices of equities continued to soar as if it would never recede. The capital world hailed the Nigerian market as one with the highest returns in the world; and one which equally offers huge opportunities for portfolio diversification in the face of the imminent depression in their markets. As a result, there were massive inflows of portfolio investments into the Nigerian stock market.

Many foreign investment banks promptly set up offices in Nigeria in order to closely monitor and take advantage of the opportunities which the market offered. Earlier in 2006, following the central bank's appointment of 14 local banks to manage the country's foreign reserve, robust relationships developed between the foreign asset managers with which local banks were then mandatorily expected to work with. This relationship further created opportunities for entry into the Nigerian financial market. There was however a series of domestic financial policy faux passes which invariably initiated a reversal of these inflows. The first was the Central Bank of Nigeria's decision to stop the then massive credit expansions which took place via bank lending for equities. The implication of this pronouncement was far-reaching as the hitherto seemingly endless upward price movement of Nigerian stocks, particularly the equities of the banks which were driven by the banks' credit-backed demand pressure, halted. Banks had sustained the equity market boom by using a combination of tactics - direct interventions through lending to stock broking firms primarily to buy their (the bank's) shares  to sustain demand pressure on their stocks such that its prices continued to rise without corresponding appreciation on the underlying values. Shares particularly by these foreign investors who reckoned that the Nigerian market was indeed headed to experience exactly what other global markets were facing. True to that perception, the price slide which started since then has not stopped. The loss of confidence in the market was further strengthened when the Nigerian Stock Exchange declared that one week was going to be a week of price increases only.  

This foreclosed two categories of investors: those who have correctly anticipated the market correction and are awaiting prices to adjust to their correct underlying values before they purchase and those who have large volumes of shares but discover that they cannot easily dispose of them because of these rigidities. For the former group, who would buy at some low prices and wait for a rebound, they are deprived of that opportunity. Furthermore tolerance of such clear violation of fundamental market rules means that indeed they could wake up any day and be confronted by yet another measure that can possibly wipe off their profits. This anti-market decision was a prompt warning to foreign investors who heightened the pace of their fund withdrawals from the Nigerian market.  Another reason for fund withdrawal by these foreign investment banks was the economic crises in their home country too which resulted in tremendous losses and required that they seek funds from wherever they could to service debts created by that situation. Withdrawals for this reason was however given fillip because of the already declining and un-cheery local market which could not correctly provide the required diversification for their weakening portfolio. If the stock market was not initially hurt by Nigeria's own monetary policies, lax bank supervision, anti-(equity)market regulations, it is most unlikely that the massive withdrawal of funds as was being alluded to would have taken place at the level at which it occurred.

Conclusion

The persistent bear run being witnessed in the Nigerian capital market, which has led to huge losses for individual and institutional investors in the past few months, has generated heated debates on the viability of continuous investment in the market.Investors when faced with risks of outright losses would be more interested in loss minimization or profit maximization where it is still possible. Thus if the Nigerian market had provided better real alternatives that would help diversify foreign investment portfolios which could equally result in substantial loss minimizations, the funds pull-out would not have been a large-scale affair. On the contrary, the Nigerian market would have served as a buffer under such emerging circumstances. However there were remedies from Securities and Exchange Commission, the Nigerian Stock Exchange, the Central Bank and even the federal government have all come up with varying measures aimed at stemming the tide in the market place. The earliest reactions came from the Nigerian Stock Exchange who imposed a one-week fixed floor on price drop such that while it was possible for the prices of stocks to go up, it was not possible for them to come down.