Interview : August 2011 - 'Second Phase Of Growth Would Depend On Developed Capital Market'
Joseph Massey is Chairman of South Asian Federation of Exchanges (SAFE), a forum of exchanges with 32 members from South Asian Region, UAE and Mauritius. SAFE works for the development of capital markets in the region and offers itself as a platform to these exchanges for global integration. Massey is also the Managing Director and CEO of MCX-SX, which currently offers currency derivatives trading and is the most recent entrant to India's public-trading exchanges. He has over 18 years of experience in the corporate and financial arena and worked with organisations like Life Insurance Corporation of India, the Reserve Bank of India (RBI), Stock Holding Corporation of India, Multi Commodity Exchange of India Ltd, Interconnected Stock Exchange of India and the Vadodara Stock Exchange. Massey was in Nepal during the executive committee meeting of the SAFE from July 6 to 8. In an interview with Gaurav Aryal of New Business Age, Massey shared his views on capital markets of South Asia and the current status of the Nepali share market. Excerpts: What is the scope for growth of secondary markets in South Asian countries?
I think, post-global crisis, this region is emerging as a high growth region because of the natural demand that it has got and also the governments are very keen to develop each sector so that more employment is created and global investors are willing to come and actually invest. If you look from a capital market perspective, there is demand both from primary and secondary markets. Whichever country you take in the SAARC region, it still has to make tremendously large progress in terms of domestic penetration. That market is huge. Then, we have another opportunity which is in global market. I think all economies have very large opportunity to develop in the secondary market.
Except India, other countries in South Asia have not been able to develop much in this field. What is the problem you see?
There are couple of prerequisites for the market to develop. Indian market has a history of 130/140 years. Over such a long period, we have developed the culture of investment. Despite that, we have penetrated the market relatively less. Indian market is more developed because we have more instruments, more investors, more companies, good infrastructure, clearing corporations, guaranteed good regulation, and infrastructure which is comparable to the best in the world. However, there are many products that we still don't have and now India is aspiring to create those products. India has progressed but it still has a lot to do. Rest of the countries, based on their position in the cycle of economic development, could have reached some level of development in the exchanges. We expect that to happen over a period of time. When global fund comes to one region or one country, visibility of the entire region gets enhanced. Today, you see a lot of funds coming to India. Soon those companies will come and set up their companies in India. Once they set up their companies and invest there, they will also gradually look for what market opportunities are there in the region. India is gradually opening up and Indian citizens can invest outside. Once we open up the market more, a lot of investment from global market will come to India and from there they will go to the other countries of the region. I think the level of development depends on the scale of economy and how much it has developed. But it need not necessarily take the same length of time for each country to reach the same stage of development. We can cut short the time by learning from other's experience. Highlight
Foreign institutional investors and foreign direct investors are still hesitant to enter this region whereas they are going to Taiwan, Singapore etc. Why so?
These countries have been rapidly growing for a very long time. So, the global communities have already identified those destinations. As a result, in the last 20/30 years, their regulatory system and infrastructure have developed so much that the global investors don't see a difference between these countries and their home markets. In SAARC region, some countries have progressed well while others have not. But we all know the model that we have to implement. We just need a more concentrated effort in finding out what are the gaps; what they have and what we don't have. And, we can put regulation and infrastructure in place. The domestic demand being so large, we will see the same level of capital coming in this region eventually. Today, we are not there but we need not take another 30 years to reach there. We can reach there in next five years.
What is the objective of creatig a South Asian network of stock exchanges?
I think we are all determined to do this. We understand each country has its regulatory mechanism and its own capital account laws. But we want to sensitise the countries that economies of scale will be realised if this region can work as one unit. Relatively, hard infrastructures like road, transport and others may take time to be developed. Financial market is soft infrastructure which can happen easily. The secondary and tertiary gains of developing an efficient financial market are very large compared to manufacturing and few primary sectors. So, instead of developing the manufacturing sector first and then going to the financial services, it would be a good idea that in this region we shift focus to financial services and the advantage of financial services trickle down to the rest of the economy. Our cost of fund will reduce and we will be able to raise more funds for developing infrastructure, for economic activity and as a result all benefits will flow such as more jobs, better education and necessary infrastructure. So, more capital gets attracted and suddenly we will get out of the vicious cycle. Today, we are in a vicious cycle of low capital, low infrastructure and therefore, low investment. All countries can't achieve the same level of infrastructure simultaneously, but when some of them achieve a level, the trickle-down benefit will happen to the entire region.
Protection of small investors in capital markets is taken as a major challenge. How can such network protect the investors?
At SAFE, we have identified the global best practices. Each country has adopted these global best practices which are prescribed by IOSCO (International Organisation of Securities Commissions). What SAFE does is that the good practices of one country are shared with others. We don't wait for those countries to learn these things over a period of time. We are sharing these experiences with each other so, until real business can get done, we can share a lot of knowhow and ensure that the level of knowledge of each one is the same.
Why are South Asian governments hesitant in opening their markets for international investment?
We are saying that we need to have investor protection. So, should we open the market or not? The first level of investor protection is that you have better infrastructure for trade, better laws, and more capital to protect them. All these things can come if you have a market of significant size. We want the best protection to be given to the domestic investors. But we cannot provide that as our markets are very narrow, we don't have all the products, we don't have large number of investors, our trading volume is small and the number of companies is low. You know that the total income from such market will be naturally very less. So, we need to invest more in increasing the capital, improving law and, giving the investor better safety. If you widen the investor base then obviously it will generate more resources. You will be able to draw more resources into the infrastructure, set up a clearing corporation, depository, have best tools and educate your people better. So, you need the capital market to be very efficient. Today, each country has domestic investors but they are very few. We need institutional investors who can bring in big money and take a deeper and longer view. So, once we complete this, we have to complete the market by getting good quality investors by offering all the products available today in the global markets. Once you create these two, your protection will improve; your market will become safe because your market is aligned to global market. If the investors are investing in the growth of Nepal, you get a diversified base of investors in which some are taking a view with 10 years, some with five years, and some with just one year or less. When you get the mix of all of them, your market will be stable. Some may go out but many others will stay.
How do you see the future of capital market in this region?
I think there are three or four facts which indicate that the future of capital market is enormously good. All the countries in this region more or less have the same level of development. They are developing and gradually going up the scale. In the initial phases, all of them are dominated by the public sector enterprises. Public sector enterprises naturally have the challenge of resources. Since the demand of economy is very large, there is a requirement of private capital and private production in order to supply that requirement which the public sector will not be able to deliver. The public sector has reached its level and now the private sector has to come up. It has to come up in infrastructure, education, manufacturing, services and everywhere. For developing all these, the people need risk capital. The risk capital can only come from the capital market. So, I think one is dependent on other. If you have a robust capital market, more people will be able to raise capital and set up an economic enterprise which will create more jobs and more business ventures. It is a cycle. Every economy has realised that we have gone through the stage where the public sector was dominant and banks had a major role to play. Second phase of growth is going to be dependent on developed capital market that should have equity, bond, derivative, service management etc. so that people can raise short term money and long term money. Then, we will see private enterprises start coming in.
Experiences have shown that the derivative trade has distorted the natural growth of the market. Can South Asia region avoid such distortion?
SAFE is advocating an exchange traded market where derivatives get traded on the exchanges. They are safe because the counterparty has a guarantee from a clearing corporation. They are better risk-managed, more tightly regulated, and more transparent. As a result, exchange traded market is always a safe market. In 2008 and in the earlier 1998 crisis, what went wrong was outside the exchanges. So, the lesson from the 2008 crisis is that we should get more and more products on the exchanges. Second lesson is we can have laws which are similar all over the world. So, G20 is now advocating that we should have such norms and regulation that are similar in all countries. The advantage SAARC region has is that we don't have to make the same errors some other countries have made. We now already have better regulation on banking system and in the securities market, we have all the institutions developed, most countries have depository, clearing corporations and most countries now trade on electronic system. Having built an infrastructure that is similar to global environment and global rules that are gradually becoming common, I think we are operating on a much safer market. Many prominent stock exchanges like those in Europe and Japan have either crashed or remained stagnant for a long time now. Is it so because those economies have reached the point of saturation?
Post-2008, two things have happened. While the exchange traded markets are same, their economy is slowing down and the financial system has observed a very large amount of loss. It will take a long time for them to come out of these losses that they have suffered outside the exchanges. Secondly, those economies are diversifying to come back to high growth phase. In doing so they are investing outside the country. You can't increase the economic growth significantly if the economy is already developed. So, they will only have to look at investing and business opportunities in rest of the world. The good news is while Europe and the US are slowing down, Asia and Africa are growing. If you look at world growth perspective, today there is more demand than it was before. According to a recent news, Boeing is supplying US$ 30 billion worth of planes but all these planes are going outside US. The world economic structure is changing. There is more demand outside Europe and US. And the world community is happy. It does not matter whether I sell my planes in US or outside US. In this process, companies benefit, the society where they work benefits, overall the whole world benefits. So, until the global market continues to be on a growth stage, I think it is a good news and more and more of this will continue to happen. Today, we are living in the era when the world market has more or less started looking similar or at least it has aspirations to look similar. So, we are getting into more openness, more transparency, similar regulation, more international trade. The growth of one will cause growth in other. I think the world economy will continue to grow, especially these emerging economies and developing countries will continue to grow for next 30/40 years and it is good news to the rest of the world.
Do you see the possibility of instruments and mechanism like regional mutual funds in South Asia to invest in the share market?
One of the discussions that we had both with the SAARC secretariat and the central bank here was in this very line. We should try and create some kind of regional hub in which we could have institutions which are not only taking domestic view but are taking the regional view. It could be regional investors, regional mutual funds and exchanges with cross border trading. It will depend on how much time it will take for each regulator and each country to digest that. But I think in the foreseeable future, in next two to three years time some of these concepts will actually become a reality.
Now, the commodities future trade is also booming in the region. And they seem to have posed sort of regulatory challenge. In Nepal such market is blamed to have facilitated capital flight. How is your view?
Commodities markets are markets for risk management. Secondly, they are market for giving price signals of what is expected to happen in future so that policy makers can take policy measures three months or six months in advance. Third, the physical market for commodities lack transparency, they are fragmented. To give a common view to the rest of the world on what is happening in this market, whether there is crisis building up or not you need to have an efficient futures market. An efficient futures market also brings an efficient physical market. I don't agree that commodities market cause flight of capital because it is essentially a market for risk management. People will not invest very large amount of money until they invest in the physical market. Futures contract should be for one, two or three months which is not a long-term investment. Typically, flight of capital takes place because of other natural economic indicators like high inflation, low growth of economy and interest rate structure. The domestic capital has to remain here and does not have an option. But if it is global capital, it goes to the most efficient market which has high growth, low interest bearing and good opportunity for growth. Commodities markets are rational markets. These markets will look at the fundamental demand and supply. Based on the fundamental demand and supply, price recovery will take place.
If someone is buying wheat, cotton or gold, that means the price of that commodity in the future can go up. But the price of a commodity futures contract will go up only if the physical commodity goes up. Physical gold is going up because someone is buying physical gold. They are too integrated together. Physical market demand and supply is dependent on actual consumption and actual supply. I don't think we should panic at the price fluctuation in the commodities exchanges. However, if we can have regulatory system, more transparent system, better safeguard on exchange, clearing corporation it will eb better because then some of these worries will go away.
Of late, the share market index as well as confidence of investors has remained low in Nepal. How can these be bolstered up ?
There are no shortcuts to it. When an economy is going through a low cycle and if you only have domestic market, the entire country has one view. You don’t have a contrary view from anyone else because you only have individual retail investors. Their appetite to take a long term call is very minimal. So, when your market is going through slowdown, the individual investors will be more scared so they will also take a view which is not more than a day. Now, you need someone who can take a view which is for one month, one year or five years. This can only be done by institutional investors. So, it is paramount that Nepal tries and builds up domestic institutional investor community so you can put mutual funds in place. I don't know how your pension industry is, but I can be pretty sure that some of those funds will come and they will invest in the capital market. And insurance industry too can invest in capital market. This is level one. You now have a person who is willing to take a call which is a longer term. But still they are domestic and have a view which is not very diversified. If you can adjust global investors inside, you will have a view which is very different. They are willing to take a call which is much longer, in much larger quantum of money because now the stocks are available very cheap. Their cost of borrowing will be less. They can come and do large borrowing and as a result the market will grow up. So, in a market which goes to such a long term low cycle, the only way to break out of the cycle is by ensuring that institutional money both from domestic and global markets gets attracted to the country and I think you should do that.
