Capital Markets as a Catalyst for Economic Growth

Economic growth is largely influenced by factors such as capital, labour, and technology. A well-functioning financial system permits an economy to fully exploit its growth potential, as it ensures that the best investment opportunities receive the necessary funding, while inferior opportunities are denied capital. Capital markets are a category of markets that facilitate the buying and selling of securities with medium-term and long-term maturity such as equities, derivatives, treasury bills and bonds, corporate bonds, and commercial papers. Key participants in capital markets include regulators, suppliers of capital, issuers of securities, financial intermediaries and third parties who serve to fulfil regulatory and supervisory roles, linking buyers and sellers of securities, and supplying commercial information. Examining Kenya’s capital market depth from various aspects such as pools of capital, corporate activity, new debt issuance, new primary equity issuance and product diversity, reveals that Kenya’s capital market is not well developed in comparison to a more developed market such as South Africa’s.

Operating in full capacity, capital markets are catalysts for economic growth, facilitating the connection between suppliers and users of capital, promoting a savings and investments culture, supporting efficient allocation of resources, financing utility and infrastructure development, and financing private-public partnerships to encourage private sector participation. South Africa was ranked first in the ABSA Africa Financial Markets Index both in 2017 and 2018. The Johannesburg Stock Exchange (JSE) is the largest exchange in Africa, with over 400 listed firms and a market capitalization of USD 13.7 tn, which is 236.2% of GDP, with a bond market estimated to be ZAR 2.7 tn (USD 186.4 bn) and the largest and most established REITs market in Africa. To get here, South Africa made regulatory reforms, as well as the restructuring of the financial system in order to be more transparent, efficient and encourage non-resident participation.

Kenya’s capital market faces a myriad of challenges that leaves most productive projects that have a developmental agenda unexploited. Factors affecting Kenya’s capital markets include; a small economy in terms of aggregate gross domestic product and per capita income, lack of sound macroeconomic policy frameworks and foresight, access to information, lack of adequate efficient market infrastructure for issuing, trading, clearing and settlement, and lack of investor awareness. For the capital markets to contribute to economic growth, there is need to address the issues facing capital markets and provide feasible solutions to spur their development. Thus, in order to improve capital market’s capacity to spur economic growth the following has to be done; there needs to be more innovation in terms of financial products and services available, put in place efficient market structures to attract investors, and improving the knowledge of retail investors on investment products and the benefits of saving, in order to channel more savings into the capital markets.

Furthermore, the economy needs to shift reliance away from bank loans towards capital market instruments to ensure better use of capital markets. For instance, in Kenya banks are the primary source of business funding, providing 95.0% of funding, with other alternative sources such as the capital markets providing a combined 5.0%, compared to developed markets where banks provide only 40.0% of the credit in the economy. There is also a raft of regulatory reforms that need to be done such as reducing the minimum amount investable in all Real Estate Investment Trusts (REIT) in order to ensure that REITs are affordable, expanding tax relief for regular savings towards home purchases and amend Home Ownership Savings Plan (HOSP) to allow fund managers to be HOSP approved institutions.

In conclusion, a well-developed capital market creates a sustainable, low-cost distribution mechanism for multiple financial products and services across the country. This, in turn, helps the business community to raise long-term funds that are used to purchase capital goods, thereby propelling their growth and supporting the country’s economic growth. In addition, capital markets improve financial inclusion by introducing new products and services tailored to suit investors’ preferences for risk and return, as well as borrowers’ project needs and risk appetite. To tap into this, there is need to align regulatory frameworks for capital markets with economic policies in order to enhance efficient financial intermediation. A well-developed capital market will encourage the flow of long-term equity capital investment into infrastructure development, which will go a long way to help achieve socio-economic development goals.