ASSIGNMENT ON: Stock market problems and solution in the context of Bangladesh capital market
What are the reasons of inefficient stock market in Bangladesh? What can be done to develop the stock market?
Stock market is a financial market, where stocks and bonds are used to buy and sell. Shareholders i.e. investors exchange their shares in the stock market. The current market price of a share is determined by the demand and supply of that particular share. Before we go through the reasons of inefficient stock market I would like to clarify about inefficient stock market.
Inefficient Stock Market
It refers that type of stock market which is not stable and healthy for investors. In inefficient stock market price level fluctuates so much. Market can not absorb large number of securities without changing price level. The main cause of share market fall is this, the inefficient stock market. Last year we have experienced a huge crash in Dhaka & Chittagong Stock Exchange.
If we would recall, Dhaka Stock Exchange Gen. Index (DGEN) soared to its highest levels from October to December last year, with the peak on Dec. 5, 2010 at 8,918 points. DSE’s index on Jan. 3, 2010 was at 4568.40 and went up at a staggering 4,350 points or 95.23% increase! But 2weeks later, Jan. 10, 2011, trading on the Dhaka Stock Exchange was halted after it fell by 660points, or 9.25%, in less than an hour, the biggest one-day fall in its 55-year history. Police and angry retail investors clashed after the stock market suffered huge losses.
Now the question is why? We will try to find out in our upcoming discussion the reasons of this huge fall in share market that means the inefficient stock market.
Reasons for Inefficient Stock Market
• Because of power and infrastructure shortages most entrepreneurs could not invest in the real sector (meaning industries).
• Bangladesh was having current account surpluses (huge remittance flows). So more money was coming in than going out.
• Interest rates went down. So, it was not a good idea to get around 8.5% interests per year (before tax) when inflation was around 5-7%.So suddenly, people had a lot of idle money which they were unable to invest anywhere. Anywhere except the stock market that is. Thus the joyride of equities (stocks) began and that situation is still continuing. Because of this excess flow of funds by both general investors as well as institutions (Banks, NBFI's and Insurance companies), multiple attempts by the regulator failed to cool down the market. I can't blame anyone because no alternative investments were available. Plus, when you can earn 30% return in 7 days why would someone invest elsewhere?
• Taking loan by showing excess P/E ratio. (Price-Earning ratio)
• Laid down a limit for investment by the banks and other financial institutions in the stocks.
• Merchant banks and Brokerage houses provide increased margin loan.
• The market through direct listing or book building method was too pricey from the very beginning. • Market P/E (trailing) is around 30 at the moment. This is probably amongst the highest in the world right now. High P/E's can only be justified when you expect superior earnings growth. But that is not the case here. The best companies in BD over the last 10 years have experienced earnings growth of about 20%. For 20% earnings average, the market P/E should be around 20 and not 30 (which it is at the moment).
• The P/E is calculated using the earnings reported by the companies. However, not all of these earnings figures earnings. Especially for banks and non bank financial institutes a large portion of income is coming from one-off equity gains that might not be repeated in the future years.
• IPO’s at premiums higher than the justified ones.
• Heavy involvement in stock market by the Commercial Banks.
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