Stock market revival plan: Pragmatic or further perilous for investors?

Bangladesh stock market has been in paralysis since December last year. The market continued to fall regardless of the economic fundamentals. The paralysis is the result of alleged massive market manipulation by a handful of well-connected and wealthy individuals. Apparently, they amassed wealth in questionable ways and developed a culture of massive loan default in Bangladesh. They artificially pumped up the secondary market through colossal share purchases to entice 2-3 million naïve investors of small means. As these naïve investors entered the market, they dumped their stocks for exorbitant profit-taking. Such unethical conduct eventually led to the market collapse. Commercial banks' stockholdings also became illiquid — one of the reasons for their current liquidity crisis.

Governmental inaction, incompetence, lethargy, delay, lack of coordination, sporadic imprudent comments by some high officials and their "we-know-it-all" attitude, and above all rampant corruption led to a severe crisis of confidence. Such crisis of confidence paralysed the market and forced the small investors to threaten a political upheaval as the last resort.

This potential upheaval finally drew the attention of the prime minister. These victims still hold her in high confidence and seek refuge in her. She called an emergency brainstorming session. No new and innovative ideas came out of this session though. The so-called expert participants stormed out their brains to invoke a few stale, failed and controversial measures in an attempt to revive the stock market. There should be no King Midas. Anybody familiar with this story knows how it ended. At least the outcomes of this session have created an immediate market euphoria that will evaporate shortly. The stock market always responds to the changes in economic fundamentals. By some measures they remain very weak and will tend to worsen further in case of failure to act soon in a coordinated way.¬

To pay full monetary compensation to investors for capital losses, the total cost will amount to several thousand crores of Taka, subject to proper reporting and accounting. Is it meant to quell the stock market or to subdue the impending political fire, temporarily? The stock market in Bangladesh became a casino. It is based on a zero-sum game. Investors' total capital loss thus must equal the total capital gain of the handful of alleged manipulators of the market. Are these windfall gainers going to be asked to give money to pay for such anecdotal compensation? I dare to say in the negative. Then, where is the money coming from? The only option left is to borrow further by printing money that is already too excessive. This will further exacerbate the inflation rate that is above 12 percent. Inflation being a tax will overburden the general public though most of them had nothing to do with the stock market. Moreover, rising public debt is a rise in future tax burden for the nation. So it makes no economic sense either.

Allowing undisclosed or tainted money for stock market investing without any questioning will create a second bout of moral hazard and an opportunity for double-dip rip-off. The same old known alleged manipulators will re-enter the market to buy stocks at rock bottom prices. They will again inflate the market devoid of any correspondence with the changes in economic fundamentals. At an opportune moment, they will flee from the market with abnormal capital gain. To put it bluntly, they may even hijack the market for the next time.

Asking the commercial banks again to invest in the stock market amid a liquidity crisis is even more perilous. They have become dependent on borrowing in call money market at an exorbitantly high rate for partial replenishment of liquidity. This market is also drying up. Moreover, they already have enormous amounts of money in stocks as illiquid toxic asset in their balance sheets. Additionally, they cannot provide full financing for LCs to import industrial raw materials. The foreign exchange reserve with the Bangladesh Bank is depleting to a level that may no longer secure even three months' import payment in the minimum. Large depositors cannot withdraw money in the full amounts they ask for. All the above may undermine public confidence in the viability of the banking sector.

Continual erosion in confidence may reach a new crisis level and create panic among depositors. I hope there will be no run on the banks necessitating massive bailouts by the government. If it happens, there may be another catastrophe in the offing. Where will the commercial banks get money to make new investments in the stock market to prop it up? For financing such illogical investment under pressure from the government, they will have to ask the Bangladesh Bank to lower cash reserve ratio (CRR) and statutory liquidity ratio (SLR). The latter has already been reduced. The resulting surge in the money supply will further aggravate the double digit inflation with the far-reaching adverse economic and financial consequences, as stated earlier. The Reserve Bank of India already regrets lowering SLR while fighting inflation. This must be a lesson for us.

All the above are bad examples, to say the least. They seem to be unwise, impractical and perilous. The key to stock market resurrection is the restoration of investors' confidence in this market.

The beginning step is to hold the allegedly identified market manipulators accountable within the existing and applicable legal and regulatory frameworks. Let them prove their innocence since they are guilty by wide perception, although the laws say that everyone is innocent until proven guilty. For the future, pragmatic measures must be undertaken to overhaul the financial regulatory system putting people in charge who understand the intricacies of modern finance in the age of globalisation. Modern finance is intricate and dry, not poetic or musical. Proper policy coordination is imperative. All the stock market related announcements must come from the Securities Exchange Commission only. Some high officials in the financial sector must refrain from making sporadic imprudent statements about the stock market since they do not understand modern finance. "We-know-it-all" mentality is a sign of shallowness.

The upper administrations in the Ministry of Finance, the Bangladesh Bank and the Securities Exchange Commission call for reshuffling and re-staffing with competent people who deeply and clearly understand modern finance and modern banking. They also must be transparent and high political risk-takers to regain confidence and to improve the financial infrastructure. What is the root problem in implementing the above to resolve the confidence crisis? The answer is very simple because neither major political party will sustain for long for such undertakings. The best politics is to save the country even if the political risk exposure is too high.

In closing, time is right now to show bold and transparent leadership as there is no other substitute for resolution of the confidence crisis. Its resolution must be followed by sequels of bold and pragmatic measures to improve the economic fundamentals. In an environment of lingering negative psychology, macroeconomic policies are not going to work as expected. We must draw lessons from the current sordid states of the Euro-zone and even from the USA.

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Matiur Rahman is the MBA Director and JP Morgan Chase Endowed Professor of finance at McNeese State University, USA.