Stock Markets, Foreign Investment, and Economic Growth in Africa

Over the course of the last decade, the economic development paradigm has increasingly shifted toward private sector approaches for achieving sustainable growth. As a result, the financial sector, and in particular, the development of efficient equity markets, are now considered to be an essential aspect of a developing economy. As the African economies attempt to develop their private sectors, it is becoming clear that the growth of equity markets can offer an important catalyst for sustainable development.

A well-functioning stock market is regarded by many as a core component of the financial sector, and proponents of stock market development argue that such markets play a critical role in realizing sustainable economic growth. This is achieved in a number of interrelated ways. First, an efficient stock market is a source of equity finance for corporations, thereby enabling them to raise long-term equity capital. This is especially relevant in those countries where commercial banks are largely state-controlled or inefficient in their lending practices. In addition, the development of a stock market will attract inflows of foreign capital and will strengthen linkages between domestic and international capital markets. Equity market development can facilitate privatization programs and encourage domestic savings and investment. Finally, by requiring good financial reporting practices and exerting market discipline through disclosure and managerial accountability, stock markets can add to the stability of domestic firms.

Critics of equity markets in developing economies argue that stock markets may actually do more harm than good. This viewpoint contends that the destabilizing effects of introducing stock markets into economies with underdeveloped legal, regulatory, and monetary systems can produce economic instability that outweighs potential gains. In such an environment, a stock market could become an arena for speculative investing and gambling and would therefore be highly volatile and inefficient, thus undermining investor confidence. This could ultimately adversely affect the financial system and the economy as a whole. ¹

Although research on the subject is limited, and no definitive conclusions can be drawn, recent evidence seems to support the view that stock markets can be catalysts for economic growth. ² The International Finance Corporation (IFC), the World Bank’s private sector arm and the leader of private sector development efforts in Africa, believes that capital markets play such an important role in sustaining private sector growth that one of its stated priorities for sub-Saharan Africa is to stimulate the development and growth of its stock markets. ³

Another motivation for establishing stock markets is to attract private foreign capital. ⁴ This has particular appeal for African countries with limited sources of domestic capital and dwindling official aid from the industrialized countries. These countries need to attract as much foreign investment as possible to fuel the development of their infrastructure (electric power stations, information and telecommunications technology, transportation systems, etc.) and industry.

Over the last decade, largely with the assistance of the World Bank and the IFC, many African countries have established new stock exchanges. These include Botswana, Malawi, Swaziland, Zambia, Namibia, and Ghana. Other countries have worked to revitalize existing but largely moribund exchanges, such as Egypt, Kenya, Nigeria, and Zimbabwe. A total of fifteen African countries currently have stock exchanges including Cote d’Ivoire, Mauritius, Morocco, South Africa, and Tunisia. Both Uganda and Tanzania are working to launch new markets. The West African Economic and Monetary Union is also in the process of establishing a regional stock exchange in Abidjan, Cote d’Ivoire which will serve its member countries—Benin, Burkina Faso, Cote d’Ivoire, Mali, Niger, Senegal, and Togo. ⁵

To have any significant impact, however, a stock market requires a conducive economic, political, and regulatory environment for private investment. Given the difficult political and economic situation in most African countries, there is a question as to whether stock markets can have a significant impact on economic growth in Africa. This article first presents an overview of African stock markets and investment funds and then examines their role in fostering private foreign investment and long term economic growth for the African continent.

African Stock Markets and Investment Funds

African stock exchanges...