Addis Abeba — Ethiopia's financial landscape is currently on the cusp of a historic transformation as it gears up for the grand unveiling of its very first stock market, the culmination of over three years of strategic groundwork.
This journey began in 2021 with the appointment of Meles Minale, a macroeconomic advisor at the National Bank of Ethiopia, to spearhead a team of 14 experts in laying the foundation for Ethiopia's first full-fledged capital market.
The efforts of this team resulted in the establishment of the Ethiopian Capital Market Authority (ECMA), under the astute leadership of Brook Taye (PhD), a young economist with extensive experience from the Ministry of Finance and the private sector.
The Authority is entrusted with critical responsibilities, including the development of a regulatory framework, the creation of a long-term capital market development roadmap, and the review of institutional investor regulations, macro-financial policies, and tax policies. These preparations are essential for the establishment of the Ethiopian Securities Exchange (ESX).
With most of the preparatory work now completed, the inauguration of the ESX is scheduled for November 2024, marking a significant milestone in Ethiopia's economic evolution.
Officials emphasize that the ESX is already attracting significant investor attention and pulling in funds.
The Ethiopian Investment Holdings (EIH) is set to be one of the largest investors on the ESX.
In October 2023, EIH and four of the largest state-owned enterprises (SOEs) under its purview--namely, the Ethiopian Shipping and Logistics Services Enterprise (ESLSE), Berhanena Selam Printing Enterprise, Ethiopian Insurance Corporation (EIC), and Ethio Telecom--announced a combined 25% stake acquisition in the ESX.
In addition to securing 275 million birr from four state-owned enterprises (SOEs), the ESX sought to raise an additional 625 million birr from private entities.
Several prominent private banks with significant capital holdings have already announced their equity investments in the ESX.
For instance, Awash Bank emerged as the leading investor two months ago, acquiring shares valued at 70 million birr. Global Bank also contributed 50 million birr to the ESX's capitalization efforts.
Authorities also highlighted strong investment intentions from companies based in Kenya, Nigeria, and South Africa.
Notably, the Nigerian Exchange Group (NGX) publicly announced its acquisition of a stake in the ESX in April 2024, though the specific investment amount remains undisclosed.
As of one month ago, the ESX had successfully secured over 95% of its targeted capitalization of one billion birr. This achievement paves the way for the exchange to officially commence operations.
Senior government officials assert that Ethiopia's progress toward opening its capital market represents a fundamental transformation in its economic landscape.
Prime Minister Abiy Ahmed recently remarked that the introduction of a stock market in Ethiopia is "poised to be a game-changer, supporting the country in achieving its growth aspirations and attracting new capital," further noting that "this marks an exciting chapter for the nation."
While pronouncements by the Prime Minister and other high-level government officials have characterized the introduction of a capital market as a transformative development, experts caution against excessive optimism.
We are designing a capital market in which everyone can be a beneficiary." Brook Taye, Director General of the Ethiopian Capital Market Authority
Their caution is partly informed by the relatively modest impact observed from the establishment of capital markets in other African countries.
The past few decades have nonetheless witnessed a growth in the number of African stock exchanges, with cross-listings within the continent also increasing. From a mere eight exchanges in 1989, the landscape has expanded to encompass 29 exchanges, representing 38 African nations.
However, a recent report by the African Development Bank (AfDB) underscores the relatively limited role currently played by capital markets in the African economic landscape. With the exception of Egypt, whose stock exchange dates back to 1883, no African exchange boasts a total market value exceeding 20% of its corresponding gross domestic product (GDP).
Despite this caveat, experts acknowledge the potential of the initiative to serve as a significant driver of Ethiopia's economic development.
"While an immediate economic transformation may not be realistic," Henok Fasil (PhD), a macroeconomist and a consultant at the World Bank office in Ethiopia, contends, "the introduction of a capital market can significantly contribute to Ethiopia's growth ambitions by attracting fresh capital and fostering improved corporate governance practices."
The establishment of a capital market in Ethiopia is not an entirely novel endeavor. Public-share subscriptions by large corporations and financial companies have been documented as early as 1956.
The practice evolved into a more formalized share trading platform with the establishment of a dedicated share exchange department by the former State Bank of Ethiopia in 1960.
This development was followed by the creation of the Share Dealing Group under the National Bank of Ethiopia (NBE).
Comprised of various members, the Group facilitated share trading until its dissolution in 1975, a consequence of the nationalization of financial institutions and large companies.
However, officials contend that the current initiative represents a significant departure from these past attempts.
In an interview with the Addis Standard, Brook Taye, Director General of the Ethiopian Capital Market Authority, underscored the government's dedication to inclusivity, including addressing the financial requirements of small and medium enterprises (SMEs).
"We are designing a capital market in which everyone can be a beneficiary," he stated. "It's going to be open for everyone."
Can SMEs thrive with new funding avenue?
Studies underscore the critical role of SMEs in fostering economic development, particularly in developing nations like Ethiopia. SMEs are instrumental in generating a substantial number of employment opportunities within these economies.
However, a critical shortcoming exists within Ethiopia's financial sector: it has not sufficiently addressed the funding requirements of aspiring small and medium-sized business proprietors. This is because conventional lenders, such as banks, typically require collateral for SME loans, effectively excluding a large portion of SMEs who lack the necessary collateral, hindering their loan approval.
A recent study revealed that 76% of micro, small, and medium enterprises (MSMEs) in Ethiopia relied primarily on self-generated savings, contributions from family or friends, Equub (informal rotating savings and credit associations), and savings and credit cooperatives for their initial capital.
Brook explains how a capital market can alleviate this obstacle.
He states that the establishment of a capital market will enhance the banking industry's capacity to lend to SMEs, as larger companies will be able to raise capital through the market.
"These benefits have the potential to be realized," the director general stated, adding, "once they have grown, SMEs will also have the opportunity to be listed on the exchange themselves, allowing them to sell shares and issue corporate bonds."
However, Henok, argues that SMEs may face significant challenges in accessing these markets due to stringent listing criteria and low visibility for investors.
To grasp the potential of capital markets for facilitating capital formation and serving as a fundraising platform for SMEs, a thorough understanding of the different types of capital markets is essential.
Capital markets can be broadly categorized into primary and secondary markets.
The primary market serves as the venue for the initial issuance and sale of new shares to the public through initial public offerings (IPOs).
The proceeds generated from these primary market transactions are not only used for various purposes but also serve the critical function of financing real investments in tangible assets such as physical structures, plants and equipment, as well as inventories. Consequently, primary markets play a pivotal role in mobilizing financial resources, specifically for capital formation.
However, Gemechu Daba, an adjunct lecturer at Addis Ababa University, argues that the process of going public through an initial public offering (IPO) can be cost-prohibitive for SMEs operating in Ethiopia due to significant legal, accounting, and marketing fees.
"These expenses can pose a substantial burden for smaller companies," asserts Gemechu.
Subsequent to the issuance and purchase of securities in the primary market, secondary markets provide a platform for the resale of these securities.
While secondary market transactions may not directly contribute to additional real investments or capital formation, research suggests that they fulfill several valuable economic functions.
A recent study published by the Ethiopian Economics Association highlights that secondary markets, also known as stock exchanges, enhance liquidity by enabling the sale of securities on short notice.
Through the continuous fluctuation of security prices, secondary markets also signal to investors the relative efficiency of companies' management. Companies with superior performance are rewarded with rising stock prices, attracting further capital.
Although secondary markets can facilitate the efficient allocation of resources by directing capital towards companies demonstrating superior performance, only securities meeting the specific listing requirements of a particular stock exchange can be traded on that platform.
Citing the findings of various studies, some academics challenge the government's claim that the new Ethiopian secondary market (ESX) will be accessible to a wide range of companies, including SMEs.
Their skepticism seems justified by the initial composition of the listed entities.
At the launch of the exchange, at least 15 companies with substantial capital backing are anticipated to list, with the possibility of expanding to at least 50 entities, primarily banks and insurance companies.
With a business portfolio valued at $38 billion, Ethiopian Investment Holdings (EIH), along with four of the largest state-owned enterprises, including Ethio Telecom, are set to be among the largest participants in the ESX.
Despite these initial listings, Brook argues that establishing a capital market will benefit SMEs.
"There will be an alternative market on the exchange where SME-type products or assets supportive of SMEs will be listed," he elaborates. "For instance, factoring could exemplify a scenario where a purchase order can be aggregated, securitized, and listed, facilitating quicker payments for SMEs, thus enabling them to sustain their operations more efficiently than under the current circumstances."
The director-general also elaborates on the ancillary advantages associated with a developed capital market. He posits that such a market would augment the lending capacity of the banking sector towards SMEs.
The process of going public through an initial public offering (IPO) can be cost-prohibitive for SMEs." Gemechu Daba, an adjunct lecturer at Addis Ababa University
"This would be achieved by facilitating the direct capital acquisition of larger corporations within the market, thereby alleviating the strain on traditional lending channels," he stated.
Brook acknowledges that the benefits may not be immediate but emphasizes that this method of raising capital represents an efficient system for allocating financial resources.
Merid Tullu, a macroeconomist currently working in the private sector, proposes an alternative solution: the establishment of a dedicated market catering to the specific needs of SMEs.
"The most prevalent global practice for SMEs to raise capital involves over-the-counter (OTC) markets," he explained.
An OTC market is a decentralized financial system where participants trade various instruments, including stocks, commodities, and currencies, directly with each other. These transactions occur outside of a centralized exchange or with minimal broker involvement.
Merid emphasizes that, unlike established exchanges like the New York Stock Exchange, OTC markets are subject to less stringent regulations. According to him, this characteristic makes them potentially more attractive options for SMEs seeking to raise capital.
Brook disclosed that the Ethiopian Stock Exchange has already expressed its intention to establish an alternative board specifically designed for the participation of small and medium-sized businesses.
However, the director general of the authority emphasized that the focus should not solely be on permitting or denying SME listings. According to him, a critical factor is whether SMEs can access the appropriate type of capital.
"Should an SME choose to list on the exchange?" Brook elaborated, "it will face extensive disclosure requirements. For an SME with limited revenue, this raises a crucial question: should they prioritize core business operations or divert resources to hire a high-cost compliance advisor solely to achieve a listing?"
Overcoming transparency challenges
Gemechu, an adjunct lecturer at Addis Ababa University, believes capital markets like the one planned for Ethiopia hold the potential to revolutionize fundraising. However, he emphasizes that their success depends on addressing investor anxieties and establishing a well-functioning, trustworthy market.
In line with Gemechu's evaluation, Henok proposes the creation of a regulatory framework that safeguards investor interests and ensures corporate integrity.
"The sustainability of capital markets necessitates robust regulatory structures," Henok remarked. "The absence of such an environment could impede the efficacy and prosperity of Ethiopia's capital market unless substantial reforms are implemented."
Empirical evidence suggests that capital markets are highly vulnerable to fraud and manipulation. Companies may resort to deliberately misleading potential investors by presenting an unrealistically positive picture in their prospectuses and other publications.
Additionally, investors may be enticed into perilous situations by companies that intentionally conceal crucial information with potentially negative consequences. Insider trading, furthermore, has been a chronic ailment plaguing capital markets worldwide.
Experts underscore the need for a comprehensive set of laws, rules, and regulations to protect investors from fraud, misrepresentation, and collusion. They also emphasize the importance of establishing institutions with extensive powers to oversee and regulate Ethiopia's capital market.
In particular, scholars like Henok express concern about the current lack of transparency in Ethiopian corporations. Their concerns stem from the fact that transparency is critical for ensuring investors have access to reliable and timely information, which is essential for making informed investment decisions.
"The inability of many Ethiopian companies, particularly state-owned enterprises, to provide transparent financial statements could indeed pose a significant obstacle to the functioning of a robust capital market," Henok stressed. "Since such a lack of transparency can deter investment and undermine market credibility, authorities may need to enforce stricter disclosure requirements and penalties for non-compliance."
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Brook, however, emphasized that adherence to this criterion is non-negotiable.
"Companies, whether public or private, that do not disclose their financial information will not be granted access to the capital market," he stated.
Haile Bayisa, a business law specialist and lecturer at Addis Ababa University, argues for a nuanced approach to financial regulation. While Haile acknowledges its importance for stability, he emphasizes that the law should also facilitate financial transactions and educate market participants.
"A stringent regulatory framework, both in legislation and enforcement, can discourage businesses from going public," Haile suggested. "Therefore, it is essential to strike a balance."
Navigating economic storm
While Ethiopian officials have emphasized the imminent launch of the Ethiopian Securities Exchange and the positive attention it has garnered, experts contend that the ongoing conflict in various regions of the country, combined with the prevailing macroeconomic instability, is likely to undermine the confidence of both companies eligible for listing on the exchange and prospective investors in shares and securities.
"Given the current challenges, including conflict, high external debt, and a scarcity of foreign exchange, Ethiopian companies might be hesitant to go public," Henok asserted. "These conditions can also undermine investor confidence, as the risks associated with economic volatility may outweigh potential returns."
Over the past two decades, Ethiopia has encountered significant macroeconomic challenges due to the soaring prices of goods and services. This phenomenon has resulted in a substantial increase in the cost of living, thereby eroding the disposable income of Ethiopian households.
Official data released by the National Bank of Ethiopia (NBE) underscores the severity of the situation.
Over the past decade, the yearly average inflation rate has been recorded at 16%, significantly exceeding the average saving interest rate offered by commercial banks, which currently stands at only 5%.
Recent conflicts have also impacted investor and entrepreneur perceptions of Ethiopia's business environment and the economic hardships the country confronts.
While acknowledging that current economic conditions are not ideal, Brook emphasizes that these difficulties are not permanent. He highlights that "while we have seen deterioration in some areas, there are significant progresses in other areas."
To illustrate this point, Brook cites the improvement in reducing the headline inflation rate from 27.8% in October to 23% in May 2024.
Given the current challenges, including conflict, high external debt, and a scarcity of foreign exchange, companies might be hesitant to go public." Henok Fasil (PhD), a consultant at the World Bank office in Ethiopia
He further clarifies that "although the reduction is not at the pace the government would prefer, inflation is demonstrably coming down."
While acknowledging concerns regarding the potential impact of macroeconomic challenges and conflicts on the exchange's effectiveness, Merid offers a contrasting perspective.
He argues that a capital market can provide a shield for both investors and entrepreneurs during economic downturns. He elaborates that, for example, during periods of inflation, investment becomes a more attractive option compared to saving.
"In a nation characterized by lower interest rates, such as Ethiopia," Merid explains, "savings can result in returns that are surpassed by inflation, essentially eroding the value of one's savings. Consequently, investing in real assets, which the capital market facilitates, becomes a preferable course of action as it offers the potential for higher returns."
