The Development of Capital Markets in Africa, with Particular Reference to Kenya and Nigeria

CAPITAL FORMATION is one of the main factors responsible for economic growth, and the availability of capital is, consequently, one of the central themes in the discussions of growth possibilities in developing countries. Because of the considerable capital investment needs of the less developed countries, particularly in the provision of basic infrastructural and educational facilities and in the development of agricultural and industrial ventures, the emphasis on the availability of capital is not misplaced but should not be allowed to obscure the limit on the capacity of a country to absorb new investment. Success in the mobilization of needed capital for development has varied among countries and has depended on the availability of domestic savings within the economy and the inflow of foreign capital.

Abstract

CAPITAL FORMATION is one of the main factors responsible for economic growth, and the availability of capital is, consequently, one of the central themes in the discussions of growth possibilities in developing countries. Because of the considerable capital investment needs of the less developed countries, particularly in the provision of basic infrastructural and educational facilities and in the development of agricultural and industrial ventures, the emphasis on the availability of capital is not misplaced but should not be allowed to obscure the limit on the capacity of a country to absorb new investment. Success in the mobilization of needed capital for development has varied among countries and has depended on the availability of domestic savings within the economy and the inflow of foreign capital.

CAPITAL FORMATION is one of the main factors responsible for economic growth, and the availability of capital is, consequently, one of the central themes in the discussions of growth possibilities in developing countries. Because of the considerable capital investment needs of the less developed countries, particularly in the provision of basic infrastructural and educational facilities and in the development of agricultural and industrial ventures, the emphasis on the availability of capital is not misplaced but should not be allowed to obscure the limit on the capacity of a country to absorb new investment. Success in the mobilization of needed capital for development has varied among countries and has depended on the availability of domestic savings within the economy and the inflow of foreign capital.

This study explores one aspect of the domestic mobilization of capital, namely, the use of the machinery of capital markets in two African countries. The paper reviews the factors affecting the establishment of capital markets in developing economies, particularly in Africa, and examines the recent attempts to establish organized capital markets in Kenya and Nigeria. The experience of Kenya contrasts sharply with that of Nigeria. Whereas in Kenya the growth of the capital market has been due largely to the initiative of the private sector, the development of the market in Nigeria has been induced and encouraged by the Government. The analysis is confined to the markets for long-term and medium-term capital, and thereby excludes direct private investment, short-term capital, and money markets. In this context, a capital market is defined as an organized market that provides facilities for dealing in stocks and shares and through which (along with special financial institutions dealing therein) new capital could be raised by the offer of securities to the public. Measures that could help to facilitate the expansion of existing markets and to foster regional or national capital markets in Africa are also analyzed.

I. Capital Markets in Developing Economies

Role of capital markets

Given the relative scarcity of capital and the small volume of savings in most developing countries, the question may be asked whether there is any need for the establishment of capital markets. The answer to such a question lies mainly in the role expected to be played by a capital market and associated financial institutions in the financing of development. The need for a capital market may arise partly because of the government’s requirement to borrow locally and partly as a result of an expanding private sector that requires local funds for both expansion and new developments. A capital market exists to offer a mechanism whereby those supplying capital can quickly and easily restore their liquidity. The size, effectiveness, and operation of such a market depends, among other things, on the supply of capital (national savings), the extent to which the economy is monetized, the number of potential investors, and the degree of sophistication of the investing public.

Two aspects of the role of a capital market in the mobilization of savings and the investment process need to be mentioned.1 First, the market for capital acts as a link between borrowers and savers in the economy. Second, the existence of a capital market facilitates the purchase and sale of “debt instruments” and of other securities (shares), particularly through dealings on a stock exchange. These two functions call for the organization of certain institutions, the network of which is referred to as the capital market. The linkage of borrowers to savers requires the organization of financial intermediaries capable of mobilizing the small savings of the public and of directing them into investment in accordance with the demand for capital in the economy. A stock exchange not only permits dealings in existing securities (secondary market) but also facilitates the issue of new securities for sale (primary market). Even where a stock exchange does not exist, substitute machinery would have to be developed to facilitate the transfer of securities and debt instruments.

On the basis of these functions, one would expect a capital market to exist in any free market economy, even if in a minuscule form. That every national economy does not have a reasonably workable capital market must therefore be attributed to other factors. For most African countries, a number of factors have operated until recent years to reduce the urgency of establishing a capital market. For example, the demand for capital by the public sector has been relatively small and has been met largely from official foreign loans and grants, while the demand for capital in the private sector (other than the rural sector of the economy) has been met largely through foreign private capital or by banks. Additionally, because of the relationship between many African countries and the former metropolitan powers, they have relied on the capital markets of the former metropolitan countries (e.g., the United Kingdom and France) to meet their capital requirements.

On the supply of savings, the size of capital markets is necessarily influenced by the low incomes in developing countries and the asset preferences of the investing public. With the low levels of income and standard of living, individuals may be more concerned with current than future welfare. Hence, any improvement in income is likely to be devoted to satisfying current wants, with the consequence that the proportion of income saved (in relation to the total domestic product and increase in income) will tend to be small. Low incomes and accompanying uncertainties will also tend to encourage savings to be held in forms that involve relatively little risk and that are quickly convertible and directly under the owner’s control. These factors influence many people existing at or near the subsistence level to hoard money, precious stones, and gold. The high social and political instability in many developing countries further contributes to the preference for short-term investments against long-term investments, which the holding of long-term securities implies. These factors underlie the accumulated findings in the economic literature of the smaller availability and holding of financial assets in developing countries than in developed countries. Hence, the size of the capital markets in developing countries will be much smaller than in developed economies.

Certain conditions are necessary for an operational capital market to emerge in a developing economy. First, there is a need for what may be called investment psychology among a wide section of the public, i.e., the attitude of individuals and institutions toward investing in nonphysical variable-price assets, such as stocks and shares. Second, there has to be a fair degree of monetization of an economy to permit a relatively constant and large volume of financial savings. Third, there should be a relatively large supply of securities and new issues available on a regular basis. Fourth, for a workable capital market, it is necessary to have a large pool of buyers and holders of securities who are willing to deal in them periodically. The vitality of a capital market depends on both the volume of financial savings being channeled into investment through its mechanism and the velocity of trading in securities.2 Fifth, a network of monetary and financial institutions must be either in existence or developed. Many of these other conditions emerge only during the process of economic development.

Factors influencing the emergence of capital markets in Africa

Income, savings, and monetization

Since a capital market is essentially a machinery for channeling the flow of financial savings into investment, the principal factors that determine its emergence in a developing economy are the size of money income, which in turn depends not only on output but also on the degree of monetization of the economy, and its distribution.

Data on income distribution are lacking in most African countries, but the level of per capita income is an indication of the potential for individuals to have financial savings. In most countries per capita incomes are low. And because of the structure of the economies, characterized by a heavy dependence on agriculture, with a sizable proportion of the agricultural output in the subsistence sector, money income per capita is lower than indicated by per capita gross domestic product (GDP), and consequently the scope for financial savings is further limited. Of the 31 countries shown in Table 1, 22 have per capita incomes of less than US$200, while 7 have per capita incomes of between US$200 and US$500 a year and in only 2 countries do per capita incomes exceed US$500—one of which is the Libyan Arab Republic, because of the petroleum industry. In the aggregate, the volume of savings in these countries would vary according to the pattern of consumption and the size of the nonwage sector. With respect to the latter, the situation varies among African countries, but the general picture is that a large segment of the population still derives its income (substantially in nonmonetary form) in the nonwage sector.

Table 1.

Selected African Countries: Per Capita Incomes, Money/Income Ratios, and Share of Demand Deposits plus Quasi-Money in Total Money in Recent Years1

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Sources: United Nations, Statistical Office, Yearbook of National Accounts Statistics, 1967 (New York, 1968); International Monetary Fund, International Financial Statistics; data from national publications.

Mainly 1966–68.

Per capita gross domestic product (GDP) is generally higher than per capita income in African countries because of large income that is due to foreign factors of production.

Money is related to GDP rather than to gross national product (GNP)—a more logical comparison—because of lack of data on GNP for all countries covered. Derived ratios are in most cases, therefore, smaller than they would be otherwise. Money is defined as currency in circulation plus demand deposits.

Total money is defined as currency outside banks plus demand deposits plus quasi-money. Data relate to 1968.

Based on estimated population of 59.7 million, which may be an overstatement.

Savings in African countries are still generally low and well below those in the developed countries. As a proportion of GDP, the African countries as a whole saved an annual average of 10 per cent during the period 1960–66, compared with about 21 per cent in the industrialized countries and countries in southern Europe, 11–12 per cent in Asia, and 17 per cent in Latin America.3

While there are marked differences, the degree of monetization of the economies of African countries is generally low compared with the developed economies. Monetization can be measured in this context by the ratio of money supply (currency plus demand deposits) to the gross national product (the inverse of the income velocity of money). Of 31 countries for which current data are available (see Table 1), 4 have ratios of money supply to GDP of more than 20 per cent, while 9 have ratios of 15–20 per cent. If money is defined broadly, i.e., currency plus demand deposits plus quasi-money, the general picture is somewhat different, with 12 countries having a money plus quasi-money/GDP ratio of over 20 per cent. Some countries, such as Zambia, Sierra Leone, the Libyan Arab Republic, and the Democratic Republic of Congo, show a high degree of monetization mainly as a reflection of mining activities (see Table 2).

Table 2.

Selected African Countries: Contribution of Industrial and Agricultural Sectors to Gross Domestic Product

(In per cent)

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Sources: United Nations, Statistical Office, Yearbook of National Accounts Statistics, 1967 (New York, 1968); data from national sources.

Mainly electricity, gas, and water.

Includes mining.

Another indicator of monetary savings in an economy is the size of quasi-money. While not constituting by any means the total savings in an economy, the proportion of quasi-money in total money gives an indication of the extent to which people are willing to hold financial assets other than currency and demand deposits. Only in 7 countries is the ratio of total deposits (demand deposits plus time and savings deposits) under 50 per cent, while in 21 countries the ratio is in the 50–75 per cent range and in 2 countries the ratio exceeds 75 per cent. Taking quasi-money (time and savings deposits) alone, the picture is slightly different. For most countries quasi-money represents a small part of total money, and it is only in Ghana, Kenya, Malawi, Nigeria, Sierra Leone, Uganda, and the United Arab Republic that the ratio exceeds 25 per cent.

The analysis of the degree of monetization in African countries gives, in the aggregate, a rough indication of the preferences of individuals between financial and nonfinancial assets. However, in terms of choice among assets, such factors as safety, yield, social conditions, and traditional methods of saving may influence preferences. At present, because of the generally low incomes in most African countries and the relatively lower degree of monetization and the general social and political uncertainties, the demand for financial assets as represented by bonds, stocks, and shares is limited.

Structure of the economies

On the whole the supply of securities for a capital market would depend on the organization of economic activity. In this respect, two aspects of the characteristics of African economies require mention: the relative importance of nonmonetized activity in the agricultural sector, and the organization of companies or corporations operating in the modern sector.

In the structure of African economies, the dominance of the agricultural sector is particularly striking. Except in a few countries with a sizable mining sector, e.g., the Democratic Republic of Congo, the Libyan Arab Republic, and Zambia, agricultural activities contribute over 25 per cent of the domestic output (Table 2). The organization of agricultural production in most countries, dependent as it is on peasant and small-scale producers (except in Kenya, Rhodesia, and until recently Tanzania), does not offer scope for mobilizing financial resources through the capital market.4 In fact, in most countries a major problem has been to raise enough working capital for agricultural enterprises. Furthermore, a number of problems connected with the landholding system make it unlikely that there will be opportunities in the immediate future for any reorganization that could permit the issue of generally marketable debt instruments.

Usually the organization of industrial enterprises in the modern sector offers scope for the supply of financial assets for the development of capital markets. The demand for fixed equipment and other investments generally requires financial resources that have to be tied up for long periods. The provision of such resources requires financing and savings, which have to be provided locally or from abroad. To the extent that such resources have to be found domestically, the expansion of industrial enterprises would call for the creation of capital markets.

However, industrialization in African countries is still in the early stages of development.5 In many African countries, industrial activities (manufacturing, mining, and construction) contribute less than 15 per cent of domestic output. In a number of countries with high ratios of industrial output to total output, the role of mining is particularly significant (see Table 2).

The fact that the supply of securities has not emerged on a wide scale in African economies reflects the limited degree of industrialization, the concentration on mining in those countries that are relatively industrialized, and the fact that these enterprises, including mining, are mainly foreign-owned or foreign-controlled companies that derive a high proportion of their long-term capital from abroad. Even in countries with some indigenous enterprises, these are closely held companies that militate against any substantial supply of securities for issue to the public. Although the government is increasingly involved in joint ventures in a number of countries, the shares in such ventures are still held by the various governments. In short, the structure and organization of the economies in most African countries at present do not facilitate the emergence of workable capital markets.

Capital markets and share ownership in Africa

Only a few countries—South Africa, Rhodesia, Morocco, Nigeria, and Kenya—have organized capital markets with stock exchanges. Ghana has announced its intention to establish a stock exchange and, with its relatively developed system of financial institutions and sizable supply of securities, an organized capital market could emerge.6 Zambia has also announced its intention to establish a stock exchange and, with existing share holdings and government securities, an organized market could emerge. An inactive stock exchange exists in Kampala, Uganda.7 The most developed of these capital markets remains that in South Africa, which has been in operation for several decades;8 it is followed by the capital market of Rhodesia. However, these markets and those of more recent origin in Kenya and Nigeria are still relatively small compared with the capital markets of Europe and the United States.9

In countries without an organized capital market, individuals or institutions owning shares lack facilities for disposing of such securities when there is need for liquidity. Unless the securities are held in bearer form, they cannot be traded easily, if at all, and hence they approach physical assets in the lack of liquidity. Apart from individual ownership of shares in closely held companies, many institutions and governments in African countries own shares in joint ventures. The ownership of such shares does not, of course, imply the existence of an organized market in which they can be traded. Information is not available on share ownership in the countries of former French Africa, but it is believed to be small, and not one of these countries has a capital market or has even announced its intention of establishing one.10

In considering the impact of fiscal policies on establishing fully operational capital markets, the central interest lies in the nature of the taxation of the property in—and of the income or capital gains that may accrue from—stocks, shares, and bonds. Where a tax liability arises, the major consideration is whether the various taxes are such as to encourage or discourage the holding of securities compared with other forms of property. With respect to taxation on income and wealth, the asset preference will most probably be influenced by the tax rate structure in the economy. This is quite important, because shareholders generally belong to the middle-income and high-income groups and are influenced by tax considerations in making investment decisions. Hence, any fiscal arrangements that in general reduce the burden of taxation are likely to encourage share ownership and the holding of securities. In addition to the taxation of income and wealth involved in ownership of securities, there may be stamp duties or a transfer tax, which constitute additional costs that have to be taken into account in determining asset preferences of holders.

The taxation practices in African countries do not appear to discriminate against the ownership of securities.11 In many countries there is no tax on capital gains realized on the sale of securities, while in most countries dividend incomes receive favorable tax treatment. Compared with the tax levels in advanced countries, the tax practices are in this context favorable to the development of capital markets. However, in a number of countries the existence of stamp duties and transfer taxes on the sale of securities adds to the cost of owning such types of financial asset.12 For example, in Kenya stamp duties amount to ½ of 1 per cent ad valorem, while in Tanzania and Uganda the rates are, respectively, ¼ of 1 per cent and ⅓ of 1 per cent.

II. The Capital Market in Kenya

The development of a capital market in Kenya has been conditioned by the need for funds in the private sector and the structure of the economy, rather than by the Government’s need to borrow locally. Public investment prior to Kenya’s independence late in 1963 was modest, and its financing was mainly through foreign borrowing and grants—hence, the minor role of the Government in spearheading the growth of the capital market. On the other hand, the presence of the European and Asian communities with their relatively higher incomes and familiarity with the intricacies of security transactions provided a stimulus for the establishment of a capital market. In conjunction with this knowledge and higher incomes, the expatriate community until recently controlled most of the industrial and estate agricultural production in Kenya. As a result, the private sector not only took the initiative in establishing a capital market but also has been the major participant in that market.

Demand for capital

During the eight-year period 1958–65, total capital formation in the monetary sector in Kenya—which may be taken as an ex post measure of the demand for capital—has been estimated at K Sh 5,848 million (Kenya shillings 7.14 = US$1), of which the public sector accounted for 34.5 per cent (see Table 3). From 1966 to 1969 the share of the public sector increased noticeably and accounted for about 37 per cent of the total capital formation, which was estimated at K Sh 6,068 million in the four-year period. This increase in the demand for capital by the public sector reflects the more vigorous implementation of the Government’s various development plans.

Table 3.

Kenya: Financing Capital Formation, 1958–69

(In millions of Kenya shillings)

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Sources: Commonwealth Secretariat, Commonwealth Development and Its Financing, 11: Kenya (London, 1967). Ministry of Economic Planning and Development, Statistical Abstract (annual); Economic Survey, 1970. Development Plan, 1970–1974. International Monetary Fund, Surveys of African Economies, Vol. II (Washington, 1969). Central Bank of Kenya, Economic and Financial Review, Vol. I (April–June 1969).

Provisional estimate.

Includes local governments and statutory boards.

Monetary sector only.

Equal to balance of payments entry, “balancing item.”

Public sector

In financing its share of capital formation during the period 1958–69 the public sector relied heavily on foreign borrowing and grants and to a lesser extent on domestic borrowing. Of total public sector capital formation during the period 1958–65, nearly 43 per cent was financed from external borrowing and grants, 49 per cent from current budget surpluses, and only 8 per cent from domestic borrowing. During the following four years (1966–69), the Government’s capital formation amounted to K Sh 1,672 million, and the proportion financed by domestic borrowing increased to 11.7 per cent. This increase is reflected in a rapid expansion of the issue of government securities.

Private sector

To finance its share of capital formation, the private sector has relied equally on funds internally generated by business firms and on the raising of new capital on the domestic market. Between 1958 and 1965 about 55 per cent of the private sector capital formation was provided by depreciation funds, while other savings, mainly new capital issues, accounted for 66.2 per cent. However, there was very little net inflow of foreign private capital during this period, and the overall net outflow amounted to nearly 18 per cent of the capital mobilized domestically. The flight of capital, particularly during 1962–65, was connected with the general business uncertainty immediately before and after the attainment of independence in December 1963. With the halting of this outflow through the extension of exchange control measures to sterling area countries in mid-1965, net capital inflows increased.13 This exchange control measure and the gradual return of confidence has also had the effect of increasing the contribution of other savings (new capital issues) to domestic private sector capital formation. During the period 1966–69, depreciation funds and new capital issues provided about 75 per cent of the private sector capital resources (excluding lending to the Government), while the net capital inflow represented some 25 per cent.

Over all, the supply of capital for Kenya’s economic development during the period 1958–69 was largely from domestic sources. Of the total capital formation, estimated at K Sh 11,916 million, domestic resources (domestic borrowing, depreciation and revenue surpluses, and new capital issues) provided almost four fifths. This has been a significant factor in helping to develop the capital market in Kenya, as the mobilization of capital of this kind and in such volume requires facilities for trading debt instruments and the structuring of the capital of companies and corporations so as to facilitate the raising of funds on the domestic market.

Government debt issues

Since the bulk of public sector capital formation has been financed by foreign funds, most of Kenya’s public debt is foreign held and has not contributed to the development of the domestic capital market. However, if it were decided to repurchase parts of these foreign debt instruments, there would be an impact on the local capital market. Domestic public debt (excluding short-term borrowing) accounts for only 34.5 per cent of Kenya’s total public debt, which at the end of June 1969 amounted to about K Sh 2,848 million.14

Table 4 gives details of the holders of the domestic portion of the public debt. The year-end totals reflect both new issues and repayments. Until 1965 the major holders of government debt were sinking and pension funds (which in 1965 accounted for 26.7 per cent), insurance companies (about 14 per cent), and other official funds (18 per cent). The enactment of the National Social Security Law in 1966 provided an important source of institutional mobilization of savings.

Table 4.

Kenya: Holders of Government Funded Debt (Local Issues), 1963–70

(Nominal values in millions of Kenya shillings)

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Sources: Ministry of Economic Planning and Development, Economic Survey, 1969 and 1970; Central Bank of Kenya, Economic and Financial Review (various issues).

Classified as central government holdings.

Holdings by the East African Currency Board (predecessor of Central Bank).

At the end of December 1970, the National Social Security Fund accounted for 29.6 per cent (K Sh 350.2 million) of the public debt on the local register. While in absolute figures the holdings of insurance companies have continued to increase, they accounted for only 8.9 per cent in 1970. The share of sinking and pension funds, which was about 30 per cent in 1968, dropped to about 19 per cent in 1969 but rose in 1970 to 22.6 per cent. Direct information on holdings by individuals is not available, but assuming that the “other” item reflects their holdings, the total remained modest. As one would expect, the supply of capital on the domestic market to the public sector has been provided mainly by financial institutions and official institutions set up primarily to mobilize individual savings.

Capital supply to the private sector

Registered companies

The supply of capital to the private sector is affected not only by the presence of a fully developed capital market but also by the structure of companies and their ability to generate internal resources for expansion. The structure of companies and corporations registered in Kenya shows a preponderance of private companies. A private company is one with fewer than 50 shareholders and whose shares are not available for public purchases. In practice, private companies are largely family business and subsidiary firms. A public company, on the other hand, is widely owned and can offer its shares for sale to the public and must publish its accounts as required by law. Between 1958 and 1969 a total of 4,710 new private companies were registered, against only 208 local public companies (see Table 5). Of the 6,601 locally registered companies at the close of 1969, public companies probably accounted for about 7 per cent.

Table 5.

Kenya: Registered Companies, 1958–69

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Sources: Ministry of Economic Planning and Development, Statistical Abstract, 1968; Economic Survey, 1969; and Kenya Statistical Digest, Vol. VIII (March 1970).

At the end of December.

Assumes removal of foreign registered companies from the local register to be nil.

Includes increase in nominal capital of existing establishments.

In financing their operations, private companies have usually relied on sources other than the public for funds, notably the individual resources of those launching the business and private borrowing from a limited number of interested investors. For the expansion of a capital market on a broad front, the significant segment is the promotion of public companies capable of issuing shares or debenture stocks. Despite a lack of data on their capital structure, the gradual increase in the number of new local public companies from 4 in 1962 to a record 48 in 1969 tends to show that the capital market itself is expanding. The total nominal capital of all the new local companies launched since 1958, amounting to about K Sh 2,440 million (representing about 42 per cent of the monetary GDP of 1969) gives an impressive figure for a developing economy. Data on actual paid-up capital, which is likely to be less than the nominal capital, are not available.

A large number of foreign companies operating in Kenya are either public or partnerships. These companies numbered 707 at the end of 1968. Except where such foreign companies offer opportunities for private participation (the extent of which is not known), the raising of long-term funds (which is largely from abroad) has no direct effect on the growth of the local capital market. However, to the extent that these foreign companies participate in launching local companies, they may provide some stimulus to the expansion of the local capital market.

Sources of finance

The supply of capital for the promotion of new companies and the expansion in operations of existing ones is reflected in the financing of capital formation noted earlier. Accumulated depreciation funds have provided an important part of the resources utilized by established companies, local as well as foreign. Between 1958 and 1965 such funds provided K Sh 2,110 million, over one half of the total capital resources mobilized by the private sector. There are no estimates of how much capital has been furnished by retained earnings, but the amount involved during the period 1958–65 was probably small. Two factors may explain this: the undistributed profits tax in force until 1964 encouraged distribution of profits, while the large net private capital outflow immediately before and after independence probably included retained earnings. As shown in Table 3, net capital inflow (including unidentified leakage) to Kenya during the period 1958–61 amounted to only K Sh 110 million, while during the period 1962–65 there was a net capital outflow of K Sh 758 million. The retained earnings of foreign companies for financing capital development during the period 1966–68 are reflected in the increasing net inflow of recorded private capital from abroad in those years.

With respect to retained earnings of local companies, no data are available, but in general such companies, particularly after the introduction of restrictions on capital movements, have tended to plow back profits for expansion and to borrow privately. During the period 1958 to 1965 retained earnings of local companies, new capital issues, and capital raised privately contributed K Sh 2,710 million (including lending to the Government of K Sh 170 million), 67.7 per cent of the total capital mobilized by the private sector in that period. The role of individuals in the supply of capital is difficult to ascertain and, in any case, is likely to be relatively small, reflecting the low income level of a large segment of the population. For high-income groups, particularly in the expatriate community, partnerships and private enterprises offer a major outlet for investment, and their contribution would be reflected in the domestic financing noted above.

Insurance companies constitute an important source of capital for the private sector. Table 6 gives an indication of the size and direction of investment by these companies. At the end of 1967 the total investment of insurance funds amounted to K Sh 558.2 million, of which investment in government securities and stocks and shares accounted for 32.9 per cent and 10.2 per cent, respectively. Investment in mortgages and real estate accounted for about 37 per cent. The sizable investment in securities has contributed to the expansion of the local stock exchange.

Table 6.

Kenya: Investments by Insurance Companies, 1963–67

(In millions of Kenya shillings)

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Sources: East African Statistical Department, East Africa Insurance Statistics (various issues), and Economic and Statistical Review (various issues).

Includes local government securities.

Other financial institutions provide capital for private sector investment. Of note are building societies, which provide mortgage loans for residential and commercial buildings out of savings generated through members’ equity participation, deposits and loans, and hire-purchase companies. Table 7 presents recent data on the sources of funds and investments of these private financial institutions. Ten such financial institutions were in existence in 1968.15 Of the total resources, amounting to nearly K Sh 236 million in 1968, deposits accounted for about two thirds (equivalent to more than one fifth of the total time and savings deposits of the commercial banks).16 Mortgages, loans, and advances in 1968 amounted to about K Sh 177 million, constituting 75 per cent of total resources, while investments amounted to K Sh 21 million. There are also a few public sector financial institutions that help to mobilize savings and to foster the development of the capital market through the sale of securities.

Table 7.

Kenya: Resources and Lending Operations of Private Financial Institutions, 1966–68

(In millions of Kenya shillings)

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Sources: Central Bank of Kenya, Annual Report, 1967–68, and Economic and Financial Review, Vol. I (April–June 1969).

Includes fixed assets.

Thus, in the structure of Kenya’s capital market, private financial institutions play a prominent role in both the mobilization of savings and the issuance of long-term and medium-term loans for capital expansion. The level of interest rates within Kenya’s capital and money market probably explains part of the success of financial institutions in mobilizing savings.

For hire-purchase companies, interest payable on deposits varies from 3 per cent to 6 per cent per annum (compared with only 3 per cent payable by commercial banks on savings deposits), while their lending rates vary from 10 per cent to 12 per cent per annum. Interest payable on deposits by building societies is in the range of 4–6.5 per cent, while their lending rates vary from 7.5 per cent to 10 per cent per annum.

In general, the role of financial institutions in fostering the expansion of the local capital market has been enhanced by a number of factors. First, the accumulation of savings has been facilitated through the extension of exchange control regulations to sterling area countries in 1965. Second, the Government’s policy of encouraging the investment of insurance funds locally to the point where local liabilities are covered by local assets is helping to increase the role of insurance companies in the local capital market. With the prohibition of the transfer abroad of premiums on life insurance, proceeds arising from this type of insurance are available for local investment. Third, the yields on industrial shares and stocks have been generally favorable (higher than on government securities) and have probably encouraged institutional investments in them.

Nairobi Stock Exchange

Establishment

Unlike the experience in Nigeria, the initiative and the main stimulus for the establishment of a stock exchange in Kenya have been due to the private sector. As observed earlier, the sizable expatriate community possesses not only the know-how for operating an organized capital market but also income that is sufficiently high to permit the accumulation of savings and investment in securities.

Prior to the establishment of a stock exchange in Nairobi, investors had the opportunity of trading on either the Bulawayo Exchange (in Rhodesia), the Johannesburg Stock Exchange, or the London Stock Exchange. For internal borrowing and capital flotation by private companies, a few local lawyers were available to buy or sell British gilt-edged securities as well as local stocks and shares,17 while external capital markets offered facilities for long-term capital lending and borrowing. Most of the government issues were made on the London capital market.

Early in 1954 stockbrokers at a meeting in Nairobi pressed for the establishment of a stock exchange.18 It was then suggested that on account of a low volume of activity in the early stages of its operation the Government should be invited to finance the Exchange from public funds until it could become self-financing. The suggestion, however, was not approved by the meeting, mainly because of the difficulties envisaged in the eventual restoration of control of the Exchange to the private sector. Following the defeat of this proposal, the stockbrokers formed a Stock Brokers Association, which was subsequently formed into a Stock Exchange with rules based on those of the Bulawayo Stock Exchange.

On July 1, 1954 the Nairobi Stock Exchange was incorporated, with members comprising the stockbrokers who were operating prior to incorporation.19 Business continued to be transacted between brokers from their respective offices, there being no “floor” trading of shares. In the early stages a weekly “call-over” was held each Thursday in which deals completed by each broker during the previous week were recorded. The system of “call-over” has continued and is now on a daily basis. In the early stages of the establishment of the Exchange, dealing was “almost entirely for the account of local investors, and, as by and large only the European community [was] interested in the Stock Exchange, both buyers and sellers [were] comparatively few.” 20

Prior to the establishment of the Exchange, institutions necessary for the operation of a stock exchange had begun to be set up in Nairobi. In 1950 firms of specialized stockbrokers were established by persons with experience of such operations in London, and such firms began to take over the functions performed on the side by estate agents and lawyers.21 By the time the Exchange was launched, there were six such firms and they became members of the Exchange; in 1969 there were still only six members. A headquarters for the Exchange is now contemplated.22

The method of dealing on the Nairobi Stock Exchange has remained relatively simple, compared with operations on, say, the London Stock Exchange or the New York Stock Exchange. No middlemen or jobbers are employed. The firms of brokers who conduct buying and selling transactions meet once a day to establish prices. However, customers are able to buy or sell shares at any time during the business day at prices that could deviate from the prices established at the daily meeting. A firm of brokers is permitted to “deal across its own book,” that is, it is free to buy or sell shares of its customers without consulting other brokers, provided that such a transaction is effected at the best possible price.23 Moreover, there are no speculative devices, such as put or call options.

Institutions such as insurance companies, investment trusts, and semiofficial bodies comprise the bulk of traders on the Nairobi Exchange. Of the individual traders and investors, it is estimated that 70 per cent are Asian businessmen, 25 per cent Europeans, and the remainder Africans.24 The relatively small proportion of African participation may be attributed to low incomes and statutory restrictions on them in the preindependence period. The amount of foreign funds on the Exchange has also tended to decline in recent years because of the exchange control regulations.

Transactions and listings

Although no statistics of turnover and transactions are kept by the Exchange, the volume of transactions is believed to be modest. However, there has been a significant increase in the number of both industrial shares and government stocks listed on the Exchange. In 1954, when it was opened, 12 public sector stocks were listed and 73 industrial shares, of which 28 were preference shares (see Table 8). By August 1961 the number of public sector stocks listed on the Exchange had increased to 33, while industrial securities rose less rapidly to 87, of which 4 were debenture stocks. At the end of 1968 the number of listed public sector stocks (66) had again nearly doubled and consisted of stocks issued by the Governments of Kenya (45 per cent), Tanzania (23 per cent), and Uganda (11 per cent), the East African Community (successor to East African Common Services Organization), and the Municipality of Nairobi. The rapid increase in the number of listed government issues reflects partly the attempt of the various governments to mobilize resources for development and partly the transfer of certain stocks from the London register to the local register. On the other hand, listed industrial securities continued to increase only slowly and at the end of 1968 numbered 92 issues of 68 companies. Since new companies seeking listing for their shares or debentures have to show a record of profitable operations for a number of years and to meet other conditions, it is not unexpected that the increase in the number of such securities would be moderate.

Table 8.

Kenya: Number of Listed Securities on the Nairobi Stock Exchange, 1954, 1961, and 1968

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Sources: The East African Economics Review (Nairobi), Vol. 8 (December 1961); East African Stock and Share List; Nairobi Stock Exchange, Official Year Book, 1969.

Issued by 68 companies.

Includes two loan issues.

The composition of stocks and shares listed on the Exchange is worthy of note. Public sector securities include issues by the Governments of Tanzania and Uganda and by the East African Community. A few of the listed industrial shares are those of companies registered in Tanzania and Uganda, and until recently many companies whose shares are quoted on the Exchange have had operations in the three East African countries. The Nairobi Stock Exchange has thus been operating as a “regional” exchange serving the three East African countries—Kenya, Tanzania, and Uganda. This development has been made possible by a number of factors, including the establishment until recently of many companies on an East African basis, the maintenance of common market arrangements (formalized in December 1967 with the inauguration of the East African Community), the virtually free movement of capital between the three countries, and the maintenance of common exchange regulations regarding capital movements to countries outside East Africa.25 Recent developments have tended to reduce the effectiveness of this regional aspect of the capital market in Kenya. For example, the nationalization measures adopted by Tanzania in February 1967 affected a number of companies operating on an East African basis, while Uganda’s exchange and currency measures in May 1970 have reduced the scope of capital movements within the Community. In addition, the recent pressures to establish industries on a national basis may reduce the attraction of companies registered in Uganda and Tanzania of having their securities traded on the Nairobi Stock Exchange. However, individuals in both Uganda and Tanzania are not restricted in dealing on the Nairobi Stock Exchange, although their participation is still negligible.

Investment yield

One of the main factors affecting the attraction of investment is the return on capital. Generally speaking, the yields on investment on the Kenyan capital market have remained attractive. The average yield on industrial shares averaged 9.2 per cent in 1967, while the yield on government securities has ranged between 6.41 per cent and 6.70 per cent.26 However, because of the higher yield on investment in property and possible capital appreciation, the tendency has been for funds to flow into building and mortgage lending. From the standpoint of demand for securities, the important factor is that the yield be such as to attract additional savings. On the other hand, the relatively high yields on investment in securities have generally restricted the flotation of new issues by companies.

After the sell-off of shares immediately before and after independence in December 1963, as a result of the general political uncertainties, share prices on the Nairobi Exchange increased rapidly. The very sharp increase in the share price index from nearly 120 in 1965 to 161 in 1966 (January 1964 = 100) reflects two factors: the restriction on capital movements to sterling area countries in mid-1965, which led to the accumulation of funds within the economy, and the extremely high rate of economic growth in 1966. Despite the unsettling effects of the devaluation of the pound sterling in November 1967 on the Nairobi market, share prices showed a marked increase of 7.5 per cent in 1967 with the industrial share index at 173. However, prices stabilized during the following year with the index at about 172. The share price index rose by 18 points in 1969, to 184.27 Apart from the exceptional situation in 1965–66, share prices have shown upward fluctuations. Although marked price variations for individual stocks from one trading day to another are reported to exist, speculative tendencies are considerably reduced because of the requirement for payment for shares at the time of purchase. Because of the narrowness of the market, considerable time may still be required to turn securities into cash without significant loss of value.

With the increasing volume of government stocks and industrial securities, the network of financial institutions, and the Nairobi Stock Exchange, a firm basis has been laid for the expansion of the capital market in Kenya. The increasing amount of domestic capital required for economic growth should also assure such an expansion.

III. The Nigerian Capital Market

Background

Although securities were floated in Nigeria as far back as 1946, the necessary institutions for the functioning of a capital market were not created until much later. The establishment of a central bank in 1959 and the launching of the Lagos Stock Exchange two years later provided the basic institutions for the operation of a capital market. Moreover, the increased tempo of economic development and the growth of banking and other financial institutions in the country along with a marked expansion in the issue of securities provided the momentum for creating such a market.

The need for a stock exchange in Nigeria was recognized when the Government appointed a committee in May 1958 to consider, among other things, “all means whereby the buying and selling of stocks and shares could be facilitated.” 28 One of the main problems at the time was the difficulty of selling government stocks, thus making lending to the Government through the purchase of stocks an unattractive proposition. In addition, there was the need to mobilize savings for development and to provide facilities for the Government to sell (if it so desired) part of the increasing volume of industrial shares that it was holding through participation in joint ventures.

The Barback Committee found conditions in the country favorable for launching a capital market, including a stock exchange, because of the increasing volume of savings in the economy, albeit these were still on a relatively small scale. Besides, it was established that, since little use had been made of public companies, there was a lack of financing of ventures through issuance of public shares. For example, of the 845 incorporated companies operating in Nigeria in 1958, only 12 were publicly owned; 92 were wholly or mainly owned as subsidiaries of overseas companies. Of the total issued shares (not necessarily fully paid) amounting to £24.2 million, about £7.5 million (31 per cent) was issued to residents in Nigeria.29 Despite the high ratio of locally held shares to issued shares, dealing in these shares was not possible because of restrictions on the transfer of shares and the limitation on the number of legally permissible owners (not exceeding 50) of private companies. Such companies were also prohibited from floating shares publicly.

On the potential demand for securities, the Barback Committee found indications of available savings that could be invested through share subscription. For example, the first and only government loan floated locally before 1959, a £300,000 issue (3¼ per cent with 10–15 years maturity) under the Nigerian (Ten-Year Plan) Local Loan Ordinance was oversubscribed by more than 160 per cent, and allotment had to be rationed. Another indication of available savings was the accumulation of assets abroad not only by official entities but also by semiofficial entities and commercial establishments. At the end of 1959 total external assets held by the Government of the Federation, the marketing boards, and the banking system totaled £211.4 million, of which the Central Bank and the West African Currency Board accounted for about 38 per cent.30

To overcome the restraints on the emergence of a capital market in Nigeria, the Barback Committee indicated four main areas that required the attention of the Government. First, fiscal measures were suggested to encourage a greater volume of personal savings. For example, the administration of income tax on dividends should be improved and the stamp duty on the issue of share capital should be reduced or abolished. Second, steps should be taken to promote the availability of securities to the public through the formation of public companies and through the elimination of restrictions on the transfer of shares in the existing public companies. In this respect, it was suggested that future government issues should be offered to the public as widely as possible, using banks as issuing agents, while public corporations and statutory bodies should be encouraged to raise loans publicly. Third, institutions should be created to facilitate the transfer of stocks and shares, notably, issuing houses and a stock exchange. Fourth, steps should be taken to enact measures to inspire confidence in shareholding as a form of investment. Among other things, share registers of public companies should be kept in government-approved custody and accounts of such companies should be audited by approved accountants, while a list of approved brokers should be published and rules and regulations governing dealings in shares should be established.

Government securities and the Central Bank

Speaking on the imminent establishment of the Central Bank in his budget speech for 1959, the then Minister of Finance of Nigeria stated: “there is at present no organised capital or money market in Nigeria; both are becoming more and more necessary to enable Nigerian capital to be employed in the expansion of … industries and in the development programmes of [the] Governments. The [Central] Bank will actively help in fostering the growth of these markets. Arrangements are far advanced for the flotation of an internal loan of two million pounds on behalf of the Federal Government … and these arrangements will take full account of the need to develop a local market in Federal Government securities.” 31

As envisaged, the Central Bank of Nigeria (CBN) has played a vital role in the management and “marketing” of government securities and, when the market became somewhat saturated, as a main holder of such securities until sold to the public. In floating the first development stock for the Government in 1959, the CBN attempted to introduce arrangements for the growth of a market in the securities. Commercial banks were requested to accept names of potential buyers and sellers and to transmit them to the Bank, where a central register was maintained. The Bank thus offered to serve as the link between potential buyers and sellers and to “suggest a price at which [the Central Bank] considered the deal might reasonably take place.” 32 The narrowness of the market and the absence of a true capital market in itself are reflected in the role of the CBN acting to establish prices for stocks. This mechanism for trading government stocks proved somewhat cumbersome. With respect to price movements, there was relative stability. Within the first nine months of issue of the first development stock, prices at which the stock changed hands reflected only the price of issue plus accrued interest to the date of transfer, and there were no variations to reflect the demand-supply position of the securities. It was not until 1961 when the Lagos Stock Exchange was established that government stocks began trading in the capital market, but even then there was not much price variation at first. The CBN has continued to manage the issue of government securities; between 1960 and 1968 there were nine issues amounting to £123.4 million, of which £96.1 million was taken by the CBN (see Table 9). The interest rate payable on the development stocks has ranged between 5.0 per cent and 6.0 per cent.

Table 9.

Nigeria: Initial Allotments of Government Development Loans, 1960–68

(Amount in thousands of Nigerian pounds)

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Sources: Central Bank of Nigeria, Annual Report and Statement of Accounts for the Period Ended 31st March 1960, and Annual Report and Statement of Accounts for the Year Ended 31st December, 1961–68.
Table 9 (concluded).

Nigeria: Initial Allotments of Government Development Loans, 1960–68

(Amount in thousands of Nigerian pounds)

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Federation of Nigeria Development Stocks.

Federal Republic of Nigeria Development Stocks.

Includes cooperatives and pension and provident funds.

Allotment and holdings of government stocks

Allotment

The importance of the role of the Central Bank in the disposal of government securities is further indicated by the increase over time in its share of the initial allotment of such securities (Table 9). The CBN did not have to take any of the first issue of government stock, as the nonbank sector absorbed 85 per cent and the commercial banks took the remainder. Beginning with the second issue, the CBN has had to take a sizable part of the initial allotment, varying from about 35 per cent of the Third Development Stock in 1962 to over 90 per cent of the Federal Republic Fifth Development Stock in 1968. The marked increase in securities initially held by the CBN before eventual sale to other holders reflected largely the saturation of the capital market with government securities and the availability of other investment opportunities. The Bank noted in its Annual Report for 1964 that “the problem facing [it] as underwriter of government stock issues has been the difficulty of disposing of old stocks held before new issues are floated.” 33 This difficulty is reflected in the increase in its holdings of government securities (Table 10).

Table 10.

Nigeria: Holdings of Government Development Stocks, 1962–68

(In thousands of Nigerian pounds)

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Sources: Central Bank of Nigeria, Economic and Financial Review, Vol. 2 (June 1964); Vol. 4 (June 1966); Vol. 5 (December 1967); and Annual Report and Statement of Accounts for the Year Ended 31st December 1968.

Largely by savings-type institutions and insurance companies.

Allotment of government stocks to individuals has been relatively small and of declining importance. Nearly 4 per cent (£92,000) of the first issue was bought by individuals in 1960, compared with only 0.1 per cent (£20,000) of the Federal Republic Fourth Development Stock in 1967. The decline in participation of individuals in the purchase of government securities may be attributed to three main factors: the increasing opportunities for investing in industrial shares as they become available; the relatively high denomination of government securities; and the paucity of funds after the mopping-up operation accompanying the first issue.

The initial allotment of stocks to savings-type institutions, mainly pension and provident funds, remained sizable until 1963 when they accounted for nearly 20 per cent of the Federation of Nigeria Fourth Development Stock (see Table 9). Investment by the savings-type institutions during these years was due in large part to the repatriation of their external investments. While new savings generated by the institutions were invested mainly in government securities, owing partly to mandatory legislation, their subscription to new issues fell sharply in 1965, to slightly over 4 per cent of the total, and showed only a modest increase in 1968. This situation may be due to the difference in timing between the issue of new government securities and the flow of funds to these institutions.

The same operative factor of repatriating external assets has influenced the volume of subscription to new issues by semiofficial bodies. Initial subscriptions were particularly large between 1961 and 1963, amounting in 1961 to £3.6 million—about one third of the total new issues in that year. Despite certain legislative requirements, the subscription of insurance companies to new issues of government securities has been rather modest, varying from 7 per cent in 1960 to 0.6 per cent in 1967. Even in absolute terms, the participation of insurance companies has remained relatively small; at its highest, in 1965, it amounted to £220,000. The commercial banks’ purchase of government securities has naturally been very modest and after reaching a peak of £ 1.7 million in 1962 declined consistently to nil in 1968.

Holdings

Table 10 shows data on the holdings of government securities by various investors; the data differ from the cumulative totals of the initial allotments shown in Table 9 to the extent that the Central Bank succeeded in selling part of its initial allotment to the public; there were net transactions among holders, and short-dated stocks matured. At the end of 1968 the total amount of government securities outstanding was about £ 117 million, representing 7.5 per cent of GDP in that year.

The major holder has remained the savings-type institutions, whose holdings at the end of 1968 amounted to £61.4 million, nearly 53 per cent of the total. Holdings by savings-type institutions have shown a steady increase, reflecting the subsequent sales of the Central Bank’s initial allotment to these bodies as new funds are generated by them. Holdings of statutory boards and corporations accounted in 1968 for about 5 per cent of the total, reflecting a lack of new resources for investment. On the other hand, the holdings of regional and local governments showed a steady increase between 1962 and 1966, and in the latter year accounted for 6.6 per cent of the total (Table 11). The proportion of nonbank sector holdings of government securities has generally declined, from nearly 98 per cent in 1962 to only 63.5 per cent in 1968. However, in absolute amount the increase by the non-bank sector has been steady, from £18.9 million in 1962 to £74.3 million in 1968. This marked increase reflects in part the expansion in domestic savings, particularly through the mobilization effected by pension and provident funds.

Table 11.

Nigeria: Holdings of Government Stocks at End of December, 1962–68

(In per cent)

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Source: Table 10.

The share of government securities held by the banking sector has increased sharply, from 2.3 per cent in 1962 to 36.5 per cent in 1968. Holdings of commercial banks have generally fluctuated and at the end of 1968 amounted to about £1.7 million, 1.4 per cent of the total outstanding. The Central Bank has been obliged to hold an increasing share of government stocks, and this became more pronounced beginning in 1964. The sharp increase in 1966–68 reflected to a large extent the financing of expanded government operations, particularly in connection with the civil war, which broke out in 1967.

A number of factors have influenced the purchase of government securities by institutional holders, among which are the repatriation of foreign assets and certain legislative measures designed to encourage domestic investment of funds accumulated by pension and provident funds, insurance companies, statutory corporations, and marketing boards. Although repatriation of foreign assets did not create new resources, it nonetheless helped in expanding the domestic capital market.

The Income Tax Management Act, 1961 (No. 21), required existing pension and provident funds to invest at least one third of their funds not later than April 1, 1963 in Nigerian Government securities in order to continue to qualify for tax exemption on interest income.34 Also, in order to be approved for exemption from income tax, new pension and provident funds established after 1961 would have to invest one half of their funds in Nigerian Government securities.35 In his budget speech for 1961, the then Minister of Finance indicated that the percentage could be varied, and he expressed the hope that “the trustees of these funds … will at the earliest possible opportunity ensure that their assets in Nigerian securities [are] at least equal [to] their liabilities in Nigeria.” 36

The Insurance (Miscellaneous Provisions) Act of 1964 was also designed to give impetus to holdings of government stocks and other securities. The Act requires all insurance companies operating in Nigeria to invest locally at least 40 per cent of premiums received on locally insured risks. The Act further stipulates that investments of insurance companies in Nigeria should by April 1, 1966 be not less than the value of funds covering endowment assurance policies in effect on March 31, 1962. To encourage holdings of government stocks in particular, the Act requires that at least 25 per cent of the life fund or total local investments (whichever is greater) by insurance companies be held in government securities.37 The Trustee Investments Act of 1962 empowers trustees to invest in debentures and fully paid shares of public companies quoted on the Lagos Stock Exchange. Subject to other specified conditions, they may invest up to a maximum of one third of the total value of their funds. The National Provident Fund is also required to invest all its available proceeds in government securities.38 Through these legislative provisions the Nigerian Government has actively encouraged institutions mobilizing the savings of the economy to invest in government and industrial securities.

New issues of industrial shares

The first domestic issue of shares of a company to the Nigerian public was made in February 1959 when the Nigerian Cement Company, Ltd. offered 174,898 (£1 par) shares. The company was launched by the Federal Government, the then Eastern Nigeria Government, and the Commonwealth Development Corporation. The response of the public was reasonably good, and the issue was oversubscribed. During the following seven years 14 other companies offered new issues of shares and debentures either through public offering or private placement with varying degrees of success. Altogether the shares and debentures of 15 companies and corporations were issued during the period 1959–66 (see Table 12). Of the 20 new issues, 40 per cent was in the form of preference and debenture stocks, while the remainder was in shares. The shares were generally in small units: three were in units of £1 (US$2.40)—of which one actually sold at £2.5—and three were in units of five shillings (US$0.60), of which one actually sold at double that price. All the debenture stocks were with a maturity of not more than six years and carried a nominal interest rate of between 6.75 per cent and 8.0 per cent. New issues during the period 1959–66 amounted to £14.5 million, of which £5.5 million (38.1 per cent) was in ordinary shares.

Table 12.

Nigeria: New Issues of Industrial Securities, 1959–66

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Sources: Central Bank of Nigeria, Annual Report (various issues); Federal Ministry of Information, The Nigeria Trade Journal, Vol. 17 (April/June 1969).

Table 13 shows the composition of subscribers to new issues of selected companies for which data are available. The selected issues represent the bulk of the issues offered publicly. Institutional investors account for more than half, reflecting partly the attractiveness of the issues in terms of yield and partly the factor of legislative direction noted above. Although the amount of participation by Nigerian individuals has been relatively small, the response nonetheless has been encouraging. In the first issue of public shares, 2,150 Nigerians applied and their allotment accounted for more than 70 per cent of issued shares. As Table 13 shows, the participation by individuals was well maintained, accounting for about two thirds of subscriptions to newly issued shares. The participation of individual Nigerians in the issues of debentures has also been small, partly because of the higher denominations of such securities and hence their appeal to mainly the higher-income groups. Expatriate individuals have also participated in new industrial issues, taking modest amounts.

Table 13.

Nigeria: Composition of Subscribers to New Issues and Selected Industrial Shares

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Sources: Central Bank of Nigeria, Annual Report (various issues); Douglas Gustafson, “The Development of Nigeria’s Stock Exchange,” Chapter 8 in Financing African Development, ed. by Tom J. Farer (The M.I.T. Press, 1965), pp. 144–87; Federal Ministry of Information, The Nigeria Trade Journal, Vol. 17 (April/June 1969).

Includes five Nigerian business firms with 2.0 per cent of holdings.

Insurance companies account for 64.1 per cent.

Includes eight Nigerian firms with 16.7 per cent of holdings.

Includes eight expatriate firms with 8.8 per cent of holdings.

Includes eight Nigerian firms with 0.5 per cent of holdings.

Includes five expatriate firms with 3.0 per cent of holdings.

Partly because of the political conditions in 1967 and 1968, there were no new issues of securities by companies or corporations. However, apart from this factor, the restrictions in force during this period on remittances abroad (including profits and dividends) 39 meant that companies could finance their operations through retained earnings, and there was less need to seek outside funds. Additionally, the general restrictions on imports and the encouragement of domestic production of certain import-replacing goods provided investment opportunities, although not of sufficient scope to induce companies to raise funds through the issue of securities. In any event, new issues—while of modest proportions—have succeeded in Nigeria and with the massive issues of government securities during this period, the supply of securities has been such as to stimulate an active capital market. The machinery for effecting transactions in these securities has also been found in the establishment of a stock exchange.

Development of the Lagos Stock Exchange

Prior to the establishment of the Lagos Stock Exchange, certain financial institutions necessary for effective operation of an exchange and related to the issuance and handling of new stock issues were set up. In 1959 an accepting house (merchant bank) was established in Lagos to concentrate on stock issues in addition to providing facilities for short-term finance (the use of bill finance) and subsequently to provide funds in connection with industrial finance.40 During the same year an investment company (the Investment Company of Nigeria) was established to provide industrial finance and a channel for raising industrial development funds.

The Lagos Stock Exchange was established in 1961 and on June 5 of that year opened for business. Transactions in government stocks were transferred to the Exchange, but there was only a limited number of existing government securities and new issues available for trading on the Exchange. By the end of 1961, of the 20 issues listed on the Exchange 6 were maturities of the Federation of Nigeria Development Stocks.

The total number of transactions in 1961 was 334, of which government securities accounted for 27.5 per cent (see Table 14), while the value of transactions was £760,000 with the government securities accounting for nearly 94 per cent. Between 1961 and 1966 the number of transactions on the Lagos Stock Exchange showed a rapid increase, reflecting the acceleration in the issue of both government stocks and company securities and the expansion in industrial activities. At the end of 1966 the number of transactions had increased more than threefold to 1,096, with industrial securities accounting for 54 per cent.

Table 14.

Nigeria: Transactions on the Lagos Stock Exchange, 1961–68

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Sources: Central Bank of Nigeria, Annual Report, 1961–68.

In value terms, the expansion of transactions on the Exchange has been rapid. The value of securities traded rose from £0.76 million in 1961 to £8.2 million at the end of 1966. Although the dominance of government stocks in the total remained relatively high, constituting about 93 per cent of the total in 1966, the increase in industrial shares traded has been modest. From an amount of £49,700 in 1961, the value of industrial shares traded rose to £734,800 in 1965 (when it accounted for nearly 10 per cent of the total) but declined sharply to £584,700 in 1966, reflecting the unsettled political conditions in the country in that year.

The continued political crisis in 1967 and 1968 is reflected in the volume of activities on the Exchange. In 1967 the number of transactions fell to only 763, moderately higher than its 1963 level. The value of such transactions also showed a decline from 1966 of about 24 per cent, to £6.25 million, and industrial securities alone showed a precipitous decline of nearly two thirds, to less than £0.2 million. While the value of government stocks changing hands showed a marked decline, the relative share in the total increased to nearly 97 per cent. The impact of the political crisis continued to be felt on the Exchange throughout 1968, when both the volume and value of transactions continued to decline. The number of transactions dropped to below the 1962 level and was only 646, of which government securities accounted for 44.3 per cent. While the number of industrial shares traded showed a smaller decline, in value terms the amount of transactions declined by 46 per cent. On the other hand, the value of government securities traded in 1968 showed some increase and accounted for over 98 per cent of the total. Data on transactions during the first half of 1969 show that the same factors that affected trading during the period 1966–68 continued. The number of transactions totaled 260, compared with 338 during the corresponding period in 1968. However, in value terms, transactions amounted to £4.4 million (compared with £2.3 million during the first half of 1968), of which industrials accounted for only £11,500.41 With the cessation of the civil war early in 1970 and the expected resumption of economic expansion and reduced business uncertainties, trading on the Lagos Stock Exchange could be expected to increase appreciably in the near future.

In its brief history, the operations of the Lagos Stock Exchange have been affected by many factors. Transactions have remained limited partly because of the small number of publicly issued shares and partly because of the newness of the institution. Moreover, as investible funds are limited, transactions in industrial shares were relatively small and were adversely affected during recent years by the civil war.

Stock Exchange operation and investment yield

Operations on the Exchange still remain rudimentary compared with exchanges in developed countries. There is a system of “call-over” as on the Nairobi Stock Exchange, and bidding takes place among the existing four brokers. A daily summary of transactions shows the prices at which bargains were made and the closing prices. A number of local dailies publish the list of transactions.

Expenses in dealing on the Exchange consist of the usual broker’s commission, contract stamp fee, and administrative expenses connected with new issues. Brokers’ commissions are set by the Exchange and vary according to the type and volume of securities. On government securities, a broker’s commission varies between 0.125 per cent and 0.375 per cent of nominal value, while the commission on private securities is 1.0 per cent of the value of transactions. A minimum commission of ten shillings is chargeable. While no charge is made for the listing of government securities, the Exchange levies an annual charge on dealing members and imposes an initial listing fee per security of £2 per £10,000 of the company’s authorized capital, subject to a maximum of £50. In addition, there is an annual charge of £25 on companies listed on the Exchange.42

Current data on dividends paid by companies listed on the Lagos Stock Exchange are not available nor are data on yields on government stocks. However, as mentioned earlier, the nominal interest rates payable on government stocks have ranged between 5.0 per cent and 6.0 per cent depending on the maturity of the loans, while rates on industrial debentures have been generally higher, ranging from 6.75 per cent to 8.0 per cent. These rates compare with a rate of about 3 per cent payable on savings deposits with commercial banks. In the absence of more detailed information, it is difficult to assess the extent to which the net return on investment made through the Exchange has influenced the asset preferences of the investing public.

IV. Promoting Capital Markets in Africa

From the analysis of the conditions prevailing in African economies and the recent experiences of Kenya and Nigeria in establishing capital markets, the need to broaden local capital markets becomes obvious if they are to function effectively and to serve a useful role in the mobilization of domestic savings. Measures that may help such an expansion are examined briefly here. However, it is not feasible to establish organized capital markets on a national basis in most African countries, mainly because of the small size of their economies and the low incomes and savings. For many countries the possibilities of securing the advantages of capital markets would seem to lie in the promotion of regional capital markets covering groups of countries.

Public companies 43

In countries where capital markets now exist and in those with potential, a number of steps could be taken to broaden the base of the markets. The encouragement of joint-stock companies or corporations generally referred to as public companies, with widespread ownership of their equity capital, is a sine qua non of making shares available to the investing public. The public company is important as an instrument of aggregating small savings and, because of the possibilities of diffuse shareholding, permits the development of trading in shares on a stock exchange. Also, the development of depositary institutions, such as mutual funds and unit trusts in Europe and the United States, may permit indirect public ownership of industrial shares.

In both Nigeria and Kenya privately controlled companies and partnerships are predominant. While this phenomenon is peculiar to the early stages of development and of industrialization, the government could adopt measures to facilitate the promotion of public companies. Apart from indigenous private enterprises becoming public as they succeed in their operations, there are three principal means of encouraging public participation in enterprises.

First, many governments have statutory corporations that engage in industrial enterprises as wholly owned entities of the government; these corporations could establish subsidiaries (as public companies) and offer their securities to the public. This would not only make funds available to such public enterprises but also permit the public to have a more direct say in the management of such enterprises. The experience of the Uganda Development Corporation in offering shares to the public, although on a restricted basis (only to Africans), is illustrative of this approach.44

Second, the practice of joint ventures between government and private or semiofficial interests is increasing in African countries. This practice offers a unique opportunity to foster the growth of capital markets, since part of the ownership of such ventures could be made available to the public. The Nigerian experience in the launching of its first public issue of shares is illustrative of the success of this device. In many countries the government now owns a sizable share of industrial enterprises. The base of equity ownership could be substantially broadened if the government would divest itself of part of the ownership in a number of such ventures as they become successful, especially where there is no overriding social or political objection to such divestiture. This approach would also further the mobilization of savings and release the funds that the government initially invested.

Third, established foreign companies operating in most countries could offer a certain proportion of their capital to the local public through the issue of shares and debentures. Admittedly, this is a matter that would involve some changes in the organization of their capital structure. However, the desirability of developing in this direction has other advantages in addition to fostering capital markets.45 The rise of economic nationalism in many countries already raises uncertainties as to the continued foreign ownership of many of these companies. The pressures for increased local participation in such companies is not confined to securing the appointment of a few local people as senior personnel who are usually without much responsibility in policy decisions. The offer of shares and securities on a voluntary basis to local subscribers might provide a safety valve and reduce the risk of nationalization.

To facilitate ownership of shares by Africans in Kenya and Nigeria certain approaches have been adopted that, if followed by other foreign companies going public, could encourage share ownership by a wide segment of the working population in many countries. Of note is the encouragement of workers in the particular companies to buy shares and to pay for them on a term basis; this is distinct from stock options to employees. Another practice is to arrange for commercial banks to extend credit to prospective share owners up to defined limits. The Kenyan experience is illustrative of these approaches. In offering 600,000 (K Sh 15) shares of British-American Tobacco (B.A.T.) Kenya Ltd. to the public early in 1969, the management of that company indicated that special consideration would be given to applications from Kenyan citizens. About two thirds of the employees of the company were offered an opportunity to buy shares through deductions from their salaries, while a local commercial bank agreed to provide credit to a total amount of K Sh 2.0 million to small investors. Under the latter scheme, a small investor could receive up to 90 per cent of the cost of the shares against the collateral provided by the shares. Because of the possibilities of share price fluctuations, the scope for this practice is limited and is attractive only in case of rising share prices.

Costs of securities issues

Because of lack of adequate data it is difficult to ascertain whether the costs involved in the issue of and dealing in securities act as a deterrent to the expansion of capital markets in Africa. However, judging from the situation in Kenya and Nigeria, costs of issues are generally less than in European capital markets,46 while for subscribers the generally high yields of industrial securities compensate for the variety of costs incurred in the buying and selling of shares. With the narrowness of capital markets and with the lack of data to compare in detail the costs and yields of various types of securities, it is also difficult to see whether a reduction in costs could promote an immediate increase in holdings of securities.

Room exists in many African countries to promote share ownership through favorable tax policies. For example, dividends received through security ownership could in the initial stages be given special treatment in the taxation of incomes, while capital gains derived from the same source could either be exempted from taxation for a specified period and/or taxed at a reduced rate compared with other sources of income. Also, any form of stamp duty on the transfer of shares would impede rather than promote the development of capital markets, especially in the initial stages.

Government securities and regulations

The role of the government in ensuring that the security market operates efficiently and smoothly is important as a factor in broadening the market. The issue of government securities is for some time to come likely to dominate the capital markets of the developing countries.47 It is, however, important that the volume and timing of such government issues accord with the growth of capacity of the market.48 A situation where government securities are held largely by the central bank for a protracted period does not contribute to the expansion of a capital market.

Another important role of the government is the provision of a framework for supervising the workings of a capital market, particularly where there is a stock exchange. Investors’ confidence is crucial to the successful operation and development of a capital market. At least initially the central banks of various countries could provide minimum supervision, possibly through requirements for a periodic reporting system. This is also important because of the importance of the capital market in the management of monetary policies.

Regional capital markets

Because of the small size of many African economies, the development of a capital market serving many countries could facilitate the mobilization of savings in such countries and encourage the holding of wealth in the form of financial assets.

The establishment of a regional capital market requires the absence of restrictions on capital movements and on dividends and profits within the group of countries setting up the market. In this respect, the existence of (1) common market arrangements, as in the East African Community49 with identical exchange control regulations, (2) countries with common monetary arrangements, such as the West African Monetary Union (Union Monétaire Ouest Africaine) 50 with a common central bank (Banque Centrale des Etats de l’Afrique de l’Ouest), and (3) the five Equatorial African countries with a common currency issuing authority51 provide a framework that could be utilized to launch regional capital markets.

Regional cooperation in this area could also facilitate African development. For example, the establishment of large industrial ventures to serve more than one country would be facilitated through joint ownership, which the mechanism of a regional capital market could encourage. In addition, it might be possible for the various industrial development banks in African countries to raise more private domestic funds on such regional capital markets. In the circumstances, the idea of regional cooperation requires active consideration by various countries if greater mobilization of domestic savings is to be realized.

V. Conclusions

Capital markets are few and scattered in Africa, and only five countries—Kenya, Morocco, Nigeria, South Africa, and Rhodesia—have such organized markets. In all these countries except Nigeria the establishment of the markets has been due in large measure to the presence of European communities. Even at present, participation by the local citizens has only just begun. The paucity of organized capital markets is due primarily to the relative low national incomes and associated low per capita incomes in virtually all the African countries, the small volume of financial savings, the limited degree of monetization of the economies, and the nature of economic activities, which precludes corporate organization especially in the predominant, agricultural sector.

The capital markets in the five countries are small in size when compared with those in many developed countries in Europe and North America. The situation is a direct reflection of the low incomes and the relatively underdeveloped financial systems. The supply of securities is limited by the lack of public companies and, until recently, by the reliance of most governments on the raising of loans on foreign capital markets. On the demand side, the asset preference of many people in these countries is in the direction of holdings of nonfinancial assets and liquid protection-giving assets.

From the experience of Nigeria and Kenya, there are indications that asset preference is easily being influenced through an awareness of opportunities for investment in securities; the increased participation of the citizens of these countries attests to this. The secondary market for securities in each of the two countries is much greater than the market for new issues. In Nigeria new issues reached a peak in 1964, when they amounted to US$135.8 million (representing about 25 per cent of gross capital formation in that year), of which industrial securities accounted for about three fifths. In Kenya data on new issues are not available, but the new issues of government securities at their peak in 1968 amounted to US$26.8 million, 11.4 per cent of the capital formation in that year. In both countries, dealings in government securities occupy a dominant position.

The expansion in existing capital markets has been fostered by the various governments directly and indirectly. In Kenya and Nigeria there are statutory requirements on certain financial institutions, especially insurance companies and officially sponsored funds, to invest in domestic securities. Also, the introduction of exchange controls on capital movements at one time or another has had the unintended effect of increasing activity on the local capital market. The reason for this is not far to seek: the funds that are not allowed to flow out seek opportunities for investment in the local capital market. Furthermore, the increasing issues of government stocks have helped the local capital markets to expand. The expansion in securities issues generally has seen increased activity on the local stock exchanges, but dealings on these exchanges remain quite small.

Despite the narrowness of the capital markets, share prices in both Kenya and Nigeria have not shown wide fluctuations. The desire to hold securities for relatively long periods and the large size of government securities have had moderating effects on price movements. Securities prices have therefore tended to reflect mainly fundamental economic and political factors rather than speculative activity on the exchanges.

One of the advantages to African countries of organized capital markets lies in the fact that they facilitate the mobilization of domestic savings, not merely in the sense of converting part of existing savings into securities but also in tapping a large part of the flow of savings. For the national economy, the raising of a sizable part of needed funds locally may ameliorate the burden of foreign debt payments: to the extent that the capital structure of companies is biased toward equity subscription, the economy is spared fixed debt service payments.

Considering the general nature of the African economies, certain measures would be needed to promote organized capital markets. The supply of industrial securities would need to be enhanced through the promotion of public companies and industrial development. For example, a number of government ventures could go public, while many foreign-owned or foreign-controlled companies could make part of their equity capital available to the domestic market. To further the demand for securities, fiscal policies favoring securities holdings would need to be adopted; in this respect, consideration could be given to more favorable tax rates on dividend incomes and capital gains, the abolition of stamp duties on share purchases, and the elimination of share transfer fees. There is a need for government regulation, particularly of stock exchange operations, in order to maintain public confidence.

Because of the small size of many African economies and the corresponding low volume of savings, it is not practical to establish effective national capital markets. In order to realize the advantages of such markets, consideration could be given to the establishment of regional capital markets. Given the existing common market and financial arrangements in certain groups of countries, e.g., the East African Community and the countries using the CFA franc, such cooperation is feasible. The advantages for the setting up of regional capital markets lie not only in the mobilization of domestic savings but also in joint industrial ventures.

Le développement des marchés de capitaux en Afrique, et tout particulièrement au Kenya et au Nigéria

Résumé

Le document étudie l’utilisation du mécanisme des marchés de capitaux dans la mobilisation intérieure du capital en Afrique, et en particulier au Kenya et au Nigéria. Le manque de marchés de capitaux organisés tient avant tout aux niveaux relativement faibles du revenu national et du revenu par habitant dans presque tous les pays africains; elle s’explique aussi par la modicite du volume de l’épargne financière, le degré limité de monétarisation des économies, ainsi que par l’absence d’une organisation à grande échelle des activités économiques sous forme de sociétés. Du côté de la demande, il convient de noter dans ces pays une préférence assez répandue pour les avoirs non financiers et pour des avoirs sous une forme liquide conférant une protection.

Alors qu’au Kenya, l’expansion du marché des capitaux a été due en grande partie à l’initiative du secteur privé, c’est l’Etat qui est à l’origine de la création et du développement de ce marché au Nigéria. Ces deux pays ont cependant pris des mesures législatives en vue d’encourager les caisses de pension et de prévoyance, les compagnies d’assurances et autres établissements financiers à placer leurs fonds recueillis en valeurs émises dans le pays. La création d’un contrôle des changes sur les mouvements de capitaux a aussi eu pour effet d’intensifier l’activité des marchés de capitaux. En outre, le nombre croissant des émissions d’Etat, lié à une augmentation modeste du volume des valeurs industrielles et à l’élargissement du réseau des établissements financiers, a contribué à créer une base solide pour le développement de ces marchés.

L’essor des émissions de valeurs au Kenya et au Nigéria a entraîné une activité boursière plus grande dans ces pays, mais avec des opérations demeurant tres limitées. Malgré l’étroitesse de ces marchés, les cours des actions, tant au Kenya qu’au Nigéria, n’ont pas enregistré de fortes fluctuations. Le désir de conserver assez longtemps les valeurs en portefeuille et la prépondérance des valeurs d’Etat ont eu un effet modérateur sur les variations des cours.

Si Ton considère les caractéristiques des économies africaines et l’expérience du Kenya et du Nigéria, certaines mesures sont nécessaires pour encourager l’évolution de marchés de capitaux organisés. II y aurait lieu de stimuler l’offre devaleurs industrielles par la création de sociétés anonymes et l’aménagement d’industries. Par exemple, certaines entreprises publiques pourraient être transformées en sociétés anonymes, tandis que nombre de sociétés étrangères ou sous contrôle ètranger pourraient ouvrir une partie de leur capital effectif à la participation locale. Pour encourager la demande de valeurs, il serait bon d’adopter des mesures de politique fiscale favorisant la constitution de portefeuillestitres. Pour garder la confiance du public, il importerait que I’Etat promulgue une réglementation particulièrement en ce qui concerne les opérations boursières.

Etant donné l’étroitesse de l’économie de nombreux pays africains, il n’est pas pratique de créer des marchés de capitaux strictement à l’échelon national. Pour tirer parti des avantages offerts par ces marchés, il conviendrait d’en envisager la création a l’échelle régionale, spécialement parmi les pays qui font partie déjà de marchés communs et qui sont liés par des accords financiers, si Ton veut parvenir à une plus grande mobilisation de l’épargne intérieure et promouvoir les échanges commerciaux entre pays d’Afrique.

La evolución de los mercados de capital en Africa, especialmente en Kenia y Nigeria

Resumen

En este trabajo se examina el uso del mercado de capital como mecanismo para la movilización interna del capital en Africa, particularmente en Kenia y en Nigeria. La escasez de mercados de capital organizados en Africa se debe sobre todo al nivel relativamente bajo, en casi todos los países africanos, del ingreso nacional y del ingreso por habitante, al reducido volumen de los ahorros financieros, al escaso grado de monetización de las economías y a la falta de organización en gran escala de la actividad económica en sociedades mercantiles. Del lado de la demanda, muchas personas de estos países prefieren poseer activos no financieros y líquidos que les sirvan de protección.

En Kenia, el desarrollo del mercado de capital se ha debido en gran parte a la iniciativa del sector privado, mientras que en Nigeria su evolución fue empezada y fomentada por el Gobierno. Sin embargo, ambos países han promulgado medidas legislativas para estimular la inversión en valores locales del dinero recaudado tanto por las cajas de jubilación y de previsión social como por las compañías de seguros y otras instituciones financieras. Los controles cambiarios que se han implantado de cuando en cuando sobre los flujos de capital también han favorecido el aumento de la actividad de los mercados de capital. Además, el creciente volumen de valores públicos que ha existido en los últimos años, combinado con el modesto aumento de la oferta de acciones industriales y de la red de instituciones financieras, ha contribuido a sentar bases firmes para la expansión.

En Kenia y en Nigeria el aumento de las emisiones de valores se ha puesto de relieve en la mayor actividad bursátil, pero el volumen de las transacciones de las bolsas de valores sigue siendo pequeño. No obstante las limitaciones de los mercados, los precios de las acciones no han experimentado grandes fluctuaciones en ninguno de los dos países. El deseo de los tenedores de valores de conservarlos en su poder por períodos relativamente largos, y la preponderancia de los valores públicos han ejercido efectos moderadores en la fluctuación de las cotizaciones.

En vista de las características de las economías africanas y de lo ocurrido en Kenia y Nigeria, es preciso que se adopten ciertas medidas para promover la creación de mercados de capital organizados. Será necesario mejorar la oferta de valores industriales mediante el fomento de empresas públicas y del desarrollo industrial. Por ejemplo, varias empresas gubernamentales podrían ofrecer parte de sus acciones de capital al público inversionista, y muchas compañías de propiedad extranjera, o que se encuentran bajo el control de extranjeros, podrían ofrecer parte de sus acciones en el mercado interno. Para formentar la demanda de valores tendrían que adoptarse medidas de política fiscal que favorecieran la tenencia de dichos valores. Asimismo, a efectos de mantener la confianza del público, es preciso que existan reglamentaciones oficiales, especialmente con respecto a las operaciones de la bolsa de valores.

En vista de la limitada magnitud de las economías africanas, no es práctico establecer mercados nacionales de capital eficaces. Para lograr las ventajas que ofrecen dichos mercados, debe prestarse especial atención al establecimiento de mercados de capital regionales, particularmente en aquel