Impact of Stock Exchange Market on the Nigerian Economy

Introduction

The achievement of a high sustainable level of economic growth and development has been the main objective of many countries, most especially after the publication of the famous book “an enquiry into the nature and causes of wealth of a nation” by Smith (1776). The search for ways to improve the level of economic growth has encouraged researchers to develop different models and theories in a bid to explain the phenomenon of economic growth. Economists traditionally have looked at factors such as capital, labour and technology as the only factors which matter to the process of economic growth. Mckinnon and Shaw (1973), King and Levine (1993), Beck, Levine and Loayza (2000) among others have argued that stock market development spurs economic growth. On the other hand, Bossone (2000), and Tsuru (2000), Levine (1997) and Gertler (1988) stressed that economic growth can be affected by functions exercised by stock market such as mobilising capital, assisting in the allocation of resources, monitoring managers, and facilitating risk management.

However, with recent developments in the economic growth theory, there has been a shift in the focus of growth literature from the traditional factors (capital, labour and technology) to other factors that might also contribute to the growth process. These other factors include financial and stock market development, macroeconomic environment, political stability and foreign direct investment (FDI), among others. Stock market development provides a platform that helps in improving the allocation of capital and thus enhancing the prospects of long-term economic growth. A liquid stock market development offers the potential for investors to quickly and cheaply alter their portfolios thereby reducing the riskiness of their investment, thus, facilitating investments in projects that are more profitable (Ezeabisili & Alajekwe, 2012). Without a liquid stock market, many profitable long-term investments would not be undertaken because savers would be reluctant to tie up their investments for long periods of time (Okonkwo, Ogwuru & Ajudua, 2014).

Beck and Levine (2002) observed that a well-functioning stock market fosters growth and profit incentives and also helps in risk management. It has also been observed that more developed market may provide liquidity that lowers the cost of the foreign capital essential for development, especially in low income countries that cannot generate sufficient domestic savings (Bencivenga, Smith and Stair 1996).

A well-functioning stock market fosters growth and profit incentives and helps in risk management more efficiently than the bank-based system does (Levine, 2002 and Beck and Levine, 2002). Bencivenga, Smith and Starr (1996) expounds theoretically that a more developed stock market may provide liquidity that lowers the cost of the foreign capital essential for development, especially in low-income countries that cannot generate sufficient domestic savings. Levine and Zervos (1998), Demirguc-Kunt and Levine (1996) and Atje and Jovanovic (1993) envisaged that stock market development is vital for economic growth. The fluctuation of general stock market index expresses the level of economic growth, the degree of trade openness and the financial depth in a developing or developed country.

Mckinnon and Shaw (1973) hypothesised that financial liberalization and stock market development would promote economic growth through their effects on the growth rate of savings, investment, and thus economic growth. This hypothesis has been supported by Ezeabisili & Alajekwe (2012), Levine (2002), Khan (2000), Basci and Wang (1997), Montiel (1995) and Greenwood and Jovanovic (1990). On the other hand, Burkett (1987) and Buffie (1984) argue that the stock market development may not affect economic growth. This is conflicting as Allen & Gale (1999), Boyd & Prescott (1986) and Stiglitz (1985) claimed that banking sector development can play an important role in promoting economic growth, as banks are better than stock markets when it comes to resource allocation. It is against these identified inconsistencies that this study is been conducted.

Concept of Stock Market

The stock market is a market which deals in long term loans (Jhingan, 2004). It supplies firms with fixed and working capital and finance medium term and long term borrowings of the federal, states and local governments. Thus, the stock market encompasses of institutions and mechanisms through which medium term funds and long term funds are pooled and made available to corporate entities and governments. The stock market has been recognised as an institution that contributes to the socio-economic growth and development of emerging and developed economies. Donwa and Odia (2010) noted that this is made possible through some vital roles played, such as channelling resources, promoting reforms to modernize the financial sectors, financial intermediation capacity to link deficit to surplus sector of the economy, and a veritable tool in the mobilization and allocation of savings among competitive uses which are critical to the growth and efficiency of the economy. Levine (1991) suggested that stock market activities spurs economic growth basically in two ways. First, stock markets make property changes possible in the companies, whilst not affecting their productive process. Second, stock markets offer higher possibilities of portfolio diversification to the agents.

Traditional Characteristics of the Nigeria Stock Market

The traditional characteristics of a stock market’s development are concerned with basic measures of its growth, including the number of listed companies and market capitalisation. These traditional characteristics provide the background for apprehending the measures used in evaluating stock market development. They are discussed briefly below.

Market Size

The size of market capitalization and its growth rates are indicators of market size and performance. Market size is also measured by the market capitalization ratio, which is defined as the value of shares listed divided by GDP. The essence of the market capitalization ratio is that the size of the market should be positively correlated with the ability to mobilize capital and diversify risk in an economy (Demirguc-Kunt & Levine, 1995).

Liquidity

Generally, the liquidity of a stock market relates to the ease with which shares are traded in the market. Liquidity is measured by the ratio of the securities traded to the total national output, which is computed as: total value traded/GDP. The liquidity of the stock market as argued by Osinubi (2002), facilitates profitable interactions between the equity and the money market, since, with a liquid stock market, shares are accepted as collateral by banks for lending purposes, consequently increasing access to credit for growth. Similarly, Oke and Mokuolu (2004) highlighted liquidity as an important characteristic of a stock market and point to its ability efficiently to allocate capital as well as allowing investors to divest their assets easily. Total value traded ratio and turnover ratio are the two main measures of stock market liquidity.

Institutional Characteristics of the Nigeria Stock Market

According to Emenuga and Inanga (1997), the key elements of the institutional characteristics are regulations, information disclosure rules and accounting standards, settlement process, transactions costs, institutional barriers and market structure. Some of these elements are briefly discussed for understanding and assessing the level of development of the institutional characteristics of the Nigerian stock market.

Regulations

The regulatory bodies in the Nigerian stock market are the Securities and Exchange Commission (SEC) which is responsible for the overall regulation of the stock market; Nigerian Stock Exchange (NSE), a self-regulatory organization in Nigeria Stock Market that supervises the operations of the formal quoted market; Central Bank of Nigeria (CBN) and Federal Ministry of Finance. These regulatory bodies are designed to encourage savings mobilization and investment; promote efficiency in resource allocation; and improve opportunities for firms to secure long-term funds.

Information disclosure rules and accounting standards

Full disclosure of information by all market participants is a requirement of the SEC and the NSE. Participation in the market requires full compliance with the listing requirements. Of these listing requirements, the submission of financial statements is the most relevant for the purpose of valuing the shares of a company in the primary securities market. For the secondary securities market, the information to be made public by the listed companies is as required by the Companies Decree of 1968 and its 1988 amendment. By their provisions, quoted companies as well as other public limited liability companies are to make public their profit and loss accounts and balance sheet. The adequacy of information supplied by the Nigerian quoted companies for investors' use could therefore be viewed from the contents of these financial statements and their availability to investors (Emenuga & Inanga, 1997).

Transaction Cost

The level of transaction costs in a market relative to others is one measure of the efficiency of that market. Inefficient markets have high transaction costs relative to efficient markets. From the point of view of companies, transaction costs cover the various expenses in the course of public offer of equity or loan stock. Aside the cost of paying for solicitors, advertising, administration and auditors, the buying and selling charges on the Nigeria stock market could amount to something between approximately 1.8% to enter and complete a two-way transaction (buy and sell); it would come to a total was of 4.05% of the sum invested including the application, valuation, brokerage and the vending fees.

Institutional barriers and market structure

The Indigenization Decrees of 1972 and 1977 were the first legislation that restricted foreign investment in Nigeria. They limited the scope of foreign participation in enterprises to 40%. This provision was amended by the Nigerian Enterprises Promotion Decree No. 54 of 1989, which allowed 100% participation of foreigners in most enterprises. Foreign interest in banking/insurance, petroleum prospecting and mining is still restricted to a maximum of 40%. The Investment Securities Act of 1999 made it possible for the participation of foreign nationals and opened the way for the inflow of foreign direct investment. There is no longer a limit on the amount of shareholding by foreign investors. The CEO of Nigerian Stock Exchange, Mr. Oscar Onyema, in an interview with Akintunde Akinleye of Reuters on the 10th of April, 2013 stated that foreign investor accounted for 41 percent of holdings on the NSE the domestic investors accounted for 59 percent of holdings in 2012, against 45 percent as at the end of 2011.

Stock Market Development and its impact on Nigeria Economic Growth

The Mckinnon and Shaw (1973) hypothesis asserts the positive effect of stock market development on economic growth. Efficient and effective operation of the stock market is expected to boost economic growth by way of providing opportunity to raise domestic savings and increasing investments in qualitative and quantitative terms (Singh,1997). Stock market provides mechanism that enables the encouragement of domestic savings through the provision of individuals and corporate entities with some supplementary financial instruments that are capable of meeting their risk preference and liquidity needs (Levine & Zervos, 1998). The Nigeria Stock Market has not only made funds available for investment but also resourcefully distributed these funds to projects of best returns to providers of funds mostly via dividend and appreciation in stock prices. The market is very relevant to the economic growth of Nigeria because it provides a transmission path for government monetary policy; monitoring managers and exerting corporate control and facilitating financial risk management.

According to Aiguh, (2013), the Nigeria Stock Market has impacted on Nigeria’s economic growth through the following under listed points: 

i.                    The stock market encouraged the inflow of foreign capital when foreign companies or investors invest in domestic securities. 

ii.                  It reduces the over reliance of the corporate sector on short term financing for long term projects and also provides opportunities for government to finance projects aimed at providing essential amenities for socio-economic development. 

iii.                The stock market aid the government in privatization programme by offering her shares in the public enterprises to members of the public through the stock exchange.

iv.                It has impacted positively by providing avenue for the marketing of shares and other securities in order to raise fresh fund for expansion of operations leading to increase production/output. 

v.                  The market provides means of allocating the nation real and financial resources between various sectors, industries and companies. Through the capital formation and allocation mechanism the market efficiently distributes the scarce resources for the optimal benefit to the economy.

Empirical Reviews.

Ovat (2012) examined the effect of stock market development on economic growth in Nigeria. The study disaggregated stock market development into stock market size and stock market liquidity with a view to providing evidence on the aspect of stock market development which is the main driver of growth in Nigeria. The applied several econometric techniques such as unit root test, co-integration and granger causality test, and the result revealed that stock market development contributes significantly to economic growth in Nigeria through the market liquidity based indicators: total value of shares traded ratio and turnover ratio.

The effect of stock market on economic growth in Nigeria was examined by Ohiomu & Enabulu (2011) using ordinary least square regression (OLS). They employed data from 1989 to 2008 and their result indicated that economic growth is positively affected by all the stock market development variables.

Examining the impact of stock market on economic growth in Nigeria, Edame, Okoro & Anne (2013) regressed annualized time series data & market variable and observed that stock market has positive and significant impact on economic growth in Nigeria between the period 1970-2010.

On the other hand, the impact of the Nigerian Capital market on economic growth was determined by Kolapo and Adaramola (2012). They applied Johansen co-integretion and Granger Causality test (Using Gross Domestic Product as a proxy for economic growth and Capital Market variables such as market capitalization, Total New Issues of transactions and Total Listed equities and Government Stock) and observed that the activities in the stock market tend to impact positively on the economy.

Koirala (2011) assessed the impact of London Stock Exchange (LSE) in Gross Domestic Product (GDP) in United Kingdom. The study adopted multivariate regression analysis and the finding disclosed that market capitalization ratio has positive effect on gross domestic product.

Afolabi (2015) empirically ascertained the effect of the Nigerian Stock Market on the Nigerian economy from 1992 to 2011. The Nigerian Capital Market was proxy as Market Capitalization against some variables of the economy such as Gross Domestic Product (GDP), foreign direct investment, inflation rates, total new issues, value of transaction and total listing. Using the multiple regression analysis, he found that stock market has an insignificant impact on the economy within the period under review.

Wang and Ajit (2012) determined the impact of stock market development on economic growth in China. Quarterly data from 1996 to 2011 were used and the empirical investigation is conducted within the unit root and the co-integration framework. The result revealed that stock market development generally does not contribute positively to economic growth in developing countries if the stock market is mainly an administratively-driven market.

Nowbutsing and Odit (2009) assessed the impact of stock market development on growth in Mauritius. A time series econometric investigation was conducted over the period 1989 -20067. They analysed both the short run and long run relationship by constructing an ECM. Two measures of stock market development namely size and liquidity are used. They also define size as the share of market capitalization over GDP and liquidity as volume of share traded over GDP and found that stock market development positively affect economic growth in Mauritius both in the short run and long run.

Ikikii and Nzomoi (2013) evaluated stock market development effects on economic growth in Kenya, Quarterly time series data on gross domestic product, market capitalization and trade volume covering the years 2000 to 2011 were used. Empirical result suggested that stock market development measured by trade volume and/or capitalization impacts positively on the economic growth in Kenya.

 Okoye and Nwisienyi (2013) studied the impact of stock market has on the Nigerian economy, using time series data for 10-year period; 2000 – 2010. The model specification for the analysis of data was multiple regression and ordinary least squares estimation techniques. The result depicted that there are significant relationship between all share index, market value and market capitalisation on GDP. This implies that the GDP is affected by the movement of the capital market’s share index, market value and market capitalisation. In other words, the stock market has impacted significantly on the economy for the years under review.

Jibril, Salihi, Wambai, Ibrahim, Muhammad and Ahmad (2015) investigated the effect of Nigerian stock exchange market development on economic growth using a 20 year time series data from 1990-2010. The method of analysis was ordinary least square techniques. The stock market capitalization ratio was adopted as a proxy for market size while value traded ratio and turnover ratio were used as proxy for market liquidity. The study revealed that market capitalization and value traded ratio have a negative correlation with economic growth while turnover ratio has a strong positive correlation with economic growth.

Echekoba, Ezu and Egbunike (2013) examined the impact of stock market on the growth of Nigerian economy under a democratic rule. The study used time series data from 1999 to 2011 and multivariate regression model. They finding revealed that total market capitalization and all share index have positive effect on economic growth proxied by GDP.

Beck and Levine (2004) assessed the impact of stock markets and banks on economic growth using a panel data set for the period 1976 to 1998 and applying generalized method of moment technique developed for dynamic panel. The empirical result indicated that stock markets and banks positively influenced economic growth and these findings are not due to potential biases induced by simultaneity, omitted variables or unobserved country specific effects.

Fynn (2012) assessed the effect of the stock market primarily on economic growth using panel data from 1990-2010. The study applied Generalized Least Squares techniques for fixed effects with the exclusion of the subgroup 2005-2010 which uses random effects. The finding depicted that the effect of the stock market on growth is based on country-specific effects and varies in different time periods.

Conclusion

The major engine of growth and development for any economy is the stock exchange market (Chris, 2012). It is the pivot upon which any economy revolves, especially in its role of creating, mobilizing and rationing long-term funds for economic growth and development. It has been identified as an institution that contributes to the socio-economic growth and development of emerging market and developing economies (Donwa and Odia, 2010). Generally speaking, the importance of the stock exchange market to any economy (developing or emerging markets) cannot be swept under the carpet. Based on the importance of the stock exchange in accelerating economic growth and development, government of most nations tend to have keen interest in the performance of its stock market (Ewah et al 2009).

The mechanism of stock exchange came into existence to enable investment, which were inherently illiquid to become liquid through re-conversion into cash at the decision of the investor without inconveniencing the company (Olowe, 1997).

The Nigerian Stock Market which is regarded as the third largest in Africa (Iheanyi, 2014) underwent a downturn in 2008, and this had an adverse effect on the development of the Nigerian stock exchange and hence, the growth of the Nigerian economy. This was exacerbated by slowdown in government expenditure, tightening of the monetary regime, and potential regulatory changes especially mixed and often conflicting messages from the authorities regarding margin lending by banks to market operators. All seem to have undermined investors’ confidence in the capital market, with potential wider implications for Nigerian financial markets. The increasing unease about valuation in the market precipitated a noticeable exit of domestic and foreign investors from the market. Regulatory pronouncements and actions seemed to only exacerbate the situation; the resultant uncertainty further undermined investors’ confidence in the market.