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Need for a shield against financial contagion

Hasan Mahmud Biplop andShakil Rahman
The capital market of Bangladesh has seen its worst in recent times. In the frontier of multivariate assumptions and perceptions, we believe that there are lessons to be learned from the mistakes and more importantly, reforms have to be initiated to avoid a financial contagion.
The term financial contagion was first coined in July 1997, when the currency crisis (better known as the Asian Crisis) in Thailand quickly spread through East Asia. The term derived through its medical inference, talks about small shocks that initially affects particular sectors of the economy or financial intermediaries but eventually affects the entire economy.
We would like to bring in context certain events of the Asian Crisis that affected the emerging economies in 1997. We will similarise certain events of the crisis with the Bangladeshi stockmarket in terms of money flow and policy phenomena.
This is necessary for two reasons. Firstly, Bangladesh has been identified as an emerging economy for the next decade and therefore, learning from the development of previous emerging economies and reformation is to our benefit
Secondly, the Bangladesh stockmarket has already faced such recession and the economy has started to show a phenomenon that was common to the pre-crisis events of those economies.
Furthermore, we will put forward some of the extra ordinary policy and project reformations that have taken place in countries like Thailand and Malaysian stockmarket for the betterment of their whole economy. The intent is to shield Bangladesh from a stockmarket debacle in the future because of flawed vision and policy. The next decade of economic growth has to be facilitated by the capital market, not hindered by it.
Being labelled as an emerging economy is a positive note for all of us. But the question will remain as to whether we are prepared to handle the growth process or not. Without dynamic management of regulations, the economy can easily suffer as the stockmarket has suffered from policy wise inertia. In such cases, Bangladesh will not be the first or a unique case either. Countries like Thailand, Malaysia, Indonesia, Philippines and South Korea faced the Asian Crisis in 1997 for similar reasons while playing the role of emerging economies in those times. In the early 90s, when these countries enjoyed GDP growth of 8 percent-12 percent, they were called by the International Monetary Fund
(IMF) as 'Asian Miracles'. In those times, there were certain events that can be considerable, although we should keep in mind that these are cursory descriptions rather than a fully comprehensive analysis.
• “A huge amount of 'hot money' influx had been observed in these economies with high short term interest rates and a fast profit generating motive.” Foreign funds got attracted to these countries for their much higher rates. Although not in the entire economy, but this phenomenon has already taken place in the Bangladeshi stockmarket and the negative after effects are still on going.
• Countries like Malaysia and Indonesia also faced the problems of Crony capitalism (a term describing an economy in which success in business depends on close relationships between business people and government officials). Development money that came through with branding the economy as an emerging one was not being invested in the
most efficient or sustainable manner but rather with people closer to power. Living in Bangladesh, we can closely relate to this.
• The Asian Crisis also massively suffered from the highly leveraged economic climate. A large amount of credit pushed real state prices to an unsustainable price level. This eventually led asset prices to start depreciating, leading to an extensive amount of individual and company debt obligations. This resulted in the loss of confidence in the credit market, withdrawals of credit services and bankruptcies in the emerging economies. Foreign investors trying to take out foreign currencies led to an overflow of the country's currency, resulting in its massive devaluation. Beyond the pegging of currency and other corruptions, this was the biggest economic disaster in East Asia. The IMF initiated currency stabilising package worth $40 billion for these economies.
We can again relate the Bangladeshi stockmarket to the highly leveraged climate
and the extremely high real estate price level. Furthermore, we are on the stepping stone of witnessing individual investors' equity hitting zero, loss provisioning by financial institutions and employee cuts in the industry.
In the process of becoming an emerging economy, the Bangladesh economy and its capital market eventually will be exposed greatly to global investors. Not having control over the process will create unbound performance for a short while, leading to a massive downfall far greater than we have witnessed recently. Therefore, growth has to be effective and sustainable.
To become a middle income country by the year 2020, we believe the capital market should undergo reforms in vision, project and policy to handle future possibilities. The following have been the skeleton of policies for many of the previously discussed emerging economies.
l.To be the preferred fund raising centre for Bangladeshi companies
We need to deeply enhance the efficiency of the fund raising process. It is required to implement a comprehensive programme to develop the corporate bond market as a competitive source of financing. Furthermore, facilitation of the development of the venture capital industry to finance emerging high growth companies should be a priority in government efforts. Most importantly, we have to foster a liquid and efficient market for the secondary trading of securities.
2 .To promote cm effective Investment Management Industry and a more conducive environment for investors
We need to develop a strong framework for corporate governance and shareholder value recognition. There has to be heightened efforts to establish a vibrant and competitive investment management industry. The role of institutional investors in the provision and management of funds have to be enhanced extensively.
3 .To enhance the competitive position and efficiency of market institutions
There has to be initiatives to restructure Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE) and clearing institutions to strengthen their efficiency and competitiveness. We will also have to ensure these exchanges are well positioned to respond to changing market dynamics through the adaptation of flexible business structures and commercially oriented strategies.
4 .To develop a strong and competitive environment for intermediation services
The stockmarket has to foster constructive competition through the deregulation of services, products and fixed fee structures. We have to develop strong full service brokers to provide a competitive market for integrated financial services. Under compliance, we have to ensure Bangladeshi intermediation services are accord on appropriate prudential standards, with high level of business conduct and professional skills.
5 . To ensure a stronger and more facilitative regulatory regime
The Bangladeshi stockmarket needs to move towards a market based system of regulation for capital market activities. Regulatory parity and consistency between all institutions and participants conducting similar capital market activities has to be ensured at all times.
To eliminate the possibility of a future financial contagion, these are necessities for the economy we dream about.
Hasan Mahmud Biplop is a lawyer and Shakil Rahman is the head of research and market development of EBL Securities Ltd.