Wealth Creation & Investments through Understanding both the Economic & Financial Spheres & the Importance of Capital Market Growth from a Risk Tolerance Perspective.
By Charles Lee
Alchemy Capital (PNG) Limited
There are in fact two spheres of influence in any country; they are the financial and the economic spheres. The former is driven by an increase in risk appetite from the financial markets and its participants while the latter is driven by fiscal and monetary policy set by the central bank.
As countries develop, its markets will tend to redefine risk. Acceptable levels of risk will gradually increase as markets become more sophisticated spurred by local financial institutions especially, procuring a surge in appetite for higher leveraged products than what the market maybe offering.
For instance, the market will demand higher yielding products than traditional cash and Interest Bearing Deposits. This new demand will then cause banks to realign their exposures in order to offer higher yielding products. Banks could potentially reallocate surplus capital invested in government sovereign bonds to higher yielding products domestically or overseas to be able to provide the returns that their customers and clients alike seek.
In effect, both parties in haste for higher returns will have then move away from their traditional and accepted levels of risk to a higher level of risk and, as is the case that risk is proportionate to return. The higher the risk, the higher the return and vice versa. What has actually transpired in the background now is that a bubble has started to take shape so to speak. Now these are all happening in the financial sphere.
This development has the potential to create a vacuum between the financial and economic spheres. Now next is where it becomes crucial and important. How developments within the financial sphere feed into the economic sphere can have drastic consequences, some of which we have seen during the Global Financial Crisis or GFC as it was coined which started in 2008.
Politicians as policy makers may have some control over the economic sphere but very little over the financial sphere. This is because the Treasurer through the Central Bank can set monetary and fiscal policies to manage the economy but they have very minimal control over the financial market participants and especially those who invest in financial market products because they cannot control forever their free will to decide on what constitutes their level of perceived acceptable risk.
Right now in PNG, we have a thriving financial system, under the circumstances. Banks and Superfunds have grown exponentially after the reforms of the Mekere Government in the late 90s. Much of this milestone must be attributed to the stringent prudential requirements set by our Central Bank.
Commercial Banks and other smaller deposit taking institutions have been able to recapitalize their balance sheets but we still have a lagging economy. Only one conclusion can be drawn from this observation. That it is important for us all to understand that how economies bridge the gap between the financial and economic spheres is critical in the countries overall economic development.
Even after the Mekere reforms, the distribution of capital is not evenly spread between key household sectors of the economy. That has to a greater extent caused imbalances in key sectors of the economy. A key solution is to broaden our domestic capital markets as opposed to banks and superannuation funds. This sector seems to have fallen through the cracks since the Mekere Reforms and has not seen much light. The Bank of Papua New Guinea’s financial inclusion programs seeks to address such an imbalance.
The reform and development of capital markets can help re-balance the spread of capital into more sustainable areas such as agriculture and livestock and tourism of which the majority of our population thrives on.
It is important for financial institutions to stay relevant within the markets that they operate in and in compliance with the regulatory framework of which they exist in. What is perhaps required in PNG and across the Pacific are reforms in the capital markets. The Securities Commission Act of PNG is currently under review by the PNG Government. This is a step in the right direction. It should be a key priority of government and hence progressed without delay.
In PNG minus the informal and unbanked sector, we have pretty much peaked in terms of our exposure to depositors. The next growth phase of PNG lies in its untapped capital markets. I believe the same can be said for other emerging markets and economies in the South Pacific and some parts of Asia especially emerging economies.
The composition of the Port Moresby Stock Exchange must be reviewed. It must be given more teeth to police its Listing Rules. The Securities Commission which regulates our capital markets should have never been a single office within the Investments Promotion Authority of PNG. It should rather be a fully-fledged office, fully staffed, fully resourced and fully funded like the Central Bank of PNG. It must be given teeth to fully implement the Securities Act and apply penalties as, where and when necessary. This is because it has a critical role to play in the development of our economy’s capital markets.
Roles of the Central Bank, the Port Moresby Stock Exchange & the Securities Commission should be realigned so as to avoid any ambiguity or clash of functions. Each of their functions should cohere and complement each other. Medium to Large corporates within sustainable sectors such as agriculture & livestock and tourism should be protected and harnessed through government sponsored incubation programs and ultimately encouraged to list on the stock exchange to allow for greater participation by the broader economy. This will help in a great way to re-balance the flow of capital to sectors in our economy that need it the most.