Why is the Macedonian Stock Exchange Unsuccessful?

By: Sam Vaknin, Ph.D.

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The Macedonian Stock Exchange (MSE) is not operating successfully. True, some of the parameters which we use to measure the success of a stock exchange have lately improved in the MSE. For instance, the monthly money volume has increased together with the number of transactions. But this is a far cry from success.

Who is to blame? Is the current management of the MSE incompetent?

I do not think so. Actually, I think the MSE has an excellent management team, doing their best to incorporate new trading techniques and to list new firms. The problems lie elsewhere.

A stock exchange is a very important financial market. It is a highly efficient and visible instrument of financing. In the West, it is used to finance most of the needs of corporations, way above financing available from banks. Individuals and firms save some of their income and invest it. The stock exchange is meeting grounds for savers wishing to invest their savings - and firms looking for investments.

Another function of stock exchanges is to assist governments in financing their internal borrowing requirements. Governments sell obligations (called bonds) to investors through the stock exchanges in their countries. A stock exchange is, therefore, an indispensable tool for re-financing national debt.

But a few conditions must prevail before a stock exchange functions properly.

The most important condition is the existence of a healthy, growing economy in the stock exchange's country. Investors flock to robust economies and shy away from sickly ones.

On the face of it, the Macedonian economy belongs to the latter category. High unemployment, low savings, retarded growth, a gaping trade and payments deficits. But this is an optical illusion. The economy is in much better conditions that most Macedonians would care to admit. The unemployment figures are skewed. They reflect efforts to evade paying social taxes - not real unemployment. The economy is growing, even by official estimates. The black economy is growing even faster. The deficits are covered by enormous capital infusions from donor countries. Macedonia is receiving more international credits per capita than Russia. It is always convenient to blame the worsening economic climate - but the cold, objective figures do not bear this out.

When an economy is growing - the profits of companies (including those listed in the MSE) will grow with it. This makes the shares of these companies an interesting buy.

Since no one is buying - we must look for the problem elsewhere.

A prospering stock exchange is linked to the existence of the right micro and macro economic management. Macedonia has more than its share of problems in this respect.

The process of transformation of businesses with social capital had four basic flaws:

first, it introduced no new management, ideas or capital to the beleaguered firms which were "transformed". The market simply does not believe that they were transformed. The same people run the same shows under a different hat.

Second, such transformation violates the concept of Hierarchy, a chain of command.

It blurs the distinction between labour (workers) and capital (owners). What is wrong with that is that a ship must have a captain - and only one. Someone must have the authority and the responsibility. Collective management is no management at all.

Moreover, innovation change and revitalization are all prevented. What change could come from the same set of worn out managers? How can thousands of owners decide to worsen the conditions of the workforce - if owners and labourers are one and the same? So, management is polluted by irrelevant, non-economic considerations: power struggles amongst groups of workers, social considerations and political ones.

We identified one villain. The other one is high (real) interest rates. When interest rates are high, three effects prevent the resuscitation of the stock exchange:

First, firms have high financing expenses (interest payments) - which reduces their profits.

Second, it is not worthwhile to borrow money and to invest in shares.

Third, it is more tempting to invest money in bank deposits, yielding high interest rates - than in shares. High interest rates are the poison of stock exchanges.

The same is true for low savings rates. If people and firms do not save - there is no capital available for investment in stocks.

This, exactly, is the current situation in Macedonia : impossibly high interest rates coupled with exceedingly low savings. There is basic mistrust between clients and their banks. They prefer other ways of keeping their money.

But all the above is far from exhausting the list of pre-conditions for the proper functioning of a stock exchange.

Investors must have timely, accurate and full information about the firms that they invest in. This will allow them to respond in real time to developments in the company and to prevent losses. This will also make it difficult to cheat them - which is were we come to the question of accounting standards. Only lately have the accounting rules in Macedonia been revised to conform to the Western systems of accounting. Even now, the similarity is very slight. Macedonian firms maintain a double accounting system. One set of books is tax-driven. It is intended to show losses or profits at the whim of the management. An elaborate scheme of hidden reserves lies at the heart of the typical financial statements of the Macedonian firm. Another set of books - if they are kept at all - reflects reality. This is an enormous barrier to foreign investment - and foreign investors are the driving force in every modern stock exchange.

The trust of investors in the stock exchange is based on legislation to protect their property rights against the firm's management' against the authorities and against other investors who might wish to rig the market or manipulate the prices of stocks.

But legislation without an effective judicial and law enforcement systems is like a stock exchange without money. To enforce property rights in Macedonia takes ages and even then the outcome is not certain. Laws, regulations are in their embryonic stage and some of them seem to have had an abortion: they were hastily and unwisely copied verbatim from legal codices of other countries (Germany, Britain).

Last - but definitely not least - is the existence of a fair, transparent and non-corrupt marketplace. The stock exchange, the banks, the regulatory authorities, the police and the courts have to be above suspicion. For the market to be utterly efficient - it must be utterly free of any ulterior considerations and motives. Corruption distorts the market's allocative mechanisms and powers. It is easily discernible in dealings in the stock exchange for all to see. A stock exchange is, after all, the showcase of the local economy.

But there is a problem which towers above all other problems and it is almost endemic to Macedonia. It helps to explain much of the predicament of the stock exchange in Skopje. It is the fact that the market is missing its most important player: the Government.

Investors - both foreign and domestic - look for the Government to be active in the local stock exchange. Governments throughout the world use their stock exchanges to sell shares of state-owned enterprises to their populace. The stock exchange becomes a mechanism for the distribution of the national wealth - as embodied by the state owned enterprises - to all the citizens. As we said before, governments also use the stock exchange to borrow money from their citizens.

The Government of Macedonia does neither. It totally ignores the MSE. Not one company was privatized through the MSE. Not one Denar was borrowed from a Macedonian citizen through it. A government's activity in the stock exchange is proof that the government believes in it. Therefore, if it does not operate in the stock exchange - it proves that it does not believe in it. If the government does not believe in the stock exchange in its own country - why should the investors believe in it?

There are a few additional structural characteristics which are considered to be the hallmarks of a healthy stock exchange. But those are the by-products of all the above mentioned conditions.

A stock exchange must be liquid so that investors would be able to convert their shares into cash easily and expediently. It must include many investment options - professionally put, it must be diversified. This will allow the investors to choose from a variety of investments and also to reduce their risks by dividing their money among a few types of investments.

The management of the stock exchange can help it by introducing efficient trading techniques, computerized trading and settlement systems and so on. The faster investors meet their money when they sell their shares - the more they will be inclined to operate in the stock exchange that allows them that. The easier it is for them to liquidate their assets by meeting buyers - the more they will prefer to work in that stock exchange.

Investing in the stock exchanges in the markets of the emerging economies has been an unfortunate decision in the last three years. Stock exchanges from Russia to Hungary and from Lithuania to Poland have jeered wildly since the end of 1993.

They resembled a roller coaster in their performance, going up and down by tens of percents annually. There are exceptions to this rule. The Ljubljana Stock exchange, for instance. The trading volume there has gone up 10 times since December 1993 - and the market capitalization is up 30 times. But this is because of the performance of the general economy in Slovenia. In Croatia, the government is privatizing its holdings in state owned companies by auctioning shares to the public through the Zagreb Stock Exchange. This has helped it a lot.

Newly-established stock exchanges are highly volatile and very dangerous. Volatility goes hand in hand with risk. They are long term investments. Since 1988, they outperformed the more established stock exchanges in the world, like Wall Street.

But these stock exchanges are growing fast, they are cheap by any measure and they are the best investment that a country can make in its own future.

Overview of the Macedonian Stock Exchange - December 2007

The Macedonian Stock Exchange, as measured by its MBI-10 index, rose to a record high of close to 10,500 in mid-2007. It has since shed 40% of its gains. This correction, or, rather, rout has its roots is a series of converging factors.

The multiple failure of the financial system in the United States, brought on by the subprime mortgage crisis and its contagion, resulted in a dollar plunge and the ascendance of the euro. Investors fled the ailing American scene in search of higher and safer returns in the markets of emerging economies of commodities and oil producing countries.

This stampede coalesced with other trends to create a bubble of hyperliquidity. Financial technology made money transfers almost instantaneous, thus reducing the need for a non-productive and illiquid float. International trade expanded at a breakneck pace, shifting unprecedented amounts of wealth from consumers to producers and manufacturers. GDP growth throughout the world outstripped inflation, generating sizable surpluses. The global monetary environment swung from inflation to deflation leading to a precipitous decline in interest rates.

Inevitably, investors migrated from cash and bonds to assets such as real-estate and stocks, fostering in the process a series of bubbles, booms, and busts as volatile "hot money" pursued returns everywhere.

Moreover: in contradistinction to the recent past, diversification offered no refuge as financial markets merged and integrated with global, around the clock networks. To their dismay, investors found that, paradoxically, as markets became more efficient, they also become more correlated. This convergence was further enhanced by geopolitical and geo-economic processes, such as the enlargement of the European Union.

Macedonia could not remain aloof. As its informal economy emerged from the shadows, capital controls were lifted, capital mobility increased, and foreign firms and investors entered the scene. The more the business climate improved, the better Macedonia's prospects appeared, the higher Macedonian stocks were valued by an euphoric public. Macedonia's professionals did nothing to restrain the hysteria or to ameliorate the casino mentality that pervaded the entire system. They benefited personally from the bubble.

The newfound optimism of Macedonia led to a repricing of risk and to heightened expectations of corporate profits, boosted by a more lenient tax regime and by decreasing interest rates. Equity risk premium plummeted until it vanished altogether and even became negative. The P/E multiple reached a stratospheric 50 before the recent correction. It is still pegged at an unsustainable 37.

Throughout this Bacchanalia, foreigners flocked into the Macedonian Stock Exchange, constituting 30-40% of the buy side. But they have begun to withdraw owing to big privatizations back home, troubles in their domestic financial systems, a more restrictive monetary policy in some countries, and the changing fortunes of the Macedonian marketplace.

The down trend in the Macedonian Stock Exchange is not a mere correction. It is a repricing of assets. It still has a long way to go. Even at 4300 - the next massive technical support - Macedonian shares are inanely overvalued.

Interview with Alexandar Dimishkovski of BID Consulting

Conducted October 2007

The Balkans as a region is experiencing a confluence of events of both fundamental and technical nature that augur well, as far as its economies go. Accession to the huge and unified market of the European Union (and to NATO) is closer and more realistic than ever. Two decades of transition from socialism and communism, privatization, institution-building, and private sector reform are finally bearing fruits. Emerging markets - and Europe - are more attractive than ever as investment destinations, now that the United States is caught in a vicious cyclical downturn which might result in a recession. These shifts in fortunes inevitably are reflected in the stellar performance of many Balkan stock exchanges and other asset markets, such as real estate.


But will the euphoria last? Is the exuberance irrational? Are we in the throes of a bubble about to burst?


Until recently and for four years, Aleksandar Dimishkovski  worked as a business and finance correspondent in Macedonia's best-selling daily newspaper, "Dnevnik". In the past year, he also served as a personal advisor to the general manager of a foreign-owned company that has established its network in Macedonia. He is known as a market analyst and a business consultant and has recently founded "BID Consulting".


1. Why did the Macedonian Stock Exchange (MSE) skyrocket when other stock exchanges plummeted in the wake of the subprime mortgage crisis and, similarly, why has it collapsed recently when Wall Street is setting new records?


AD: There are many reasons for this, starting with the size, the position, and the strength of the floated companies and down to the origin of the portfolio investors and the speed of the reaction to global trends.


The Macedonian Stock Exchange is a relatively young market and in its early phase of development. Though it has existed since 1996, it has just recently started to open its doors to foreign portfolio investments. It has been only a few years since the annual as well as the daily turnover on MSE started to be dictated mainly by foreign investors (especially investment funds), which could be cited as the sole reason for the incredible percentages of price hikes in the past few years.


Bearing in mind the fact that the speed of reaction even to internal factors and influences is still relatively low, global trends impact the MSE with a delay of between three to six months. For example: there were some instances when oil or steel prices grew rapidly, but the value of the shares of Macedonian companies, which work with the production or distribution of oil or steel has decreased!


Nevertheless, this started to change recently. If the period of delay in reaction to global trends was more than six months in 2006, now in some cases it is less than a month.


One other fundamental reason for the difference in trends between the MSE and the major Stock Exchanges like New York, Tokyo or London is the origin of its major investors. For instance, the majority of the foreign money invested in the MSE is of Balkan origin and does not constitute a diversified list of portfolio investors coming from all parts of the world. Therefore, the fluctuations in the investing of capital in the major Stock Exchanges or in its allocation from one market to another at this time don't affect the trends in the MSE, or at least not instantly, because the investors present at the Macedonian capital market are not present in the big Stock Exchanges such as Wall Street.         


2. Are the stock exchanges in the Balkans correlated? Do they move and react to external shocks in unison?


 AD: Yes, they are correlated in many ways, and not just by way of reacting to external shocks. Actually, if you look at the statistics, especially of the Stock Exchanges of the countries of former Yugoslavia, you can find similarities in almost all parts of the capital markets, from price growth, crisis management, and institutional establishment, to reactions to shocks.


It seems like every Stock Exchange in the Balkans is growing in a similar pattern. They all faced similar crises, obstacles to growth, lack of efficiency and especially lack of general knowledge regarding financial tradable instruments. In some cases, it even seemed like two stock exchanges faced an identical situation within just a few months, disregarding the phase of development they were in. In 2006, there was even a case of two stock exchanges from two different countries that have had almost identical annual index growth.     


However, what determines the type of reaction and development is the palette of investors. Investors from Slovenia are present in Macedonia, Croatia, Serbia, Montenegro, Bosnia, etc. And the ones from Croatia are also present in Macedonia, Serbia, Slovenia…So these markets are all intertwined within the borders of the Balkans. Even in Slovenia and Croatia or Serbia, which may be seen as the most developed, the majority of investors hail from the neighborhood.


Because of all of these similarities, your suggestion in the question is correct. They do react and move in unison. And this is also one of the postulates for the initiative for the creation of one Balkan Stock Exchange, similar to the case of the Nordic countries and NORDEX. Because of these similarities and interconnections, the creation of one single stock exchange, in my opinion, would be beneficial to all parties involved. Unfortunately this process is developing very slowly.


3. How vulnerable are the stock exchanges in the region to insider trading? Is there a need for Sarbanes-Oxley types of laws?


AD: The transition process left many open wounds as far as legislation in the Balkans goes, especially in fields where there was no experience to draw on for the creation of laws. The Stock Exchange is a perfect example of this deficiency, likewise the protection of industrial property, the protection of copyrights etc. All these were emerging fields in the newly established democratic order. Though in many cases laws were translated and adapted to the needs of the market, relics of the communist regime can still be found, thus engendering an open space for manipulations like insider trading.


Attempts to deny the existence of insider trading are unquestionably present. But in practice, little has been done and can be done to protect shareholders from it. So, there is a definite need for Sarbanes-Oxley type of laws in almost all Balkan countries. Nevertheless, these laws can't be merely translations of the legal corpus of some Western Europe country. Experiences from abroad are welcome and helpful, but only as a basis on which to build.


In fact, to protect shareholders and investors from insider trading, first a new and up to date corporate law must be implemented. When even the smallest shareholders would know their rights and obligations concomitant with the corporate-responsibility type of organization, the efforts and the laws intended to prevent insider trading will take hold.


However, it must be noted that discernible progress in this field has already been made with the present legislation and strangely, by inertia, under the influence of foreigners. This progress must continue at a faster clip.


4. Some analysts say that foreign money makes the bulk of investments in the smaller, poorer stock exchanges in the region (Macedonia, for one). Is this your impression as well? Will this money dry up now that the world is in the throes of a global credit crunch? What will happen if sentiment changes and the foreigners leave?


AD: It seems that the fact that the world is in the throes of a global credit crunch doesn't influence investor decisions in the Balkans. In fact, in Macedonia for instance, the tremendous growth in share prices in the past two years contributed to an increase in the demand for credit. People started to borrow money in order to invest in the Stock Exchange, expecting a quick return on their investments and "fat" profits. Nevertheless, the lottery type of investment didn't have sufficient influence to noticeably tilt the capital markets. 


Bearing in mind the fact that the majority of foreign investors in the smaller stock exchanges, like the one in Macedonia, are regional, of Balkan origin, I can't say that foreign investments will decrease. On the contrary, the official statistical data, released by the MSE, show a constant increase in the presence of foreign money in the market, especially on the buying side.


At this point, foreign portfolio investors contribute as much as half of the buying side, and 30 percent of the overall turnover. I think that this is only the beginning of the "bulk of investments" as you say. With the MBI-10 (the MSE's index- SV) growing by more than 100 percent in 2006, the Macedonian Stock Exchange caught the eyes of even more distant investors who started to invest in this market.


Will this trend continue? If there is no major crisis – political or economic - in the region, it is not too optimistic to expect that it will. However, if the money inflow from foreign investors starts to decrease, it will be a major step back for the capital market. The influence and the financial clout of  foreign investors can't be easily substituted for by an increase in domestic demand. It can even be the sole reason for a total collapse of some of the smaller stock exchanges in the region.    


5. Can you tell us a bit about the recent financial innovations in the region: mutual and investment funds, short selling, options?


AD: Except for investment funds, which were accepted with open arms, it seems like these markets are very heavy and slow as far as the introduction of new financial instruments or innovations goes. This could be easily verified by having a look at the gamut of tradable securities in almost all the countries in the region.


The typical capital market comprises state bonds and corporate stocks. In Macedonia for instance, the Securities Law actually allows for the issuance of corporate bonds and even for financial instruments such as short selling and options. But, because of the low level of general knowledge as well as the phase of development of the market, these instruments are not in place. Nobody is even willing to ask, or to do something to expand the range of tradable securities, which may be the most frightening thing. This leaves serious portfolio investors with very little flexibility and it may be the principal determinant of how these markets will develop in the mid term, and especially in the long term.


On the other hand, the paucity of the sell side is one of the reasons for the increases on the bid side and, consequently, in the prices and value of the floated shares. The value of the shares of some companies skyrocketed by more than 2000 percent in the second half of 2006 and in the first half of 2007.


However, the massive growth in the inflow of money will eventually stop mainly because of the insufficient number and type of securities on offer.       


6. What is the role of bonds - both government and corporate - in the capital markets in the region? Are there any municipal bonds issued and traded?


AD: State bonds are of interest to investors in Macedonia's neighborhood mainly because they represent a safe investment or even more so a type of savings. The banking system in this area faced huge risks on many occasions and interest rates are still prohibitively high for debtors and low for savers. This exerted an upward pressure on the interest rates payable on government issued bonds: they offer a stable source of interest income which in most cases is higher than the interest rates offered by the banks on savings by at least 30 percent annually.


As for corporate bonds - hmmm...  Now, this is one of the issues that I have mentioned earlier. In Macedonia, these type of bonds are not yet developed, nor are municipal bonds. Although, there are some announcements that a few firms will issue bonds, there still are none extant. It seems that they tend to prefer the issuance of shares as a source of financing. Still, even shares are not issued too often.


Bonds in general aren't that interesting when the prices of shares grow exponentially. Even investors with no professional knowledge at all are more willing to risk and to invest in shares than to expect safe and stable returns from an investment in bonds. When these capital markets will mature, price growth will level off and I guess that then investing in bonds will become more interesting.    


7. How would you rate the performance of the Securities and Exchange Commissions in the region? Are the courts able to tackle securities fraud and complex financial transactions and instruments?


AD: With the lack of general knowledge ruling this part of the world, to expect the Securities and Exchange Commissions, or the courts to ably perform in cases involving very complex financial scams or illegal activities is exaggerated. While the SECs do have some influence and they do take some basic actions to prevent illegal activities such as insider trading, the courts aren't sufficiently prepared to handle these kinds of cases.


However, reforms in the judicial system yielded some results even in the first phases of their implementation. Now, these types of frauds and criminal activities are taken much more seriously and the whole attitude is changed, not just by the courts, but in general, by all other relevant institutions. Big progress has been accomplished even with the adjustment of domestic laws to European Union code.


However, if I have to rate the performance of the SECs and the courts in the region, I would have to say that they are "trailing behind" the actual market players, both from an organizational as well as from a technical point of view. With insufficient human resources, lack of finance and deficient inter-institutional cooperation, the SECs and the courts are not as efficient as they should be, especially in these early phases of development of the capital markets, when big changes in a company's shareholders list can be done in a minute.

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