Photo: AFP

THE Dhaka Stock Exchange (DSE) is one of the best performing stock markets in the world in recent years. During the 4-year period since January 2006, the DSE general index has increased by more than four-fold to more than 5,800 in recent weeks.
The DSE gained further momentum with the Grameen Phone IPO in November 2009. Along with the price index, the market capitalisation has also increased rapidly, from $3.4 billion in January 2006 to $34.2 billion today.
The strong market performance also attracted an increasing number of small investors to the market, with the number of new Beneficiary Owners' (BO) accounts surging to high levels.
All these positive developments have opened up the potential for the stock market to become a real alternative to mobilise funds for investment, moving away from the traditional dependence on the banking system. However, while welcoming these developments, we also observe a number of disturbing phenomena, which, if unattended, may seriously undermine the sustainability of this positive trend.
Significance of healthy stock market
It is generally well accepted in economic and financial literature that both banking and stock market developments play important roles in output expansion, capital formation, and productivity gains, even after controlling for many other factors associated with long-run economic performance of an economy. Beyond the macro-economic relationship, even micro-economic studies of finance and growth, and firm-level data also find that financial development disproportionately boosts the growth performance of industries that are naturally heavy users external finance.
The banking sector, which dominates the financial sector in Bangladesh, has served the economy very well, and its coverage is broadly comparable with other developing countries. However, equity markets which generally serve as the second most important pillar of the financial sector, have significantly lagged behind in Bangladesh. The recent
increase in investor interest in the Bangladesh capital market, as reflected in terms of market capitalisation and turnover, has significantly changed this situation; the capital market is gaining its position as a sizable source of investment financing after the banking sector, which is a welcome development.
Market developments and sustainability depend on market fundamentals, and the fundamental strength of the market essentially comes from financial strength of the listed enterprises. Strong regulatory environment created and maintained by the regulatory bodies (like the SEC) and participation of institutional investors and professional market analysts help orderly market operations.
The problem comes when market prices overshoot fundamentals in a big way, transactions become speculative, and market becomes unstable in terms of prices, turnover, and volatility. Such developments are not new in Bangladesh; we experienced it in the boom and bust of 1996 (see box).
The global landscape is also littered with such boom and bust episodes, the recent ones being: the crash of the US stock markets in 2000 (NASDAQ tumbling from 5,100 to less than 1,600); Japanese stock market crash of 1989 with Nikkei tumbling from 31,000 to less than 10,000; the crash of GCC (Saudi Arabia, UAE, Kuwait, and Qatar in particular) stock markets in 2005; and more recently the crash of Chinese stock markets in 2007.
We must keep in mind that a sharp rise in stock prices does not necessarily mean formation of a bubble. Sometimes stock prices may rise sharply across the board when some things change fundamentally in the economy or in the economic outlook, as happened in the case of Spanish and Irish stock markets on the eve of their joining the EU. Several East European (former Soviet Bloc) countries also experienced surges in their stock markets because of their anticipated integration with the EU. Furthermore, no two bubble episodes are exactly the same across countries or across time. Each episode had its own features and unique background.

For the full version of this article please read this month's Forum, available free with The Daily Star on April 5.

Ahsan H. Mansur is Executive Director, Policy Research Institute.