Here is how to reverse steep decline of the Nairobi bourse

Nairobi Securities Exchange (NSE) trading floor. [fILE, sTANDARD]

Kenya's stock market recently suffered steep losses, making it the worst performing globally. The weak performance has persisted: The Nairobi Securities Exchange 20-share index stood at about 1420 on 10 November 2023, having fallen from 1509 on 29 September 2023, a drop of 6 per cent over the six-week period.

In better days, the index has risen above the psychological 5000 mark: for example, it was 5491 on 23 February 2015.

The stock market matters for the Kenyan public for several reasons. First, up to 70 per cent of the retirement savings of Kenyans may be invested in the stock market. So the market's weakness might inhibit retirement funds from meeting their pension obligations.

Second, many Kenyan companies use the stock market to raise capital and weak market performance discourages them from doing so.

Given these benefits, it is important to understand reasons for stock market value fluctuations. Here, I discuss some possible reasons for the market's dismal performance and suggest possible ways to reverse the trend.

What moves markets

Stock prices move in response to new information that conveys signals about the risks faced by investors. The new information may be something that an investor has uncovered, or that is known by company insiders (although trading on that knowledge is usually illegal), or that is announced publicly by an authority like the central bank.

New information may be about something unique to the company, or something that affects the entire market. New information about a company often affects the company's price without affecting the market index.

However, in small markets such as Kenya's, where the market index may reflect the presence of a few large companies (such as Safaricom and KCB), changes in the price of one firm's stock may cause a noticeable change on the index value.

What ails Kenya's stock market?

An important risk factor that affects the entire market is sovereign (country) risk. Sovereign risk may be responsible for the persistent selling off of shares by international investors at the Nairobi bourse in recent months.

When there are more investors selling shares than those willing to buy, share prices, and the market index, fall. This is because sellers must lower their prices to appeal to the few buyers.

In 2022, Kenya's international investors sold about US$158 million (Sh24 billion) worth of shares, slightly lower than the US$191 million recorded during 2020.

The sell-off may indicate deep-seated political issues affecting Kenya's economy. These include fears of possible instability post-2022 presidential elections. The country has previously experienced election related violence.

The sell-off may also speak to economic factors. For instance, when US interest rates increase, as they have, international investors tend to pull their money out of developing markets and invest it in US debt markets, a phenomenon called flight to quality.

Indeed, anecdotal evidence suggests that emerging stock markets slumped to their lowest between March and September 2023 driven by expectations that US interest rates would remain high.

Third, the stock market jitters may be explained by the weakening Kenyan shilling. For international investors, investing in a Kenyan stock means taking a risk on both the stock and the value of the Kenyan shilling. If the shilling falls in value relative to the investor's domestic currency (like the US dollar), it may wipe out all the gains on the stock and cause the investor to lose money.

The Kenya shilling lost 21 per cent of its value between 13 September 2022 and 10 November 2023. This has been largely attributed to capital flight and reduced inflow of foreign currency due to the low value of exports.

Then there's Kenya's burgeoning public debt. It's the chicken-and-egg story: a falling shilling increases the burden of debt owed to outside lenders. And the rising cost of servicing debt in a foreign currency increases the supply of the shilling in the currency markets, weakening it further.

In an attempt to stem the slide in the shilling's value, keep domestic inflation in check, and respond to rising US interest rates, Central Bank of Kenya, like its counterparts globally, has chosen to restrict money supply.

Consequently, the central bank rate, a policy interest rate that guides domestic loan pricing, has increased from 7 per cent in March 2022 to 10.5 per cent in November 2023.

When interest rates rise, returns (yields) on debt assets like bonds also rise, making them more attractive than stocks. This induces investors to move their money from stocks to bonds, causing a decline in stock prices.

Expectations

An important recent development is the enactment of Kenya's Finance Act in June 2023. The Act imposes new taxes and tax increases. The World Bank has warned that higher taxation may discourage investment and increase unemployment.

So there's an expectation of weaker economic performance and, concomitantly, weaker company performance (due, for example, to lower product demand). The expectation of weaker company performance causes investors to anticipate lower future cash flows (like dividends), which is reflected in lower company valuations today.

Expectations about public debt also matter for companies. Kenya is expected to borrow more, which will increase interest rates on government debt, making it more lucrative for banks to lend to the government than to the private sector. Reduced private sector lending discourages private investments and lowers company valuations.

What should be done?

There is no quick fix to a stock market collapse. Although stock market performance may be driven by sentiment in the short run, it is more beneficial to think long-term.

There's a close relationship between the broader economy and the stock market. So, as a finance scholar, I offer only one recommendation: diversify and grow the economy.

There is clear evidence of the long-term economic growth benefits of investing in human capital, boosting a country's entrepreneurial orientation and investing in infrastructure. To grow the economy, therefore, the government's policymakers should draw from such evidence.

Importantly, the need to strengthen the country's institutions has never been stronger. This will have the effect of improving governance and accountability as well as investor confidence.

With such actions, the stock market needs no intervention.

Kodongo is an associate professor of finance, University of the Witwatersrand. This article was first published on theconversation.com