Balkan Rational Exuberance - 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.