\\\'Irrational Exuberance\\\' about the stock market in Bangladesh

What is the relationship between stock market and economic development? The answer is not plain and straight forward. Yes, developed countries have a strong stock market. But that does not necessarily mean a strong stock market is the reason for their development. The coexistence or parallel movement of two things implies correlation between them. But whether the movement of one of them is really caused by another, technically known as causality, cannot be concluded from such correlation.
Let's take an example. Suppose two floating objects are moving with the current in the Meghna river. One can easily trace a positive correlation between the distances crossed by these two objects at different periods of time. But does this mean one object is causing the other object's movement? Certainly the answer is no. Both objects are separate and independently moving with the current of the river Meghna. Only and only if these objects are tied with one another by a piece of 'rope', one can claim, although not irrefutably, that the movement of one causing the other object to move as well.
Before claiming that a strong stock market contributes to the economic development, one has to first identify the 'rope' through which the strength of the stock market is transmitted into the production sector. A mere cross-sectional observation that developed countries have a strong stock market should not be a reason to be exuberant about its role in economic development. More importantly, it should suffice to divert resources from alternative uses to develop a 'vibrant' stock market.
The only rope through which the stock market is connected with the production sector is the primary share. A company can collect investable funds by selling the primary share. This is what we call equity financing. When a primary share is bought and sold in the secondary market at whatever price, the issuing company neither loses or gains any investable fund. It should be clear without any 'if and but' that money spent by someone to buy a share in the secondary market has in no way  implications for the financing of investment of the issuer company of that share.
From a national point of view, investment is something that enhances the productive capacity and thus expands the production possibility frontier of the country. It raises a number of legitimate questions: can we call the money transacted in the stock exchange in buying and selling the secondary shares 'investment' and the people involved in buying and selling of them 'investors'? Do we really have any economic logic in favour of policy support to attract more traders in the secondary market to fuel the price of shares and amount of money traded?
The top level public policymakers, including the senior officials of the central bank of the country, recently argued in favour of reducing the interest rate of the national savings certificate, so that people will use their savings in the share market instead of buying the savings certificate. Every year on the eve of the announcement of the fiscal budget media is swamped by the discussion about the measures to be taken to develop a 'vibrant' stock market. The rate of return on savings certificate has recently been reduced to help the stock market. This is ridiculous.
There may exist other grounds to reduce this rate of return, but how justified it is to reduce it to drive more money in the secondary share market? The economic history of Bangladesh and the world suggests that increase of price in the secondary market, driven by discriminatory policy, always lead to more economic damage than benefit. The price bubbles in the New York Stock Exchange in 2000 and the Dhaka Stock Exchange in a more recent time (in 2010) eventually became more injurious rather than beneficial to economic development.
As a country develops, more and more companies issue primary share and collect more money from the stock market. This explains why the stock markets in the developed countries are big. Development triggers equity financing through the issuance of primary share, which in turn, move development forward. This is how the nexus between development and share market can become self-propelling. No matter how much the price of share in the secondary market is increased through policy support to allure more traders into it, this will not help development unless the issuer of primary share increases over time.
This is not to deny the importance of a strong capital market to promote equity financing, rather to stress the fact that the current exuberance about the secondary stock market and policy measures to pump more money into it is wrong. The policymakers should be more focused on how to create an encouraging environment for equity financing with increased participation of more companies in the stock market. Although the number of enlisted companies in the stock market is increasing over time in Bnagladesh, the rate of this increase is very slow.  

A decade ago, in FY 2003-04, total 259 companies were enlisted in stock exchange in Bangladesh. This number has increased to 300 by FY 2008-09. Following the stock market debacle, triggered by price bubbles in 2010, this number decreased to 267 in FY 2010-11 (graph 1). The price bubbles in the stock market not only led to a near-credit crunch in country's credit market, but also eroded the confidence of companies in equity financing as evident by absolute decline in number of enlisted companies. Measures needs to be taken to avoid similar crash that erodes company's confidence in stock market to use it as a new avenue to mobilise overall investable resources.
Equity financing is yet to be fully exploited in Bangladesh. Instead of fuelling the price of stock in the secondary market, the government should take measures to eliminate the obstacles and distortionary policies that discourage the equity financing. To promote equity financing on development financing, the government should reform the current flawed corporate tax structure, which involves double taxation of equity earning. At present, dividend paid out to the shareholders is not deducted in calculating the taxable net profit. It means dividend income is taxed as part of the taxable profit. The same income is again taxed as part of personal income. Thus the effective rate of corporate income tax is actually higher than the announced rate. However, in case of estimating the taxable profit, the interest payment is deducted from the gross profit. This creates a bias towards debt financing as opposed to equity financing. To promote equity financing and its positive impacts on development financing, the current discriminatory corporate tax policy needs to be rectified.
From theoretical point of view, stock market is assumed to be efficient and all stock traders are assumed to be economically rational. They are also assumed to make decision on the basis of all available information, thus the market always lead to efficient outcome. Many academicians became suspicious about these theoretical assumptions following a number of stock price bubbles even in the developed world. The 2013 Nobel Prize (in economics) winner Rober Shiller coined a term 'irrational exuberance' in 2000 implying that people do not always act rationally in the stock market. This is the reason why price bubbles occur and major debacle happens. Since then the efficient market hypothesis became questionable and issues of regulation in the wake of irrational exuberance became prominent not only in stock market but also in other asset markets.   
The way the development role of secondary stock market is perceived in Bangladesh and the policy support is provided to fuel prices of stocks in this market, it seems that not only the stock traders but also the policymakers of the country suffer from irrational exuberance about the secondary stock market. Such irrational exuberance may lead to another major debacle and will eventually harm the development process of the country.   
Abul Basher, PhD is Researcher at Bangladesh Institute of Development Studies (BIDS), former
 economist, World Bank, and former faculty, Willamette University, USA.
[email protected]