Because of the hidden destructive capacity of hot money, also known as “hot potato”, the Central Bank of Nigeria (CBN), Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE) may have to be vigilant and heighten strategic agility in the economy generally and the capital market in particular.
Recently, either the SEC or the NSE announced with glee that foreign portfolio investors accounted for 70 percent of trading activities in the capital market. One’s reaction to that was with cautious joy, because foreign portfolio investors who often are in a flux operate with hot money. Hot money is short-term speculative funds which seek quick gain. It is volatile and impatient and usually streams into economies in phases, but moves out en masse, which is wherein lies the inherent danger.
Globalisation or internationalisation or “Americanisation”, as a school of thought has claimed, promotes free trade across borders with financial markets operating internationally. It is powered by the internet, as a result of which continents can be accessed in a fraction of seconds and multi-billion dollar deals consummated or collapsed at a touch of a button. This breakdown in geographical barriers has necessitated a monumental trans-border flow of hot money seeking quick gains in competitive markets and economies. Such inflows offer domestic businesses a wider access to cheaper funds and enhance market liquidity. But, on the converse, it has a destructive propensity when the outflow begins.
In a globalised economy, the sole impetus is money. As such, foreign portfolio investors have no loyalty to nations and markets. They study and track exchange rates and navigate across continents because exchange rate is a major determinant in cross-border capital inflow. Favourable exchange rates and markets with weak corporate governance often attract the influx of hot money which heightens economic activities and creates bubbles in stock markets. But when the outflow begins in a demonstration of the ‘herd mentality’, it can wreak havoc and destabilise the recipient economies and markets.
The European monetary crisis in 1992 and the Mexico financial crisis in 1994 were both triggered by hot money. It also wreaked havoc on the Asian economy with the financial crisis in 1997 which collapsed the economy of Thailand and resulted in massive layoffs, while their stock market also dropped 75 percent in one year, and the baht, the official currency, lost more than half of its value.
Remarkably, the Nigerian stock market fiasco in 2008 was also triggered by the exit of local hot money which invaded the stock market in form of margin loans. The exit was triggered by CBN when it mismanaged the information on its belated decision to ban margin loan. The suddenness of the information created panic and all hell broke loose in the market as massive dumping of shares ensued. Unfortunately, the development coincided with the exit of foreign portfolio investors as a result of the US financial crisis. It became, therefore, a double whammy for the Nigerian stock market. In the melee, lucky speculators and those who had their antennae up escaped unscathed, others managed to exit but with their fingers badly burnt, while the majority were entrapped and watched in bemusement and hopelessness as share prices nosedived uncontrollably with an alarming rapidity. A similar stock market cataclysm at the New York Stock Exchange in 1987 resulted in “madness”, as fist fights erupted in trading pits.
The regulatory authorities should be watchful to avoid a repeat occurrence of the 2008 downturn and always gauge the direction and pulse of the market. As stockbrokers trade, emphasis should be more on the market fundamentals and they should avoid over-speculation or excessive emotional trading.
The increased presence of foreign investors is not unconnected with the high return on investment which is typical of the Nigerian stock market. They have more appetite for risk than their local counterparts who are yet to fully return to the market.
Because of the cyclical operating dynamics of the stock markets, the regulatory authorities should heighten strategic agility, that is, be proactive and be ready to shift balances when necessary. They are faced with the challenge of installing a built-in protective mechanism in the market to create a buffer against any contrary happenstance. Otherwise, going by the Random walk theory and the concept of Brownian motion, one cannot be too sure of an automated stock market and the myriad of thresholds in the operating environment. That is the cold, hard fact.
ARIZE NWOBU
