1. Introduction

Economic theories lend themselves to the view that changes in monetary conditions of an economy affect asset markets and therefore economic activity through induced changes in yield. Since the early 1980’s, asset prices have undergone major fluctuations. The impact of these fluctuations on economic activity and on the soundness of the financial market has been a concern for central banks and monetary authorities alike. For instance, the global stock markets crash of October 1987 in the USA was preceded by a vigorous upswing in equity prices which neither the Federal Reserve Bank nor the US government could prevent. In Ghana the bearish nature of the stock market in 1999 in particular has been blamed on the slowdown of the Ghanaian economy.

The mission of central banks worldwide is to achieve price stability in the economy, in pursuance of its monetary polices. In this regard, movement in prices of goods and services including all assets must be of concern to the central bank at all times. It also follows that corporate earnings, share prices and expected returns on investments must of necessity be of interest to a central bank. If the yield from shares and other investments are expected to be more stable in the future than it has been in the past, some downward adjustment of the expected return could lead to a higher valuation.

In addition, an upward trend in asset prices is accompanied by an expansion in credit in an economy as it adds to the value of collateral, strengthens the borrowing capacity of investors and the lending propensity of banks. However if this expansion is not based on realistic expectation of future prospects, a financial bubble occurs.

The real rate of return otherwise called pure time value of money, is the price necessary to induce investors to forego consumption and save. The real rate of interest is thus defined within the context of no uncertainty and no inflation. To ascertain this rate, reference is usually made to Treasury bills which is regarded as a risk-free asset, the returns of which normally lags behind risky investments such as equities. The difference between the returns on risk-free assets and risky assets is the risk premium, which compensates investors for the risk taken.

Even though the apparent increase in volatility of stock prices of the Ghana Stock Exchange since (GSE) 1992 may be associated with underlying economic conditions within the economy, investment decisions may be primarily driven by anticipated capital gains and/or by income streams to be derived from the assets.

In this paper, end period inflation; 91-day Treasury bill rates and the GSE All Share index have been used to derive the real rates of return. The paper is in 4 parts - Part 2 evaluates the real returns of GSE stocks and the Treasury bill markets. Part 3 examines the relevance of asset prices and real returns. Part 4 of the paper covers conclusions and recommendations.

2. Evaluation of Real Returns on the GSE Stocks and Treasury Bills

The total annual real returns on stocks listed on the GSE have followed an undulating pattern since 1991, falling every two years and rising the following two years (as shown in chart 1). It recorded an average annual real return of 9.7% compared with 4.9% in treasury bills during the same period 1991-99). The average annual nominal returns for the same period however stood at 38.1% and 31.5% for stock and treasury bills respectively.

Table 1: Returns on GSE Stocks & 91-Day T'Bills (1991 - 1999)
(%)

			Returns (%)
	End Period	Stocks		T'Bills
Year	Inflation	Nominal	Real	Nominal	Real

1991	18.1	-7.95	-22.06	29.23	9.42
1992	10	-3.63	-12.39	19.38	8.53
1993	27.7	113.74	67.38	30.95	2.55
1994	34.2	124.34	67.17	27.72	-4.83
1995	70.8	6.33	-37.75	40.5	-17.74
1996	32.7	13.82	-14.23	42.8	7.61
1997	20.8	41.85	17.43	41.0	16.72
1998	15.7	69.69	46.66	26.78	9.58
1999	13.8	-15.22	-25.50	31.5	15.55
2000	40.5	16.55	-17.05	38.0	-1.78
Period Avg	27.09	38.11	9.63	31.52	4.79
Std. Dev.	18.41	53.00	41.25	8.14	11.43

Between 1997 and 1998, real return on the stock market increased by 168.4% but decreased by 153.5 per cent between 1998 and 1999. This seemingly good performance of the stock market between 1997 and 1998 could be attributed to the effect of the Asian crisis in 1997. Some investors, who were looking for a haven, invested funds here only to withdraw them in 1999 when the crisis eased causing a slow down of activities on the Ghana Stock Exchange.

Real returns on the treasury bills market showed a downward trend from 1991, with a record of lowest returns in 1995 (-17.74%) as a result of a hyperinflation (70.8%). The continuous reduction in inflation rate since 1996 resulted in positive real returns on treasury bills, though very erratic. (See table 1).

Changes in annual real return on stocks and treasury bills analysed above points to

the fact that the stock market is more sensitive to inflation than the Treasury bill market. When the economy is in recession, the stock market records more negative real returns whilst treasury bills maintain a lower but stable positive returns. During periods when the economy is booming, the stock market records astronomical real returns such as shown in 1993, 1994 and 1998. (Refer to Appendix 1)

The monthly results on real return (shown in Appendix 2) also reflect the assertion made above. Real returns on the stock market improves with low inflation rate, which suggests that when the underlying fundamentals of the economy is sound, informed investors would prefer to invest in long-term securities.

In 1997, while inflation rate declined from 31.5 per cent in January to 20.8 per cent in December (-34%), real returns on Treasury bills and stocks increased by 76.8 per cent and 195 per cent respectively.

In 1998, with inflation rate declining by 20.7 per cent, that is (19.8% to 15.7%) from January to December, real returns on treasury bills declined by 45.4 per cent and that of stocks increased by 31.5 per cent during the year.

Table 2: Changes In Returns on GSE Stocks & 91-Day T'Bills (1991 - 1999)
(%)

			Returns (%)
	End Period	Stocks		T'Bills
Year	Inflation	Nominal	Real	Nominal	Real

1991
1992	-8.10	4.32	9.67	-9.85	-0.89
1993	17.70	117.37	79.77	11.57	-5.98
1994	6.50	10.60	-0.21	-3.23	-7.38
1995	36.60	-118.01	-104.92	12.78	-12.91
1996	-38.10	7.49	23.52	2.3	25.35
1997	-11.90	28.03	31.66	-1.8	9.11
1998	-5.10	27.84	29.23	-14.22	--7.14
1999	-1.90	-84.91	-72.16	4.72	5.97
2000	26.7	31.77	8.45	6.5	-17.33

In 1999, when inflation declined from15.3 per cent to 13.2 per cent (-13.7%), real return on treasury bills increased by 222.4 per cent whilst real return on stocks declined by 140.3 per cent.

Table 3: Percentage Changes (Between Jan and Dec.)

Year	Inflation	Real Return T’Bills(%)	Real Return Stocks (%)
1997	-34.0	+76.8	+195.0
1998	-20.7	-455.4	+31.5
1999	-13.7	+222.4	-140.3
2000	26.7	-1.78	-17.05

Should the earlier assertion hold, real returns on stocks for 1999 ought to have increased significantly above the 1998 position since inflation fell further by 13.7%. However, 1999 was classified by analysts of the financial markets in Ghana as an

exception. This could lend support to the assertion that even though lower inflation is expected to result in positive real returns on stocks, other factors such as information dissemination, real growth in GDP etc. that influence activities in the market, may affect pricing of assets and hence returns. For instance in 1998, real returns on stocks rose as high as 159.5 per cent and 118.4 per cent in April and July respectively but fell to 28.3 percent in November when inflation was low.

3. Investment Objectives and Ownership Structure

Analysts attribute the motive for investment in stocks to the following: income, capital growth, security and pure speculation. For individual investors, much also depend on the age of the investor. Where the investment objective is for income, money market instruments are normally the preferred investment. For capital growth, investment in equity is preferred whilst investors who want security normally invest in bonds. Lack of liquidity and the small number of equities on the GSE discourage retail investors from investing on the GSE.

A look at the ownership structure of equities on the GSE indicate that with the exception of 9 equities (out of the current 22), non-resident foreign investors (NRF) own more than 50% of the total shares issued. These NRF are usually institutional investors who want to immunise losses in their investment portfolios by investing in emerging markets where returns are usually higher than that of their local markets. As a result, a greater part of returns on the GSE accrue to foreign investors. In contrast, returns on treasury bills accrue to Ghanaian investors since foreigners are not permitted to invest in these instruments.

4. Conclusion and Recommendations

The study shows that real returns on Treasury bills are relatively higher than on stocks. Thus there is no incentive for investors to go into long-term investments. This implies that the economy is not expanding as is expected. Besides, a greater percentage of investor funds that could otherwise be used to finance the private sector are being diverted to cover government expenditure. It is predicted therefore that if this trend continues, real returns on stocks could fall further this year.

Interest rates have generally moved downwards since 1997. The average 3-month deposit money banks borrowing rate fell from 36.21 per cent in 1997 to 29.50 per cent in 1998 and further to 23.25 in 1999.

On the other hand, Treasury bill discount rates which fell by 27 per cent between 1997 and 1998 rose by 18 per cent between 1998 and 1999. The performance of the GSE stock prices followed an inverse pattern and therefore became unattractive. The combined effect of the declining stock prices and borrowing rates resulted in the upsurge in the market for treasury bills.

With high interest rates the banks were willing to lend to companies at rates higher than Treasury bill rates. However, the high interest rates rendered companies incapable of obtaining financing from the banks and were thus crowded out from bank lending. At the same time, companies could also not raise funds on the Stock Exchange due to low stock pricing.

It is recommended that:

§ The Bank of Ghana continues to pursue its policy of reducing the rate of inflation until it becomes possible to float medium to long term bonds as a way of financing the budget deficit instead of the current practice of using treasury bills. This will reduce the financing cost for budget deficit and also make investment funds available for the private sector.

§ The Ghana Stock Exchange is not a representation of all the sectors in the economy. The use of GSE All-Share index for the study could be biased. This calls for efforts to increase the number of listed companies on the Exchange.

FINANCIAL MARKETS DEPARTMENT

January 16, 2001

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