Issue 6, 2012. December-January



With pension reform on the agenda in Georgia, the Georgian Stock Exchange could be a potential vehicle for encouraging long term savings.

Bruce Packard

Georgia's stock exchange is currently dominated by one large stock (Bank of Georgia was over 90% of the turnover last year). Despite being by far the most liquid stock on the exchange, Bank of Georgia turnover was low by international standards, and management felt the need to seek a premium listing on the London Stock Exchange for more liquidity. In many ways this has been a success, with the share price up over 30% in the last 12 months. But it is also a shame that Georgian companies feel they must go overseas for recognition, while at the same time limiting the opportunity for Georgians to invest their money in companies they know well.

Perhaps the biggest obstacle to a more active stock exchange in Georgia is the high interest rates offered by deposit accounts. Savers in bank accounts are offered interest rates in Lari at 12% for 1 year (around 8% if you prefer to save in US dollars). With these very attractive interest rates, combined with the security of saving in a bank account, it seems Georgia's stock exchange faces stiff competition if it is to attract long term savings.

But Georgian banks have already started to reduce interest rates. If we look at other countries, we can see that bank deposits tend to be a poor long term investment as their value has tended to be eroded by inflation. Cash and short term deposits are often described as low risk investments. But they are not low risk for people who wish to protect their living standards over the coming decades. Money held in bank deposits might offer near term certainty, but very little long term security.

In contrast, the stock exchange offers Georgian households the chance to hold equity shares in productive businesses. These businesses are likely to hold their value against the slow erosion of value that inflation brings. Interestingly, research by HSBC in Asia has shown that when a country has reached $5,000 to $10,000 GDP per capita, it starts to need long term savings. Before that point, households are more worried about putting food on the table for their families, and are too distrustful of the financial sector to save. After that point, households can feel confident enough in the future to see that it is worth their while to put some proportion of their income aside for later years.

The point is not exactly the same for each country, and depends on culture and other factors. So, South Korea saw its long term savings market accelerate at $5,000 GDP per capita, Taiwan at around $8,000 GDP per capita and Singapore $12,000. But all these countries, plus Hong Kong and Japan saw significant growth in life premiums at around $5,000-$10,000 GDP per capita. Georgia, with $5,600 GDP per capita, is just at that point of financial penetration. This in turn creates a positive feedback loop - with home grown companies able to raise finance from their own customers, rather than having to rely on going overseas for external funding.

While I was in Georgia this summer, various people suggested to me that Georgians were not sophisticated enough, and that it was too early to expect the stock exchange to be a success. In fact, the stock exchange has already been a success. Chairman Gogi Loladze explains how, in the 1990s, the exchange existed, but when it became obvious that the then Government was devaluing the currency, they closed it down. "They were like a patient with a fever, and they blamed the thermometer for showing a high temperature," he says.

Most Georgians understand markets. Even communism failed to eradicate this. Anthropologist Gerry Mars, an expert on the underground economy in the Soviet Union of the 1970s and 1980s, points out that Georgia was the most capitalist and entrepreneurial culture of the time, even more so than the Baltic region. The stock market, while it also involves a risk of loss, tends to reward thoughtful risk-taking and creates more winners than losers.

What Georgia doesn't need:

Although Georgia needs a more liquid stock market, it is possible to look to other countries to see what it doesn't need: high frequency trading, complex derivatives, pension consultants, hedge funds, and leveraged buy-outs. There is a large amount of academic research showing that institutional investors - despite their many "competitive advantages," including full time staff, consultants etc -typically underperform their chosen benchmark. Extensive and readily available data shows that, after taking costs into account, over a ten year period 70% of fund managers under-perform. What the academic research rarely focuses on is that amateur investors who "buy and hold" good quality stocks tend to outperform.

Households tend to think about risk and return in a far superior way than is taught to the finance profession. Holding 75% of your wealth in a stock such as Unilever for the past few decades would appear incredibly risky to a student of modern portfolio theory, and yet studies show less volatile, high quality stocks tend to have higher than average returns over the long term.

As interest rates fall, the stock exchange has a role to play in helping households save. Perhaps the government could lead the way by floating the Georgian Railways on the Georgian exchange at a realistic price.

Bruce Packard CFA is a stockbroker and banking analyst. He began his career at Credit Suisse in 2000 and most recently worked at Seymour Pierce, where he helped Bank of Georgia with their premium listing on the London Stock Exchange. In July 2008, based on analysis of Nordic and Japanese banking crises, he predicted the nationalization of the UK banking sector. He has a degree in Theology from Durham University.