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Analysis: How the Tehran Stock Exchange rally could benefit the Iranian economy

The unprecedented bull run on the Tehran Stock Exchange has been a major boon to Iranian investors, but the upward trajectory is dependent on reforms to attract more liquidity.
Iranian investors monitor an electronic board at the Tehran Stock Exchange, Iran, January 17, 2016. REUTERS/Raheb Homavandi/TIMA ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY. FOR EDITORIAL USE ONLY.  - GF20000097697

The Tehran Stock Exchange (TSE) has hit astonishingly new highs in past months, netting a return of above 15% in the week ending Sept. 26 alone — the highest weekly rise in its over half a century of existence. Since the start of the Iranian year on March 21, the TSE index has risen almost 90%, while its average volume of transactions has jumped by more than 400% compared to the same period in the previous Iranian year.

The stock market boom has been mostly due to the record devaluation of the national currency. Indeed, the weakening of the rial has tremendously impacted the revenues of commodity exporting firms, which constitute approximately three-quarters of the TSE market capitalization. The entry of fresh and massive liquidity, the relative positive outlook for global commodity markets, solid quarterly earnings reports and, finally, securities transaction tax cuts are among the reasons behind the continuing TSE benchmark growth.

But for the stock exchange market to see more investment inflow, certain pre-conditions must be met. Failure to fulfill them will set the stage for a dramatic sell-off, despite the dramatic hike.

The limited depth and breadth of the Iranian capital market has long been deemed a major stumbling block to the market's development. The absence of ample initial public offerings, shrinking free float percentages of listed companies and lower quantity of firms raising capital are major shortcomings of Iran’s capital market, not to mention the technical and trading regulations restrictions. As such, the odds are that amateur investors might get misguided by speculative traders in the stock market and end up losing their capital.

Studies show that the floating stock of companies in the TSE is just over 15%. This is while this figure exceeds 80% in developed markets. Consequently, if TSE-listed firms are pushed to lift up this meager percentage of their outstanding shares to an average of, for instance, 25% in the short term, new liquidity will easily be absorbed into the real economy. This level of liquidity is not only beneficial for the Iranian economy, but it could also prevent the stock price bubble that is just around the corner with current stock valuations.

One viable solution to this issue is for the state-run companies to follow the government’s privatization policies to the letter, floating their shares in the equities market. They can also sell the existing shares of listed companies at current share prices to new retail investors. But it is not clear why banks and pension funds that are owned by the government are so reluctant to seize this golden opportunity to divest their affiliates. In the years to come, the government needs to slowly shift financing of large enterprises to capital markets and allow the banks to get engaged with financing of small- and medium-sized enterprises. Thus, the number of initial public offerings should be leveled up in tandem with the amount of liquidity entering the stock exchanges. This will, in turn, gradually increase the production capacity in the country as well as employment.

Furthermore, the existing bullish market sentiment has bestowed a great opportunity to the bankers to relieve themselves of their toxic assets. Amid the current stock rally, banks could be required to sell their extra assets on the TSE. Nevertheless, in this mechanism, they should be urged to offer their subsidiaries’ shares at the current trading prices and not be allowed to await higher bids by investors. Adopting such a wrong strategy might bring about negative results, as bull markets with present features won’t last long in the Iranian context. As such, large pension funds are advised to follow suit.

Some market actors and pundits may doubt such measures by large state shareholders and claim that they could potentially eradicate investor interest in entering the market. But minimally, a yearlong outlook is poised to lead to a favorable outcome. In this regard, should the major shareholders decide to spike their public float in good faith — although this could slow down the rising trend of the main index — stocks will ultimately move toward their intrinsic value. Needless to say, this will in time deepen the Iranian stock market and bar abnormal price swings in the trading sessions in the long run. Besides, raising stock ownership and the culture of shareholding among the public in Iran is another worthwhile objective that can be achieved in this process.

In recent years, the TSE failed to attract rampant liquidity due to its inadequate depth and, at the same time, lack of diversification of securities for various industries. That being said, the prosperity of the TSE chiefly hangs on adhering to the paradigm of a liberal economy by the economic team of President Hassan Rouhani. As such, it is safe to say that one prominent solution that could hinder inflationary pressures is to channel the extra liquidity to manufacturing and production through the mechanisms of the capital market. In this context, the continuing flood of liquidity said to have been mostly created by credit and financial institutions could eventually be utilized for the advantage of the whole economy.

Without adequate political will, however, it would be next to impossible to stifle the extreme economic fluctuations in Iran. Thus, any attempt to maintain a command economy — which Iranian statesmen have traditionally been addicted to — would only derail the development and upward trajectory of the capital market.

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