development and determinants

7/30/2019 Development and Determinants

1/15

The Iraqi Stock Market:Development and Determinants

Juergen Kaehler* and Haider Salahal-Din Aref**

May 2010

* University of Erlangen-Nuremberg and ZEW

** University of Baghdad and University of Erlangen-Nuremberg

Address for correspondence:

Prof. Juergen Kaehler PhDInstitute of Economics

University of Erlangen-Nuremberg

Kochstr. 4 (17)

D-91054 Erlangen

Germany

Phone: (+49) 9131 852 2083

Fax: (+49) 9131 852 2060

Email: [email protected]


2/15

1 Introduction

A well-functioning stock market is one of the cornerstones of an efficient market economy. It

facilitates the transfer of funds from the savings of investors to the financing requirements of

companies. Iraq, with all its recent and current political upheavals, its security and economic

problems and reoccurring terrorist attacks is still in a quite unstable situation. To some extent,this is also reflected in the lack of development of the Iraqi Stock Market. Certainly,

significant improvements have been made in recent years but it seems that there is still some

way to go towards a well-developed stock market both in terms of size and of sophistication.

In many nascent stock markets, price volatility is very high and stock prices often have a

tendency to follow short-run bubble paths. Liquidity is typically low and, therefore, large

orders can move stock prices quite substantially. The Iraq Stock Market Exchange (IRX)

began operation only a few years ago in June 2004. Therefore, one would expect to find

similar inefficiencies on it as on other nascent stock markets. However, we are not aware of

any previous academic research of the market to quantify this expectation. Therefore, our

analysis is, to a large extent, exploratory in nature.

The aim of this paper is to describe the development of the Iraqi Stock Exchange and to

present some preliminary results on the efficiency, or otherwise, of the stock market in Iraq.

The paper proceeds by first providing background information on the macroeconomic

development in Iraq since the beginning of this century. In section 3, the development of the

stock market is explained with statistical data. We explore determinants of the price index of

the IRX in section 4 and we draw conclusions from our analysis in the final section.

2 Macroeconomic Background

Before analyzing the Iraqi stock market, it is important to consider the macroeconomic

background of the country. Clearly, the military invasion of 2003 and the political instability

and security problems since then have had a major impact on the economy. Given the state of

turmoil, the quality of official statistics is difficult to judge. This general caveat applies to

several data reported in this paper.

The real growth rate, measured by the percentage change of GDP, is one such variable

that was strongly affected by the political, military and security situations that have prevailed

during the last few years. Table 1 reports GDP growth rates from 2000 to 2009. In three of

those ten years, GDP decreased, with 2004 showing a staggering decline of 21.8 per cent.

Quite surprisingly, GDP increased by 52.3 per cent in both 2003 and 2005.

2


3/15

Table 1: Real Growth and Inflation 2000 - 2009

GDP Real Growth Rate Inflation Rate (CPI)

2000 13.0 135.02001 15.0 100.02002 -5.7 60.0

2003 52.3 70.02004 -21.8 29.32005 52.3 25.42006 -3.0 33.02007 2.4 64.82008 5.9 4.72009 7.8 6.8

Source: indexmundi

Equally spectacular was the development of inflation in the first decade of this century.

Both in 2000 and 2001 there was 3-digit CPI inflation, but from 2002 to 2007 inflation was in

the 2-digit range. Although inflation fell to single-digit figures in 2008 and 2009, the average

annual inflation in this 10-year period was still as high as 48 per cent. With such a strong

cumulative increase of the price level, one would expect at least under PPP a

corresponding strong depreciation of the Iraqi dinar (ID).

However, as Figure 1 shows, the nominal exchange rate of the Iraqi dinar to the US

dollar appreciated from 2004 to 2009 when inflation was still very high. The exchange rate is

recorded in price notation from the Iraqi perspective. On 30th

June, 2004 there was a strong

revaluation of the dinar against the US dollar when the exchange rate was lowered from nearly

3,000 ID per dollar to about 1421 (or from 0.000335 dollars per ID to 0.000704). But even

after this massive revaluation, the dinar continued to appreciate against the dollar. At the endof 2009 the exchange rate was only 1134 ID to the dollar. This is very surprising because it

implies an extremely strong real appreciation of the dinar. Unless the dinar was grossly

undervalued prior to June 2004, this real appreciation should have implied a massive loss of

price competitiveness of the Iraqi economy. Apparently, the Central Bank of Iraq (CBI) saw

this appreciation of the dinar as a means to fight inflation and to counter the dollarization of

Iraq (Al-Salam, 2009).

3


4/15

Fig. 1: Exchange Rate of the Iraqi Dinar to the US Dollar

800

1,200

1,600

2,000

2,400

2,800

3,200

2004 2005 2006 2007 2008 2009

Source: OANDA

An implication of this unusual and unexpected path of the exchange rate is that it is not

advisable to convert values in ID into dollar values by the exchange rate for the period from

2004 to 2009. The revaluation of the ID in June 2004 would strongly bias any dollar values.

But also the real appreciation of the dinar from 1400 ID/dollar in November 2006 to around1200 in February 2005 would have a large effect on dollar values.

Oil production and the export of oil are of crucial importance for the Iraqi economy.

After the military invasion of 2003, oil production quickly recovered but, as illustrated by

Figure 2, from 2004 to 2009 there was no clear upwards trend in oil production. Instead oil

production seems to be a stationary variable with a quite strong seasonal pattern. In most years,

oil production decreased substantially in January. However, the sample period is probably too

short to generalize this observation.

4


5/15

Fig 2: Crude Oil Production (millions of barrels/day)

1.6

1.8

2.0

2.2

2.4

2.6

2004 2005 2006 2007 2008 2009

Source: Brookings Institution (2010), p. 28

The overall conclusion about the macroeconomic developments in Iraq since 2004 is,

therefore, that despite a clear recovery in many respects the economy is still very volatile.

Inflation has come down substantially but the strong nominal and real appreciation of the dinar

is puzzling. Clearly, those macroeconomic trends can have repercussion on the development ofthe stock exchange in Iraq.

3 Development of the Iraq Stock Market

The ISX has a rather short history. It was founded and started trading in June 2004. Before the

military invasion of 2003, stock trading took place at the Baghdad Stock Exchange that was

founded in 1992. However, the Baghdad Stock Exchange is not considered to be the direct

predecessor of the ISX because the Baghdad Stock Exchange was operated by the Ministry ofFinance whereas the ISX is a non-profit organization that is owned by its member brokers.

Although the ISX started operation June 24th

, 2004 there was only one day of trading in

that month. Figure 3 displays the number of trading sessions per month from June 2004 to

December 2009. It is obvious from this graph that, until quite recently, trading was restricted to

only a few working days per week. Some of the variation in trading sessions, of course, is also

due to calendar effects (fewer days in February than in, say, January) but sometimes the

exchange had to be closed for security reasons. It also suffered from power outages that are

typical for Baghdad where it is located.

5


6/15

Figure 3: Number of Trading Sessions per Month at the ISX

0

4

8

12

16

20

24

2004 2005 2006 2007 2008 2009

Source: ISX

Currently, stocks are traded on five days per week, from Sunday to Thursday. Trading

hours are from 9:30 to 12:00 am. Initially, trading took place on the floor and stock prices

where recorded manually on whiteboards but on April 19th

, 2009 electronic trading was

introduced. The technology for electronic trading was provided by NASDAQ OMX.

When the ISX opened in June 2004, only 15 companies were listed and 6 were traded. As

Figure 4 illustrates, the number of listed companies has since increased substantially. In

January 2006, the number of listed companies increased to 94 and in November 2008 there

was a peak of 96 companies. There was a sudden and drastic drop in the number of listed

companies in July 2009 from 91 to 47. Presumably, this is partly related to moving companies

from manual trading to electronic trading.

6


7/15

Figure 4: Companies Listed and Traded

0

20

40

60

80

100

2004 2005 2006 2007 2008 2009

Companies listed

Companies traded

Source: ISX

Figure 4 also displays the number of companies whose shares were traded in the months

from June 2004 to December 2009. A comparison with the number of listed companies shows

that many stocks on the ISX are illiquid. In the early years of the exchange, only about half of

the stocks listed were actually traded in a month. In more recent times the markets seems to

have become somewhat more liquid. In March 2009, 84 per cent of stocks listed were traded.

Another key feature of the ISX is the concentration of sectors. The ISX allocates

companies into seven sectors but market capitalization is clearly dominated by the banking

sector. Figure 5 shows monthly values of market capitalization by sector from the end of 2004

to the end of 2009. There are only three sectors that are identifiable in this graph: Banking,

industry and tourism & hotels. The other four sectors of agriculture, insurance, investment and

services have typically a market share (in terms of capitalization) that is smaller than 1 per

cent. In 2009, even the industry sector declined so much in importance that only two sectors

remain to dominate the market. This is certainly surprising. The banking sector is not

traditionally a strong sector in Iraq and, given the persistent security problems, Iraq is currentlynot a very attractive tourist location.

7


8/15

Figure 5: Market Capitalization by Sector

0

400

800

1,200

1,600

2,000

2,400

2,800

2005 2006 2007 2008 2009

Agriculture Banks

Industry Insurance

Investment ServicesTourism & Hotels

Source: ISX

Another important indicator of market depth is the number of traded shares and trading

volume. Time series of both variables are shown in Figure 6. The overall trend is clearly an

increase in the number of traded shares and in trading volume, especially after 2006. Most

remarkable, however, is the spectacular increase of both variables in July 2007 when more

than 72 billion shares were traded and trading volume was about 260 billion dinars. Trading

also peaked in June 2008 and May 2009. The incredible volatility in trading confirms the fact

that the ISX is still a nascent stock market.

8


9/15

Figure 6: Traded Shares (in million) and Trading Volume (in million ID)

0

40,000

80,000

120,000

160,000

200,000

240,000

280,000

2004 2005 2006 2007 2008 2009

Traded shares

Trading volume

Source: ISX

The surge in trading activity in July 2007 is a puzzle. It was the result of trading in the

shares of just one bank: North Bank. Total trading volume in July 2007 was 260 billion ID to

which the trading of North Bank shares contributed 240 billion. That is more than 92 per cent.

North Bank was an extremely dynamic bank. It was founded in January 2004 with a capital of

2.5 billion ID but by December 2006 its capital had increased to 100 billion ID. During July2007 the share price of North Bank increased from 2.25 ID to 3.90 ID with a peak of 4.75 ID.

This price rally had a large impact on the market. In July 2007, the ISX index increased from

25.9 to 40.9. This is an increase of almost 60 per cent!

The surge in trading activity in July 2007 is even more surprising given the fact that

shortly after, on August 2nd

, 2007, the ISX was opened to foreign investors. Perhaps the puzzle

can be explained by a kind of front-running activity. Figure 7 shows again the total monthly

trading volume but superimposed on the blue shaded area is a red area that represents the

trading volume by non-Iraqis. In general foreigners contributed less than 20 per cent to the

total trading volume. But there was one significant exception when in April 2009 the tradingvolume of non-Iraqis (81 billion ID) represented 77 per cent of the total volume. Their trading

activity was almost entirely concentrated on the shares of the Bank of Baghdad (Iraq Stock

Exchange, 2009, p.4).

9


10/15

Figure 7: Trading Volume (million ID)

0

40,000

80,000

120,000

160,000

200,000

240,000

280,000

2004 2005 2006 2007 2008 2009

Total Trading Volume

Trading Volume by Non-Iraqis

Source: ISX

The general conclusion that can be drawn from the analysis in this section is that the ISX

is a small, very volatile and rather illiquid market. In such an environment, large orders can

move the market substantially. This is not unusual for a nascent market. But often nascent

stock markets offer great opportunities to investors. In the next section we examine potential

determinants of stock prices in Iraq, as measured by the ISX index.

4 Determinants of the ISX Index

The overall stock price development at the ISX is measured by the ISX index. This index has

been criticized for being opaque and dubious (Kubba Consultants, 2007) but it is the only

index available. Figure 8 traces the monthly index values from 2005 to 2009. Four points are

noteworthy: First, the ISX had its first crash when the index dropped from 72.6 in November2005 to 25.4 in March 2006. Second, from March 2006 to August 2008 the index was quite

static, with the exception of the price surge in July 2007 that was mentioned above. Third, the

index was on an apparent bubble path between August 2008 and April 2009 when the index

rallied from a value of around 40 to a value of more than 280. Considering that many large

international stock markets suffered heavy losses during this period, it is quite miraculous that

Iraq was able to escape the global stock-market bust. Fourth, apparently the bubble burst in the

summer of 2009. Trading continued but the ISX does not report index values for July and

August 2009.

10


11/15

Figure 8: Development of the ISX Index

0

50

100

150

200

250

300

2005 2006 2007 2008 2009

Source: ISX

The fact that trading of foreigners peaked in April 2009, just before the speculative

bubble burst, might raise the suspicion that selling by foreigners led to the crash.

Unfortunately, for the months prior to September 2009, published ISX information is only

available for trading activity of non-Iraqis in general, without the distinction between buyingand selling. However, closer examination shows that it was a transfer between foreigners that

explains the large trading volume in April 2009. On April 14th, the Kuwaiti Burgan Bank

acquired a 45.3 per cent stake (31.7 billion shares for a price of 80.9 ID billion) in the Bank of

Baghdad from the Bahraini United Gulf Bank (AMEinfo, 2009). This transfer constituted 99.9

per cent of the trading volume of foreigners in that month and 76.7 per cent of the total market

volume. Moreover, the ISX index continued its surge after April 14th

. On that day an index

value of 207.6 was recorded but the all-time high was reached one month later on May 14th

with a value of 302.1. By all standards, a nearly 50 per cent increase within 30 days is

spectacular.

It is notoriously difficult to explain the movement of stock prices, especially when theyseem to be on a bubble path because then, by definition, they are detached from their

fundamental determinants. On the other hand, stock price indices are often modeled as random

walks and associated with market efficiency (e.g. Ruppert, 2004). Under both the bubble

hypothesis and the random-walk hypothesis it would be futile to try to find fundamental

determinants of stock-price developments. We take here an alternative position that has a long

tradition in financial research (Chen et al., 1986). We apply a model that identifies

macroeconomic factors as determinants of stock prices. In the past, variables such as industrial

production, inflation, real interest rates, risk premia or term-structure spreads have been used

as determinants. But, because of the special situation of Iraq, we have to be flexible in

specifying the model. First, there are serious limitations due to data availability and datareliability. Second, we take the security situation into account because it does not only have an

impact on politics but also on the economy. Third, we refrain from isolating unexpected

11


12/15

components of the variables since the available time series are simply too short for this kind of

analysis.

The first variable to consider is electricity generated and measured in megawatts (MW).

Figure 9 displays the time series from June 2004 to the end of 2009. There is enormous

monthly variability but the series is probably too short to identify seasonal factors or to

decompose it into trend, cyclical and seasonal component. Visual inspection seems to suggest,however, that there was an increasing trend that started in early 2007. We regard the

production of electricity as a good proxy for economic activity because electricity is needed for

the production of virtually all goods and services. In Iraq, electricity was also clearly a

bottleneck factor for economic activity. According to the Iraq Index of the Brookings

Institution (2010), there was no month in 2007 when the average hours of electricity supply per

day in Baghdad was more than 9. Advantages of this proxy are that electricity production can

be measured precisely and that the variable is available on a monthly basis.

Figure 9: Electricity Generated (MW)

3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

2004 2005 2006 2007 2008 2009

Source: Brookings Institution (2010), p. 30

There are numerous methods and sources available to measure the security situation of

Iraq. We decided to use the Iraq Body Count (IBC) data because they are provided by an

independent organization and are based on crosschecked media reports as well as hospital,

morgue, NGO and official figures. The IBC reports, on a monthly basis, the number of civilian

deaths from violence. As Figure 10 shows, the peak of the death toll was reached in 2006.

Since then the security situation has improved substantially but by 2009 the monthly death toll

was still in the order of 400 or so.

12


13/15

Figure 10: Civilian Deaths from Violence

0

400

800

1,200

1,600

2,000

2,400

2,800

3,200

2005 2006 2007 2008 2009

Source: Iraq Body Count (2010)

The next step is to enter both the electricity and the death-toll factor into a regression

model with the ISX index as the dependent variable. The results are shown in Table 2. The

estimated coefficients have the expected signs. An increase of electricity generated by 100MW would, on average, lead to a rise of the ISX index by 3.4 points and a decrease of the

death toll by 100 per month would, on average, lead to a rise of the ISX index by 1.6 points.

The estimated coefficients are significantly different from zero at the conventional 5 per cent

level. The adjusted R2

shows that the model explains nearly 40 per cent of the variation in the

IXS index.

Table 2: Determinants of the ISX Index

Dependent Variable: ISX INDEX

Newey-West HAC Standard Errors & Covariance (lag truncation=3)

Coefficient Standard Error t-Statistic Probability

C -67.13381 51.53663 -1.302643 0.1981

ELECTRICITY 0.034235 0.013462 2.543105 0.0138

DEATH TOLL -0.016128 0.006944 -2.322573 0.0239

Adjusted R-squared 0.392036 Durbin-Watson statistic 0.340746

13


14/15

However, the Durbin-Watson statistic indicates that there is strong positive first-order

autocorrelation of the residuals. Econometrically, the problem of autocorrelation is taken care

of by computing heteroskedasticity-and-autocorrelation corrected (HAC) standard errors. But

in this particular case, it is instructive to have a look at the pattern of residuals. Figure 11

shows that the residuals were strongly positive from March to June 2009. In fact, the largest

value of 183 is obtained for April. Also drawn into Figure 11 are the two solid lines of44.0

that represent the standard deviation of the residuals (standard error of regression). A rough-

and-ready 95 per cent confidence interval of the residuals would be the interval 88.0. With

this benchmark, the period from April to June can be identified as a bubble with a peak in

April.

Figure 11: Residuals of the Regression Equation

-100

-50

0

50

100

150

200

2005 2006 2007 2008 2009

On the other hand, in 2008 the ISX index underperformed with respect to the two

fundamental factors. Economic activity, as measured by electricity supply, increased and the

security situation improved noticeably but throughout 2008 the ISX index gained little. That is

why the residuals of the regression model remained negative through the whole year.

5 Conclusions

The Iraq stock market is a very young and, therefore, quite immature market. Like many other

stock markets in this stage of development, it shows high volatility and, in general, a lack ofliquidity. Every month, there is quite a gap between the number of stocks listed and the

14


15/15

number of stocks traded. Even as recent as December 2009, only 73 per cent of the stocks

listed were also traded.

Despite its short history, the ISX has already witnessed one apparent bubble period and

two crashes. The Iraq stock market would certainly benefit greatly from further improvements

in the security situation in the country both directly and indirectly. Our regression analysis has

quantified the gains to be realized if and when civilian deaths from violence can be reduced.The indirect effect would work via increased economic activity. Economic growth would

certainly pick up once political instability and terrorist attacks are overcome. Some progress

has certainly been made in macroeconomic performance. Real growth has increased and

inflation has come down but there is room for further improvement.

Our analysis of the Iraq stock market is restricted by data issues. First and foremost, data

reliability is still questionable. There are several inconsistencies in published data and

sometimes it is difficult to square the development of the ISX index with that of its sub-sector

indices or with that of individual shares. For more sophisticated analysis, like co-integration

analysis, the time-series are still too short. In addition, the availability of daily ISX index data

would make it possible to conduct more in-depth time-series analysis. Therefore, we hope thatthe future will bring both an improvement in the market and in our analysis of it.

References

Al-Salam, Taha Ahmed (2009), Iraq Stock Exchange Presentation; http://www.isx-iq.net/-

isxportal/portal/chiefExecutive.html

AMEinfo (2009), Burgan Bank completes transfer of Bank of Baghdad and Algeria Gulf Bank,

http://www.ameinfo.com/195362.html

Brookings Institution (2010), Iraq Index: Tracking Variables of Reconstruction & Security in

Post-Saddam Iraq, 27th

April 2010; http://www.brookings.edu/~/media/Files/Centers/-

Saban/Iraq%20Index/index.pdf

Chen, N.-F., R. Roll and S.A. Ross (1986), Economic Forces and the Stock Market, Journal of

Business, 59 (3), 383-403

Iraq Body Count (2010), Documented Civilian Deaths from Violence; http://www.-iraqbodycount.org/database/

Iraq Stock Exchange (2007), Monthly Bulletin, July 2007

Iraq Stock Exchange (2009), Monthly Bulletin, April 2009

Kubba Consultants (2007), Dubious ISX index; http://www.isx-aman.com/news/rep_index_-

2007_03_28.htm

Ruppert, D. (2004), Statistics and Finance, Springer

15

development and determinants

Documents