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Iraqi Stocks Bounce Back

By Mark DeWeaver.

This week saw a dramatic turnaround in Iraqi stocks. Last Thursday’s selloff (see this post) accelerated into a mad dash for the exits on Sunday, with the RSISX losing 4.3% on virtually no advancing volume and 60% of the trading in limit-down stocks. On Monday the index fell another 3% to bottom at 1603, just north of long-term support at 1600, a level that hasn’t been tested since January, 2013.

Stocks moved up sharply for the rest of the week, particularly on Wednesday, when not a single stock declined and heavyweights BBOB, BNOR, and BUND closed limit up after closing limit down only three days before. By the Thursday close, the market had recovered about half of the previous two weeks’ losses. (See chart.)

This week’s action mirrored the situation on the battlefield quite closely, with the 1600 support level serving as a market analogue for the army’s line of defense at Samarra. Indeed Iraqi stocks now seem to have become almost entirely a play on the progress of the security forces.

Given that the insurgents are unlikely to push farther south, this suggests that the market is unlikely to see further steep losses. But for the RSISX to bounce all the way back, the front may have to start moving north.

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The Wrong Time to Panic

By Mark DeWeaver.

Iraqi stocks held up surprisingly well for most of this week despite the dramatic loss of much of Northwestern Iraq to extremists. Even following the fall of Mosul on Tuesday, Rabee Securities’ RSISX index was down only 2.6% for the week by Wednesday’s close. And while the ISX index fell 3.3% on Wednesday, about half of that decline was due to a 10% drop in Asiacell on a mere US$ 659 worth of turnover.

Thursday, however, was a different story. Five of the top banks—BBOB, BCOI, BNOR, BROI, and BUND—were down by the 10% daily limit (or close to it) on heavy foreign selling. Net foreign buying, which had been positive every day since the start of the week, swung sharply negative. Having accumulated US$ 627,000 worth of Iraqi stocks from Sunday to Wednesday, foreigners ended the week by net selling US$ 415,000 in a single day.

While I don’t have any way of knowing for sure, it seems obvious to me that one of the foreign funds has finally panicked.

Should I be panicking too? I don’t think so. Orc-like hordes of invaders descending on the capital is undoubtedly a scary prospect, but ISIS has almost certainly reached the limit of its advance by this point. The Iraqi army is unlikely to melt away from the Shia areas in that way that it did in Mosul. It is already being backed up by Kurdish forces in the territories bordering Kurdistan and may quite possibly be able to call upon US airpower by as early as next week. Meanwhile, the enemy is stretched thin and vastly outnumbered.

The scenario to bet on is not the fall of Baghdad but rather a series of reversals for ISIS. Once that happens, the market should stabilize and, in the event of US airstrikes, will easily erase its losses. If one is going to sell at all, now is not the time to do it.

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Big Changes Planned for Iraqi Stock Markets

By Melissa Hancock for Al-Monitor. Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

With the world’s eyes focused on the recent Iraqi elections, little attention is being paid to the major changes taking place in Iraq’s banking and finance industry.

As part of an effort to liberalize the economy, in the first three months of 2014, the Iraqi Central Bank granted approval to 15 Arab and international banks to open branches in Baghdad, with additional branches expected to open soon. There is also a notable drive to grow and promote the stock markets, with senior Iraqi government officials and representatives from the country’s two stock exchanges hosting a two-day forum in Dubai May 14-15 in a bid to court regional investors.

The Iraq Stock Exchange (ISX) is currently in the process of upgrading to the latest Nasdaq trading platform after signing an agreement with Nasdaq OMX in June 2013. The new platform, currently used by more than 25 exchanges globally, is capable of supporting multiple asset classes, although the ISX concentrates mainly on cash equities.

“We will complete the implementation at the end of June, and it will go live at the beginning of July,” said Taha Ahmed al-Rubaye, chief executive of the ISX. “We are working hard to modernize the exchange.”

The ISX is also assisting the Erbil Stock Exchange (ESX), the first exchange in Iraq’s semi-autonomous Kurdistan region, in setting up its Nasdaq trading system. It is due to be fully implemented in July, and the ESX hopes to see around five to 10 listings by the end of 2014, including a major telecom company. The ESX has $8 million in initial capitalization and 56 shareholders, primarily from the private sector.

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Stocks Brace for Iraqi Election

By Mark DeWeaver.

This hasn’t been a particularly good year for Iraqi stocks. So far the Rabee Securities Index (RSISX) is down 3% year-to-date and off 8% from its recent high on January 28. The ISX index has been dropping all year. It’s now down 5% year-to-date.

Uncertainty in the run up to Iraq’s April 30 parliamentary elections seems to be the most obvious explanation for this downturn. Market participants may well be expecting a repeat of the last elections, on March 7, 2010, after which the government formation process lasted until November 11. That year the RSISX was already down 12% from its November, 2009 pre-election peak by election day. It fell a further 8% before finally rebounding in October. (See chart.) Investors could hardly be blamed for getting cold feet this time around.

But this year is unlikely to be a rerun of 2010 for three reasons. First, Iraqi oil production is set to jump sharply. This should lead to strong growth in the money supply—always a positive for asset prices. Second, bank capital increases will be less of an overhang than they were four years ago as many banks have already met the central bank’s final capitalization target of IQD 250 bn. Finally, there isn’t really that much uncertainty about the outcome of the election. Presumably some compromise will once again be reached after a protracted period of government formation. The situation will continue to be bad but there is no reason to expect it to get worse.

This time, look for Iraq’s strong economic fundamentals, rather than its fractious politics, to be the main driver for stocks.

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Why Two Exchange Rates?

By Mark DeWeaver.

Since the Central Bank of Iraq (CBI) began changing the rules for its USD auctions in 2012, Iraq has been operating a de facto dual exchange rate system. (There’s a summary of some of the CBI’s recent rule changes on pages 12-14 of this report from Sansar Capital.) For those with access to the CBI auction—mainly banks and (as of March, 2013) importers using letters of credit—the rate has been fixed at IQD 1,166: USD 1.00. For the rest of us, the dinar has ranged from 1,194 to 1,292, with two major episodes of depreciation in mid-2012 and mid-2013 (see chart).

The ostensible purpose for this arrangement is to limit illicit outflows of foreign exchange to Iran and Syria. In practice, it serves mainly as a subsidy to banks, large importers, and anyone in a position to generate phony trade documents. The losers include everyone from foreign investors in Iraqi stocks to the government itself, which gets the CBI rate on its oil-export revenues.

Iraq is unusual in this regard. Dual (or even multiple) exchange rates are usually only found in countries suffering from chronic trade deficits and foreign exchange shortages. Typically the objective is to make foreign exchange available for “essential” imports or to control inflation by lowering import prices. Examples include Hitler’s Germany, China in the 1980’s and early ‘90’s, Burma prior to 2012, and Venezuela today. (See this note from the Asian Development Bank for an excellent introduction to this topic.)

It’s hard to see why Iraq belongs on this list. The country has a trade surplus, inflation is low, and the central bank has ample foreign exchange reserves. Even USD outflows to Iran are presumably no longer a major issue.

One exchange rate should be enough.

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Another Look at Corporate Actions

By Mark DeWeaver.

In this old post from 2010, I considered the possibility that ISX share prices might fail to adjust completely for corporate actions. There didn’t seem to be much evidence for this but it was a bit hard to be sure. In those days, stocks would generally be suspended for a number of months following rights and bonus issues. Discrepancies between theoretical and actual ex rights prices might as easily be due to developments during the long intervals between cum rights and ex rights trading dates as to a failure to reflect changes in the number of shares in issue.

In September, 2011, the ISX changed the rules on stock suspensions to allow trading to resume within four weeks of shareholders’ meetings (see this post). Following this dramatic reduction in suspension periods it should be now easier to identify departures from theoretical ex-rights prices. Given the importance of corporate actions to ISX investors, I thought it would therefore be worth revisiting this question with some more recent data.

Since the end of 2012, the “Corporate Actions” table in the Rabee Securities monthly gives 78 examples of rights, bonus, and dividend issues. Taking out cases where the cum rights price was below IQD 1.00 (in which case minority shareholders would be unlikely to subscribe) and a few others where I thought the stocks were too thinly traded for the prices to be meaningful, I ended up with a sample of 49 observations.

The chart shows the premium/(discount) of actual to theoretical ex-rights prices, where the theoretical price is the last traded cum-rights price adjusted for rights, bonuses, and dividends. For example, if the cum-rights price were IQD 2.00, following a 50% rights issue, a 30% bonus issue, and a IQD 0.25 dividend, the theoretical ex-rights price would be: (2.0+0.5-0.25)/(1.0+0.5+0.3)=1.25. (Note that the dates following the ticker symbols on the x axis are for the start of ex-rights trading.)

In half of the cases actual prices deviated by no more than 5% from the theoretical prices; two thirds of the time the difference was no more than 10%. Extreme examples of over- or under-adjustment were relatively rare.

Once again there doesn’t seem to be much reason to expect outsized gains or losses following corporate actions.

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Does ‘Mental Accounting’ Matter?

By Mark DeWeaver.

ISX observers sometimes blame share price declines on people selling their recently listed bonus or rights issue shares. Such behavior would be interesting to document because it seems to imply a departure from perfect rationality. From the point of view of conventional finance theory, there just isn’t any reason to differentiate between different lots of the same name.

If you’re holding twelve shares of company X and today’s market price is IQD 2.00, for example, the only thing that should matter to you is that your position is now worth IQD 24.00. And the only thing that should matter for your sell decision is what you think the shares will be worth tomorrow. What you originally paid for them shouldn’t make any difference.

Yet it seems that some investors tend not only to sell winners more readily than losers (see this article) but also to keep track of rights and bonus shares in separate “mental accounts.” The person with twelves shares worth IQD 2.00 each might think of herself as holding three positions. Perhaps she imagines one 10-share position, originally acquired at IQD 2.50, on which she has lost IQD 5.00; a rights share position on which she has made a IQD 1.00 profit; and a bonus share position with a IQD 2.00 profit.

If this kind of thinking is common, listing dates for new rights and bonus shares would take on a special significance. They would generally be occasions on which large numbers of people suddenly found themselves in a position to close mental accounts at a profit. There might then be a tendency for these to be times when the shares in question significantly underperformed the market.

To test this hypothesis, I looked up all the rights and bonus issues since the end of 2012 and identified 31 for which I could find the listing dates for the new shares. (Perhaps the most user-friendly source for this information is the “Corporate Actions” table in the Rabee Securities’ monthly.) And indeed there was some underperformance. In the average case, I found that the shares underperformed Rabee’s RSISX index by 1.05 percentage points on the initial day of rights and bonus share trading.

But it turns out that 1.05 percentage points isn’t statistically significant. The trouble is that the variation of the listing-date relative returns is quite high. While there were 20 cases of underperformance—by as much as 9 percentage points—there were also 11 cases of outperformance—by as much as 7 percentage points. Unfortunately for anyone hoping to base a trading strategy around mental accounting (or, as in my own case, write a behavioral finance article on the subject), the null hypothesis of no underperformance cannot be rejected.

This isn’t to say that Iraqi investors never assign bonus and rights shares to separate mental accounts from the rest of their holdings. If they do, however, it remains unclear whether or not this has any systematic effects on the market as a whole.

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In State Banks We Trust

By Mark DeWeaver.

2013 was another strong year for deposit growth at the ISX-listed banks. Deposits at the 19 names that have so far reported year-end financials were up 17% year-on-year as of December 31. (Only BDFD and BELF, which together accounted for 8% of 2012 listed-bank deposits, have yet to report.)

While their deposit growth slowed from 32% in 2012, these 19 banks nonetheless continued to outpace the rest of the sector, where deposits rose by only 10%. As a result, their share in the deposits component of Iraq’s M2 money supply rose for a second year to reach 13%. (Click here for full-sized chart.)

This is the highest share in at least six years. Nevertheless, it represents only a modest improvement from the 10% low in 2011.

Clearly the playing field remains steeply tilted in favor of the state-owned banks. These lenders not only enjoy a virtual monopoly on government deposits but also accounted for 60% of private sector deposits as of year-end 2012. They held about 85% of total deposits, despite having only a fifth of total bank-sector capital and somewhat fewer branches—479 versus the private banks’ 515. (See pages 27 and 112 of the central bank’s 2012 bulletin.)

From the depositor’s point of view, the state-owned banks’ obvious advantage is their lack of bankruptcy risk. While private banks have been allowed to go under, it is highly unlikely that state-owned institutions would be permitted to suffer a similar fate. The central bank can always be counted on to rescue them in a crisis.

This means that the private banks’ deposit share is likely to remain low for the foreseeable future. In the absence of deposit insurance or any effective mechanism for dealing with bank failures, depositors can hardly be blamed for continuing to view the state banks as their safest bet.

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