Capitalisation of the New Zealand stock market

McMillan hints that New Zealand’s low market capitalisation may be a sign that “all is not well” with New Zealand’s otherwise apparently strong protection of minority investors(p. 166). Market capitalisation is often used as an indicator of stock market development.[1] This section takes a closer look at interpretations of stock market capitalisation in the case of New Zealand.

New Zealand has low stock market capitalisation compared to Australia and other OECD countries

Figures 1 and 2 confirm that New Zealand has a fairly low capitalisation (measured against GDP), compared to other OECD countries. Australian market capitalisation is currently much higher than New Zealand’s (151% of GDP versus 42% of GDP) as of 2005. As recently as 1994, New Zealand and Australia had the same level of stock market capitalisation (just under 60% of GDP). However, in the second half of the 1990s, Australian capitalisation surged while New Zealand’s shrank.

Figure 1: Stock market capitalisation: OECD countries (1999-2003 average)

Source: Djankov and La Porta et al (2006).

Figure 2: Stock Market Capitalisation: Australia and New Zealand

Source: Calculations, based on data from Statistics New Zealand, Australian Bureau of Statistics and World Federation of Exchanges.

While weak investor protection could explain low stock market capitalisation it is only one of a number of possible factors. For example, savings policies and the tax treatment of savings can influence household holdings of financial assets and therefore stock market capitalisation. Other factors may also have played a part in New Zealand including the integration of trans-Tasman capital markets.

Differences in savings policy and past tax settings could be contributing to low capitalisation

A recent Treasury project[2] shows that differences in saving policy between New Zealand and Australia could be contributing indirectly to the relatively low capitalisation of the New Zealand stock market. An earlier Treasury study by Claus et al (2004) indicated that New Zealand’s past tax treatment of savings (which was unusual compared with practice in other OECD countries) could have constrained market capitalisation.[3]

Some major changes occurred in the Australian financial system in the 1990s which contributed to the surge in the capitalisation of its stock market. These changes included the privatisation of government owned assets and financial deregulation and the introduction in 1991 of compulsory retirement savings (Gizycki and Lowe, 2000). The first two changes, but not the last, also occurred in New Zealand, although there were timing differences. This leaves compulsory retirement savings as a possible explanation for the difference in stock market development between in the two countries.

The recent introduction by the New Zealand Government of the KiwiSaver scheme and reduction in taxation of collective investment vehicles[4] has the potential over time to lead to a marked increase in household saving held in the form of financial assets, including stocks. This is expected to filter through to the stock market gradually increasing capitalisation over a period of time (Cameron et al, 2007).

Low capitalisation could be a reflection of strong links between the New Zealand and Australian economies

Relatively low capitalisation of the New Zealand stock market could also be a reflection of strong links between the New Zealand and Australian economies. There have been numerous cases of acquisitions and mergers resulting in firms with bi-national operations listing in Australia alone. The banking industry is one example. Nearly all banks in New Zealand have parent companies headquartered in Australia that list on the Australian stock exchange.

According to overseas studies on competition and economies of scale in stock markets (eg, Bördlein 2002, Malkamäki 1999 and Ramos 2003), there are strong global forces toward the centralisation of some stock market activities, but there are also opposing forces toward decentralisation.

There are strong global forces towards the centralisation of some stock market functions

Economies of scale and network effects contribute to liquidity and market depth and are the main centralising forces – these are important particularly in relation to the trading function, where information can be standardised and use made of centralised technology. In addition information spillovers between a larger pool of firms and investors can be an additional benefit for New Zealand firms listing in Australia.

Decentralising forces are at play where local information is important

However, decentralising forces are also at play resulting from market-access costs and the need for local information, particularly for new listings where information is more complex and firm-specific requiring personal relationships and trust for effective communication. These forces are important for small and distant countries.

Market access costs appear fairly low for New Zealand firms listing on the Australian stock exchange. Initial listing fees and ongoing fees are comparable between New Zealand and Australia (du Plessis 2005). According to a trans-Tasman agreement in 2006[5], firms now only need one prospectus to issue securities in both countries. However, the localisation of information appears to be an important factor, influencing the ongoing demand for listings on the New Zealand stock exchange, especially for small and medium sized New Zealand firms.[6]

Liquidity shows a stronger connection to long term growth than capitalisation. New Zealand has similar levels of liquidity to other comparable OECD countries

McMillan was concerned that low capitalisation of the New Zealand stock market, could be a problem if it is a reflection of some distortion in the economy, potentially constraining aggregate productivity and growth. However, stock market capitalisation has some limitations as an indicator of economic development. A study by Levine (1997, p.2-3) shows that market liquidity – the ability to buy and sell securities easily - exhibits a stronger connection to long term growth. Based on aggregate measures of liquidity (CRA, 2003)[7] New Zealand’s stock market appears to be characterised by similar levels of liquidity to other directly comparable OECD countries of similar size and economic development. This tends to allay McMillan’s concerns, although liquidity appears to be concentrated in the stocks of large New Zealand firms, while the stocks of small firms have low liquidity.