Development of capital markets in developing economies

Abstract

This report attempts to thread out the various aspects of capital market openness in Emerging andFrontier economies. MSCI market classification has been used to categorize economies as Emerging or Frontier markets. The report presents a macro-level comparison of the current state of capital markets in Emerging and Frontier economies through averages of seven Global Financial Development Database indicators. Indicators like bank credit to deposit ratio, corporate bond issuance volume to GDP ratio, outstanding total international debt securities to GDP ratio, and domestic credit to the private sector as a percentage of GDP show that Frontier markets are performing better than or catching up to Emerging economies. However, indicators like stock market turnover ratio, stock market total value traded to GDP ratio, and stock market capitalization to GDP ratio show that Frontier markets are performing very poorly in the equity market space. The analysis suggests that Frontier markets meet their funding requirements through domestic credit and bond issuances with little reliance on the underdeveloped equity market. The report then presents a comparative study of capital market openness in Emerging and Frontier economies using averages of eight out of twelve openness indexes from the IMF working paper. Indexes like equity market liberalization, bond market liberalization, money market liberalization, collective investment liberalization, derivatives investment liberalization, financial credit liberalization, and direct investment liberalization show that Frontier markets are performing better than Emerging economies. The Emerging economies are marginally better than Frontier markets only in the commercial credit liberalization. The analysis suggests that Frontier markets are opening in all avenues of the capital market faster than their counterparts on a macro level. After the macro-level analysis, the report presents a country-level analysis for one Emerging and one Frontier market through eight indicators, i.e., bank credit to deposit ratio, turnover ratio of domestic shares, government debt to GDP ratio, outstanding total international debt to GDP ratio, stocks traded value to GDP ratio, the market capitalization of listed shares to GDP ratio, domestic credit to the private sector as a percentage of GDP, and FDI as a percentage of GDP. Vietnam was chosen as the representative Frontier market because of its relatively stable categorization as a Frontier market and a reasonably developed equity and a bond market that aided in the comparative study. Vietnam’s turnover ratio of domestic shares is 22.30% vis-à-vis 1.90% for Kenya and 5.99% for Sri Lanka (Bank, n.d.). South Africa was chosen as the representative Emerging economy because of similar reasons. It has a stock turnover to GDP ratio of 81.05% vis-à-vis 43.68% for India and 40.80% for Brazil. The analysis suggests that indicators like bank credit to deposit ratio, government debt to GDP ratio, etc., are comparable for both countries. However, ratios like turnover percentage of domestic shares, stocks traded value as a percentage of GDP, etc., are much higher for SA vis-à-vis Vietnam suggesting that a wide gap exists in the equity markets for Frontier economies. A qualitative study of Vietnam and the Brazilian stock market from multiple sources like the World Bank and SSRN is presented to explore the reasons for underdeveloped equity markets in Frontier economies. The corporate governance framework turns out to be a significant issue with Frontier markets. The Global Competitiveness Index by the World Economic Forum also highlights the lack of trustworthiness and confidence in Vietnam's financial market vis-à-vis SA and Brazil. The report ends with policy recommendations like modernizing the legal and regulatory framework of capital markets, improving governance, etc., for Frontier economies to develop their equity markets.