December 13, 2013
During the past few years, emerging markets have attracted immense capital inflows from the international capital market which is abundant with liquidity, driving debt yields down to abnormally low levels. Many analysts consider the current situation unsustainable, and the inevitable process of correction may be magnified for countries that have been very reliant on short-term external capital flows, with the possible result of fundamental imbalances within the economy.
In order to assess the ability of emerging markets to withstand global reallocation shocks of this nature, it is helpful to take a closer look at the financial depth (a measure of the size of financial institutions and financial markets) of some developing countries, and in particular the size of their debt markets. An economy’s financial depth and its debt market size are closely related concepts, as amounts outstanding on the debt market are important indicators of financial development. Measuring the total size of a particular debt market and, by extension, obtaining an idea of the country’s financial depth, could be daunting and challenging. Variables such as the scale of government debt and corporate bond market, equity market capitalisation and monetisation levels are considered good proxy indicators for this purpose.
CORPORATE SECURITIES AND DEBT ALLOCATION
South Korea reported government debt amounting to KRW 447.47 trillion (almost USD 400 billion) as of the second quarter of 2013, or about a third of its nominal Gross Domestic Product (GDP). The total amount of government debt and listed corporate bonds (a significant proportion of the total debt of the economy) has increased by 3.95% year-to-date, piling up to KRW 787.80 trillion (USD 694.09 billion) as of June 2013. Corporate bonds, in particular, constitute a relatively high proportion (43%) of total outstanding bonds, which indicates the completeness of the domestic financial market. A similar trend has been observed in Malaysia (43%) and Russia (41%), where the corporate bond markets are somewhat equivalent in size to the government debt outstanding.
This is in contrast to debt distribution in emerging markets like India, Taiwan, and especially Indonesia, where debt capital markets are mainly focused on government securities. A deeper and more diversified debt market will be more resilient to changes in global asset reallocation by the international investment community. The recent downward pressure on the currencies of these economies, compared to those with a more developed debt market, shows that a well-developed corporate bond market does play a role in the risk diversification of the financial system.
MARKET CAPITALISATION AND MONETISATION INTERDEPENDENCE
The level of monetisation (calculated as the ratio of Money Supply (M2) to Nominal GDP) and the Equity Market Capitalisation to GDP ratio (MCAP/GDP ratio) are other proxy variables that measure the financial depth of a country. The expansion of the monetary economy stimulates a stable trend towards expansion in size and depth, as well as diversification of the financial market. The MCAP/GDP ratio in itself is seen as a measure of the available investment potential of the public stock market.
In most of the emerging economies the levels of monetisation are relatively low. Brazil, Indonesia and Russia, for instance, have monetisation levels at around 40% of GDP. As expected, these countries are characterised by the smaller size of their equity markets - Brazil (57% of GDP), Indonesia (50% of GDP), and Russia (43% of GDP). These are again the countries which saw the more significant impact on their currencies during the recent spate of capital reversal amid the scare of the US quantitative easing (QE) tapering.
In contrast, emerging markets with fully-developed financial systems and high capitalisation of their stock exchange markets, such as Malaysia, Singapore and South Korea, tend to have monetisation levels and market capitalisation above 100% of GDP.