The last few months have been rocky for developing countries’ economies. Plummeting commodity prices, the looming threat of rising interest rates, and insecurity in Chinese markets have created the fear that money will leave developing markets in favor of more secure investments in the US and other developed economies. However, the long-term trends are more encouraging. Over the last fifteen years, market capitalization in developing countries as measured by the MSCI Emerging Markets Index has grown at a healthy 9 percent annually. In spite of the instability and volatility in recent months, it is important to take a long-term view of local capital markets and their role in developing countries’ growth.
There is considerable discussion about “financing for development” – the UN conference in Addis Ababa, Ethiopia in July focused on this topic. The conclusion after all the meetings and papers presented at the conference is: there is never going to be enough aid or charity from the donors to develop a country. “Development” is instead something that the developing country must do, and while official donor assistance (ODA) can play a catalytic role, it is a very small component of the process. Instead, domestic resources must play a central role in funding economic growth.
When we look at the “Addis Ababa Action Agenda,” there is a focus on how the effective use of domestic public resources – specifically taxes and other government revenue– allows for greater national ownership of a country’s trajectory. While the focus on tax systems and policies that encourage private sector investment and entrepreneurship is important, given the large and growing domestic assets held by the private sector, the development of strong domestic private capital markets should receive greater emphasis as well.
In 2013, the IMF noted that $54 trillion in domestic bank assets, bonds, and equities is from developing countries, composing 20 percent of the entire world’s share of domestic assets, with $34 trillion in Asia alone. The savings rate among all developing countries is up from only $14 trillion in 2002. At the same time, the growth in the middle class in developing economies has fueled the growth in domestic savings rates. The emerging global middle class represented 13 percent of the world population but 32 percent of global consumption in 2010. The growth in the middle class has paralleled the growth in domestic savings rates – from 2001 to 2011, the amount of people living on between $10 and $20 per day nearly doubled, increasing by 386 million. This growth means more disposable income – income that could feed capital market growth and sponsor local businesses.
Capital markets – which include any financial institution that deals in long-term investments in equity and debt, like pension funds, local stock and bond markets, and mutual funds – require economic stability, predictable and manageable inflation rates and, ideally, an open economy in order to function. For the markets to create viable investment opportunities, developing countries also need capable regulators, transparency, fairness for minority shareholders and public confidence in the rule of law. When capital markets are fair, transparent, and efficiently managed, a developing country can expect to see local businesses selling shares to local and international shareholders in order to finance growth.
Many countries in sub-Saharan Africa seek security by issuing sovereign bonds on global markets rather than domestic ones – the interest rates internationally can be less than half of the domestic rate. Malawi, Ghana, and Gambia all face interest rates of over 20 percent, while 16 African countries’ interest rates are above 10 percent. Stronger local capital markets would provide the secure investment prospects that local governments require, creating another option for issuing bonds.
Sub-Saharan Africa will look to official donors such as the United States or the World Bank Group with a history of building local capital markets through technical support. These donors have also helped create the conditions and offered the advice to enable new financial products such as leasing products or municipal bond finance to come about in developing countries.
For example, USAID spent $30 million to create a Romanian stock market virtually from scratch. The USAID program wisely focused on technical assistance and training rather than loans to the local government – the RASDAQ was decidedly successful as an independent entity and continues to function as part of the Bavarian Stock Exchange today. The IFC has supported many local capital markets through the issuance of local currency bonds, including in Rwanda, Indonesia, Zambia, and Nigeria. U.S. donor agencies have the ability to provide this kind of support to capital markets, and there is high demand among developing countries for their services, but more can and should be done.
The dramatic growth of private assets held in developing countries suggests that policymakers and others should revisit support for the development of local capital markets and find other ways to tap this growing source of funding.
Article Published in Forbes.com on October 9, 2015.