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Can emerging markets save the day?

Aug 22, 2011

Almost every single index across global stock markets is in deep in the red after the turmoil the global stock exchanges have seen over the past few weeks. The downgrading of the US economy and the prolonged Euro debt crisis being the main reasons for weakness in the system. If in 2008 it was companies and banks that were in distress and had to be bailed out, this time it is whole countries. Recession fears are now paramount. Earlier, all eyes were on the US government, which arranged rescue packages to support its financial system. But who will save the day this year? The question on everyone's mind is whether the emerging markets (EMs) will be able to the job? They are the only ones seeing some growth. So, can the developed world piggy back on their shoulders?

On the face of it, the situation doesn't look very rosy. This is especially true of India. As of date, Indian indices have lost one fifth of their value since the start of the year. Real Estate, metal and IT indices have been the worst hit. The market capitalization of almost every large business group including the Tatas, Mahindras, Ambanis and companies from the government's stable have been eroded. Foreign Institutional Investors (FIIs) have been pulling funds out of the country to meet margin calls on their home soil. Will there ever be any respite from all this selling?

Well we believe so. There is still some hope left. According to McKinsey Global Institute (MGI), out of the total outstanding debt and equity in the world as of 2010, the US accounts for 32% or US$ 67.5 trillion. However, in EMs households, corporations and governments accounted for only 18% of the total or just US$ 37.1 trillion. But their share of world GDP is comparatively much higher at 32%. So there is tremendous potential for this to grow. India and China have been the fastest growers over the past decade. Their share of global financial stock has risen at an average rate of 23% and 21% respectively since 2000. Comparatively the US and Western Europe have grown by only 5% over the past 10 years, according to data from MGI. Thus, even though there might be short term blips here and there, we believe that EMs will continue to shine over the longer term.

Source: McKinsey Global Institute
Note: 100% is equal to US$ 212 trillion, representing the end of period stock of
outstanding debt and equity. EM stands for Emerging Markets

One main reason why we believe that the EMs will continue to perform going forward is because their financial depth is much lower as compared to that of their developed market peers. Financial depth being - the country's outstanding debt and equity as a percentage of the GDP. The financial depth of emerging markets is in the range of 50% and 250% of the GDP, compared to 300-600% in developed markets.

While China's depth has reached around 300%, India's is still well below 200%. South Africa, a recent addition to the ‘BRIC' countries (now BRICS) has a closer to 400% financial depth ratio. India's financial markets thus have a stronger potential to develop further. It has potential to growth without getting overleveraged. A strong equity market for capital raising and a well regulated banking system can enable companies to raise funds for investment. Once these investments bear fruit, capital can once again flow back to the system. But this doesn't come without challenges. India's regulatory watchdogs RBI and SEBI have been prudent in their regulations. However, the government has still not been successful in its efforts to weed out corruption and scams in the county. Once this is sorted out, we believe that India's growth can be a benchmark for other emerging markets.

Source: McKinsey Global Institute, Mapping Global Capital Markets 2011

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