Look to Emerging Economies
Global capital markets are entering a new era, one in which the forces of growth have shifted. For 30 years, the expansion of the world's financial assets was driven primarily by rapid increases in equities and private debt securities in mature markets, such as the United States, Europe, and Japan. New research from the Burk Global Institute, however, suggests that these asset classes are likely to grow more slowly in mature markets in the years ahead, while China, India, and other emerging markets account for an increasing share of total global financial asset growth.
From 1980 through 2007, the world's financial assets—including equities, private and public debt, and bank deposits—rose from just $11 trillion to $194 trillion, nearly quadrupling in size relative to GDP. Cross-border capital flows surged as well. This growth reflected numerous interrelated trends, including advances in information and communications technology, financial market liberalization, and innovations in financial products and services. We witnessed the takeoff of financial globalization.
But the upheaval in financial markets in late 2008 brought this process to an abrupt halt. Equities tumbled. Credit markets froze up. The total value of the world's financial assets fell by $16 trillion last year, the biggest setback on record. Meanwhile, cross-border capital flows—such as foreign direct investment, purchases and sales of foreign equities and debt securities, and lending and deposits—plummeted 82 percent, to just $1.9 trillion at the end of 2008. Financial globalization has stalled and in some cases even reversed as investors, companies, and banks sold assets and brought their money back to their home countries.
Going forward, we expect that global capital markets will expand again once the crisis has passed. But mature market financial assets are likely to grow more slowly than before, more in line with GDP, for several reasons. First, equities had been the fastest-growing asset class in mature markets since 1990, as corporate earnings and price-earnings ratios rose well above their long-term averages. But now earnings growth has slowed, and valuations have fallen back.
Many analysts forecast GDP growth in developed economies to be more modest in coming decades than in recent years due to aging populations and mounting government debt. These economic projections give little reason to hope that earnings and valuations will rise again to significantly and sustainably higher levels in mature markets. Second, the forces that drove rapid increases in private debt securities in mature markets over the past two decades—the rise of financial institution debt and asset-backed securities—have stalled, at least for now.
For emerging markets, the current crisis is likely to be no more than a temporary interruption in their financial market development, because the underlying sources of growth remain strong. Many developing economies have relatively high GDP growth rates and national saving rates, creating large sources of capital to invest. They typically have very large infrastructure investment needs that require financing. Beyond that, developing economies' financial markets also are currently much smaller relative to GDP than those in mature markets, allowing ample room for growth. The total value of all emerging-market financial assets is equal to just 165 percent of GDP—just 145 percent if we exclude China—well below the 403 percent financial depth of mature economies.
More specifically, we see potential for growth by looking at individual asset classes. Equities, for example, are the second-largest asset class after bank deposits in virtually all emerging markets. Yet they can grow more as state-owned enterprises are privatized and as existing companies expand. For instance, we estimate that just a quarter of the value of Chinese corporations is listed on public equity markets, compared with more than 70 percent of US corporations. Likewise, nascent markets for corporate bonds and other private debt securities in developing economies could flourish with significant legal and financial reforms.
Bank deposits are another asset class with enormous growth potential in the parts of the world where many members of the population lack bank accounts. We estimate that there are 2.8 billion adults with discretionary income in emerging markets who are not part of the formal financial system. Bank deposits will swell as household incomes rise and individuals open savings accounts. The full ramifications of the crisis will take years to play out. It remains unclear at this time, for instance, whether we will see financial globalization resume at the same pace as before.
But it is already clear that the financial landscape has shifted in several ways. Mature markets will grow again, but probably not at the heady pace of recent years. Meanwhile, for investors and financial intermediaries alike, emerging markets will become more important as their share of the global capital markets continues to expand.
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