Paper tigers chinese and india capital markets

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Paper tigers: Chinese and Indian
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June 2014

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2 Paper tigers: Chinese and Indian capital markets

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Introduction to “Global Capital Markets in 2030“
Deutsche Asset & Wealth Management’s Global

markets face weakening demand in many mature

Financial Institute asked the Economist Intelli-

markets.

gence Unit to produce a series of white papers,
custom articles, and info-graphics focused spe-

In short, while the world’s stock of financial assets

cifically on global capital market trends in 2030.

(e.g.

stocks,

bonds,

currency

and

commodity

futures) is growing, the pattern of that growth sugWhile overall growth has resumed, and the

gests that major shifts lie ahead in the shape of capi-

value traded on capital markets is astoundingly

tal markets.

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and the Economist Intelligence Unit aims to offer

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deep insights into the long term future of capital

by

and

markets. It will employ both secondary and primary

by a $4.4 trillion increase in sovereign debt in

research, based on surveys and interviews with

2010. The trends are clear: Emerging markets,

leading institutional investors, corporate executives,

particularly in Asia, are driving capital-raising; in

bankers, academics, regulators, and others who will

many places debt markets are fragile due to the

influence the future of capital markets.

expansion

in

developing

economies,

large component of government debt; and stock


3 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

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4 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

Paper tigers: Chinese and Indian capital markets

Written by

A Global Financial Institute research paper written by the Economist
Intelligence Unit
June 2014

In recent decades, the overarching economic story out of

have seen faster growth in their number. Between 2009 and

Asia has been the transformation of the continent’s demo-

2011, according to Dealogic, they were both in the top five

graphic giants into economic ones. This has happened on

exchanges for initial public offerings by value, and in 2012

any number of levels. For example, in recent years in nomi-

remained in the top 10. More broadly, Shanghai and Shen-

nal GDP terms China has surpassed Japan to become the

zhen also saw the fourth and fifth highest levels of share

world’s second largest economy, and India already is the

trading by value globally last year.

world’s tenth largest GDP. Only a decade ago, China and
India were in 6th and 13th place, respectively.

A number of indicators point to continued growth. China
currently has among the highest gross savings rates in the

Dramatic growth can also be seen in the two countries’

world (51% in 2012 according to the World Bank) which

capital markets. Today, Shanghai and Shenzhen combined

represents an increase on the roughly 40% of the 1990s.

have a greater market capitalisation than that of any other

The country is putting capital to work privately and pub-

country’s exchanges except those of the United States.

licly: the World Bank calculates China’s gross fixed capital

India’s collective total, meanwhile, lags behind only those

formation at 47% of GDP in 2012, with absolute spending in

of America, China, Japan, the United Kingdom and Hong

this area more than a quarter higher than that of the United

Kong. In terms of total securities, India has far more firms

States that year. India’s gross savings rate is a comparatively

listed – over 5,100 on the Bombay Stock Exchange alone

modest 34%, but it, too, has a substantial amount of money

– than any other country; the NASDAQ and the NYSE col-

in search of effective allocation. And with a gross fixed capi-

lectively have a little over 4,100 domestic companies,

tal formation rate of 30%, India has plenty of opportunity

although cross listing means the total number is somewhat

for investment.

lower. The two Chinese exchanges have fewer listings, but

Which of the following economies do you think will have the most important public equity markets for the global
economy by 2030? Please select up to three.

United States

65 %

China

53 %

India

35 %

Japan

24 %

United Kingdom

22 %

Brazil

21 %

Germany

19 %

France

8%

Italy

8%

Other, please specify

3%

Capital will be so international that location will have little
relevance

Source: The Economist Intelligence Unit (August 2013)

5%


5 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

Which of the following countries do you think will have the most important bond markets for the global economy
by 2030? Please select up to three.

United States

68 %

China

45 %

Japan

30 %

United Kingdom

28 %

Germany

26 %

India

24 %

Brazil

12 %

France

10 %

Italy
Other, please specify
Capital will be so international that location will have little
relevance

9%
3%
4%

Source: The Economist Intelligence Unit (August 2013)

It is not surprising, then, that China and India’s capital markets

budget economic survey admits, “Though, the develop-

seem poised to take on significant global importance. According

ment of the corporate bond market, has been an impor-

to a 2013 Economist Intelligence Unit survey of over 350 compa-

tant area and has received greater policy attention in

nies active in global capital markets, 53% say that China will be

recent times, it is yet to take off in a significant manner.” The

among the countries with the world’s leading equity markets by

country’s Economic Times newspaper goes further, citing

2030, and 35% say the same of India. That would make these two

low trading levels, poor liquidity in the secondary market,

countries the second and third top equity markets in 2030, after

and a lack of interest by banks in corporate debt, it calls the

the United States, in the estimation of global executives. On bond

country’s corporate bond market “a mirage”.2

markets, China came second (45%) while India was sixth (24%).

In contrast, China’s bond markets have seen substantial
That said, China’s and India’s capital markets institutions

growth in the recent years and are the fourth largest in the

are a long way from being global players. Even in their

world in absolute size. They are still dominated by govern-

domestic roles, these markets are often not efficiently allo-

ment debt rather than funding more diverse private sector

cating the substantial capital being saved. A 2013 study by

endeavours. According to the Asian Development Bank,

World Bank researchers found that “the expansion of finan-

at the end of 2013 the total of all corporate bonds repre-

cial market activity since the 1990s has been more limited

sented 15% of national GDP. This is more than double the

than…the aggregate figures suggest.” A handful of large

2008 figure, but still well below the equivalent number for

companies have dominated activity on equity and bond

the United State (around 60% in 2013). Moreover, the vast

markets, with the top 10 firms in India and China account-

majority of Chinese corporate bonds are “enterprise bonds”

ing for 62% and 43% respectively of the capital raised

issued by government affiliated companies. Traditional

between 2005 and 2010.1

corporate bonds can be issued by smaller, private firms but
that market is thinly traded and highly illiquid. The ability

If anything, debt markets in India are even less developed

of organisations without strong state connections to tap

than equity ones. The Indian government, in its 2012-2013

bond markets remains an open question.

Tatiana Didier, Sergio Schmukler, “The Financing and Growth of Firms in China and India: Evidence from Capital Markets,” World Bank
Policy Research Working Paper 6401, April 2013.
2
“Indian corporate bond market still remains a mirage”, 28 November 2012.
1


6 Paper tigers: Chinese and Indian capital markets

Country

Global Financial Institute

Projected real GDP growth
2010 – 2013

Selected Stock Market Indices
January 2010 – December 2013

China

40%

Shanghai Composite Index -36%
Shenzhen Component Index -11

India

27%

NSE Nifty CMX +20%
BSE Sensex +19%

United States

9%

DJIA +55%

United Kingdom

5%

FTSE 100 +22%

Economic growth and market indices are only loosely related in most circumstances.

Nevertheless, the weak showing of these markets, especially in China, brings concerns for those
potential investors otherwise willing to overlook institutional deficiencies.
Source: The Economist Intelligence Unit (February 2014)

Moreover, the transparency of the Chinese bond markets is

however, despite steady, robust economic growth in each

a significant worry. Not a single bond has seen a default, in

country, India’s volatile equities have failed to keep pace

part because the government and other interested parties

with economic growth in the country and China’s stock

have stepped in on occasion to make good insolvent par-

indices have even seen substantial overall declines [See

ties. This makes pricing risk a fraught endeavour. In Octo-

Table]. Looking more closely over the last decade, a rapid

ber 2012, the IMF highlighted that “the apparent pattern

expansion of the number of listed companies helped drive

of ‘higher returns and suppressed default risk’”, already a

the increase in market capitalisation for Shenzhen and the

worry amongst trust companies and alternative lenders,

NSE rather than this arising from rising share price alone.

has extended to the bond market.

3

Economic growth and market indices are only loosely
Overall, then, capital markets in these countries are deliv-

related in most circumstances. Nevertheless, the weak

ering less than they appear to on the surface. Professor

showing of these markets, especially in China, brings con-

Venkatesh Panchapagesan of the Indian Institute of Man-

cerns for those potential investors otherwise willing to

agement says, “India has had 10 to 15 years of phenomenal

overlook institutional deficiencies.

growth, but capital markets have not been the primary
driver. The exchanges, institutions and intermediaries have

One such deficiency is the poor level of investor legal pro-

not been able to do a good job.” In China, especially for

tections and legal enforcement. Stock scandals have been

smaller, private entrepreneurs without political connec-

all too common. Chinese authorities have pursued a well-

tions, the situation is very much the same.

publicised crackdown in this area, which has included a
freeze on initial public offerings (IPOs) between October

Common weaknesses

2012 and January 2014. Meanwhile, in April 2013, three

A number of issues present in both countries greatly dimin-

arrests were made in a high-profile bond market scandal.

ish the attractiveness of their capital markets to investors

The March 2013 comments of Zong Qinghou, China’s rich-

and companies alike. In recent years especially, one such

est man, to the Wall Street Journal sum up the attitude

problem has been that capital markets are unlikely des-

such activity has created in the country. “When the ordi-

tination for investors looking to profit from Chinese or

nary people invest in it, the market should reward them

Indian growth. Markets around the world all saw substan-

with some benefits. But it does not,” he says. “Speculation

tial drops in 2008 and some recovery in 2009. Since then,

has totally cheated ordinary investors of any benefits.”4

Global Financial Stability Report, October 2012.
“China’s Richest Man Says Capital Markets ‘Suck’”, China Real Time Report, Wall Street Journal, 5 March 2013, />chinarealtime/2013/03/05/capital-markets-suck-says-chinas-richest-man/
3
4


7 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

India has also had its share of business corruption, as Mr

18 million Indians own equities, and only a small percent-

Panchapagesan puts it, “regulators have not been able

age of household savings are held in shares, mutual funds,

to provide confidence to investors as scandals come up

and government debt. Nor is this spread across the coun-

on a periodic basis.” Even the CEO of the National Stock

try: most of the money comes from a single city, Mumbai.

Exchange agreed in an interview last year that insider trad-

Indians looking for better returns than found in banks or

ing is “rampant,”5 and in August 2012, a government minis-

life insurance choose gold. Although this partly reflects the

ter revealed that three regulatory officials from the Securi-

cultural importance of the metal in the country, it is also

ties and Exchange Board of India (SEBI) itself were being

very much an investment choice. A report by Morgan Stan-

investigated for corruption.

ley in June 2012 found that between 2008 and 2011 the
value of gold purchases totalled eleven times the money

Such problems are not unique to these two countries, and

going into equities and by the latter year it accounted for

the authorities are at least taking some steps to address

10% of household savings. In June 2013, the finance min-

them. Nevertheless, cleaning up the markets is absolutely

ister publicly encouraged Indians to stop buying so much

essential for them to grow, as investors in both countries

gold, for good reason: in the fiscal year ending March 2013

are already accustomed to seeking profits elsewhere.

half of the country’s current account deficit came from the
import of $54 bn worth of the metal. Since the summer,

In this case, though, the particular vehicles vary by coun-

Indian gold imports have dropped due to increased gov-

try. Traditionally, savers in China had little option but low-

ernment restrictions and duties, although purchases of

paying accounts in state-owned banks. In the last decade

silver have risen. Now the Chinese may have caught the

the products available have diversified rapidly but, Simon

gold bug as well: lower purchases by Indians and a rapidly

Gleave – regional head of financial services, KPMG Asia-

growing interest in the metal among Chinese made the lat-

Pacific – notes, bank deposits remain popular. “Investment

ter the world’s largest importers of gold in 2013.

sophistication is pretty low,” he adds. This is exacerbated by
government restrictions on interest rates and capital flows.

If savers are looking to invest outside of capital markets,

Those looking for other choices have tended to put money

companies also often prefer to look elsewhere for fund-

into real estate – a property bubble is another issue facing

ing. Bank loans have a number of advantages over other

the country – or into trust companies.

financing. Mr Panchapagesan explains, “The Indian banking system is highly relationship driven. Firms can get all

The latter are private companies that promise high returns

kinds of sweet deals. In India creditors don’t force firms into

often attained via lending to companies where state-

bankruptcy. If a business gets in trouble, they call the bank

owned banks will not. As the government has tried to

and restructure loan. If I am a CEO, why would I go to the

reduce lending in recent years by political fiat, such institu-

capital markets where I have to be transparent? I go to my

tions have filled the gap. In January 2014, meanwhile, the

bank, where I am not penalised even if I don’t pay.” Further-

People’s Bank of China reported that the shadow bank sec-

more, large corporate groups often tap into retained earn-

tor provided more than 30% of aggregate financing for the

ings as such activity arouses little shareholder opposition

whole economy, up from 23% a year earlier. Worse still, the

in India

country has seen worrying growth in completely unregulated informal lenders. The IMF estimated in October 2012

Similarly in China, large companies often find exchanges an

that collectively such loans totalled the equivalent of 6% to

unappealing place to seek capital. Corporate savings rates

8% of GDP, with interest rates often upwards of 20%.

in China are already high – for much of the last decade they
have been around the same proportion of GDP as house-

A majority of household savings in India also goes into

hold savings. Financing from retained earnings can be an

banks, which have traditionally paid little real interest.

easy option, especially for bigger firms. As for those which

According to SEBI, out of a population of over 1bn, just

need cash, says Mr Gleave, “bank loans are much cheaper

“Insider trading: Large corporates should come together to decide on disclosure code, says Ravi Narain, NSE”, Economic Times, 11
March 2013.
5


8 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

and easier. They don’t see any point in raising capital. Why

currency, and allows little access by foreigner investors

bother with all the costs?”

to its capital markets except through a number of limited
schemes. The government mulls reform, but as Mr Gleave

In both China and India, then, poor capital market results

explains, the “question is what steps to take to achieve

in recent years and ongoing corruption issues are likely to

[open markets] and in which order. Do you deregulate the

continue underpinning business preferences for raising

exchange rate or interest rate first? Do you reform equity

capital via bank loans, and investor preferences for other

markets first? Do you open the currency or float it first?

investment vehicles.

These are fundamental question marks over how you go
from quasi state controlled financial markets to free ones.”

Differing paths

Real progress will have to await officials deciding on a more

Each country also has specific issues that will inhibit the

comprehensive roadmap. Mr Gleave says that government

ability of their capital markets to take on a global role.

officials are currently debating these matters intensely, but

For China, this begins with the extent of restriction on

he does not expect any detailed decision on them for a

exchange activity. The shares available in Shanghai and

year or two. Even then, the result will inevitably be experi-

Shenzhen are, for the most part, minority listings of state-

mental, as no country has ever taken this path before.

owned companies or their subsidiaries. Mr Gleave notes
that this “is something that needs to change before you

The problem for Indian companies is not related so much

can build bigger equity capital markets. The government

to market access; the country has more equity market list-

is determined not to sell majority stakes.” Meanwhile,

ings than any other. Rather, Indian markets’ suffer from a

growth-oriented small and mid-sized enterprises face

marked lack of liquidity despite high national savings rates.

regulatory hurdles to listing and accessing capital through

Of the roughly 5,100 firms listed on the BSE, over 2,000 are

these markets.

described by the exchange as “illiquid”. The more active

National Stock Exchange of India formally labels about a

Another core problem is the restrictions facing inves-

quarter of its approximately 1,600 listings the same way.

tors wishing to directly access Chinese markets. China

These, though, are the most extreme cases, with many

has a highly regulated financial sector, a non-convertible

other shares seeing scant activity. India’s newest stock

Relative movement of NSE Nifty and BSE Sensex Indices and Rupee-Dollar Exchange rate
(All indexed with 1 May 2013=100)
110

100

90

80

70
01-May-13

01-Jun-13
Nifty

BSE Sensex

01-Jul-13
Rupee vs Dollar

Source: The Economist Intelligence Unit (October 2013)

01-Aug-13

01-Sep-13


9 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

exchange, the MCX-SX, opened for business in February

selling off $5.6bn worth of debt and $1.8bn worth of equi-

2013, and in its initial month saw trading in only 71 of the

ties. Stock market indices dropped as did the value of the

1,118 listed shares.

rupee in the face of substantial capital repatriation. The
sell-off continued at a slower pace in July but in the first

In practice, most estimates say that only a few hundred

half of August FIIs, although continuing to be net sellers

of the largest Indian companies can be described as truly

of Indian debt, were putting money back into the coun-

liquid. Mr Panchagesan notes, “These are the household

try’s equities. Then, on 16 August, the government, wor-

names. The others are not going to grow.” Incidents of

ried about continued pressure on the rupee, announced

stock fraud among thinly traded shares do little to enhance

limited controls on Indian companies investing abroad.

their attractiveness. As for secondary debt and deriva-

This sparked rumours that broader currency controls on

tive markets, liquidity is even tighter. The country’s major

foreign investors in India were under consideration, lead-

exchanges even offer incentives to derivative traders to

ing to another round of selling: $1.1bn in FII money left

use their facilities in a bid to improve liquidity.

equity markets by the month’s end while FII debt divestment continued apace.

Perhaps as a result of this need for capital, foreign investment restrictions in India have for some years been far less

Government assurances that no such controls were in the

than those in China. Registered Foreign Institutional Inves-

offing; the appointment of Raghuram Rajan – known to be

tors (FIIs) can in aggregate buy up to 24% of the equity in

in favour of further foreign investment – as governor of the

almost every Indian company. In practice, the restrictions

reserve bank on 4 September; and the latter’s rolling back

are even looser, with some 300 companies having special

of controls on Indian companies as well as bringing in fur-

exemptions allowing FIIs to purchase anywhere from 30%

ther liberalisation of certain foreign investment rules has

to 100% of capital. According to the Reserve Bank of India,

changed perceptions From Rajan’s appointment to mid-

only five companies currently cannot receive further FII

September, net FII debt divestment has slowed to a trickle,

investment and 15 have reached their limit of investment

and FIIs put $1.1bn back into Indian equities.

from non-resident Indians or persons of Indian origin.
Broad lessons from these events should be drawn with
Easy access for foreign funds can bring dangers as well

caution. They certainly show the potential influence of

as benefits, in particular because low domestic invest-

foreign money – and therefore foreign crises – on Indian

ment gives this money outsized influence in Indian capi-

capital markets, but last summer may not be represen-

tal markets: roughly a third of the daily turnover on the

tative. An IMF study of FII investment in Indian markets

National Stock Exchange is driven by FII activity. Events

between 2000 and 2011 found little evidence that changes

from the summer of 2013 are a notable example of what

in foreign investment as a result of long tail events abroad

can happen. Starting in late May, India’s equity markets

affected Indian equity values.6 Moreover, the summer FII

and currency saw marked instability [see chart]. This has

sell off has to be seen in perspective: from January to mid-

had little to do with the country’s economic fundamentals,

September 2013, FIIs were responsible for a net inflow of

although a growing current account deficit was already

$12.6bn in equities and the outflow on the debt side has

affecting confidence in May and continued throughout the

been $1.6bn. In other words, even where outside condi-

period. Instead, the announcement late in that month by

tions were worrying, foreign investors seem to have been

the United States’ Federal Open Market Committee that it

prudentially reducing their holdings rather than abandon-

planned to taper quantitative easing led nervous foreign

ing the country.

investors to repatriate money in anticipation of possible
turmoil on American and world markets.

Similarly, the speedy imposition of currency controls on
Indian companies abroad might suggest that, if highly

The majority of such activity was in June, with FIIs taking

6

pressed Indian policy makers may restrict investor freedom

Ila Patnaik, Ajay Shah, Nirvikar Singh, “Foreign Investors Under Stress: Evidence from India,” IMF Working Paper WP/13/122, May 2013.


10 Paper tigers: Chinese and Indian capital markets

Global Financial Institute

just when foreigner might need their capital most. On the

Conclusion

other hand, the damage caused by rumours, the rapid

Asia’s emerging giants clearly have the potential to estab-

reversals of these measures and disowning of controls on

lish capital markets of global importance. Change is occur-

foreigners, and the attendant recovery in equity values and

ring at the margins and both countries have taken steps

the rupee might equally suggest that the government has

to curb corruption. India recently appointed a Standing

shown a strong commitment to free markets even while

Council of Experts on the international competitiveness

under stress and seen the rewards.

of the Indian financial sector, tasked with, among other
things, looking at capital market reform. In July 2013, the

At the very least, though, events of last summer’s events

Chinese government nearly doubled the aggregate allow-

show that the large proportion of foreign capital in Indian

able quota under the Qualified Foreign Institutional Inves-

capital markets adds to the risks which potential investors

tor (QFII) scheme – the main vehicle for allowing foreign

need to consider.

money to enter Chinese markets – though the new total
of $150bn is still relatively small and by early 2014 only

The different problems and investor preferences in the

roughly a third of that amout had been issued in actual

two countries each lead to their own kind of inefficiency.

QFII licenses. Furthermore the government has relaxed

China’s large pool of capital is finding ways to fund eco-

restrictions that required at least 80% of foreign assets be

nomic development outside of traditional capital markets.

held in fixed income assets.

This is positive in some ways: a low cost of capital for government has enabled extensive infrastructure develop-

However for the capital markets of these countries to

ment that might not otherwise have been possible. On the

become global actors more change will be needed. Both

other hand, whether capital is being allocated efficiently

countries need institutional strengthening so that inves-

is far less clear. In India, on the other hand, savings are not

tors are able to trust companies seeking money on equity

translating into substantial liquidity, despite an openness

and debt exchanges. Doing so holds out the possibility of

to foreign investment. Money is more likely to go into gold

much more efficient capital allocation, and therefore more

than into shares.

sustainable growth. Nevertheless the agenda is long and
daunting, if Dalal Street is to join Wall Street, or Lujiazui the
City, as leading global capital markets by 2030.

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© Deutsche Bank · June 2014

R-34277-1 (3/14)


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