paper tigers: chinese and indian capital markets

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Paper tigers: Chinese and Indian capital marketsJune 2014 Dr. Paul Kielstra

Deutsche Asset & Wealth Management

S6 SPECIAL ISSUE

Paper tigers: Chinese and Indian capital markets2

Deutsche Asset & Wealth Management’s Global

Financial Institute asked the Economist Intelli-

gence Unit to produce a series of white papers,

custom articles, and info-graphics focused spe-

cifically on global capital market trends in 2030.

While overall growth has resumed, and the

value traded on capital markets is astoundingly

large (the world’s financial stock grew to $212

trillion by the end of 2010, according to McKin-

sey & Company) since the global financial crisis

of 2008, the new growth has been driven mainly

by expansion in developing economies, and

by a $4.4 trillion increase in sovereign debt in

2010. The trends are clear: Emerging markets,

particularly in Asia, are driving capital-raising; in

many places debt markets are fragile due to the

large component of government debt; and stock


Introduction to “Global Capital Markets in 2030“

markets face weakening demand in many mature

markets.

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

(e.g. stocks, bonds, currency and commodity

futures) is growing, the pattern of that growth sug-

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

tal markets.

This series of studies by Global Financial Institute

and the Economist Intelligence Unit aims to offer

deep insights into the long term future of capital

markets. It will employ both secondary and primary

research, based on surveys and interviews with

leading institutional investors, corporate executives,

bankers, academics, regulators, and others who will

influence the future of capital markets.

Paper tigers: Chinese and Indian capital markets3

About the Economist Intelligence Unit

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This article was written by Dr. Paul Kielstra and

edited by Brian Gardner.

Dr. Paul Kielstra is a Contributing Editor at the

Economist Intelligence Unit. He has written on

a wide range of topics, from the implications of

political violence for business, through the eco-

nomic costs of diabetes. HIs work has included

a variety of pieces covering the financial services

industry including the changing role relationship

between the risk and finance function in banks,

preparing for the future bank customer, sanctions

compliance in the financial services industry, and

the future of insurance. A published historian, Dr.

Kielstra has degrees in history from the Universi-

ties of Toronto and Oxford, and a graduate diploma

in Economics from the London School of Econom-

ics. He has worked in business, academia, and

the charitable sector.

Brian Gardner is a Senior Editor with the EIU’s

Thought Leadership Team. His work has covered a

breadth of business strategy issues across indus-

tries ranging from energy and information tech-

nology to manufacturing and financial services. In

this role, he provides analysis as well as editing,

project management and the occasional speaking

role. Prior work included leading investigations

into energy systems, governance and regulatory

regimes. Before that he consulted for the Commit-

tee on Global Thought and the Joint US-China Col-

laboration on Clean Energy. He holds a master’s

degree from Columbia University in New York City

and a bachelor’s degree from American University

in Washington, DC. He also contributes to The

Economist Group’s management thinking portal.


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4

In recent decades, the overarching economic story out of

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

graphic giants into economic ones. This has happened on

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

nal GDP terms China has surpassed Japan to become the

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

world’s tenth largest GDP. Only a decade ago, China and

India were in 6th and 13th place, respectively.

Dramatic growth can also be seen in the two countries’

capital markets. Today, Shanghai and Shenzhen combined

have a greater market capitalisation than that of any other

country’s exchanges except those of the United States.

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

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

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

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

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

lectively have a little over 4,100 domestic companies,

although cross listing means the total number is somewhat

lower. The two Chinese exchanges have fewer listings, but

have seen faster growth in their number. Between 2009 and

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

exchanges for initial public offerings by value, and in 2012

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

zhen also saw the fourth and fifth highest levels of share

trading by value globally last year.

A number of indicators point to continued growth. China

currently has among the highest gross savings rates in the

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

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

The country is putting capital to work privately and pub-

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

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

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

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

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

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

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

for investment.

Paper tigers: Chinese and Indian capi-tal marketsA Global Financial Institute research paper written by the Economist Intelligence UnitJune 2014

Paper tigers: Chinese and Indian capital markets Global Financial Institute

Written by

65 %

53 %

35 %

24 %

22 %

21 %

19 %

8 %

8 %

3 %

5 %

United States

China

India

Japan

United Kingdom

Brazil

Germany

France

Italy

Other, please specify

Capital will be so international that location will have little relevance

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.

Source: The Economist Intelligence Unit (August 2013)

5 Paper tigers: Chinese and Indian capital markets

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

seem poised to take on significant global importance. According

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

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

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

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

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

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

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

That said, China’s and India’s capital markets institutions

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

domestic roles, these markets are often not efficiently allo-

cating the substantial capital being saved. A 2013 study by

World Bank researchers found that “the expansion of finan-

cial market activity since the 1990s has been more limited

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

companies have dominated activity on equity and bond

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

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

between 2005 and 2010.1

If anything, debt markets in India are even less developed

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

budget economic survey admits, “Though, the develop-

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

tant area and has received greater policy attention in

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

country’s Economic Times newspaper goes further, citing

low trading levels, poor liquidity in the secondary market,

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

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

In contrast, China’s bond markets have seen substantial

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

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

ment debt rather than funding more diverse private sector

endeavours. According to the Asian Development Bank,

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

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

2008 figure, but still well below the equivalent number for

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

majority of Chinese corporate bonds are “enterprise bonds”

issued by government affiliated companies. Traditional

corporate bonds can be issued by smaller, private firms but

that market is thinly traded and highly illiquid. The ability

of organisations without strong state connections to tap

bond markets remains an open question.

1 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.


68 %

45 %

30 %

28 %

26 %

24 %

12 %

10 %

9 %

3 %

4 %

United States

China

Japan

United Kingdom

Germany

India

Brazil

France

Italy

Other, please specify

Capital will be so international that location will have little relevance

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.

Source: The Economist Intelligence Unit (August 2013)


Moreover, the transparency of the Chinese bond markets is

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

part because the government and other interested parties

have stepped in on occasion to make good insolvent par-

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

ber 2012, the IMF highlighted that “the apparent pattern

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

worry amongst trust companies and alternative lenders,

has extended to the bond market.3

Overall, then, capital markets in these countries are deliv-

ering less than they appear to on the surface. Professor

Venkatesh Panchapagesan of the Indian Institute of Man-

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

growth, but capital markets have not been the primary

driver. The exchanges, institutions and intermediaries have

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

smaller, private entrepreneurs without political connec-

tions, the situation is very much the same.

Common weaknessesA number of issues present in both countries greatly dimin-

ish the attractiveness of their capital markets to investors

and companies alike. In recent years especially, one such

problem has been that capital markets are unlikely des-

tination for investors looking to profit from Chinese or

Indian growth. Markets around the world all saw substan-

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

however, despite steady, robust economic growth in each

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

with economic growth in the country and China’s stock

indices have even seen substantial overall declines [See

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

expansion of the number of listed companies helped drive

the increase in market capitalisation for Shenzhen and the

NSE rather than this arising from rising share price alone.

Economic growth and market indices are only loosely

related in most circumstances. Nevertheless, the weak

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

cerns for those potential investors otherwise willing to

overlook institutional deficiencies.

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

tections and legal enforcement. Stock scandals have been

all too common. Chinese authorities have pursued a well-

publicised crackdown in this area, which has included a

freeze on initial public offerings (IPOs) between October

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

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

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

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

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

nary people invest in it, the market should reward them

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

has totally cheated ordinary investors of any benefits.”4

3 Global Financial Stability Report, October 2012.4 “China’s Richest Man Says Capital Markets ‘Suck’”, China Real Time Report, Wall Street Journal, 5 March 2013, http://blogs.wsj.com/chinarealtime/2013/03/05/capital-markets-suck-says-chinas-richest-man/


Country 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)


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

Panchapagesan puts it, “regulators have not been able

to provide confidence to investors as scandals come up

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

Exchange agreed in an interview last year that insider trad-

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

ter revealed that three regulatory officials from the Securi-

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

investigated for corruption.

Such problems are not unique to these two countries, and

the authorities are at least taking some steps to address

them. Nevertheless, cleaning up the markets is absolutely

essential for them to grow, as investors in both countries

are already accustomed to seeking profits elsewhere.

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

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

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

the products available have diversified rapidly but, Simon

Gleave – regional head of financial services, KPMG Asia-

Pacific – notes, bank deposits remain popular. “Investment

sophistication is pretty low,” he adds. This is exacerbated by

government restrictions on interest rates and capital flows.

Those looking for other choices have tended to put money

into real estate – a property bubble is another issue facing

the country – or into trust companies.

The latter are private companies that promise high returns

often attained via lending to companies where state-

owned banks will not. As the government has tried to

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

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

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

tor provided more than 30% of aggregate financing for the

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

country has seen worrying growth in completely unregu-

lated informal lenders. The IMF estimated in October 2012

that collectively such loans totalled the equivalent of 6% to

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

A majority of household savings in India also goes into

banks, which have traditionally paid little real interest.

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

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

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

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

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

Indians looking for better returns than found in banks or

life insurance choose gold. Although this partly reflects the

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

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

ley in June 2012 found that between 2008 and 2011 the

value of gold purchases totalled eleven times the money

going into equities and by the latter year it accounted for

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

ister publicly encouraged Indians to stop buying so much

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

half of the country’s current account deficit came from the

import of $54 bn worth of the metal. Since the summer,

Indian gold imports have dropped due to increased gov-

ernment restrictions and duties, although purchases of

silver have risen. Now the Chinese may have caught the

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

growing interest in the metal among Chinese made the lat-

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

If savers are looking to invest outside of capital markets,

companies also often prefer to look elsewhere for fund-

ing. Bank loans have a number of advantages over other

financing. Mr Panchapagesan explains, “The Indian bank-

ing system is highly relationship driven. Firms can get all

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

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

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

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

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

more, large corporate groups often tap into retained earn-

ings as such activity arouses little shareholder opposition

in India

Similarly in China, large companies often find exchanges an

unappealing place to seek capital. Corporate savings rates

in China are already high – for much of the last decade they

have been around the same proportion of GDP as house-

hold savings. Financing from retained earnings can be an

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

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


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


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

bother with all the costs?”

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

in recent years and ongoing corruption issues are likely to

continue underpinning business preferences for raising

capital via bank loans, and investor preferences for other

investment vehicles.

Differing paths

Each country also has specific issues that will inhibit the

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

For China, this begins with the extent of restriction on

exchange activity. The shares available in Shanghai and

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

owned companies or their subsidiaries. Mr Gleave notes

that this “is something that needs to change before you

can build bigger equity capital markets. The government

is determined not to sell majority stakes.” Meanwhile,

growth-oriented small and mid-sized enterprises face

regulatory hurdles to listing and accessing capital through

these markets.

Another core problem is the restrictions facing inves-

tors wishing to directly access Chinese markets. China

has a highly regulated financial sector, a non-convertible

currency, and allows little access by foreigner investors

to its capital markets except through a number of limited

schemes. The government mulls reform, but as Mr Gleave

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

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

exchange rate or interest rate first? Do you reform equity

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

These are fundamental question marks over how you go

from quasi state controlled financial markets to free ones.”

Real progress will have to await officials deciding on a more

comprehensive roadmap. Mr Gleave says that government

officials are currently debating these matters intensely, but

he does not expect any detailed decision on them for a

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

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

The problem for Indian companies is not related so much

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

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

marked lack of liquidity despite high national savings rates.

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

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

National Stock Exchange of India formally labels about a

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

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

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)

Nifty BSE Sensex Rupee vs Dollar

01-May-13 01-Jun-13 01-Jul-13 01-Aug-13 01-Sep-13

110

100

90

80

70

Source: The Economist Intelligence Unit (October 2013)


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

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

1,118 listed shares.

In practice, most estimates say that only a few hundred

of the largest Indian companies can be described as truly

liquid. Mr Panchagesan notes, “These are the household

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

stock fraud among thinly traded shares do little to enhance

their attractiveness. As for secondary debt and deriva-

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

exchanges even offer incentives to derivative traders to

use their facilities in a bid to improve liquidity.

Perhaps as a result of this need for capital, foreign invest-

ment restrictions in India have for some years been far less

than those in China. Registered Foreign Institutional Inves-

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

almost every Indian company. In practice, the restrictions

are even looser, with some 300 companies having special

exemptions allowing FIIs to purchase anywhere from 30%

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

only five companies currently cannot receive further FII

investment and 15 have reached their limit of investment

from non-resident Indians or persons of Indian origin.

Easy access for foreign funds can bring dangers as well

as benefits, in particular because low domestic invest-

ment gives this money outsized influence in Indian capi-

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

National Stock Exchange is driven by FII activity. Events

from the summer of 2013 are a notable example of what

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

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

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

although a growing current account deficit was already

affecting confidence in May and continued throughout the

period. Instead, the announcement late in that month by

the United States’ Federal Open Market Committee that it

planned to taper quantitative easing led nervous foreign

investors to repatriate money in anticipation of possible

turmoil on American and world markets.

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

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

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

rupee in the face of substantial capital repatriation. The

sell-off continued at a slower pace in July but in the first

half of August FIIs, although continuing to be net sellers

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

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

ried about continued pressure on the rupee, announced

limited controls on Indian companies investing abroad.

This sparked rumours that broader currency controls on

foreign investors in India were under consideration, lead-

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

equity markets by the month’s end while FII debt divest-

ment continued apace.

Government assurances that no such controls were in the

offing; the appointment of Raghuram Rajan – known to be

in favour of further foreign investment – as governor of the

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

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

ther liberalisation of certain foreign investment rules has

changed perceptions From Rajan’s appointment to mid-

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

and FIIs put $1.1bn back into Indian equities.

Broad lessons from these events should be drawn with

caution. They certainly show the potential influence of

foreign money – and therefore foreign crises – on Indian

capital markets, but last summer may not be represen-

tative. An IMF study of FII investment in Indian markets

between 2000 and 2011 found little evidence that changes

in foreign investment as a result of long tail events abroad

affected Indian equity values.6 Moreover, the summer FII

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

September 2013, FIIs were responsible for a net inflow of

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

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

tions were worrying, foreign investors seem to have been

prudentially reducing their holdings rather than abandon-

ing the country.

Similarly, the speedy imposition of currency controls on

Indian companies abroad might suggest that, if highly

pressed Indian policy makers may restrict investor freedom

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



just when foreigner might need their capital most. On the

other hand, the damage caused by rumours, the rapid

reversals of these measures and disowning of controls on

foreigners, and the attendant recovery in equity values and

the rupee might equally suggest that the government has

shown a strong commitment to free markets even while

under stress and seen the rewards.

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

show that the large proportion of foreign capital in Indian

capital markets adds to the risks which potential investors

need to consider.

The different problems and investor preferences in the

two countries each lead to their own kind of inefficiency.

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

nomic development outside of traditional capital markets.

This is positive in some ways: a low cost of capital for gov-

ernment has enabled extensive infrastructure develop-

ment that might not otherwise have been possible. On the

other hand, whether capital is being allocated efficiently

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

translating into substantial liquidity, despite an openness

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

than into shares.

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

lish capital markets of global importance. Change is occur-

ring at the margins and both countries have taken steps

to curb corruption. India recently appointed a Standing

Council of Experts on the international competitiveness

of the Indian financial sector, tasked with, among other

things, looking at capital market reform. In July 2013, the

Chinese government nearly doubled the aggregate allow-

able quota under the Qualified Foreign Institutional Inves-

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

money to enter Chinese markets – though the new total

of $150bn is still relatively small and by early 2014 only

roughly a third of that amout had been issued in actual

QFII licenses. Furthermore the government has relaxed

restrictions that required at least 80% of foreign assets be

held in fixed income assets.

However for the capital markets of these countries to

become global actors more change will be needed. Both

countries need institutional strengthening so that inves-

tors are able to trust companies seeking money on equity

and debt exchanges. Doing so holds out the possibility of

much more efficient capital allocation, and therefore more

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

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