EMERGING MARKETS

Financial Markets and Institutions

Woldu, Daniel
Zahoor, Hira

Winter Semester 2020-2021

Contents
• Introduction of Emerging
Markets
• Salient Features
• Opportunities and Risks
• Case Study:
• Indian Financial System
• Financial institutions in
India
• India Financial Markets
• Credit Rating
• SMEs
• Question & Answer Session
 Introduction
Emerging Markets

1981 Now
1981 Now

Third World Economy Fastest Growing Economies

Third World Economy ➢ Coined by Van Agtmeal in Fastest Growing Economies
1981,IFC.

➢ Initially
Initially named
named as Thirdas Third
world World
countries Countries
Coined by Van Agtmeal,
in 1981, IFC

Source: IFC, World Economic Outlook (October 2020)

 Characteristics
✓ High economic growth

✓ High dependence on oil and agricultural

sectors

✓ Higher political risk

✓ Higher exchange rate risk

✓ The average GDP per capita of Emerging

Markets is below World average $10,950

✓ Little protection against minority

shareholders

✓ Large number of family business

Source: IMF World outlook October 2020

Emerging Markets contribution to
World GDP
✓ Emerging markets makes 57.51% of world
GDP in 2020

✓ The GDP is expected to grow on average

between 4-7%

✓ Out of top 10 economies, 3 are emerging

markets namely, China, India and Brazil

✓ Emerging markets could grow around

twice as fast as advanced economies (G7)
on average

✓ As a result, six of the seven largest

economies in the world are projected to be
emerging economies in 2030 led by China
(1st), India(2nd) and Indonesia (4th)
 Main Reasons for High
Growth
✓ Development of Financial Institutions and
markets

✓ The Rise of oil and energy price (OPEC

countries and Russia)

✓ Low production cost

✓ Development of Innovation
and IT Centers

https://news.yahoo.com/sound-investment-emerging-markets-growing-170023976.html?guccounter=1&guce_referrer
Opportunities and Potentials
✓ Raw Material–Based Comparative Advantage

✓ The Fastest growing middle class

✓ Growth Diversification

✓ Lucrative target market

Source:https://www.brookings.edu/research/the-unprecedented-expansion-of-the-global-middle-class-2/
Challenges and Risks in Emerging
Markets

Source: https://www.propertycasualty360.com/2019/05/15/emerging-markets-the-silver-lining-amid-a-challenging-outlook/?slreturn=202010131635460
 Country Moody’s S&P Fitch

Credit Quality of Argentina Ca CCC+ CCC

Emerging Market Bonds Brazil

Chile
Ba2
A1
BB-
A-
BB-
A-
China A1 A+ A+
✓ The credits of Chile, China, Malaysia, and Poland are Columbia Baa2 BBB- BBB-
among top ranked notes. Hungary Baa3 BBB BBB

✓ Argentina, Brazil, and South Africa are highly speculative India Baa3 BBB- BBB-
with impaired repayment ability. Indonesia Baa2 BBB BBB
Malaysia A3 A- A-
✓ Moody downgrade India from Baa2 to Baa3
Mexico Baa1 BBB BBB-
Philippines Baa2 BBB+ BBB
Poland A2 A- A-
Russia Baa3 BBB BBB
Turkey B2 B+ BB
South Africa Ba2 BB- BB-
Source: https://countryeconomy.com/ratings UAE Aa2 AA AA-
Cross Country Comparison
Economic Indicators INDIA CHINA
Unemployment Rate(%) 7 5.3
GDP Annual Growth Rate(%) -4 3.5
Inflation Rate(%) 7.61 0.5
Interest Rate(%) 4 3.85
Government Debt to GDP(%) 69.62 50.5
Manufacturing PMI (Points) 58.9 53.6
Government Budget (% of GDP) -4.59 -2.8
Corporate Tax Rate (%) 25.17 25
Cash Reserve Ratio (%) 3 12.5
Business Confidence (points) 99.5 51.4
Government Bond 10Y (%) 5.9 3.29
Source: https://tradingeconomics.com/india/indicators
Emerging Markets Monetary and
Fiscal Policy (Now-End 2020)
✓ Monetary policy in Russia, Poland, and
Chile is likely to be loosen than is
currently priced into financial markets.
But in Turkey and India, the direction is
skewed towards further tightening.

✓ Global debt soared to $258 trillion in the

first quarter of 2020.

✓ Columbia’s government forecasts its debt

will rise to 65-66% of GDP from 50% of
last year.
Case Study:
India Financial
Markets
•India’s Central Bank
•Money Markets
•Equity Markets
•Debt Markets
•Derivatives
 India: Demography and Economy
Capital City New Delhi
Population(billion) 1,352,617,328
GDP(billion) 2610
GDP per capita (PPP) $6,610
GDP Annual Growth Rate -4
Currency Rate(against USD) 0.014
Unemployment Rate(%) 7
Inflation Rate(%) 7.61
CPI Point 161
Ratings Baa3(Moody’s),BBB-(S&P), BBB-(Fitch)

GDP composition by sector Agriculture: 15.96%

Manufacturing: 24.88%
Service: 49.88 %
Membership BRICS, G20, UN
Source: https://www.statista.com/statistics/271329/distribution-of-gross-domestic-product-gdp-across-economic-sectors-in-india/
https://tradingeconomics.com/indicators?g=forecast
Reserve Bank of India
✓ India’s Central Bank, Reserve Bank of India,
was established in 1935, by the act of 1934.

✓ The key responsibilities of RBI is to

maintain the stability Rupee.

✓ The Reserve Bank of India uses different

monetary policy instruments to control the
supply and interest rates.

✓ These instruments includes open market

operations, cash reserve ratio, Statutory
liquidity ratio(SLR), Bank rate policy.
Financial Intermediaries in India
✓ Public sector banks: 27

✓ Private sector banks: 22

✓ State Cooperative banks: 16

✓ Regional Rural banks: 196

✓ Urban Cooperative banks: 52

✓ State bank of India:8

✓ Life Insurance: 24

✓ General Insurance: 25

✓ Reinsurance: 2
 Financial Institutions
India’s Top private banks by Market Cap in 2020
✓ India Infrastructure Finance Company Ltd (IIFCL)
✓ Export-Import Bank of India (EXIM Bank)
✓ Small Industries Development Bank of India(SIDBI)
✓ National Housing Bank (NHB)
✓ Industrial Finance Corporation of India (IFCI)

✓ HDFC Bank was the leading Indian private bank

based on market capitalization of over 5.8 trillion
Indian rupees as of August 2020.

✓ Kotak Mahindra and ICICI followed rounding off

the top three during the measured time period.

https://www.statista.com/statistics/944662/india-leading-private-sector-banks-based-on-market-capitalization/
 Money Market
Repo rate of the Reserve Bank of India (RBI) from
FY 2014 to FY 2019

In fiscal year 2019, the RBI's repo rate is projected to increase with 5.6 percent.

Source; https://www.statista.com/statistics/717387/india-reserve-bank-repo-rate-annual-percentage-change/
Main Pension Systems
 Insurance
✓ The market share of private sector
companies in the non-life insurance market
rose from 15% in FY04 to 56% in FY20.

✓ The Government has approved an

ordinance to increase Foreign Direct
Investment (FDI) limit in the Insurance
sector from 26% to 49%.

Source: https://www.ibef.org/industry/insurance-presentation
Liquidity
Participants
✓Central Government
✓State Government
✓Public Sector Undertakings
✓Scheduled Commercial Banks
✓Private Sector Companies
✓General Insurance Companies

Trading Hours
All trading on stock exchanges
takes place between 9:55 a.m. and
3:30 p.m., Indian Standard Time
(+ 5.5 hours GMT), Monday
through Friday.
India Foreign Exchange

✓ Rupee rose as much as 0.6% to 73.43 per dollar

, it’s highest since march. The currency
strengthened by 1.3%.

✓ Given the current inflation spike has been due

to supply disruptions, may be the RBI is
looking at rupee appreciation more favorably.
 Investment Culture
Entry route for Foreign Direct Investment in India
✓ Automatic Route
E.g. Medical Devices

✓ Government Route
E.g. Food Products, Print
Media

✓ Government Route +
Prohibited Investments
Automatic Route
✓ Lottery Business including government/private lottery, online lotteries, etc E.g. Airlines Services

✓ Retail Trading (except single brand product retailing)

✓ Real Estate Business or construction of Houses

✓ Gambling and Betting Including casinos etc

✓ Manufacturing of Cigars, cheroots, cigarettes, of tobacco or tobacco substitutes

Source:https://www.slideshare.net/corporateprofessionals/foreign-direct-investment-14035697
 India Stock Markets

BSE NSE
(Bombay Stock Exchange) (National Stock Exchange)
Headquarter Mumbai, India Headquarter Mumbai, India
Founded 9 July, 1985 Founded 1992
No. of Listings 5,155 No. of Listings 1,955
Market Capitalization $2.11 Trillion Market Capitalization $2.28 Trillion
Indices BSE Sensex Indices Nifty 50
S&P BSE smallcap Nifty Next 50
S&P BSE midcap
Segments Capital Markets
Segments Capital Markets Debt Markets
Derivatives Derivatives
Nifty 50 Sector Breakdown

✓ Nifty 50 Sector allocation which shows

Financial sector is still leading the allocation
with HDFC Bank, HDFC Ltd, Kotak
Mahindra Bank & ICICI Bank being part of
top 10 market cap companies in India.

✓ Information Technology (IT) sector has

second largest allocation after financials due
to stellar performance of IT giants TCS and
Infosys.

Source:https://blog.investyadnya.in/latest-nifty-50-stocks-their-weights/
 The outbreak of COVID-19 pandemic
and its Impact on India’s Stock Market

✓ As a result of fall out in the global financial market, the Indian stock
market also witnesses sharp volatility.

✓ BSE Sensex had the biggest single-day fall of 13.2 percent and Nifty by
29%.

✓ At the beginning of the January, trade of BSE and NSE were at their
highest levels Hitting peaks of 12362 and 42273 index points.
BSE Sensex and S&P CNX Nifty 50
Performance

Source: fi.yahoo.com
 Market Volatility
Log return of BSE

✓ BSE Sensex become volatile during the

pandemic period. In the case of another
stock index, NSE Nifty, it was found
that there is no such significant impact
of the COVID-19 period on the
volatility of NSE stock prices.

Log return on NSE ✓ The result revealed that with negative

mean returns, the stock market faces
losses during the pandemic, whereas
return is shown positive in the pre-
COVID-19 phase.
 Government Bond Markets

• Functions
✓To Deal with inflations
✓To fulfill the
✓ Budget Deficit

Source:https://dea.gov.in/sites/default/files/Quarterly%20Report%20on%20Public%20Debt%20Management%20for%20the%20Quarter%20January%20-%20March%202020.pdf
 Corporate Bond Markets
✓ Corporate bond investors in India are
signaling mounting concern about borrower
credit risks as the nation’s economy staggers
under coronavirus down.

✓ Spreads on longer rupee corporate notes have

widened to the most since 2009 despite the
move, as investors reduce risk.

✓ Some investors are already calling for the

central bank to step in & purchase longer debt
directly to bring down borrowing costs.

Source: https://www.bloombergquint.com/global-economics/decade-high-spreads-on-longer-india-company- bonds-flash-concerns

Foreign Dominated Bonds in India

✓ Returns on the notes have dropped to 3.45% so far this in June

from 6.8% in May.

✓ Offshore loans to the nation’s borrowers have declined to an 11-

year low on Second quarter on this year. And onshore bond
investors increasingly prefer only top-rated companies.

Source: https://www.bloomberg.com/news/articles/2020-06-21/indian-dollar-bonds-are-cooling-just-as-firms-need-to-issue-more
Corporate Bond Markets

✓ The spread of three year AAA India’s

Corporate bond over a similar Tenor
government bond stood at 106 basis
points after widening to 109 basis
points, the highest since October.

✓ The gap for the 10 year company debt

was at 118 basis points, the highest
since mid November.

Source; https://www.bloomberg.com/news/articles/2020-03-19/india-fund-managers-hunt-for-spreads-liquidity-amid-credit-woes
 Challenges for Corporate Bond
Market in India

Issuing entities and types of securities

✓ A limited number of entities have issued various types of corporate bonds, resulting in a relatively small outstanding of
Individual bonds and therefore inactive transaction in the secondary market.

Investor class
✓ Obligation on major bond investors to hold government securities has decreased investor’s flexibility in deciding
investment targets. Further lowering of Statutory Liquidity Ratio (SLR) and other deregulations are desirable.

Transaction costs
✓ In the corporate bond market, establishment of Securities Depository Center and development of credit default swaps
market are areas to be addressed.

Supervisory and legal frameworks

✓ As for the corporate bond market, it is undeniable that the existence of multiple supervising agencies has complicated
the regulation and supervision. Deregulation of investment regulations on major bond investors should be considered.

Source: Researchgate
 Derivative Market in India

History:
✓ Bombay Cotton Trade Association started futures
trading in 1875.

✓ In 1952 the government banned cash settlement

and options trading and derivatives trading

✓ The ban on futures trading of many commodities

was lifted starting in the early 2000s.

✓ Index futures and index options were introduced

in 2000
Participants in Derivative Markets
✓ As of 2005, the NSE trades futures and options
Hedgers Speculators Arbitrageurs
on 118 individual stocks and 3 stock indices.
 India: Commodity Market

✓ National Commodity and derivative exchange Limited or NCDEX

✓ MCX or Multi Commodity Exchange of India Ltd
✓ Indian commodity exchange Limited (ICEX)
✓ ACE derivatives and commodity exchange

India’s Most Exported Commodities in 2020

Commodity Amount (Annually)

Oil & Mineral Fuels $48.6 billion

Precious Stones & Metals $39.2 billion
Iron & Steel $9.9 billion
Cotton $8.1 billion
Aluminum $5.2 billion

Source: https://commodity.com/data/india/
 Futures Markets

✓Stock index futures launched on 12th June, 2000 and stock futures in 9th Nov, 2001.
✓Futures on Stock Index and stocks
✓ NSE: S&P CNX Nifty Futures, CNXIT Futures, Bank Nifty, CNX 100, CNX IT, CNX
Nifty Junior, Nifty Midcap 50, futures on 207 Individual stocks.
✓Commodity Futures
✓Currency Futures
✓Interest Rate Futures
✓NSE: Notional T-Bills, Notional 10 year bonds(coupon bearing and non-coupon
bearing).
 NSE Derivative Market

✓ India’s National Stock Exchange becomes the world’s

largest derivatives exchange by volume.

✓ Volume on the Indian exchange grew 58% to about 6

billion derivative contracts in 2019 compared to CME
4.83 billion.

✓ The growth in volumes has come on the back of new

investor registrations and as derivatives to cash market
turnover ratio remained around 3 times.

✓ India’s stock market value stays at $2.2 trillion compared

to with the U.S.’s $35 trillion.

https://www.bloomberg.com/news/articles/2020-01-21/india-now-has-world-s-largest-derivatives-exchange-by-volume
 Exchange Traded Options: Types of
options available. Who uses them? Why &
how?

✓ Call and Put options are the two most

popular types of options.

✓ On the basis of styles, there are two types

of options, one is American and other is
European style options. It can be used by
individual or corporate entity.

✓ More than 60% of Indian corporate risks

are hedged. Why we use options?
 Clearing and Settlement: The role of the
Clearing House ✓ There are 860 Bankers clearing houses in
India, of which 840 are managed by State
Bank of India and its Associates, 14 by
Reserve Bank of India, and the rest 6 by
nationalized banks.

The Major Clearing Corporations:

✓ Indian Clearing Corporation Ltd.

✓ National Securities Clearing Corporation

Ltd.
✓ Multi Commodity Exchange Clearing
Corporation Ltd.
Function: to clear and settle trades in Securities
or other instruments or products traded
on the stock exchanges.

Source: https://tradebrains.in/trade-cycle-clearing-and-settlement-india/ ✓ India the settlement system is T+2

https://www.sebi.gov.in/clearing-corporations.html
 Over-The-Counter Exchange of India
(OTCEI)
Unique Features of OTCEI

✓ Stock Restrictions:
Repos Based Repos Based
Forward ✓ Minimum Capital Requirements
Government Corporate Debt
Security SWAP
OPTION Credit Default ✓ Large Company Restrictions
Interest Rate Swap
Swap
Forward Rate ✓ Member Base Capital Requirement
Agreement Credit linked
Notes
Interest Rate
Option Total Return Swap

Hybrid Instrument Credit Default

Like Swaption, Basis Swap
Swap, ETC

Source: https://www.investopedia.com/terms/o/otcei.asp
http://ronoxivipyr.web.fc2.com/binary-option-fatwa/otc-forex-derivatives-30-lo.html
 Rating agencies in India

There are three qualified rating agencies in India,

✓Credit Rating Information Services of India Ltd(CRICIL)
✓Investment Information and Credit Rating Agency of India Ltd(ICRA)
✓Credit Analysis and Research Ltd(CARE)

Company P/E (x) EPS (Rs) MKT CAP (Rs m) 52-WEEK

HIGH / LOW (Rs)

Care Rating 15.93 27.49 12,690.37 727 / 236

ICRA 30.11 86.30 25,076.97 3,227 / 1,968

CRISIL 42.6 47.03 144,683.15 2,015/1,980

 Crypto-Currency and Fin-Tech
in India
✓ The blockchain technology is generating interest
across industries in India. The technology,
which is based on concepts that underlie
cryptocurrency such as bitcoin,

✓ The most common uses of this technology are in

digital identity, fund transfers, and payments
infrastructure.

✓ Several mainstreams banks like ICICI Bank,

Kotak Mahindra Bank, YES Bank and Axis
Bank have used the tech for international trade
finance and vendor financing.
Source: https://www.deskera.com/blog/how-india-is-embracing-fintech-like-blockchains-and-cryptocurrency/
 Roles of SMEs in Indian Economy

✓ Accounts for 45% of manufacturing output

✓ Contributes almost 40% of India Export

✓ Contributes to 6.11% of India GDP

Source: Sktuligroup.com, SME Chamber of India

 Question & Answer
1) Why is South Korea categorized as developed market by FTSE and as emerging market in
MSCI?

2) Why Derivative markets are crucial for the development financial market segments such as
stocks and Bond Market?

3) Why India downgrade from Baa2 to Baa3 by Moody?