9/18/22, 5:12 PM Deepening capital markets in the Philippines | McKinsey

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Deepening capital markets in the

Philippines
September 28, 2017
| Article

By Nitin Jain, Fumiaki Katsuki , and Kristine Romano

Establishing pro-market policies, along with supportive rules and

institutions, should increase the flow of money to companies and public
projects that can benefit society.

A
cross the Philippines and Asia’s other emerging economies, some $800 billion in
investment opportunities go unfilled each year because capital markets are less

reliable than issuers might like. Infrastructure is a particularly acute need for the

Philippines, which has set an ambitious goal of increasing its infrastructure spending to 7
percent of GDP. In addition, if the cost of capital in the Philippines were lower and more

stable, businesses would have an easier time raising money to fund new ventures and

growth projects that could turbo-boost the country’s development and add to the
incomes and wealth of its people.

Although the situation is getting better, the Philippines has capital markets that are not

yet as deep as those of several other Asian emerging economies (Exhibit 1). As our

colleagues note in a recent report on the capital markets of emerging Asia , the

Philippines has room to improve on several important indicators of capital market depth.

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Exhibit

Equities, private and public bonds, and securitized products amount to 130 percent
of GDP. This is comparable to China (136 percent) and India (118) but below

Malaysia (275) and Thailand (184).

Issuances of private capital market products and government bonds each totaled 4
percent of GDP, on average, between 2013 and 2015—not much less than the 5-

plus percent level in China, Malaysia, and Thailand, but well under the 9 percent
threshold associated with the capital markets of developed economies.

The Philippines’ ratio of outstanding government and private debt to GDP is below
the 1:1 level that is considered deep.

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Companies pay higher costs of capital in the Philippines—more than 14 percent for
equity, and between 2 and 3 percent for debt—than in several other Asian
emerging economies.

The market for equities in the Philippines, its largest asset class, has rewarded equity
investors with high risk-adjusted returns. The country’s Sharpe ratio, which measures

returns per unit of risk, was 1.4 from 2008 to 2015. Most other markets in Asia had
Sharpe ratios below 1 during that period (higher ratios indicate greater returns for a

certain amount of risk). On the other hand, low liquidity, high trading costs, and
problematic hedging mechanisms are significant issues to address in the equities

market. Tapping into the equity markets could also be made easier. As it is, more than 40
documents are required to list shares on the main trading exchange.

On the debt side, the government bond market is deepening more quickly than the
market for corporate bonds, although it lacks liquidity across much of the yield curve.

Overall, more accurate and timely pricing information would help attract investors.

Policies and institutions to promote

deeper capital markets

Policy makers in the Philippines recognize the country’s need for deeper capital markets,
and the country’s Capital Market Development Plan Blueprint  (PDF) calls for a variety of

measures to strengthen markets and build the capacity of regulators. Two

complementary courses of action could augment this.

The first is creating basic economic and social policies that will provide a foundation for
longer-term market growth. We see four areas that warrant particular focus:

1. Expanding the investor base would help to expand the supply of capital. This base
would ideally become both deep and broad, encompassing the full range of
investors: buy-and-hold investors such as insurance companies and pension funds;

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buy-and-trade investors such as mutual fund managers; active investors, such as

hedge funds, who help provide liquidity and improve pricing, but also need to be
regulated appropriately; and private-market investors, who can provide capital to
fund early stage businesses as well as turnarounds. Pulling in more investors will
likely require a combination of marketing and education efforts.

2. Increasing the participation of issuers in the capital markets would help increase

demand for capital. Various policies can help in this regard, such as encouraging
the development of fast-growing small companies, accelerating the release of
public-private partnership (PPP) initiatives that require fund raising by larger
companies, and providing incentives for more private investment in infrastructure.

Privatizing or listing state-owned enterprises, or at least mandating the use of debt

markets by these entities, would also bring more issuers into the Philippines’
capital markets.

3. Charting a path toward sustainable integration with global markets should make it
easier for foreign players to invest in the Philippines and for local investors to place

money abroad, thereby diversifying sources of capital and types of investments.

This might include marketing the Philippines as a destination for investments in
industries other than business-process outsourcing, opening the Philippines to
flows of inbound and outbound capital and trade, and aligning regulations with
international standards.

4. Developing a deep, liquid government bond market would provide the benchmark
pricing information that can help the corporate bond market to expand. To do this,
governments need to issue debt on an ongoing basis, even when they run budget
surpluses. In many cases, they also need to adopt different practices for issuing
and managing debt: following a predictable issuance calendar, reopening “on the

run” benchmarks (the most recently-issued debt securities of a given maturity),

and establishing primary-dealer programs that balance dealers’ duties and
privileges.

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The second course of action available to policy makers is developing a market

architecture: the institutions, regulations, and backbone systems, such as technology
networks, that capital markets need to function well. This architecture consists of five
important elements.

1. Independent, accountable regulators are vital to market development. Policy

makers will need to determine what to regulate, so as not to stifle innovation, and

how different regulatory bodies work together.

2. Cornerstone institutions, such as stock exchanges and credit rating agencies, play
important roles in setting standards and focusing development. Establishing a
mortgage regulator, for instance, could release capital that is now locked up in
housing and help create a large securitization market. Policy makers will need to

decide what institutions to create, and who should own and govern them.

3. Transparent rules and regulations, with predictable enforcement, help to decrease

costs and risks for market participants. Policy makers must strike a balance
between supervision and regulation and establish enforcement mechanisms that
do not exceed the legal system’s capabilities.

4. Taxation policies have a strong influence on the development of capital markets:

they can support, hamper, or distort them. In some markets, policy makers have
gone beyond tax-neutral policies and provided tax incentives that encourage the
development of specific activities and asset classes.

5. Using advanced technology in key parts of the financial infrastructure could be the

biggest factor in the development of high-quality capital markets. Policy makers

need to decide whether to permit the accelerated use of technology for certain
market functions, such as blockchain technology for clearing and settlements. With
the right policies in place, private players could fund and deploy most of the
technologies to power effective markets.

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Indeed, a coordinated, sustained effort by policy makers would likely do much more to
deepen the Philippines’ capital markets than a series of ad hoc initiatives. Our
discussions with officials outside the Philippines suggest that effective policy

implementation is perhaps the most important factor for deepening capital markets—and
one that can present challenges. Policy makers can start by setting long-term goals, then
make a few simple but significant changes to get things moving in the right direction.
Setting up effective regulatory institutions and reaching out to other stakeholders, such
as private and public companies at home and abroad, encourages participation in the

new system. Finally, policy makers can invest in educating and developing the talent that
companies will need as their capital-markets activities increase.

Efficient allocation of funds is a key enabler of economic growth and social progress.
Deepening capital markets in the Philippines should increase the flow of money to
companies and public projects that can benefit society. Policy makers can do much to
help deepen capital markets. By establishing pro-market policies, along with supportive
rules and institutions, they can enable investors to put more of their money to work in the

Philippines.

ABOUT THE AUTHOR(S)

Nitin Jain is a Senior Knowledge Expert with McKinsey Knowledge Center's
Guargaon office, Fumiaki Katsuki is a partner with McKinsey’s Tokyo office,
and Kristine Romano is a partner with the Manila office.

Talk to us

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