By: Ashley Kindergan From The Financialist

When it comes to the size of their capital markets, emerging countries have long punched below their economic weight. While they make up 39 percent of global GDP, their share of global equity market capitalization is just 22 percent, and that of corporate and sovereign bond markets is even lower, at just 14 percent. But over the next generation, that may change. The Credit Suisse Research Institute believes that by 2030, emerging equities, corporate bonds, and sovereign bonds markets will comprise 39 percent, 36 percent and 27 percent, respectively, of their total global markets. The main driver of that growth? China, which should overtake Japan as the world’s second-largest capital market by that time.

In a new report entitled “Emerging Capital Markets: The Road to 2030,” the Institute estimates China’s equity market capitalization will grow 15.6 percent a year to reach $53.6 trillion between now and 2030, a thirteen-fold increase from today’s levels. It sees similar growth in the corporate bond market, to $31.9 trillion (an eleven-fold increase), as well as the sovereign bond market, to $12.3 trillion (eight-fold). In that event, China would be second only to the U.S. in each of the three major asset classes. What’s more, the country could also account for 55 percent of all emerging market debt underwriting fees and 70 percent of equity fees between now and then – a total of some $159 billion. “There is no way around it: China is the most important place for the development of capital markets,” says Markus Stierli, Head of Fundamental Micro Themes in Credit Suisse’s Private Banking and Wealth Management division. “It’s the place everyone’s watching.”

What will drive the increase? Stierli believes the government’s efforts to provide a national social security system for the 235 million people who will be over age 65 by 2030 will be the single biggest driver of capital market growth. At 47 percent, China has the highest savings rate of the largest emerging market countries, but Chinese citizens increasingly expect a comprehensive social safety net. Stierli says the government’s commitment to providing a pension fund bodes well for markets. “Creating a pension fund requires the evolution of an asset management market,” he says. “Pension systems require the kind of returns only financial markets can generate, and those financial markets need to be regulated.”

At the same time, Credit Suisse expects the country’s savers to start seeking more remunerative financial products than low interest rate bank deposits for their nest eggs. That will drive growth in domestic mutual, pension, and insurance funds, which will, in turn, encourage domestic companies to start tapping the debt and equity markets for their financing needs, in addition to their historical source, the country’s banks.

An increase in domestic capital markets activity will likely attract more foreign capital, but there are a number of obstacles to overcome before that happens. The government, wary of the destabilizing effect large inflows of foreign capital have had on other countries in the past, still limits foreign investors’ participation in domestic stock markets. It also controls both interest rates and the exchange rate.

But officials are making good on a November promise for financial reform, having loosened controls on the yuan and announced a plan to liberalize interest rates earlier this year. In March, regulators raised the cap on foreign ownership of a company’s shares from 20 percent to 30 percent and allowed smaller companies to issue debt. China’s state-owned enterprises are also actively seeking private investment. Chinese industrial giant Citic, for example, recently announced that its Hong Kong subsidiary will buy the parent company, with the result that nearly all of the merged entity’s shares will trade on the Hong Kong stock exchange. The move will subject Citic to stricter disclosure standards and investor scrutiny, which it clearly hopes will attract additional foreign interest. And earlier this week, the government announced a “mixed ownership” pilot program in which it would seek private investors to take stakes in two state-owned firms.

Financial stability is an additional potential concern for investors, especially when it comes to corporate debt. Concerns that China’s financial system is dangerously overleveraged preoccupied markets in the first half of this year, especially after a solar company became the first-ever Chinese firm to default on a payment in the domestic bond market in March. Fears about China’s slowing economic growth also have plagued markets this year. Stierli points out that China has so far avoided the banking and debt crises some investors have been predicting for more than a year and that even annual GDP growth of 6.5 percent – as opposed to the 8 percent-plus that was the norm before 2012 – has the power to generate significant earnings. But he nonetheless cautions that there are bound to be significant risks along the path to a $98 trillion capital market. Investors will have to figure out how to assess management and governance at state-owned enterprises when they go public or open up to private-sector investment, for example. And it remains to be seen if Chinese firms will move up the value chain, which would deliver even more earnings potential to investors. But overall, there is an enormous expansion expected in China’s capital markets over the next 16 years. And, if it plays out as Credit Suisse’s Research Institute expects, the shift will require nothing short of a redrawing of the landscape of global finance.

Photo of Shanghai’s Yuyuan Garden during the annual lantern festival by BassKwong courtesy of Shutterstock.com.

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