Why is there equity gap in the emerging markets?

Some time back, McKinsey & Co, a consulting firm, released a report on what it calls the ‘Emerging Equity Gap’. The report points out that as the global financial weight shifts to emerging markets, equity investing is set to be a smaller and smaller proportion of financial assets.

Some time back, McKinsey & Co, a consulting firm, released a report on what it calls the ‘Emerging Equity Gap’. The report points out that as the global financial weight shifts to emerging markets, equity investing is set to be a smaller and smaller proportion of financial assets.

HT Image

This is likely to happen as equity are a much smaller of individuals’ investment pie in emerging markets as it is in developed markets. Fixed income assets (mostly bank deposits) are much preferred in these countries.

In Europe and North America, about 30 to 40% of assets are held as equities while the corresponding number for new investors in emerging economies is 25%. However, the role of equities in India is far lower than this emerging market average. Indian households hold only about 8% of their financial assets as equities.

Why is the case? The report says that ‘trusted, transparent markets with strong protections for small investors, as well as the institutions and systems to provide easy market access. Rules and regulations may be in place in emerging markets today, but enforcement is often unreliable.’

While this may be generally true, the lack of an institutional mechanism for guiding long-term savings into the equity markets is the biggest problem in India.

In the US, for example, a large part of retail equity participation comes from the 401(k) retirement accounts.

If the New Pension System had gotten going in its original form, then in India too, a large and regular flow into the equity markets would have been on its way now. As things stand this may never happen as political opposition to retirement money flowing into equities seems well-entrenched.

Another factor is the generally high inflation rate and the resulting high interest rates for deposits. If our inflation was 3% and consequently fixed deposits offered 5% then people would have looked for alternatives. However, the chances of that happening in the foreseeable future are also negligible.

All things considered, the equity gap in India is well-entrenched and the businesses that need equity inflows will have to live with this reality.