Understanding 'emerging markets'
Discussion of capital markets regulation in Jordan cannot be complete without fully understanding the conditions that make emerging economies what they are. The debate whether Jordan is a “third world” country or an “emerging economy” is no longer an exclusive technical domain reserved to those interested in capital market reforms. As recently as last week there has even been friction in the Kingdom's Arabic press over whether Jordan is a “developed” or “underdeveloped” country.
Yet the question here should not be seen in terms of “conventionalists” who often present emotional arguments “based on national pride” that Jordan is a developed country and “detractors” who allegedly always want to put the country down, arguing that Jordan is still underdeveloped. There are clearly defined socio-economic criteria and abundance of literature on delineating the boundaries between “developed” and “underdeveloped” countries. The proper question to ask is not whether Jordan is indeed developed or underdeveloped, but “why is it important in the first place to make such a distinction?”
The developmental needs, macro and microeconomic strategies vary considerably between the two categories. This question (i.e., the differences between developed and emerging markets) is also particularly important in the context of reforming capital markets in Jordan. Emerging markets display certain socio-legal characteristics and financial structures that separate them from developed economies.
Additionally, that capital markets in emerging economies display different characterizes from markets in advanced economies is also relevant. Such differences are naturally reflected in the regulatory needs of emerging economies, which differ from advanced economies. Accordingly, establishing an accurate/dispassionate understanding of the term “emerging economies” is needed as one of the first basic steps for a successful assessment of the regulatory needs of developing countries. Indeed, it is very surprising that expanding on this question (in terms of its regulatory implications) hasn't been professionally addressed by the writings of those in charge of reforming our Jordanian capital markets — whether foreign or local.
The use of the term “emerging markets” as a collective term denoting a varying spectrum of developing economies is not without criticism for lack of precision. The borderline between an emerging and a developed market can be delineated quantifiably, relying on three broad indicators.
First, traditional indicators such as number of listed companies, total capitalization divided by GDP, total value traded divided by GDP, new issues, etc. [Such country statistics are available from the IFC's Emerging Markets Database.] Second, institutional indicators such as sophistication of underlying accounting rules, lack (or existence) of well-functioning prudential regulation and supervisory bodies, etc. In this context, a developed market is one which, inter alia, enjoys low transaction costs, short term settlement periods, together with favorable externalities such as free convertibility of currency, easy entry, etc.
Yet, although such indicators have been criticized as being “subjective” and “qualitative”, they nevertheless remain useful in providing guiding variables that distinguish quantitatively between “emerging” and “developed” markets. [Institutional indicators can be obtained from the International Financial Corporation's Factbook] Third, asset pricing.
The Arbitrage Asset Pricing Model is often used to compute the “measures” of stock market development. For their part, market measures are computed by using the Capital Asset Pricing Model. However, the former two indicators have been criticized on the grounds that they could project an imperfect account of the level of market development. For example, although the turnover ratio accounts for the level of trading in listed shares, it does not assess the efficiency with which assets are priced during the trading process. Nor does it inform about the level of integration with international markets.
Neither are securities markets in emerging economies a homogenous group. For, one can broadly speak of substantial differences between them, inter se. These differences include market capitalization, structure and number of listed companies. They also relate to the role and size of the private sectors, entry to markets, clearing and settlement arrangements, accounting standards, etc. However, a number of “common characteristics” have been advanced to collectively identify emerging markets. These include thinness (even when they are relatively old), high illiquidity, concentration of trading in a small number of listed corporations, high volatility and proneness to excessive speculative bubbles and high susceptibility to fraudulent activities. Another general characteristic of emerging securities markets is low equity ratio earnings.
Despite this lack of homogeneity, quantitative indicators have again been used to justify a division of emerging markets into four broad groups. The first group includes markets in incipient stages of development. These exhibit limited numbers of quoted companies, limited capitalization, high concentration and volatility, low liquidity and rudimentary institutional setting. The second group has a wider variety of quoted companies, increased liquidity, and despite their small size in relation to the overall economy, the corporate sector relies more increasingly on equity financing.
The third group is less volatile, with increased issuance and trading activities. They enjoy more considerable market activity and capitalization, together with reasonably developed risk transfer mechanisms such as equity and currency hedging instruments. The fourth group is relatively mature markets with high levels of liquidity and trading activities, substantial breadth and equity risk premia approaches internationally competitive levels. [Premia can be defined as risk adjusted returns relative to short-term money market interest rates.]
However, as such division of emerging markets into four groups depends on quantitative indicators, it should not be considered conclusive. It merely provides a helpful structure for identifying emerging markets. In practical terms, emerging capital markets have also been subdivided into three broad categories. The first includes Malaysia, Mexico, Taiwan and Thailand. The second includes Argentina, Brazil, India, Nigeria and the Philippines. The third includes the rest of the emerging markets, including Central and Eastern Europe, African and Middle Eastern countries.
Equity related inflows to emerging economies comprise direct flows to equity markets, purchases through country regional and sector-specific mutual funds, and placements of equities of emerging countries on industrial equity markets. [The long-term favorable impact of equity related inflows to emerging economies is often viewed with suspicion due to their short-termism.] Needless to say, high fiscal deficits, overvalued exchange rates, together with barriers to inflows of foreign capital, have all discouraged the growth of equity markets in emerging economies — adverse local tax systems that levy high capital gains taxes on dividends are also among the important factors that have made securities markets in emerging economies less enticing to investors. — (Jordan Times)
Lu'ayy Minwer Al-Rimawi
The writer is a part-time lecturer in law at London School of Economics
© 2000 Mena Report (www.menareport.com)
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