Equity and bond issuance have emerged as pivotal drivers of revenue growth and expansion in low- and middle-income countries, contributing a significant $4 trillion in new capital over the past three decades. This capital influx has led to a 5 percent increase in job creation, marking a positive shift from traditional reliance on bank lending. These findings, highlighted in a new World Bank Group book, underscore the growing importance of capital markets in financing businesses in developing economies.
Between 2000 and 2022, the share of capital raised from equity and bond issuances as a proportion of Gross Domestic Product (GDP) in low- and middle-income countries has doubled. This indicates the deepening of capital markets in these regions, which is a favorable sign for broader economic development. By channeling more private capital into emerging market firms, these markets enable increased investment, leading to a boost in economic growth.
The research reveals that much of the capital raised is directed toward productive activities. In the first year following capital raises, companies in low-income countries saw a 16 percent increase in investment in physical capital, while firms in middle-income countries experienced an 8 percent rise. This increase in investment translated to higher employment levels and improved revenues, further fueling economic expansion.
Impact of Capital Market Issuance on Firm Growth
The effect of capital market issuances on firm growth is notably strong among first-time market participants. These companies experience a more significant reduction in financial constraints compared to those issuing capital for the second or subsequent times. Interestingly, the type of financial instrument—equity or bonds—also plays a critical role in determining the growth impact.
Equity issuance has a particularly strong impact on firm growth, with companies experiencing a 13 percent increase in physical capital, compared to just a 5 percent increase following bond issuances. This suggests that firms with high growth potential are more likely to gravitate toward equity markets, as they offer a less restrictive approach to raising capital compared to bonds, which involve regular payments.
Broader Economic Impact
The research highlights that the effects of capital market activity extend beyond individual companies, influencing broader economic factors such as employment and physical capital. In low-income countries, capital market activity among firms accounted for 21 percent of the growth in physical capital and 12 percent of the increase in employment among publicly listed firms from 2000 to 2022. In middle-income countries, these figures rose to 22 percent for physical capital and 20 percent for employment growth.
Role of Pension System Reforms
The study also emphasizes the importance of pension system reforms in boosting domestic capital markets. Countries that implemented prefunded pension systems between 1990 and 2022 saw a significant increase in domestic capital raising, with bond and equity market activity rising fivefold as a share of GDP within four years of reform. This surge in domestic fundraising outpaced any rise in the role of international capital, highlighting the crucial role of local financial systems in supporting firm growth.
Conclusion
In conclusion, developing domestic bond and equity markets is crucial for low- and middle-income countries to foster firm growth and economic stability. By facilitating greater access to capital for financially constrained firms, capital markets can direct funds toward the most productive companies, thereby benefiting the economy as a whole. The research emphasizes that, in addition to traditional lending channels, capital market growth offers a powerful tool for driving sustainable economic development.
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