Financial markets and economic resilience
During the last three months, I have posted multiple times on the growing maturity and depth of Indian financial markets (for example, here, here, and here). Implicit in these posts has of course been the unstated belief that this is a good thing for the economy as a whole, but I did not make any serious attempt to justify this belief.
A couple of weeks back, the Liberty Street Economics blog of the New York Federal Reserve carried an interesting article on Emerging Market Resilience During Recent Shocks which classified emerging markets into two groups based on their stock market maturity and compared the resilience of these groups. Their measure of financial market maturity is based on the country classification used in the MSCI indices for world stock markets.
I found this definition a bit surprising as the MSCI classification would surely reflect the past performance of the countries. However, on reviewing the data on past reclassifications, I feel that this is not as serious a problem as one might fear. MSCI has not changed the set of Emerging Markets much since the inception of the index in 1988. Argentina and Pakistan entered the Emerging Markets index for a brief period before exiting the index. A few Middle Eastern petro-states entered the Emerging Markets index when they opened up their stock markets over the last decade. The only significant changes in my view are (a) Russia was dropped after the Ukraine war and (b) Greece was downgraded from Developed to Emerging after its sovereign default (it is scheduled to be upgraded back to Developed in 2027). In fact, MSCI has not yet upgraded Korean and Taiwan to Developed though almost everybody else regards them as developed economies. It also helps that the MSCI criterion for inclusion in Emerging Markets is essentially that it should have at least some large sized companies, and that the stock market must be accessible to foreign investors. This is totally different from saying that the top 25 stock markets by market capitalization are classified as Emerging Markets. Nevertheless, I would very much have liked Liberty Street Economics to use the MSCI Classification as of 1995 (or at least 2005) so that there is no hindsight bias in the analysis. I suspect that the results would be similar, but we would have more confidence in these results.
Liberty Street Economics' list of 22 Core Emerging Markets is the MSCI's list of 24 emerging markets less Korea and Taiwan. Their list of 92 Periphery Emerging Markets are the other emerging economies excluding countries that are in sustained large-scale armed conflict and small island states. The first key finding is that Core Emerging Markets have had faster economic growth, lower inflation, lower government borrowing costs, larger buffers of foreign exchange reserves, and a much bigger fraction of their government debt in local currency.
The more important analysis is in terms of how the two groups of emerging economies fared in the face of three recent shocks: (i) the Covid-19 pandemic of 2020, (ii) the Russia-Ukraine war of 2022, and (iii) the Iran conflict of 2026. Liberty Street Economics find that Core Emerging Markets suffered less credit rating downgrades and much smaller increases in sovereign borrowing costs than Periphery Emerging Markets.
It may appear surprising that having deep stock markets can be good for a country's credit rating and borrowing costs. But this is exactly what one should expect. First, there is a high degree of correlation in the development of different financial markets. Deep stock markets tend (with a lag?) to lead to deeper bond markets, currency markets and derivative markets. Second, foreign participation in stock markets increases foreigners' familiarity with the country. The coverage of the country in the global financial media improves (and the coverage is no longer only about floods, earthquakes, and famines). All of this leads to a nuanced understanding of country risk and less panic selling of assets during a risk-off episode. All of this means that India's success in building a large vibrant stock market is indeed a very good thing. And replicating this success in the bond markets is something to be looked forward to.
Posted at 1:34 pm IST on Fri, 24 Apr 2026 permanent link
Categories: bond markets, equity markets, Indian financial sector, international finance
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