The Role of Capital Markets in Driving Business Expansion and Economic Growth

The study explores how capital markets in low- and middle-income countries have expanded, enabling firms to raise funds, invest, and drive economic growth. It highlights the role of policy reforms, domestic markets, and financial accessibility in fostering business expansion and productivity.

International Finance Corporation (IFC) research in collaboration with the World Bank examines how capital markets contribute to business expansion, particularly in emerging economies, with insights from institutions such as the International Monetary Fund (IMF) and leading universities. Covering financial trends across 106 countries over three decades, it highlights the growing reliance on capital markets as a source of business financing and its broader economic impact. As financial globalization accelerates, firms in low- and middle-income countries are increasingly tapping into bond and equity markets to fuel growth and productivity. Despite the persistent dominance of high-income countries in capital markets, the gap is closing as more firms in emerging economies gain access to financial resources.

The Surging Expansion of Capital Markets Worldwide

Over the past three decades, capital market financing has surged, enabling firms to secure record amounts through bond and equity issuances. The share of global capital market financing by emerging economies has increased significantly, with middle-income countries experiencing a fourfold rise in cumulative net capital issuance (CNI) from 2000 to 2022, while low-income countries saw an eightfold increase. Much of this growth has been driven by domestic capital markets, which have become the primary source of funds for firms in these regions. While capital markets in advanced economies remain larger, the expansion in low- and middle-income countries signals a shift in global financial dynamics. Domestic markets, particularly those issuing bonds and equities, have played a crucial role in providing financial access to businesses, allowing them to raise funds for investment and expansion. The study also finds that capital market activity in these regions has outpaced traditional bank financing, giving firms greater flexibility in structuring their financial strategies.

The Rising Participation of Firms in Capital Markets

A key factor in this expansion has been the increasing participation of firms in capital markets. Between 2000 and 2022, approximately 14,000 firms in low- and middle-income countries accessed capital markets for the first time, marking a significant transformation in financial accessibility. This shift has enabled younger and smaller firms to secure funding that was once limited to well-established corporations. In contrast, high-income countries continue to see market concentration, with most activity dominated by firms that were already active before 2000. Despite the growing number of firms accessing capital markets, a high level of market concentration persists, meaning that while new firms are participating, a substantial portion of the capital raised is still controlled by a few large companies. Nevertheless, the increasing number of new issuers suggests that capital markets are becoming more inclusive, offering businesses more opportunities to scale and compete in the global economy.

Capital Market Financing and Economic Growth

The impact of capital market financing on firm performance and economic growth is substantial. The study provides strong evidence that firms issuing bonds or equities utilize the funds productively, leading to significant increases in investment, employment, and revenue. The effects are particularly pronounced in low-income countries, where financial constraints are more severe. Issuance activity is associated with a 16 percent increase in physical capital investment within a year, with long-term effects persisting for several years. Additionally, firms that access capital markets see higher sales and employment growth, demonstrating the broader economic benefits of market expansion. A crucial finding is that firms with higher marginal returns to capital (MRK) benefit the most from capital market access. These firms tend to be more efficient, generating greater output per unit of investment. Consequently, capital markets contribute to a more effective allocation of financial resources, directing funds to firms that can use them most productively. This improved efficiency enhances economic growth and innovation, particularly in sectors requiring long-term investment, such as manufacturing, infrastructure, and technology.

Key Policy Drivers and Future Challenges

The study identifies several policy factors that have contributed to capital market growth in emerging economies. Pension reforms have been particularly influential, with countries that introduced mandatory retirement savings schemes seeing a significant increase in domestic capital market activity. The transition to prefunded pension systems has created large pools of investable savings, which have fueled corporate bond and equity markets. Additionally, countries that liberalized financial markets and eased restrictions on international capital flows saw a boost in foreign investment. However, the research warns that capital market expansion alone is not sufficient to sustain economic growth. Governments must implement broader financial sector reforms, including stronger investor protections, enhanced financial transparency, and the development of sovereign bond markets as pricing benchmarks. Strengthening domestic financial infrastructure is essential to ensuring that capital markets function efficiently and continue to support business growth.

While domestic capital markets have played a crucial role in providing financing opportunities, challenges remain. Many firms in emerging economies still struggle with high borrowing costs and limited access to financial markets, emphasizing the need for targeted policy interventions. Better corporate governance, enhanced disclosure requirements, and efforts to attract institutional investors are necessary to ensure the continued development of capital markets. Governments and financial institutions must work together to improve access to finance, particularly for smaller firms facing higher entry barriers. Strengthening financial literacy and investor confidence can also help expand market participation. Furthermore, firms can enhance their access to capital by improving corporate governance structures and voluntarily increasing financial disclosure.

The Road Ahead for Capital Markets in Emerging Economies

The study offers a comprehensive analysis of how capital markets drive firm growth and economic development. By enabling efficient allocation of capital, these markets support business expansion, job creation, and innovation. While significant progress has been made, sustaining this momentum requires continued policy reforms and institutional support. The role of capital markets in shaping the economic landscape of low- and middle-income countries will only become more critical in the coming years. Governments, investors, and businesses must collaborate to address existing challenges and create an environment that fosters sustained financial development. By doing so, capital markets can continue to serve as a powerful tool for economic progress, unlocking new opportunities for businesses and contributing to the long-term prosperity of emerging economies.