The Future of Domestic Capital Markets in Developing Countries

Chapter 2. Trends in Developing-Country Capital Markets around the World

 Trends in Developing-Country Capital Markets around the World 2 One of the key structural changes in a growing number of emerging markets has been the rapid development of local securities markets since the mid-1990s. This change has reflected both policy efforts by the authorities in major emerging markets and trends in global financial markets . In this paper, we review some of the trends in the development of local markets as well as some key policy issues, as reported in several of the International Monetary Fund’s Global Financial Stability Reports.1 The efforts to develop local securities markets have been motivated by a number of considerations, especially the desire to provide an alternative source of funding in order to self-insure against reversals in capital flows. One motivation has been a desire to stimulate domestic saving by offering savers new financial instruments that broaden the set of investment opportunities and allow for better portfolio diversification. In many emerging markets, for example, domestic residents traditionally have had access to only two types of domestic instruments—bank deposits and domestic equities—and have had little access to international markets. Another consideration has been to improve the intermediation of domestic savings and attract foreign investors. This has become particularly important as a    .    1. International Monetary Fund (2002a, 2002b, 2002c). greater number of emerging markets have privatized their pension systems. In some countries, such as Chile, the private pension funds and insurance companies have been key sources of demand for high-quality corporate bonds, reflecting a desire to achieve a rate of return higher than can be obtained on bank deposits and also to access longer-duration assets (which better match their long-duration obligations). Moreover, emerging markets have sought to develop alternative sources of funding for both the public and corporate sectors to either domestic bank lending or international capital markets.2 In addition, local derivatives markets have been seen as providing a vehicle for managing financial risks, especially those related to exchange rates and interest rates. The measures adopted to further the development of local securities and derivatives markets have typically encompassed efforts to strengthen market infrastructure and create benchmark issues, expand the set of institutional investors, and improve corporate governance and transparency. However, there are several key policy areas where no consensus has emerged regarding either the factors that will influence the likely outcomes or the most appropriate policies. Issues remain regarding the following: —The use of instruments indexed to changes in such variables as the price level and exchange rates, —The government’s role in promoting the development of local equity markets, —The role of foreign investors in local securities markets, —The sequencing of reforms in local securities and derivatives markets. The paper is organized as follows. The first section reviews recent trends in the development of local capital markets in the major emerging markets and draws some comparisons to the mature markets. This is followed by an analysis of the role that local markets have played as an alternative source of funding in the absence of access to international markets or the banking system. Next, the main policy measures undertaken to promote the development of these markets are reviewed, as well as some areas where there is less than full consensus in the policy community. We conclude with some final thoughts on the future of these markets.  , ,   2. Drawing on lessons from recent emerging-market crises, Greenspan (1999) notes that welldeveloped bond markets can act like a “spare tire” and substitute for bank lending as a source of corporate funding when bank lending dries up. Recent Trends in Emerging Local Securities Markets Local bond markets in emerging markets have grown considerably over the last decade, but they are still much smaller than bond markets in the G-7 countries. Although emerging local bond markets have nearly doubled in size since 1993, to roughly 36 percent of gross domestic product (GDP), they are still a long shot from developed-country bond markets (see table 2-1). Mature markets average 122 percent of GDP, although this is influenced by the large 151 percent of the United States, with euroland showing a lower figure of around 88 percent of GDP. Until the mid-1990s, emerging local bond markets were generally underdeveloped, with restricted demand for fixed-income products, a limited supply of quality bond issues, and inadequate market infrastructure. However, particularly in the period after the Asian crisis...