Financial systems and development

esources in government securities or programs ance between safety and real returns and by fosterwith
low returns in the social sectors. (Sometimes ing greater competition.
contractual savings institutions hold government
securities because they lack alternative investment Securities markets
opportunities.)
Although a government with a deficit needs Well-developed securities markets enlarge the
funds from a source other than the banking sys- range of financial services. Short-term money martem,
it does not necessarily need long-term fi- kets provide competition to the banks in supplying
nance. Furthermore, the government's legitimate credit to larger corporations, and under appropriconcern
with the soundness of the assets in which ate conditions capital markets can provide longpension
funds invest need not preclude invest- term finance to government and large firms.
ment of those funds in the private sector. Governments
in high-income countries have enacted MONEY MARKETS. The development of securities
prudential rules for pension and insurance invest- markets usually starts with trading in a short-term
ments, and these rules allow pension funds to in- money market instrument, often a government sevest
in private sector activities. Chile and Singa- curity. Other money market instruments are interpore
have moved in recent years to allow the bank deposits, bankers' acceptances, certificates of
pension authorities to invest in other than govern- deposit, and commercial paper issued by nonfiment
securities (see Box 7.7).
nancial corporations. Money markets provide a
Because pension and insurance institutions are noninflationary way to finance government defilikely
to be relatively large and therefore able to cits. They also allow governments to implement
afford professional management, these managers monetary policy through open market operations
are able to play a role in the monitoring and control and provide a market-based reference point for
of the firms in which they invest. Governments setting other interest rates. Furthermore, money
can encourage the industry to develop by creating markets are a source of funds for commercial
a regulatory framework that seeks a proper bal- banks and other institutions with limited branch
Box 7.8
Capital markets in India
In the 1950s India's capital markets helped to mobilize bay exchange increased from $11.8 billion to $19.4 bilfinancial
resources for the corporate sector. The impor- lion between the end of 1980 and 1987; average capitalitance
of these markets then diminished, because subsi- zation ratios remained roughly equal to 6.5 percent of
dized credits were available from commercial and de- GNP. The number of listed companies on all exchanges j
velopment banks, equities had to be issued at a increased from 2,114 in 1981 to 6,017 in 1987. New I
' discount substantially below market value, the capital issues of debentures also multiplied. However, there
* market lacked liquidity, and investor safeguards were were also abuses, such as the use of misleading proj
inadequate.
spectuses and insider trading. In addition, the process-
A reform of the Foreign Exchange Regulations Act in ing of new issues, which were heavily oversubscribed
the early 1970s limited the expansion of foreign-owned because of their low prices, was plagued by delays in
and foreign-controlled companies. In response, many share allocation.
companies decided to become Indian companies. This In April 1988 the Securities and Exchange Board of
* led to the issue of substantial quantities of company India was established to oversee and regulate the marshares
at low prices. The market's revival continued in kets. In August 1988 a credit rating agency was estab- , 1
the 1980s, as various measures were introduced to lished to grade capital issues. In January 1989 pro- i l
stimulate both demand and supply. Incentives for eq- posals were published regarding the appointment of
uity and debenture issues included reducing the corpo- market makers offering bid-and-asked quotations, the
rate rate of tax for listed companies and fixing the per- responsibility of stockbrokers for vetting companies bemitted
interest rate for debentures above that for fixed fore listing, the opening of stockbroking to banks and
deposits but below that for bank loans. The govern- other financial institutions, and the creation of a seci
ment also authorized the use of cumulative, convert- ond-tier market for smaller enterprises, with less onerible
preference shares and equity-linked debentures ous listing requirements. The measures were intended
and gave generous fiscal incentives to investors. to improve market liquidity and transparency and to
The growth of the Indian capital markets has been provide adequate protection to investors.
impressive. Equity market capitalization on the Bom- i
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