Financial systems and development

strides in recent years in establishing and invigo- requires all limited liability companies of a certain
rating equity markets. Such markets now exist in size to make the same financial disclosures as pubmore
than forty countries. Indeed, the market cap- licly listed firms. In the past, demand for securities
italization of stock exchanges (that is, the total has been inhibited by the lack of investor confivalue
of listed shares) is a greater proportion of dence. In the future, much of the demand is likely
GNP in Jordan and Malaysia than in France and to come from institutional investors.
Germany, and India's stock exchanges list more A primary reason for the underdeveloped state
companies than the stock markets of any other of capital markets in many developing countries is
country except the United States (see Table 7.1). In the absence of an appropriate legal, regulatory,
many countries, however, equity markets remain and tax framework. In some countries new shares
small. Only a few countries have active corporate have to be issued at par value, which makes them
bond markets; they include Canada, India, Korea, unattractive to companies if the market value of
and the United States.
their shares has appreciated significantly. In other
The supply of equities has been limited by the countries the tax-free status of time deposits or
reluctance of owners of private companies to dilute government and public enterprise bonds lessens
their ownership and control by issuing stock or to the appeal of private corporate instruments. Far
comply with requirements to disclose information more important in developing countries, however,
about their operations. The availability of less ex- is lax enforcement of corporate income taxes. This
pensive debt finance has also discouraged equity makes it possible for closely held corporations to
issues. Some countries-for example, Korea-have avoid taxes by showing very low accounting
provided considerable tax incentives to encourage profits; publicly traded corporations cannot hide
corporations to go public. In Jordan, any firm seek- their profits without hurting investor confidence.
ing limited liability must offer a substantial per- A common problem in securities markets, especentage
of its shares to the general public. Chile cially early in their development, is the danger of a
speculative boom followed by a sharp decline.
Such crises have affected markets in Brazil, Hong
Kong, Korea, Mexico, the Philippines, Singapore,
and Thailand. Large increases and declines in
Figure 7.2 Stock indexes in selected developing prices also affect securities markets in high-income
countries and the United States, 1987 and 1988 countries, but they can be much more pronounced
in young markets. The Wall Street collapse of Oc-
Index (December 1986 = 100)
tober 1987 was far less abrupt than the collapse of
800 many smaller markets (see Figure 7.2).
Countries with a relatively large business sector
700 and middle class should encourage the develop-
600 Portugal Turkey ment of securities markets. Fiscal policies that dis-
___- -- / -- criminate against equities should be changed.
500 ___ Governments also need to define the operational
400 i } \ X X ; ' 2 scope of underwriters, brokers, dealers, merchant
----------
_-- - -- ¢-t-- banks, and mutual funds and to encourage the es-
300 tablishment of credit rating agencies. Privatization
200 Mexico
/----t---- i ..
of state-owned enterprises can be another stimulus
to securities markets. Privatization has been one of
100 ' the forces revitalizing Chile's equity market in re-
0 Philippines UnitedStates cent years. In France, 167 state enterprises and
I
0
March September March September
subsidiaries were divested from late 1986 through
early 1988, and their shares were taken up by more
December June December June December
1986 1987 1988
than 13 million individuals. As a result the capitalization
of the Paris stock market increased by an
amount equivalent to 6 percent of GDP.
Note: For the developing countries, the stock index is the IFC Enouraging fori portf i s ns
index of total returns in U.S. dollars; for the United States, it is Encouraging foreign portfolio investment is anthe
Standard and Poor's 500.
other way to raise demand for securities in devel-
Sou(rce: IFC 1988 and 1989.wa
oping countries. The increasing role of institutional
investors means that foreign portfolio
110