Latin American Capital Markets

92 VALERIANO F. GARCIA AND LUIS ALBERTO GIORGIOidea that the government has to create a market for public debt in order to establishbenchmarks and nurture the development of private issues.This approach and a longtermview have indeed been a successful model in many developed countries.However, in Latin America and the Caribbean, once the market is initially setup through government debt, it is used as an instrument for running an unsustainablepublic deficit with significant negative effects on the development of capital markets.Under these circumstances, the private sector, which was supposed to be the finalbeneficiary, can never compete with the high interest rates and public guarantee ofofficial debt Consequently, a natural tendency prevails for crowding out the privatesector because the public sector is seen as providing high returns with low risks.Researchers have studied the legal design of financial markets, the relationshipbetween financial market development and the macroeconomic environment, financialreform, and other structural factors (King and Levine 1993; La Porta and others1997; Beck and others 2000; Henry 2000; Bekaert, Harvey, and Lundblad 2001).In general, there is consensus on the fact that financial markets tend to develop as incomeper capita grows and financial reform progresses.The purpose of this chapter is to provide policymakers and financial expertswith an overview of relevant issues related to the impact of macroeconomic policyand structural factors, such as institutional arrangements, on the development of capitalmarkets in emerging economies, with particular emphasis on Latin America.Thechapter analyzes the constraints imposed by exogenous macroeconomic factors onthe effectiveness of capital market performance. The chapter highlights the negativeimpact of financial regulations giving ineffective preferred status to banking over capitalmarket investment and financing instruments. It begins with a broad approach inanalyzing the traditional moral hazard issues derived from financial policies and bankingregulations. The analysis evaluates the main trends prevailing in the institutionalframework affecting capital markets and summarizes the main lessons from the LatinAmerican experiences.Macroeconomic and Structural Constraints to Capital MarketDevelopment in Latin AmericaCapital markets intermediate funds across economic units and time preferences.Theyallow separation between those economic agents that produce surpluses and savefrom those that produce deficits and invest. In addition, by creating a menu of options,capital markets cater to different risk and time preference profiles. For example, thetime profile of investors' demand for funding usually exceeds that of savers.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub