Latin American Capital Markets

144 KAREN GOLDSTEIN ROSSOTTOChile, the replacement of public pay-as-you-go systems with privately managed, fullyfunded pension systems has led to a prevalence of private defined-contribution systemswithin the region. However, with the exception of Chile, most countries' pensionreforms are relatively recent, and their benefits are not yet fully realized.Without further reforms to establish the other conditions necessary for institutionalinvestor growth, pension reform alone will likely have little impact. For example,defined-contribution plans will be less effective at encouraging long-term savingswithout stable macroeconomic conditions (Uthoff 2000). Regulatory frameworksthat limit the scope of pension fund investments influence the development of efficientand innovative capital markets.Availability of CapitalA sufficient amount of capital is a prerequisite for a well-functioning, liquid marketTherefore, the smaller markets of Latin America and the Caribbean are at a disadvantagerelative to more liquid foreign markets. Furthermore, the fact that large localcompanies are able to finance their activities in foreign markets adds to the problemof a lack of adequate capital for a local market to provide funding for small andmedium enterprises (SMEs). Many SMEs must rely on their own resources or otherlocal credit sources (Gaa and others 2001).Dependence on the infusion of foreign capital to increase market liquidity hasproved an unreliable strategy because foreign capital flows can be quickly cut off inperiods of crisis, thus further disrupting local markets.The history of financial instabilityin Latin America and the Caribbean has resulted in households being reluctant tohold their assets in the formal financial markets. In a vulnerable environment, somemiddle- and upper-income households may invest their savings outside domestic markets(World Bank and CGCED 1998); others may meet their liquidity needs by holdingcash (Rojas-Suarez and Wiesbrod 1996).Lock of a Sound Regulatory Framework and Effective SupervisionTo protect fund affiliates, Latin American and Caribbean countries with defined-contributionplans restrict the investment of pension fund portfolio assets in foreign orequity securities (Vives 1999). Because these regulations tend to create uniform investmentportfolios, the institutional benefits of innovation, increased efficiencies, anddiversification are not realized in the capital markets. For example, in Mexico,A pensiofunds may not invest in equities, so their portfolios consist almost entirely of fixedincomesecurities. Other investments with broader social benefits are also prohibited,Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub