Latin American Capital Markets

302 CLEMENTE DELVALLEexpectations discourage investors from allocating resources to government bonds, increasethe cost of funds, and shorten the maturity of issues. A credible commitmentto contain inflation is an essential step in developing a securities market; therefore, anindependent and well-managed central bank is necessary to complement fiscal policy.Likewise, sound fiscal policy must complement the monetary authority's efforts tocontain inflation.Exchange Rate RegimeExchange rate and capital account policies have a direct impact on government bondyields, reflecting exchange rate and default premiums. Inadequate policies increaseboth volatility and interest rates. Volatility has a negative impact not only on developinglong-term government bonds but also on secondary market liquidity, especiallywhere no complementary markets exist to hedge the risk of price movements. Capitalaccount deregulation needs to be carefully considered because unrestricted capitalmovements could expose the economy to risks of contagion from external crises.Sound monetary and fiscal policies combined with good management of debt and reservescan lessen these risks. An unstable macroeconomic framework not only constitutesan impediment to capital market development but also destroys efforts andachievements in that direction.Financial Sector Reform and StabilityInvestors' concerns about the banking system adversely affect the government's effortsto develop the market. Moreover, lack of financially healthy intermediaries willcause secondary market liquidity to fall.Therefore, with a banking system in crisis, it isnot possible to develop a government securities market, because markets—such asthe repo and interbank markets—are closely related to both government securitiesand the financial market and cannot function properly with an unsound banking system.Financial system reform—liberalization and stabilization—must address informationinfrastructure, sound supervision and regulation, interest rate liberalization, andcompetition.Information InfrastructureInformation disclosure plays a key role in building market credibility, not only becauseinvestors are reluctant to deal without properly disclosed information but also be-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub