Latin American Capital Markets

DEVELOPING BOND MARKETS: A COMPREHENSIVE VIEW 309rency issues and dependence on international bond markets. In fact, if it is combinedwith sound debt management policy, the domestic bond market reduces exposure tofinancial risks. Moreover; a market-oriented funding policy based on a liquid governmentsecurities market will reduce debt service costs over the medium to long term.It is only by having a less risky portfolio and lower real costs that governments canachieve more sustainable growth in their debt portfolio.From a microeconomic and market architecture perspective, the governmentsecurities market leads to the development of financial infrastructure, products, andservices, creating a competitive environment that helps to build long-term financial sustainability.If properly developed, the securities market could change the financial architectureof a country from a bank-oriented system to a bipolar system with a significantcapital market component aimed at more harmonious financial development. In addition,the government bond market helps develop legal, information, and institutional infrastructurethat benefits the entire financial system. Finally, some financial products,such as derivatives, repos, and money market instruments, which help to manage risksfor the overall economy and improve financial stability, can only be introduced after thegovernment securities market is either developed or being developed.Money Markets and Monetary PolicyGovernment cash transactions and movements have a significant impact on themoney supply, not only because governments are the largest participants of the bankingsystem in most economies but also because they deposit their cash in the centralbank in order to avoid credit counterparty risks. Since uncertain government cashmovements are an unpredictable source of liquidity for central banks and could forcethe monetary authority to tighten conditions for banks, sound cash managementpractices are essential. And proper cash management practices support the efforts ofthe central bank to stabilize inflation and develop money markets.Banking systems need to manage liquidity and risks, and both can be addressedthrough government securities, which bear zero risk and are the most liquid instrumentsin almost every market. After short-term interest rate liberalization, the developmentof short-term government securities and money markets can grow simultaneouslyand reinforce each other A sound money market is a necessary condition for thegovernment bond market because it provides liquidity for those securitiesThis marketnot only makes government securities cheaper and less risky to warehouse but alsofunds trading portfolios of securities, which is essential for the effective involvement ofmarket intermediaries in developing secondary markets (for example, market makers).Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub