Latin American Capital Markets

DEVELOPING BOND MARKETS: A COMPREHENSIVE VIEW 31on building a sovereign yield curve, issuing simple and standardized government securities,avoiding market fragmentation, and providing enough liquidity for each issue. Inthe early stages, the authorities may need to issue inflation-linked or floating-rate securitiesto obtain longer maturities, particularly in countries that have recently experiencedpoor macroeconomic management (high inflation, debt restructuring, or unsustainabledeficits) or that could face significant refinancing risk due to the size of their debtThe most common type of government bond benchmarks in developedmarkets are those issued at fixed interest rates; the benchmark maturities usually are2-3, 5, and 10 years.Treasury bills issued as zero-coupon instruments dominate theshort-term portion of the yield curve. Some Latin American countries have reachedan interesting level of development in benchmark issues. Colombian authorities haveestablished a 10-year fixed-interest-rate bond benchmark, extending the average lifeof the debt portfolio (box 10-2). Chile has achieved an extended range of maturities,reaching 30-year maturity. However, given that the instruments are indexed to theinflation rate and the issues are not very liquid, the market is not active; therefore,the yield does not necessarily constitute a true benchmarkThe limited liquidity of themarket could lead to higher interest rates as a result of liquidity premiums. Brazil hasbeen issuing indexed bonds (to the overnight rate, the inflation rate, or the U.S. dollar)to reach longer maturities, but this strategy diminishes the country's rollover riskand brings other risks, such as interest rate and currency risks. In fact, the governmentcarries all the risks and still pays high real interest rates, while the bondholder basicallyonly assumes the sovereign credit risk This practice has not been conducive tosustainable market developmentAnother important component of a sound debt issuance strategy is accessto primary markets.The main objectives for implementing an effective securities salemethod are to increase competition in the primary market and to efficiently deliversecurities to investors.It is important that the legal framework supports government actions andreinforces market development The most common sales procedure in mature marketsis by auction, but early-stage syndication is also useful because it ensures theallocation of the issue and minimizes placement risks. Primary dealers could play akey role in the government's funding strategy because their principal goals are topromote investment in government securities and to ensure activity in the governmentbond market Some rules of the game must be established in order to regulaterights, limits, and obligations. Some of the benefits of using primary dealers are thatthey provide liquidity, the government can reach different types of investors, and primarydealers can facilitate the shift to a market-based funding environment However,Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub