Latin American Capital Markets

PRAGMATIC ISSUES IN CAPITAL MARKET DEVELOPMENT IN EMERGING ECONOMIES 491It is extremely difficult to undertake a full cost-benefit analysis when assessingwhether a particular market may be viable. Capital markets may perform a widerange of economic and political functions (Lee !998).They may offer forums for trading,investment, speculation, hedging, and arbitrage; serve as mechanisms for price discoveryand information dissemination; provide vehicles for raising finance for countriesand companies; help obtain effective corporate governance and facilitate changesin corporate control; and be used to implement privatization programs.They may facilitatethe development of emerging and transition economies. Measuring many ofthese objectives is extremely difficult. In addition, the direct costs of establishing a marketare shrinking as the costs of installing and operating a computerized trading systemcontinue to decrease.Consistency with the Entire Financial Sector Reform ProcessA capital market is only one element in a complex, tightly linked network of differentelements that together compose the financial sector of a country. A capital marketdevelopment strategy for a country should therefore be encapsulated within, and beconsistent with, a wider strategy for financial sector development in the country. Aholistic approach is necessary that ensures consistency between, for example, the developmentof the capital and financial markets, the role of institutional investors, andthe solution to social problems. A good example of the latter is the case of Chile,where the reform of the pension fund system was a key to significant growth in theliquidity of the markets in the late 1980s and 1990s. Several European countries thathave linked the development of domestic capital markets to privatization, reductionof government deficits, and pension reform provide other examples.There are many ways in which to exploit synergies between reform in otherareas of a financial sector and the capital markets. For example, strategies targetingpension systems, access to housing finance, monetary and fiscal policy, the developmentof small and medium enterprises (SMEs), privatization, and the construction ofa country's large physical infrastructure can all be opportunities to increase the viabilityof capital market instruments.Institutional investors can be a good vector for corporate governance andshareholder activism. However, policy initiatives to develop institutional investors oftenrequire handling policy issues outside the realm of capital market development, suchas reform of pension funds. It is important in such contexts that the policy objectiveof capital market development be balanced against other social objectives. While reformof a pension system can bring benefits for the capital markets, policymakers mustCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub