Latin American Capital Markets

PRAGMATIC ISSUES IN CAPITAL MARKET DEVELOPMENT IN EMERGING ECONOMIES 509lating capital market development, the government's role must also have a specificdemonstration effect based on the nature of the deal or transaction undertaken.In addition, the government should ensure that there is equity in the waytransactions are completed so that other transactions could be initiated in the futureand there is no unfair advantage provided to a select group that can capture theprocess and retain the gains independent of the functioning of the system. At a minimum,government's action should create a suitable environment to stimulate privatesector participation and risk taking.Private SectorThe private sector, especially market infrastructure institutions, institutional investors,listing companies, and financial intermediaries, clearly has a central role to play in furtheringcapital market development. Ideally, the objective should be to encourage theprivate sector to engage in capital market transactions with manageable levels of riskand to limit inequities in the process. This represents a major challenge for manyemerging economies, where a basic and, in some instances, relatively well-developedmarket infrastructure and legal regulatory framework may exist, but where there islittle market activity. Companies thus have little incentive to issue securities, investorshave few assets in which to invest, and firms find it scarcely profitable to provide financialintermediation.For many emerging economies, the challenge of private sector involvementoccurs alongside the increasing interest in taking capital market activities offshore viaADRs and foreign currency-denominated issues. During the past decade, issues fromemerging markets raised an average of $7 billion a year though ADRs, with the averageclose to $22 billion in more recent years, peaking at $32 billion in 2000. In the early1990s, Latin American ADRs dominated the market, but these have recently shifted toAsia. 10 However, these markets are relevant only for the largest issuers.There are many issues that reduce the willingness of the private sector toparticipate in domestic capital market activities. First, the reinforcing cycle of illiquidityis a common feature of many capital markets in developing economies. The lack ofliquidity in local capital markets encourages major private sector issuers to shift to offshoreor more developed capital markets, which further reduces the liquidity in thelocal marketplace. On the investor side, corporate governance particularly concernsthe treatment of minority shareholders and discourages some investors from demon-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub10 See IMF (2000a, box 3.6) for more details and discussion of depository receipt programs.