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Managing the economic and financial mechanisms of the global markets.

1. Introduction

Ocampo et al. remark that the exchange rate fluctuations generated by capital account fluctuations generate major pro-cyclical wealth effects in countries that have net liabilities denominated in foreign currencies. Countries with open capital markets are typically forced to raise interest rates to stop capital outflows. Countries dependent on borrowing face the problem that foreign creditors may demand repayment of their loans. Booming capital inflows tend to reduce interest rates and increase credit and the money supply. The exchange rate plays the central role of linking the external and the domestic macroeconomic dynamics. del Valle and Ugolini state that national economies become increasingly open and interlinked with a market-oriented global financial architecture, and maintain that central banks share debt management responsibility for auction administration, record keeping, disbursements, and interest payments. There is a need to introduce appropriate accounting, auditing, and disclosure practices for financial sector reporting. Banks writes that financial risk can be divided into market risk, liquidity risk, and credit risk. Market risks can arise from directional, volatility, correlation, dividend, basis, and curve movements. Capital markets investors providing liquidity via commercial paper or medium-term notes may choose not to roll over their investments. Significant crises are a fairly typical occurrence, striking every few years. A properly structured risk management process is at the heart of any sound financial system. Das claims that the emerging market economies are better integrated in the global economy than the rest of the developing world. The emerging markets of Asia and Europe became important destinations for the private capital flows.

2. Effective capital account regulations

Ocampo et al. note that capital inflows can have a positive effect in the short run during periods of booming capital inflows, but a negative effect in the long run. Higher risk increases the return investors require, limiting long-term investment. Crises are often followed by an extended period of slow economic growth. Short-term capital inflows do not lead to efficiency gains or to sustained development of the financial system. The greater macroeconomic discipline imposed by CML is not appropriate for many developing countries. Capital market liberalization exacerbates real macroeconomic instability and the incidence of financial crises. There is an empirical relationship between capital account openness and income inequality (inequality frequently increases following capital account liberalization). Ocampo et al. remark that governments need to take into account how their actions affect the attractiveness of investment. The policies demanded by capital markets are not those that maximize long-term growth. Capital market interventions can be used to stabilize short-term volatile capital flows and can give policymakers additional policy instruments that allow them more effective and less costly macroeconomic stabilization measures. Ocampo et al. claim that effective capital account regulations can promote growth and increase economic efficiency by reducing the volatility of financing and the volatility of real macroeconomic performance and can discourage long-term capital outflows.

Ocampo et al. observe that interventions designed to prevent crises can be effective even if controls are partially circumvented. Capital controls include quantity and price-based regulations. Capital market regulations segment the domestic capital market from international markets and capital flows. A market failure prevalent in many developing countries is the lack of well developed capital markets. Ocampo et al. notice that segmentation can have positive macroeconomic effects for four reasons: (i) it leads to a more stable demand for locally denominated assets; (ii) it reduces risks associated with foreign borrowing; (iii) it helps insulate the economy from pro-cyclical foreign borrowing; and (iv) it enhances the ability of government to control the macroeconomy. Capital market interventions can be used to segment the market and reduce the capacity of domestic residents to substitute foreign assets for domestic assets. Segmentation reduces the magnitude of pro-cyclical wealth effects that characterize economies with large dollar- or euro-denominated debts, enhances the ability of government to control the macroeconomy, increases the ability to use the exchange rate as a macroeconomic policy tool, and improves the effectiveness of exchange rate management. (1)

3. Developing domestic bond markets

del Valle and Ugolini provide an overview of the policy framework and building blocs for reform that are necessary to develop a government bond market. Developing domestic bond markets is a complex process involving challenges in several areas. Macroeconomic stability and clear debt management objectives are necessary stepping stones toward developing a market for domestic government bonds. Macroeconomic and financial stability are essential for developing a well functioning government bond market. del Valle and Ugolini insist that longer-term maturities are characteristic of East Asian countries, signaling low expectations of inflation, devaluation, or risks of default. Auctions are the dominant selling technique in domestic government bond markets. Timely and systematic disclosure of information enhances transparency of policies, reduces uncertainty, allows investors to make well-informed business decisions, and lowers borrowing costs. The primary dealer arrangement helps the absorption and distribution of bonds. The legal framework should define the requirements for information disclosure. Market regulation should ensure that secondary-market trading is conducted in a transparent and efficient manner. del Valle and Ugolini characterize the challenges confronting many emerging debt markets to diversify their investor base. Institutional investors tend to prefer low-risk instruments and long-term products. The money market is the cornerstone of a competitive and efficient system of market-based intermediation. The structure of the reserve requirements can contribute to money market stability. Coordination with the central bank on matters pertaining to debt management and monetary policy is necessary. Government securities play an important role in monetary policy. Primary issues in emerging regions are generally conducted via auctions. The issuance of nonmarketable securities, which tend to segment the market, is not common in emerging regions.

del Valle and Ugolini suggest that the dominance of short-term maturities may indicate high expectations of inflation, devaluation, or risks of default. Most markets are phasing out paper securities and moving toward fullfledged book-entry securities. Exacerbating the lack of liquidity in the secondary markets are restrictions on liquidity-enhancing transactions. Bond markets are key tools for a country to diversify risks and enter a sustained phase of development. The development of a corporate bond market helps the private sector to diversify its sources of funding and generates competition in financial services. del Valle and Ugolini stress that the emergence of a benchmark government yield curve can encourage the development of new financial products. (2)

4. The financial markets in the emerging market economies

Banks describes the range of market and credit risks a banking institution may face and considers how the four-stage risk process operates in theory. There is no reinsurance market or securitization market for financial catastrophe risk. regulators shape the rules and regulations that govern the markets and institutions operating within their purview (the market and credit risk models of individual financial institutions are reviewed on a regular basis by regulatory authorities). (3) Das maintains that the contagion effect became a defining feature of the emerging market economies during the 1990s and early 2000s, and focuses on what could be called an absolute pre-condition for the creation of an emerging market economy, delves into the domestic and global economic and financial environment affecting the emergence of an economy, and explores the macroeconomic factors in the emerging market and industrial economies that shaped the global financial scenario of the 1990s. As Das puts it, global trade in goods and services has expanded many-fold, benefiting many new dynamic developing-country traders. Poorly managed integration can result in myriad problems (4) for the integrating emerging economies. (5)

5. Conclusion

Ocampo et al. hold that developing countries are likely to continue to be subject to strong pro-cyclical swings in external financing. Financial and capital markets are not selfregulating and are highly segmented under the current globalization process. del Valle and Ugolini affirm that the central bank assumes the role of fiscal agent for the government issuer, encompassing auction administration, record keeping, disbursements, and interest payments. The development of bond markets has taken very different courses in different regions at varying stages of development. del Valle and Ugolini highlight a number of complementary policies and structural developments that are important for encouraging and enabling the development of government bond markets. Banks contends that credit ratings may again become a credible and useful dimension of the financial markets. Corporate and sovereign issuers cannot access the broad debt markets without a rating. The securitization market remains a valid and viable risk transfer mechanism. The market for securitizing low severity/high frequency is by now well-established. Das remarks that global financial markets are highly sensitive to policy inconsistencies and their outcome. A depressed external environment reverses capital market flows to the emerging market economies.


(1.) Ocampo, J.A. (2008), "Capital Market Liberalization and Development", in Ocampo, J.A. and Stiglitz, J.E. (eds.), Capital Market Liberalization and Development. New York: Oxford University Press, 1-47.

(2.) del Valle, C. and Ugolini, P. (2003), "The Development of Domestic Markets for Government Bonds", Litan, R.E. et al. (eds.), The Future of Domestic Capital Markets in Developing Countries. Washington, DC: Brookings Institution Press, 45-76.

(3.) Banks, E. (2009), Risk and Financial Catastrophe. New York: Palgrave Macmillan.

(4.) Zaharia, C. et al. (2009), "The Improvement of Agricultural Marketing Systems in European Countries", Economics, Management, and Financial Markets 4(3): 313-317.

(5.) Das, D.K. (2004), Financial Globalization and the Emerging Market Economies. London-New York: Routledge, 3-8.


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Author:Cristea, Andrei
Publication:Economics, Management, and Financial Markets
Date:Dec 1, 2009
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