Construction in Dakar, Senegal: IMF-World Bank debt issuance plan includes focus on bond financing for African infrastructure (photo: Djibril Sy/Panapress)
EMERGING MARKET COUNTRIES
In a world of large-scale capital flows, the development of a local bond market has become a priority for many emerging market countries. Well-functioning local bond markets make a vital contribution to the efficiency and stability of financial intermediation and to economic growth.
Many emerging market countries have liberalized their capital accounts, improved their macroeconomic environment, and made advances in financial innovation—steps that have increased capital inflows to these countries.
At the same time, demographic changes, second-pillar pension reforms (a fully funded system of privately managed savings accounts), and changes in accounting and regulatory frameworks have led to a rapid growth of assets under management of institutional investors in both mature and emerging market countries. In some emerging market countries, the increase in demand for investable domestic financial assets has outpaced availability, leading to sharp increases in asset prices, rapid credit growth, and currency appreciation.
Deeper, well-functioning local capital markets can help countries cope better with volatile capital flows, provide institutional investors with instruments that satisfy their demand for fixed-income assets, and help contain financial instability associated with asset price bubbles. The substitution of domestic for external sources of finance also helps emerging markets protect themselves from being shut out of international capital markets.
Meeting the challenge
The challenge for many of these countries is to develop sound markets and instruments that will enable market participants to share and transfer risks to those most able and willing to bear them. The IMF and the World Bank have been helping countries pursue that goal, in line with a Group of Eight (G-8) action plan for developing local bond markets in emerging market economies and developing countries. The plan was issued last year at the G-8 meeting in Potsdam, Germany, followed by an implementation report issued after the IMF-World Bank Annual Meetings in October 2007.
Among the areas in which the two institutions' commitment has been evident are the Financial Sector Assessment Program (FSAP), technical assistance, and a joint work program.
The FSAP: A joint IMF-World Bank initiative introduced in May 1999, the FSAP aims to increase the effectiveness of efforts to promote sound financial systems in member countries. Supported by experts from a range of national agencies and standard-setting bodies, work under the program seeks to identify the strengths and vulnerabilities of a country's financial system; determine how key sources of risk are being managed; ascertain the sector's developmental and technical assistance needs; and help prioritize policy responses.
Technical assistance: Both the IMF and the Bank have provided significant technical assistance in response to country requests. Traditionally, IMF financial sector technical assistance focused on central banking and bank regulation. However, as countries have moved toward second-generation reforms, the focus of the IMF's Monetary and Capital Markets (MCM) Department has been broadened to cover issues related to capital markets and asset-liability management. The Bank is also promoting a local currency bond fund (GEMLOC) that represents an important new channel for focusing technical assistance work.
IMF-World Bank collaboration: The International Finance Corporation/World Bank Capital Markets Advisory Group and the IMF's MCM Department have been coordinating closely on issues related to local capital market development. The teams hold regular monthly meetings to coordinate in the following areas:
• Regulatory and supervisory frameworks and trading, settlement, custody, and delivery mechanisms. Through International Organization of Securities Commissions assessments carried out under the FSAP, and as part of individual country and regional advisory programs, the IMF and the Bank have identified reform priorities in various countries and stand ready to offer technical assistance, in coordination with other international financial institutions, to address weaknesses in these areas.
• Public debt management and market development. Ongoing country assistance activities in debt management and debt market development include the recent formulation of an augmented work program for monitoring and improving frameworks for public debt management; and a sharper focus on helping countries develop effective debt management strategies.
• Securitization. Asset-backed securities markets can help improve access to long-term funding for housing and infrastructure investment while also providing pension funds and insurance companies the long-term instruments they need to match their liabilities. Although the recent subprime crisis highlights that risk dispersion can amplify volatility, securitization has fostered the development of financial markets and its merits cannot be discounted. However, it will be critical to ensure that financial innovations are carried out with adequate safeguards and risk management capacities. The IMF has initiated a major project in this area, and the Bank has extensive operations to support individual securitization transactions and is also helping countries build domestic securitization markets through technical assistance on legal and operating frameworks.
• The investor base. Domestic pension and mutual funds, as well as foreign investors, are key to developing broader, more liquid bond markets. MCM, as part of the Capital Markets Consultative Group, is exploring the drivers of change in investor behavior in emerging markets, key impediments to the development of emerging capital markets and local and foreign institutional investors therein, and remedial measures. The IMF is also developing best practices for developing the domestic institutional investor base (including enabling reforms such as pension fund reforms) and for improving regulation and consistency of treatment of institutional, foreign, and other investors. The Bank, whose technical assistance and investment operations promote pension funds and insurance companies, plans to increase efforts to develop bond products that attract more institutional investment. In addition, the GEMLOC project is expected to help diversify the investor base in emerging market countries.
• Emerging repo and derivative markets. These markets are essential for improving liquidity and the ability of market participants to hedge risks across markets. MCM has been working with several emerging market countries in this area, including on a major project on derivatives markets. The Fund, in collaboration with the Bank, will also be hosting regional workshops with participation from regulators and policymakers. The Bank offers derivatives to clients as part of its risk management services and is outlining a strategy to help countries develop these markets.
• Bond markets in less developed countries: A joint IMF-Bank initiative has recently been launched to help low-income countries, including in sub-Saharan Africa, develop and implement their Medium-Term Debt Strategy for debt issuance and debt management. A properly sequenced, designed, and implemented debt strategy will help provide the market with a choice of instruments and other primary market-related incentives needed for the development of the local public bond market. The Bank's Efficient Securities Markets Institutional Development (ESMID) program, funded by the Swedish International Development Cooperation Agency, will also help build bond markets in selected African countries, with an initial focus on improving bond financing for housing and infrastructure development.
• Data quality and availability: The lack of high-quality and internationally comparable bond market data hinders market development in emerging market countries. The staffs of the IMF and the Bank are working with other international financial institutions, such as the Bank for International Settlements and the European Central Bank, on this front. At a September 27-28, 2007, meeting in Washington, D.C., the Working Group on Securities Databases agreed on a sequence of goals to improve data on securities, including the development of a handbook on bond securities. In addition, the Bank is investigating the possibility of creating a bond market indicator and is developing an investability index for emerging bond markets related to the GEMLOC initiative.
• Regionalization. The IMF and the Bank are scaling up their efforts to identify how regionalization should be designed and implemented to bring greater efficiency, scale, and market access to small capital markets. The Bank is studying examples of successful regionalization to draw lessons for future efforts. A study is being launched under ESMID on the regionalization of East African securities.
• Exchange of knowledge and experience. The IMF and the Bank plan to continue to work on this front in the context of workshops and seminars (such as the Bank's Sovereign Debt Conference, the Organization for Economic Cooperation and Development/World Bank/IMF Global Bond Forum, the IMF's Debt Managers' Forum) involving debt managers, regulators, investors, and other market participants.
