By Helen Oji
Capital markets, globally, are an integral part of the financial
system, providing efficient delivery mechanisms for savings mobilization
and allocations, risk and liquidity management and corporate
governance.
In addition, they facilitate the management of the government’s
debts, the conduct of monetary policy and provide a channel for
privatisation.
Capital markets can also be a driving force and benefit from the
development of institutional investors such as pension funds, insurance
companies, and mutual funds, fiscal decentralisation and the development
of mortgage markets.
A sound domestic capital market provides a market signal on currents
situations and future expectations. Strong domestic capital markets help
ensure the efficient and sustainable funding of large scale or long
term projects.
Well functioning markets ensure that corporations efficiently
mobilise capital for growth and that markets price well so that valuable
projects will be financed.
Where a country does not have access to equity capital, it faces a
higher cost of capital, leading to the segmentation of markets.
However, capital markets cannot function efficiently unless a number
of elements are in place. These include exchanges and clearing and
settlement systems, money market arrangements to facilitate settlements,
and a legal system to enforce contracts.
Capital markets link issuers having long term financing needs with
investors willing to place funds in long term interest-bearing
securities.
A mature domestic capital market offers a wide range of opportunities
for funding both the public and private sectors of the economy.
Capital markets are built on a number of elements, these include a
number of issuers with long term financing needs, investors with a need
to place savings or other liquid funds in interest-bearing securities.
Intermediaries bring together issuers and investors and the
infrastructure that provides a conducive environment securities
transactions and ensures legal title to securities and settlement of
transactions and provides price delivery information.
Another important element to the development of the domestic capital
market is the regulatory regime, which provides the basic framework.
Efficient capital markets are characterised by a competitive market
structure, low transaction costs, low levels of fragmentation, robust
and safe market infrastructure and a high level of heterogeneity among
participants.
Benefits of the efficient domestic market
There are some important benefits of an efficient domestic capital
market. At the macroeconomic policy level, an efficient market provides
an avenue for domestic functioning of budgets, other than that of the
central bank, thereby reducing the need for direct and potentially
damaging monetary financing of government, especially its deficits.
Furthermore, it helps to avoid a build-up of foreign
currency-denominated debt. It can also strengthen the transmission and
implementation of monetary policy, including the achievement of monetary
target inflation objectives, and can enable the use of market-based
indirect policy instruments.
Also, a shift towards market-oriented funding of government budget
and deficits will reduce debt service costs over the medium long term
through the deep and liquid market for securities.
At the micro-level, the development of a domestic capital market can
increase overall financial stability and improve financial
intermediation through greater competition and development of related
financial infrastructure, products, and services.
Development of the domestic capital market can help the financial
system from a primary bank oriented to a multi-layered system, as the
capital market can complement bank financing.
In an economy with a well-developed capital market, commercial banks
are forced to develop new products to intermediate credit more
competitively.
Fiscal incentives
If a country is not seen as having the ability to manage its public
expenditures or collect tax revenue, or if it has built up substantial
explicit or implicit domestic and foreign debt obligations, investors
will perceive a high default risk and the cost of financing will rise.
The development of the capital market will be more successful when a
consistent macroeconomic framework involving fiscal, monetary, exchange
rate and capital accounts policies are in place.
The fiscal incentives are economic governance- institutional and
legal framework that can ensure proper governance. A record of
accomplishment of fiscal prudence will influence investor perception of
default risk and help build the country’s ability to honour long term
obligations.
Without such credibility, the development of a long term capital market will be more difficult and costly.
For instance, NewZealand, Argentina, and Brazil developed enforceable
fiscal responsibility laws and this helped to create incentives for
proper economic governance.
A reasonably robust fiscal regime is another credible fiscal
incentive. Such a regime should have the capacity to collect direct and
indirect tax revenues and effective budgeting and expenditure control.
For the capital market to develop and become relevant as providers of
the efficient delivery mechanisms for savings mobilisation and
allocation, risk and liquidity management and corporate governance,
fiscal policies and incentives must be right in the context of sound
macroeconomic management.
Fiscal incentives, among others, serve as a prerequisite for
successful capital development. Others include sufficient supply of
funds, sufficient demand for funds and adequate legal and regulatory
framework.
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