Capital Markets for Development Financing

Globally, stock markets’ topical issues in recent times are: how dark pools can be better alternatives to trading platforms, or the role of blockchain technology and Distributed Ledger Technologies as alternatives or complementarities to legacy stock exchanges systems, or how to enhance the role of central counters parties (CCPs) in clearing and settlement for over the counter (OTC) transactions and exchange traded derivative instruments, these are some — one thing to note is that we are all operating in the same global markets competing for same share global capital for economies development.
While these are topical issues in the capital markets space, our domestic issues remains: i.e. lack of awareness and education about the role and relevance of the stock markets in the economy, enhancing of listings of cash-based instruments, how can local institutional investors, such as pension funds can be liquidity providers in the market, etc. Should we up our game? Yes – obviously, our capital markets eco-system needs more players such as private equity and venture capital funds, liquidity providers and market makers, we need transaction underwriters and we need to at least have the second generation plain-vanilla products such as Real Estates Investment Trusts (REITs), Exchange Traded Funds (ETFs), Closed-Ended Collective Investment Schemes, Municipal Bonds, Industrial or Infrastructure bonds, Securities Lending and Borrowings, etc — seems to be in our distant future.
However, as I think of that, I am also mindful of some of the progress we have made in these two past decades. However, despite these milestones, the potential for capital market’s contribution to the economic growth and social development could be better. And hey, if it could be better, what would that mean to us? To respond to such a question, one has to ask — what is the role of the capital market in an open society, whose economic model is market based and supposed to encourage private enterprise?
The existence and actually the growing of the capital market offers a variety of financial instruments that can enable economic agents with the country to raise efficiently priced capital and manage financial risks. Additionally, through assets with attractive yields and enough liquidity but with still risk characteristics, the capital market has the potential of encouraging savings in the long-term financial form. Capital markets as an integral part of the financial markets plays a pivotal role, essential for government, private enterprises and other institutions who are in need of long-term funds to source such funds. Government uses the capital market to raise funds for infrastructure development and state related activities; while the private enterprises use the market for business expansion, growth and development.
Given its role in the market-based economy, the capital markets occupies an important place, via their specific mechanisms, capital markets can efficiently succeed to give its contribution to the economic development of the society. The importance of the capital markets is more significant in the case of emerging markets as it is for developed economies, being well-known for their contribution in reorienting financial resources to efficient activities, contributing to the economic reform, but also in implementing economic empowerment and enterprises transparent-based policies.
Economic growth in a modern economy hinges on an efficient, vibrancy and effective financial sector that pools savings and mobilizes capital for productive projects and enterprises. Absence of effective capital market leaves most productive projects/enterprises which carry developmental agenda unexploited. But if exploited, capital market has the potential for connecting monetary sector with the real sector (such as agriculture, manufacturing, infrastructure, etc), therefore facilitates growth in the real sector and economic development. The fundamental channels through which capital market is connected to the economy, economic growth and development can be in the following aspect:
The contact between economic agents with deficit of money and the ones with monetary surplus can take place in a direct way (direct financing), but also by the means of any financial intermediation form (indirect financing), situation in which specific operators realize the connection between the real economy and the financial market. In this case, the financial intermediaries could be banks, investment funds, or other non-bank financial institutions.
Furthermore, Capital market increases the proportion of long-term savings (in the form of pensions, life insurance, etc.) that is channeled to long-term investment. Capital market enables these long-term contractual savings units to mobilize long-term savings from individual household and channel them into long-term investments. Capital markets fulfills the transfer function of current purchasing power, in monetary form, from surplus sectors to deficit sectors, in exchange for reimbursing a greater purchasing power in future. In this way, capital market enables firms to raise capital to finance their investment.
The necessity of capital markets activities in an economy results into an increase in productivity within the economy leading to more employment, increase in aggregate consumption and hence growth and development. It also helps in diffusing stresses on the banking system by matching long-term investments with long-term capital. The existence of the capital market encourages broader ownership of productive assets by small savers. It enables citizens to benefit from economic growth and wealth distribution and provides avenues for investment opportunities that encourage a thrift culture critical in increasing domestic savings and investment ratios that are essential for rapid industrialization.
Additionally, the capital market mechanism allows not only an efficient allocation of the financial resources available at a certain moment in an economy – from the market’s point of view – but also it permits allocating funds according the return and the risk – from the investor’s point of view – offering a large variety of financial instruments with different profitableness-risk characteristics, suitable for saving or risk covering.

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