Publication: The Role of Foreign Investors in Debt Market Development : Conceptual Frameworks and Policy Issues
Date
2000-08
ISSN
Published
2000-08
Author(s)
Lee, Jeong Yeon
Abstract
To take full advantage of foreign
investors, a host country must provide an appealing
environment: a stable economic and political environment; a
fair, rational, and, comprehensive legal system; a fair,
reasonable, and, balanced tax program; a fair, productive,
and, balanced regulatory system; and transparency in
economic, financial, legislative, and regulatory systems.
The country should also liberalize capital account
transactions. To do so successfully, and minimize risks
associated with foreign investors, capital account
liberalization must be properly sequenced. The chief danger
is removing most restrictions on capital account
transactions, before addressing major problems in the
domestic financial system, and hence risking a crisis.
Typical major problems include shaky, inconsistent
macroeconomic management; severe asymmetric information
problems (such as inadequate accounting, auditing, and
disclosure practices) in the financial, and corporate
sectors; implicit government guarantees; and inadequate
prudential supervision, and regulation of domestic financial
markets, and institutions. Essential infrastructure must be
developed if domestic debt instruments are to be opened to
international portfolio investment. Developing countries
should implement well-synchronized settlement, and
depository arrangements. The risks from short-term debt -
which could threaten financial stability - are best through
sound financial management, and prudential regulation. A
case could de made for additional policy measures aimed at
curbing over-reliance on short-term debt. (Chile, Colombia,
and Israel, for example, have adopted measures to influence
the level, and composition of portfolio capital inflows).
Arguably, liberalization of trade in financial services is
integral to full liberalization of capital markets. Foreign
firms operating in a domestic market may transfer useful
technology, and know-how. Concern that hedge funds can
dominate, or manipulate markets, can be dealt with through
measures to strengthen supervision, regulation, and market
transparency - as well as by strengthening reporting
requirements for larger traders, and positions. The ability
of hedge funds, and other foreign investors to take
positions in domestic financial markets, could also be
limited to: a) Taxing short-term capital flows (as Chile
does). b) requiring banks, and brokers to raise margin, and
collateral requirements. c) Limiting financial institutions;
ability to provide the domestic credit needed to short the
currency, and their ability to loan the securities needed to
short equity, and fixed-income markets.
Link to Data Set
Citation
“Lee, Jeong Yeon. 2000. The Role of Foreign Investors in Debt Market Development : Conceptual Frameworks and Policy Issues. Policy Research Working Paper;No. 2428. © World Bank, Washington, DC. http://hdl.handle.net/10986/19810 License: CC BY 3.0 IGO.”
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