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Developing Essential Financial Markets in Smaller Economies Stylized Facts and Policy Options

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Developing Essential Financial Markets in Smaller Economies Stylized Facts and Policy Options OCCASIONAL PAPER 265 Developing Essential Financial Markets in Smaller Economies Stylized Facts and Policy Options Hervé Ferhani, Mark Stone, Anna Nordstrom, and Seiichi Shimizu INTERNATIONAL MONETARY FUND Washington DC 2009 ©International Monetary Fund. Not for Redistribution ©2009 International Monetary Fund Production: IMF Multimedia Services Division Typesetting: Julio Prego Figures: Andrew Sylvester Cataloging-in-Publication Data Developing essential financial markets in smaller economies : stylized facts and policy options / Hervé Ferhani ... [et al.] – Washington, D.C. : International Monetary Fund, 2009. p. cm.—(Occasional paper, 0251-6365 ; 265) Includes bibliographical references. ISBN 978-1-58906-775-2 1. Finance — Developing countries. 2. Money market — Developing countries. 3. Foreign exchange market — Developing countries. 4. Government securities — Developing countries. 5. Stock exchanges — Developing countries. I. Ferhani, Hervé. II. International Monetary Fund. III. Occasional paper (International Monetary Fund) ; no. 265 HG195 .D484 2008 Please send orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201 E-mail: [email protected] Internet: www.imfbookstore.org ©International Monetary Fund. Not for Redistribution Contents Preface vii Executive Summary ix I Introduction 1 II Impediments to Financial Market Development in Smaller Economies 5 Intrinsic Obstacles 5 Structural Obstacles 8 Institutional Obstacles 10 Policy Rigidities 11 Lack of Political Will and Vested Interests 13 III Foreign Exchange Markets 14 Stylized Facts 14 Market Development: From Central Bank Dominance to Market-Led 15 Fixed Exchange Rate Regime Issues 18 IV Money and Secondary Government Securities Markets 20 Stylized Facts 20 Market Development 20 V Secondary Equity Markets 26 Stylized Facts 26 Market Development 26 VI Regional Integration 33 The Potential Benefits of Regional Integration for Smaller Economies 33 Preconditions: Strong Linkages and Potential Business Opportunities 34 Government Policies: Markets Lead and Governments Supervise 34 Infrastructure Centralization 35 Annex I. Stylized Facts: Foreign Exchange Markets 36 Degree of Market Development 36 Potential Reasons for the Lack of Smaller Economy Foreign Exchange Market Development 37 Case Studies 39 Annex II. Stylized Facts: Money and Secondary Government Securities Markets 47 Money Markets 47 Secondary Government Securities Markets 47 iii ©International Monetary Fund. Not for Redistribution CONTENTS Annex III. Stylized Facts: Secondary Equity Markets 50 Cross-Country Data and Patterns 50 Case Studies 53 Annex IV. Case Studies: Regional Integration 67 Market Integration in Europe 67 Integration of the Baltic Markets with Nordic Area Markets 67 Central America 68 Other Examples of Smaller Economy Regional Equity Market Integration 69 References 70 Tables 1.1. GDP, GDP Per Capita, and Financial Market Development in Developing and Emerging Market Countries 2 1.2. Smaller Economy Countries 3 2.1. Banking Sector Structure 6 2.2. Selected Countries: Size of Insurance Sector 7 2.3. Pension Fund Assets 7 2.4. Smaller Economies and Emerging Market Countries: Broad Money 8 2.5. Selected Countries: Agriculture Share of GDP, 2004 8 2.6. Selected Countries: Foreign Currency Deposits to Total Deposits, 2001 9 2.7. International Investment Position Data, IMF Member Countries, 2003 9 2.8. Selected Countries: Capital Account Openness 10 2.9. Business Environment Indicators, 2005 12 2.10. Selected Countries: Indicators of the Effectiveness of the Legal Framework 12 2.11. Smaller Economies and Emerging Market Countries: Corruption 13 A1.1. Selected Countries: Foreign Exchange Market Annual Turnover 36 A1.2. Kolmogorov-Smirnov Comparison Tests of Median Volatility of Daily Exchange Rate Movements for Smaller Economies and Emerging Market Countries 37 A1.3. Smaller Economy and Emerging Market Floating Exchange Rate Countries: Number of Licensed Banks, 2004 40 A1.4. Capital Inflows of Emerging Markets and Smaller Economies with Floating Arrangements, 2000–06 40 A1.5. Serbia: Foreign Exchange Market Turnover, 2002–07 43 A2.1. Selected Countries: Interbank Money Market Annual Turnover 47 A2.2. Government Securities Secondary Market Trading by Foreign Banks, 2001–05 48 A3.1. Smaller Economy Countries, Stock Market Indicators, 2005 51 A3.2. Smaller Economy Equity Markets: Trading Volume, 2005 52 A3.3. Number of Listed Companies on the New York and London Stock Exchanges, 2006 52 A3.4. Percent Share of Smaller Economies with Equity Market by GDP and GDP Per Capita 53 A3.5. Botswana: Stock Market Indicators, 1995–2005 54 A3.6. Croatia: Stock Market Indicators, 1995–2005 56 A3.7. Estonia: Stock Market Indicators, 1997–2005 57 A3.8. Fiji: Stock Market Indicators, 1996–2005 58 A3.9. Guyana: Stock Market Indicators, 2003–05 59 A3.10. Jamaica: Stock Market Indicators, 1995–2005 60 A3.11. Jordan: Stock Market Indicators, 1995–2005 61 A3.12. Kenya: Stock Market Indicators, 1995–2005 63 A3.13. Mauritius: Stock Market Indicators, 1994–2004 64 A3.14. Sri Lanka: Stock Market Indicators, 1995–2005 66 iv ©International Monetary Fund. Not for Redistribution Contents Figures 2.1. Smaller Economies: Number of Banks 6 2.2. Emerging Market Countries and Smaller Economies with Floating Arrangements: Controlled Transactions 11 A1.1. Emerging Market Countries and Smaller Economies: Selected Foreign Exchange Market Aspects 37 A1.2. Median Daily Exchange Rate Percent Change, Emerging Markets and Smaller Economies with Floating Exchange Rate Arrangements 38 A1.3. Maximum Daily Exchange Rate Percent Change, Emerging Markets and Smaller Economies with Floating Exchange Rate Arrangements 39 A2.1. Market Turnover of Government Securities by Foreign Institutions 49 A2.2. Market Turnover of Government Securities, Emerging Market Countries and Smaller Economies 49 A3.1. Market Capitalization, 2005 51 A3.2. Smaller Economies and Emerging Market Countries: Number of Listed Companies 52 A3.3. Smaller Economies and Emerging Market Countries: Market Capitalization 53 A3.4. Smaller Economies and Emerging Market Countries: Turnover 53 Boxes 3.1. The Danish Foreign Exchange Market 19 5.1. Stock Exchange Trading Systems in Smaller Economies 28 A3.1. Implications of the Literature for Secondary Equity Markets in Smaller Economies 50 The following conventions are used in this publication: • In tables, a blank cell indicates “not applicable,” ellipsis points ( . .) indicate “not avail- able,” and 0 or 0.0 indicates “zero” or “negligible.” Minor discrepancies between sums of constituent figures and totals are due to rounding. • An en dash (–) between years or months (for example, 2005–06 or January–June) indi- cates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2005/06) indicates a fiscal or financial year, as does the abbreviation FY (for example, FY2006). • “Billion” means a thousand million; “trillion” means a thousand billion. • “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point). As used in this publication, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are main- tained on a separate and independent basis. v ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Preface The dictum that country policy advice must always be tailored to the circumstances at hand is nowhere more true than in the area of financial market development. The size and sophistication of financial markets vary enormously across International Monetary Fund (IMF) member countries. Correspondingly, the financial sector policy challenges faced by different countries are quite different, ranging from dealing with the systemic stabil- ity implications of complex financial products in a large advanced country, to assessing whether a money market is worth developing in a small developing country. Fiscal, mon- etary, and many structural policy challenges are of course also highly country-specific, but at the same time the broad objectives and challenges in these policy areas have much more in common across countries than do financial market development policies. This paper is motivated by the relative lack of guidance for the development of key financial markets for one important group of countries: smaller economies. They face a qualitatively different set of policy challenges than do their medium-sized and large coun- terparts, but there has been much less policy work done for them. This paper is meant to inform regular financial market surveillance and technical assistance, and be helpful to central banks and government agencies. The contents of this paper are based on informa- tion through late 2007 and early 2008. This paper benefited from contributions from Zsofia Arvai, Brian Bell, Ana Carvajal, Mangal Goswami, Jennifer Moyo, Inese Buzeneca, Harald Anderson, Allison Holland, Jan Woltjer, and Elias Kazarian. Helpful comments were provided by Ceyla Pazarba- sioglu, Simon Gray, Karl Habermeier, Arto Kovanen, Judit Vadasz, colleagues in the Monetary and Capital Markets Department (MCM) and in other departments
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