Developing Government Bond Markets
By Jorge Castellanos (03/98, IFM-111, En) See also Infrastructure and Financial Markets
Executive Summary
This document reviews alternatives to promoting financial development in Latin America. Specifically, it concentrates on the role that government bonds can play in the development of capital markets.
The government bond sector forms the backbone of a modern securities market. It is the sector that contributes most to transforming savings into investment, disseminating information, managing risk, and supporting activity in other securities. Government bonds serve to implement the most important transfer of savings in an economy. The yield curve of government securities provides the paramount guide to the future behavior of inflation and interest rates. Moreover, it establishes the benchmark for the valuation of all other fixed-income securities. Government bonds mitigate domestic financial risks, allowing firms to concentrate on their advantages in production. Their superior liquidity and absence of credit risk makes government bonds an efficient proxy for trade in other securities. Superior liquidity and absence of credit risk. They are therefore excellent surrogate instruments to hedge, speculate, or arbitrage interest rates. This flexibility helps to increase liquidity in other securities. Government bonds also act as a catalyst that accelerates the development of new financial products and techniques. For these reasons, government bonds increase financial efficiency and thus the competitiveness of the economy.
The benefits of government bonds accrue to all economic agents, but especially to the government and the central bank. Public enterprises and local governments, financial institutions, businesses, and households also benefit from government securities. With these benefits come additional responsibilities. For example, if the government does not implement sustainable economic policies, bond markets will warn the public and help exercise control. Government bonds--and financial innovations in general--may in some instances reinforce the actions of the central bank, but they create a more challenging environment for the conduct of monetary policy. The institutional changes that have taken place in the region over the last decade indicate that financial innovations in banking and securities may accelerate over the next few years. Governments can contribute to this process by modernizing financial regulations, and strengthening financial infrastructure. As this paper will show, government bonds provide a means for channeling government efforts in this respect. Indeed, that seems to be the course followed in industrial countries in recent years.
Jorge Castellanos (former Superintedent of Banks, and Manager of the Public Debt for Colombia) is currently a member of the Emerging Markets Sovereign Advisory Group at J. P. Morgan in New York City. The findings, interpretations, and conclusions expressed in this paper are enterely those of the author and should not be attributed in any manner to the IDB.
Last updated: 05/08/07
