Subnational Capital Markets in Developing Countries: From Theory to Practice

By John Petersen; Mila Freire | Go to book overview

Chapter 3
Market Setting and Legal
Framework

The financial operations of subnational governments are strongly affected by the financial market and the legal framework. The two are intimately linked. For markets to thrive, laws and regulations on their operation and structure should be in place and enforced. Financial markets, dealing in vast amounts of funds with numerous buyers and sellers, are by definition advanced marketplaces that are efficient and ultimately sustainable only to the degree that an equally vast variety of transactions is quickly and hon- estly handled. Borrowing rests on the premise that funds are lent with the expectation of their repayment and with compensation for their use. The debt instrument is a contract to that effect. The capacity of subnational governments to access credit markets, by bank loan or bond issue, depends on the perception of their debt contracts as a strong promise to pay so that funds can be secured on favorable terms.


Financial Market Structures and Subnational Finance

Credit market access for subnational governments is strongly tied to the character and stage of development of domestic financial markets.1 While financial markets vary greatly, some generalizations seem to apply. In grow- ing market systems, liberalization of capital markets and greater devolution have tended to go hand in hand, although not always at the same pace. These are difficult transformations, still under way.


Stages of Development

Domestic financial sectors are undeveloped in most emerging economies, with limited formal financial market activity and few institutions to supply credit and mobilize savings. The size and vigor of financial markets are typ-

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