This Selected Issues paper on Bolivia reports that it has experienced major increases in its gas reserves, production, and exports. Not only have their levels increased significantly, but also there have been extensive regulatory changes, which range from the privatization of the mid-1990s to the increase in the government’s tax take from the hydrocarbons industry. The government has reached new agreements with foreign oil companies that will allow foreign companies to continue recovering part of their old investments.
The need to develop domestic securities markets has, following the recent international financial crises, increasingly attracted the attention of national and international policymakers.1 This has resulted in the issuance of a number of policy recommendations by various organizations, such as the Asia-Pacific Economic Cooperation (APEC) collaborative Initiative on Development of Domestic Bond Markets. The issue of government debt management is intrinsically linked to government securities market development. Work is currently under way on this issue at the International Monetary Fund (IMF) and the World Bank, where guidelines have been developed to guide government actions as an issuer, thereby steering development of the government securities market.2 This handbook on government securities market development seeks to fill an existing gap between specific technical studies about securities market microstructure and publications that offer general policy recommendations about securities market development. The handbook integrates these two perspectives by outlining important issues confronting senior strategic policymakers or those implementing policies to support development of a government securities market.
Tax policy has significant impact on financial decisions of investors and firms. Certain tax policies, such as transaction tax, can stifle the development of capital markets. New financial products, such as mutual funds and asset-backed securities, will have difficulty in competing against traditional substitutes without proper tax treatment. Thus, a well-developed financial system requires a well-designed tax policy.
Decentralization of some governmental functions is taking place in many developing and transition countries. Decentralized entities are becoming responsible for undertaking various infrastructure investments required to meet basic needs at the local level, including utilities, water and sanitation, transportation, health and education, and environmental protection. Owing to fiscal constraints at the center, decentralized entities can rely only partly on capital grants from the center to fund these investments. To meet their funding needs, decentralized entities, therefore, need to broaden their own resource base, access subnational bond markets, and increase the efficiency of resource use. In emerging-market countries, these funding needs must be weighed against the prospect that multiple issuers of securities with varying claims to sovereign creditworthiness will fragment a nascent market and thereby reduce its liquidity and efficiency. On the other hand, properly managed subnational bond market can complement the national bond market.
The issuance of debt securities by private sector entities has considerable public policy benefits. Such securities help the private sector contribute to economic development through more efficient reallocation of capital. In particular, they improve access to capital for housing and infrastructure at a time when privatization and deregulation in many developing countries are shifting the financing of these projects from public to private hands. Private sector securities also help diffuse stresses on the banking system by matching long-term investments with long-term capital. There is thus a strong public interest in a viable bond market for private sector issuers. Authorities can support private sector bond market development by maintaining a well-functioning market for government securities and by helping to establish disclosure procedures and a credit-rating system for private sector securities, bankruptcy laws, avoiding public sector crowding out, and limiting statutory restrictions on the issuance of private sector debt securities.
The money market is the cornerstone of a competitive and efficient system of market-based intermediation, and should normally be in good working order before a government bond market is developed. The money market stimulates an active secondary bond market by reducing the liquidity risk attached to bonds and other term financial instruments and assisting financial intermediaries in managing liquidity risk. The money market serves as the medium for government cash management and provides the first link in implementing monetary policy using indirect instruments.
To be a successful issuer of government securities, the government must earn the confidence of financial market participants. In addition to pursuing sound and sustainable fiscal and monetary policies and establishing an appropriate legal and regulatory infrastructure, the government needs a credible government bond issuing strategy, based on a strong commitment to market financing and a well-structured management framework. The strategy must provide a clear mapping of the portfolio structure and the instruments to obtain that structure. It must also devise procedures for marketing government securities issues and managing the government’s cash position in ways that establish efficient distribution channels and encourage the development of secondary markets.
By concentrating government bond issues in a relatively limited number of popular, standard maturities, governments can assist the development of liquidity in those securities and thereby lower their debt-issuance costs. Markets, in turn, can also use such liquid issues as convenient benchmarks for the pricing of a range of other financial instruments. In addition, spreading the relatively few benchmark issues across a fairly wide range of maturities—building a “benchmark yield curve”—can facilitate more accurate market pricing of financial instruments across a similar maturity range and more generally facilitate better risk management in financial markets. Most industrial countries and some emerging economies have succeeded or made significant progress in developing a benchmark government bond yield curve that spans short-term bills to long-term bonds. Many other countries are in the early stages of developing a yield curve, and often do not have much freedom to issue securities in the full range of maturities needed for a complete yield curve. These countries may seek to develop a more limited number of benchmark securities in those maturities for which there is a market.
A well-functioning primary market for government securities is essential for the orderly funding of government financing requirements, the foundation for a secondary market, and a source of price (interest rate) signals in many less-developed markets. The government has the responsibility for establishing a primary market. Its choice of procedures will depend on country circumstances.
Government securities issuers need buyers. Policymakers can do much to develop voluntary demand by financial institutions, nonfinancial institutions, and retail investors. Historically, governments have relied on their taxation and coercion powers to ensure adequate demand for their securities issues, resulting in captive sources of government funding. They did not always achieve their aim of lowering the cost of finance, but a certain outcome of this forced funding was economic inefficiency from misallocated resources. Although most developed countries have shifted from captive sources of government funding toward reliance on a diverse base of voluntary investors, captive sources of government funding are still a major feature of government finance in some developing countries. Governments can, through appropriate reform programs, licensing, regulation, and supervision, encourage the development of wholesale investor institutions that invest in government securities for income, hedging, trading, and repo transactions. Governments can also develop a retail investor base for government securities, and can further broaden and diversify the investor base by opening the market to foreign investors.