The developing countries and access to capital markets: An analysis, and suggestions for making such access easier

Although developing countries have been able to raise funds from credit markets recently, their borrowing from the major bond markets of the world has been relatively small. The crucial factor has been the market perception of their creditworthiness, but there are regulations and practices which also tend to inhibit their access. This article examines the situation from the point of view of the less developed countries.

Abstract

Although developing countries have been able to raise funds from credit markets recently, their borrowing from the major bond markets of the world has been relatively small. The crucial factor has been the market perception of their creditworthiness, but there are regulations and practices which also tend to inhibit their access. This article examines the situation from the point of view of the less developed countries.

M. M. Ahmad

The primary areas of interest of the review included (1) restrictions and other obstacles to access to markets; (2) direct measures to support the creditworthiness of developing country borrowers in capital markets, including possible multilateral guarantees or active use of guarantee authority of international lending institutions; (3) the problem of secondary markets for developing country securities; (4) cofinancing involving international lending institutions and private lenders; (5) a possible international investment trust; and (6) technical assistance to developing countries seeking market access, and the related problem of educating potential investors regarding the situation and prospects of developing countries.

The Secretariat of the Development Committee had held consultations with representatives of the Governments of Brazil, Korea, Mexico, and the Philippines, and also with the authorities and the banking communities in Belgium, France, the Federal Republic of Germany, Japan, Luxembourg, the Netherlands, Switzerland, the United Kingdom, and the United States. The results of the survey relating to regulations and practices that are presented in part in this article, were put before the Development Committee at its October 1976 meeting in Manila, and a number of concrete steps to improve developing country access were agreed upon at this meeting.

The credit and bond markets

It is a well-known fact that the less developed countries (LDCs) have been able to tap the Eurocredit market substantially in the past few years (see Table 1). While recognizing the important and valuable role played by banks during the recent period of pronounced balance of payments difficulties, domestic monetary authorities have increasingly questioned the wisdom of continuous and large-scale commercial bank involvement in straight balance of payments financing. The sizable bank exposure in particular areas coupled with some fears about possible defaults has led authorities to call for a re-examination of bank lending and to refrain from what might be regarded as the excesses of 1973 and early 1974. In fact, in most countries where international banking plays an important role, the domestic authorities have already taken measures to regulate Eurocredit lending.

While concern about bank lending to LDCs as such cannot be justified on the basis of commercial banks’ loan/loss experience vis-à-vis the LDCs, which has been good, the Eurocredit markets may not be able in the future to provide LDCs with resources of the same magnitude as in the past few years.

The problem of “crowding out” of LDCs on account of increased loan demand generated by the economic recovery in the industrial countries may not be imminent. It is, however, unlikely that whatever capital continues to be available through the credit market will be on terms and maturities generally suitable for development purposes. In fact, in 1975 and 1976, loan maturities have shortened considerably and spreads over the London interbank offer rate (LIBOR) have increased to levels more than twice those applying early in 1974. (Maturities of five to seven years and spreads of 2 per cent and above are presently typical for loans to LDCs.) In these circumstances, the importance of the bond markets as a stable source of long-term capital for LDCs can hardly be overstressed.

Although LDCs have been able to tap the credit markets successfully, their borrowing in the bond markets has been relatively small. As compared with $25.4 billion or 36 per cent of all publicized Eurocredits raised from 1973 to 1975, LDCs raised only $2.9 billion or 6.4 per cent of total bond issues (foreign and Eurobonds) during this period (see Table 2).

When allowance is made for the substantial borrowings by Israel in the U.S. market, the share of other LDCs in the bond markets comes down to 3.6 per cent in 1973-75 (of which 3.1 per cent was in the foreign bond market and 4.2 per cent in the Eurobond market), and among these, bond issues by Mexico and Brazil have been predominant.

This performance has been explained in large part by the fact that in the bond markets LDCs face investors who are generally unfamiliar with them and are, therefore, not willing to take risks as readily as bankers. In addition, larger institutional investors who are in a better position to assess the quality of the borrower, are limited in their investment, by regulations as well as by their traditionally conservative behavior. For the developing countries there has been more incentive to take bank credits than to issue bonds since at present they are generally of similar maturities, although the fact that bonds are fixed interest obligations might appeal to a number of borrowers. In addition, some practices or regulations, particularly in the domestic markets, have had the effect of limiting access to bond markets by foreign borrowers. The LDC share has been relatively small in both the foreign and Eurobond segments of the international capital market where practices and regulations are quite different.

Table 1.

Publicized Eurocredits, 1973-75

(In millions of U.S. dollars)

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Source: World Bank.

Includes oil exporting countries. Excluding them, the figures are $4.3 billion (20 per cent) in 1973, $6.7 billion (23 per cent) in 1974, and $7.7 billion (37 per cent) in 1975. Excludes loans to European countries amounting to $1.3 billion in 1973, $2.3 billion in 1974, and $1.5 billion in 1975. These are included above in the “Other” category.

Regulations

The Eurobond market: Unlike the foreign bond market (see below), the issuing activity in the Eurobond market is relatively unregulated. Some degree of regulation, nevertheless, exists, arising mainly from the reluctance of some countries to permit the use of their currencies as international reserve assets. Thus, the Swiss and the Dutch authorities do not encourage Euroissues denominated in their currencies. The authorities of the Federal Republic of Germany do permit the use of the deutsche mark (DM) in international bonds, but require that such issues should be treated like any other deutsche mark issues and thus Euro-DM issues are in practice governed by the queue system operated by the Capital Markets Committee. The Eurodollar issues are the freest of all. Like the domestic and foreign dollar issues in the U.S. market, they do not require any authorization, and unless they are publicly offered in the United States, Securities and Exchange Commission (SEC) registration is also avoided.

Table 2.

International bond issues, 1973-75

(In millions of U.S. dollars or equivalent)

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Source: World Bank.

Includes issues by oil exporting countries amounting to $226 million during 1973-75 but excludes issues by European countries amounting to $450 million during the same period.

A substantial portion of the foreign bond issues have been by Israel, amounting to $468 million in 1973, $560 million in 1974, and $243 million in 1975. If these were excluded, the LDC share in the total comes down to 5.3 per cent in 1973, 2.3 per cent in 1974, and 2.7 per cent in 1975.

It is not surprising, therefore, that the large bulk of the Euroissues is denominated in dollars. The next in importance is the deutsche mark. Given the large investor demand for strong currencies like the deutsche mark, its share in Euro-issues could possibly have been larger if Euro-DM issues could be made as freely as dollar issues. More generally, the prospects for LDC borrowing in the Eurobond market would improve if the authorities would take a more liberal view of bonds denominated in their currencies and issued by LDC borrowers.

“a continuing relationship with developing countries is an important factor in generating familiarity and trust”

Regulations also apply to the purchase by resident investors of Eurobonds. Individuals are generally free to purchase foreign bonds and Eurobonds in most countries. Restraints, when imposed, are for balance of payments reasons. There are also conditions imposed as to the type of foreign security which can be freely purchased in an effort to protect the investor. The test applied most generally is that the security must be listed—thus ensuring that some authority somewhere has gone through the motions of examining the prospectus and requiring essential disclosures. Resident institutional investors in some countries cannot however acquire securities (domestic or foreign) denominated in foreign currencies except to the extent that they have liabilities to match in those currencies

These rules do not seem to have a restraining influence in the Eurobond market, although they contribute to the “retail” character of the market in which individual investors predominate. One consequence of this, for LDC borrowers is that creditworthiness considerations, important in other markets, carry even more weight in the Eurobond market. The quality of the issue is of prime importance, and’ even developed country entities—especially public sector corporations—find it difficult to establish themselves in such a competitive market. There is little systematic information on the pattern of Eurobond holdings, and the banking community seems to have developed a conspiracy of silence on the subject This may be a reflection of the fact that Eurobonds-which are invariably in the form of bearer bonds—are used as safe tax havens by wealthy individuals from all over the world. (It is recognized, for instance, that nearly half of all Eurobonds end up in Switzerland.

Bankers who manage and underwrite Eurobond issues feel a “moral” obligation toward unsophisticated individual investors and are not willing to admit issues of unfamiliar borrowers or those whose creditworthiness has not been established. The authorities also seem to take a similar view when they permit individuals to purchase Eurobonds but do not permit active marketing, especially when the issues have not gone through their own clearance procedures. Quite a few of the Eurobond issues by developing country borrowers have been essentially Eurocurrency credits dressed up as bonds. They have virtually remained on the books of the banks.

The foreign bond market: It is useful to distinguish between the U.S. market of foreign bonds and other markets. In the U.S. market, where formal permission for an issue is not required, the main problems seem to be the registration requirements of the SEC and limitations on institutional investors. Compliance with SEC requirements is generally regarded as difficult, especially for corporate borrowers, and tends to be costly. While, in the aggregate, institutional investors in the United States have room for increased investments in foreign bonds, there be particular cases where such limits have already been reached.

In the European and the Japanese markets, on the other hand, the main problem seems to be the authorization for foreign issues and/or the existence of issue calendars or ceilings. Some governments with large borrowing requirements of their own or their public sector agencies, seek to prevent competing foreign issues altogether and have strict regulation of competing domestic private issues. Others maintain a regulatory system, but are either more willing or more able to accommodate nongovernment issues, including foreign issues. In almost all cases developing country issues, although not formally discriminated against, tend to have a poor chance of admission. The queues are not always on a first-come-first-served I basis; nor are the criteria for priority in the made known. In some esses the “Queue” is like a “crowd” from which the underwriters with explicit or implicit government blessing pick the best potential winners in the market

Restraints are placed on foreign access in both the Eurobond market and the foreign bond market, but they are considerably greater in the latter. In either case, they are nondiscriminatory. Yet, bond issues by developed country borrowers have been sizable, while the share of developing countries has been small in both the foreign bond market and the relatively unregulated Eurobond market. It would seem therefore that the more crucial limitation to developing country access is lack of familiarity on the part of investors of conditions in developing countries and more generally credit-worthiness and the market perception of the creditworthiness of these countries.

The banking community in several countries has expressed the view that a continuing relationship with developing countries is an important factor in generating familiarity and trust. They point to the fact that developing countries have had success in raising finance through bank loans. When it comes to the bond market, however, one is dealing with a large number of individual and institutional investors who are concerned primarily with purchases of “good quality” paper. Individuals tend to be unsophisticated investors and are unlikely to be interested in bonds about which there is the slightest doubt. Institutions such as insurance companies might be expected to be more sophisticated about their port-folio structure and might be able to assess risks and be prepared to purchase slightly riskier bonds if the yield is commensurate. They would be more willing to do so especially in respect of bonds of countries where they happen to have a business relationship. To some extent, a further development of their interest in such bonds tends to be constrained by the existence of regulations which put ceilings on their foreign investments.

The Development Committee

The Development Committee, formally known as the Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries, emerged as a result of two major factors. First, the Committee of Twenty (set up to study the reform of the international monetary system and related issues), in its Outline of Reform in June 1974 suggested the formation of a committee to continue the study of the broad question of the transfer of real resources to developing countries. Second, the developments in the world economic situation during 1973 and 1974, which left most of the developing countries facing serious difficulties such as trade and current account deficits, created the need for a flow of financial resources of a concessional nature to these adversely affected countries.

Parallel resolutions of the Boards of Governors of the Bank and the Fund established the Committee on October 2, 1974 under the following terms of reference:

  • (a) The Development Committee shall maintain an overview of the development process and shall advise and report to the Boards of Governors of the Bank and the Fund on all aspects of the broad question of the transfer of real resources to developing countries, and shall make suggestions for consideration by those concerned regarding the implementation of its conclusions. The Committee shall review, on a continuing basis, the progress made in fulfillment of its suggestions.

  • (b) The Development Committee shall establish a detailed program of work, taking account of the topics listed in Annex 10 of the Outline of Reform. The Committee in carrying out its work shall bear in mind the need for coordination with other international bodies.

  • (c) The Development Committee shall give urgent attention to the problems of (i) the least developed countries and (ii) those developing countries most seriously affected by balance of payments difficulties in the current situation.

The members of the Development Committee are governors of the Bank, governors of the Fund, ministers, or others of comparable rank.

At the inaugural meeting of the Committee, held October 2-3, 1974, Mr. Henri Konan Bédié, Minister of Economy and Finance of Ivory Coast, was selected as Chairman, and Mr. Henry J. Costanzo, Executive Vice President of the Inter-American Development Bank, was appointed Executive Secretary. Mr. Costanzo resigned effective April 15, 1976, and on that date, Mr. M.M. Ahmad, Deputy Executive Secretary, assumed duties as Acting Executive Secretary.

At its seventh meeting in Manila on October 6, 1976, the Committee selected Mr. Cesar E. A. Virata, Secretary of Finance of the Philippines, as Chairman, and appointed Sir Richard King, K.C.B., M.C., Permanent Secretary of the Ministry of Overseas Development of the United Kingdom, as Executive Secretary.

Over the long term, the Committee aims to focus on the long-range real resource requirements of all developing countries, with particular reference to the poorest income group, in order to assist these countries to achieve and maintain reasonable growth rates during the balance of this decade.

Other long-term subjects which have been under review are broadly (1) the amount and quality of official development assistance; (2) programs and resources of multilateral development finance institutions; (3) improvement of access to capital markets; and (4) international financing schemes for commodity regulation and price stabilization.

In sum, a relaxation of regulations per se may not result in any substantial improvement in the prospects for developing countries—especially for those developing countries which have no established record. But, if other measures are taken at the same time to provide better information about their situation to the market, to strengthen the contacts of potential developing country borrowers with the investment bankers and underwriters, to improve the creditworthiness of these countries, (which will require efforts by these countries themselves), and to support their approach to the markets, a potential for substantial increase in their borrowing could be created which will not be realized unless some of the existing restrictions on access of nonresident issues are relaxed. Such relaxation will, in any case, be of considerable help to those developing countries which have an established record of creditworthiness in some markets but are unable to diversify their borrowing by approaching other markets.

Modifying the regulations

Three approaches to the modification of the existing regulations and practices may be explored:

  • General liberalization of capital outflows to developed as well as developing country borrowers, ending progressively the existing discrimination against nonresident borrowers;

  • agreement to grant preferential treatment to developing country borrowers;

  • agreement that capital market countries would take such specific actions as may be appropriate to their situations to improve the access of developing countries to their markets.

General liberalization: The main rationale of the present regulations is threefold: balance of payments considerations (countries facing a deficit might seek to prevent a capital outflow; but those in a surplus situation might seek to prevent an “excessive” appreciation of their currency by regulating the creation of instruments denominated in their currency); domestic capital needs; and protection of the investor.

A general liberalization does not appear feasible so long as large disequilibria in balance of payments persist. It is arguable that other methods to correct these disequilibria could be employed, including domestic, fiscal, and monetary policies as well as greater flexibility in exchange rates, rather than imposing regulations on capital movements. But at the present stage of debate on these questions, it is unrealistic to expect a general move toward liberalization of capital movements. The efforts of the Organization for Economic Cooperation and Development (OECD) in that direction may be noted in this context, and to the extent they succeed there will be indirect benefits for developing countries.

Nonresident borrowing will invariably compete with domestic needs of capital; and the unwillingness of governments to compete freely for their own requirements arises primarily from their desire to keep their own costs of borrowing as low as possible. It is unlikely that governments would consider greater freedom for capital movements if this reduces their freedom to set interest rates at levels considered desirable for achieving the objectives of domestic economic policy. Also, so long as domestic private borrowers are subject to authorization and queue procedures, it would be politically difficult to extend a generally favorable treatment to foreign borrowers.

Preferential treatment: None of the countries studied discriminate against developing country borrowers. The regulations are applied uniformly to all foreign borrowers, although, in practice, developing countries tend to be at a disadvantage in a restricted market. Discrimination between a developing country borrower and a domestic borrower could be politically difficult—for instance, when the market is closed to all issues, including domestic issues, it may be difficult to permit a foreign issue. Discrimination among foreign borrowers in favor of developing countries looks more feasible politically, but may not yield more than marginal benefits so long as the degree of restriction on nonresident borrowing remains severe. A general agreement to grant preferential treatment to developing countries can be of greater benefit if it is accompanied by (1) willingness to discriminate against domestic borrowers as well in certain situations and/or (2) a willingness to reduce the severity of restrictions as applied to nonresident borrowers generally to permit greater room for developing countries.

Specific actions: Under this approach, the content of the actions to be taken could be determined by each capital market country in the light of its own situation, but there would be an understanding that each country would take action to improve the access of developing country borrowers to its market.

At the Development Committee meeting in Manila it was agreed that governments of capital market countries would afford favorable treatment, among foreign borrowers, to developing country borrowers in their markets with regard to: (1) permission to make bond issues; (2) a place in the issue calendars; (3) quantitative limitations on foreign bond issues in their markets; and (4) denomination of Eurobond issues in currencies which are in strong demand. The Committee also urged capital market countries to give earnest consideration to a number of recommendations concerning the removal of legal and administrative barriers so far as was consistent with investors’s protection.

Finance & Development, December 1976
Author: International Monetary Fund. External Relations Dept.