International Capital Markets
Developments, Prospects, and Key Policy Issues
September 1997

Published by the International Monetary Fund
© 1997

I.    Introduction

This year's capital markets report reviews developments and trends in the mature and emerging capital markets and banking systems, and it examines two important policy challenges—the implications of European Economic and Monetary Union (EMU) for financial markets and the management of external liabilities of emerging market countries. A key development in the mature markets was the continued appreciation of the dollar, which was in large part due to large capital flows into the on- and off-shore dollar markets and the relatively strong performance of the United States economy vis-à-vis Europe and Japan. Many of the mature equity markets also advanced further to reach record highs. In an environment of low inflation and stable growth, investors entered into a broad spectrum of debt markets in search of higher yields, thus contributing to the compression of interest rate spreads that was a prominent feature of most markets. Against the backdrop of continuing globalization of financial markets, a record net inflow into the emerging markets reinforced the compression of borrowing spreads and contributed to surges of activity in domestic securities markets. But this generally favorable financial environment was not without problems, as markets challenged the ability of authorities in some emerging market countries to maintain currency stability in the presence of external imbalances.

This year's report discusses two major international policy challenges. The European Union (EU) countries are entering into the most significant international financial arrangement since Bretton Woods, the establishment of EMU. It will create a stateless currency, the euro, and a multinational central bank to manage it. As a catalyst for change, the euro can provide impetus to existing initiatives for transforming the nationally segmented European financial markets into one of the largest, single-currency financial markets in the world. Such an outcome would secure many of the benefits promised years ago by Europe's single market initiatives. The opportunities are far reaching, but so too are the remaining institutional and financial challenges (see Chapter III).

The second policy challenge is the need for emerging and transition countries to better manage the risks associated with their external liabilities. The immediate cost savings of borrowing in foreign currencies at historically low interest rates has not always been met with an appropriate effort to assess and manage the currency and maturity risk of such borrowing. As more emerging market countries become closely integrated into the international financial system the problem of external debt management is becoming more pressing (see Chapter V).

The report is followed by two groups of self-contained background papers. The first paper has three chapters, which provide background material pertaining to recent developments and trends in the emerging capital markets, the mature international capital markets, and in selected banking systems, respectively. The second background paper addresses three issues in as many chapters: the implications of EMU for international capital markets; the management of sovereign external liabilities; and a retrospective on developing country access to international capital markets.

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