Arab Academy for Science, Technology and Maritime Transport Graduate business school MBA International Business Financial

Market & Institutions Presented by: Ahmed Maher Abd El-Aal

Assignment No.1

The importance of financial market in emerging country

1 Introduction The development of financial markets has long been recognized as a key determinant of economic development. There is a firm consensus nowadays that a well-functioning financial sector is a precondition for the exploitation of an economys growth potential. While there is still an ongoing debate on the exact transmission channels from finance to economic activity, and its quantitative impact in particular, a large and growing amount of empirical research has documented a robust correlation between finance and growth and a causality running from financial development to economic growth. The economic literature highlights three main channels by which financial development can affect growth. Firstly, a more efficient financial system reduces the cost of financial intermediation and hence raises the fraction of savings funneled to investment. The more efficient the transformation of savings into investment, the lesser the loss of resources, and the more savings are channeled towards productive investment. Competition and increased efficiency should bring interest-rate margins down. The availability of credit to firms and households should correspondingly increase. Secondly, a well-functioning financial sector is a precondition for the efficient allocation of resources. Improvements in financial intermediation are expected to lead to a better allocation of resources across investment projects. A better trading, hedging and pooling of risks allows the funding of highly profitable, but risky investment projects that would be relinquished otherwise. The more advanced financial systems become, the better they should be able to deal with the problems of asymmetric information that are persistent in financial markets. This should further reduce the cost of financial intermediation. Moreover, financial sector should be more capable of distinguishing between good and bad investment opportunities, increasing the social marginal productivity of capital.

A third way by which financial development could affect economic growth is through influencing households savings rates. While the effect in the two channels mentioned before is generally positive, it is ambiguous in this case. A higher efficiency of the financial system should yield more favorable return-risk combinations for savers. But it is not clear whether or not the prospects of higher returns or lower risk on savings would induce households to save more, which in turn would stimulate higher economic growth. 2 case study: South Africa as emerging country The South African capital and derivatives markets are fairly advanced compared to other emerging markets. The bond market plays a key role in the mobilization of capital, particularly for the government that dominates the market. Since 2007, foreign issuers are allowed to list Randdenominated bonds at the South African Bond Exchange, opening up further towards foreign market participants. Growth in South Africas securitization market has remained relatively healthy, which is largely due to the heavy concentration of industry activity around the five major banking groups. However, securitization issuances represent only about 6 % of South African banks total on-balance-sheet loans and advances. South Africa has followed the global trend, and witnessed an unprecedented growth in its derivatives market which include exchange-traded derivatives, and over the- counter (OTC) market in derivatives. All markets can be regarded as very liquid. One area in which South Africa lags behind the industrialized countries is the extent to which credit risk transfer products are available. While securitization has grown at high rates, the transfer of credit risk separately from the underlying asset is not yet readily available.

3 Some figure form emerging market in USA: Dedicated emerging market U.S. mutual funds have been growing rapidly, from US$27 billion in late 2000 to about US$230 billion as of mid-2006; and the stock of domestic securities in emerging market economies increased by some estimates from 26% of GDP to 40% between 1996 and 2006. 4 Conclusion Possible benefits include reduced cost of capital for investors, mitigated risk exposures, broader access to capital and increased liquidity. Financial incentives at the individual level, coupled with advancements in technology and financial engineering skills, can result in situations where new instruments outpace the existing market and regulatory infrastructures. An advantage for emerging markets in pursuing financial innovation is that they can learn from the mistakes of others. However, there remains a threat that the pace at which new financial products are imported may outpace the ability of domestic market participants, investors and supervisors to properly understand new products 5 References
1- Financial Innovation and Emerging Markets Opportunities for Growth conference (3 4 July 2008 in Berlin). 2- https://www.imf.org/external/np/speeches/2007/020207a.htm