What is the role of capital markets in economic development?

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What is the role of capital markets in economic development?

By Cytonn Investments / Posted May 5, 2022 | 2:00 p.m.

KEY POINTS

Capital markets are a general class of markets that facilitate the buying and selling of medium to long-term securities, one year or longer.

KEY POINTS TO REMEMBER

Capital markets are a network of specialized financial institutions, a series of mechanisms, processes and infrastructures that, in various ways, facilitate the bringing together of providers and users of medium and long-term capital.

Ensuring economic growth and development is a primary objective of all countries. According to the World Bank, an estimated annual investment of $4 trillion is needed for developing countries to achieve the Sustainable Development Goals (SDGs) by 2030.

Given the investment needs, there is a greater need to develop and strengthen capital markets in order to mobilize commercial finance.

The role of capital markets in financing the development of infrastructure, large corporations and small and medium-sized enterprises (SMEs), as well as the links to economic growth, are increasingly highlighted.

Economists have traditionally viewed factors such as capital, labor and technology as the main factors affecting economic growth.

The recent financial crisis has shown that there are substantial economic effects when there is a lack of confidence in financial systems. Consequently, the functioning of financial systems has been the subject of particular attention in the academic literature in recent years.

A well-functioning financial system allows an economy to fully exploit its growth potential, as it ensures that the best investment opportunities receive the necessary financing, while the inferior opportunities are denied capital; in this regard, we endeavor to study the role that capital markets play in economic development.

What are capital markets?

Capital markets are a general class of markets that facilitate the buying and selling of medium to long-term securities, one year or longer.

Capital markets channel savings and investment between capital providers and capital users through intermediaries.

The main actors in the capital market process are:

Capital providers: Also known as surplus units, suppliers receive more money than they spend or have immediate use for. They can be qualified as investors. They provide their net savings to the financial markets for a return on the capital provided. Examples include retail investors and institutional investors,

FINANCIAL INTERMEDIARIES: A financial intermediary is an institution or an individual who acts as an intermediary between various parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, fund managers and stock exchanges,

Capital users: Also known as loss-making units, capital users spend more money than they take in or need funds to invest or grow. They are also called, borrowers. They access capital market funds. Examples include business, government, and individuals.

How Capital Markets Facilitate Economic Development

Capital markets are a network of specialized financial institutions, a series of mechanisms, processes and infrastructures that, in various ways, facilitate the bringing together of providers and users of medium and long-term capital.

Capital markets link the monetary sector to the real sector, which is the sector of the economy concerned with the production of goods and services.

Given this role in the economy, capital markets play an important role in economic development as they facilitate the growth of the real sector by empowering producers of goods and services and entities in charge of infrastructure development. access to long-term financing.

The fundamental channels through which capital markets are connected to the economy, economic growth and development can be described as follows:

Create a bridge between capital providers and users: Contact between agents in monetary deficit and those in monetary surplus can be made directly through direct financing, but also through a financial intermediary in the form of indirect financing, a situation in which specific operators facilitate the connection between the real economy and the financial market.

Promotion of savings and investments: Capital markets increase the share of long-term savings (retirement, life insurance, etc.) that is channeled into long-term investment. Capital markets allow the contractual savings industry (pension and provident funds, insurance companies, medical aid schemes, UCITS, etc.) to mobilize the long-term savings of small individual households and channel it into long-term investments.

Facilitate efficient allocation of scarce financial resources: Capital markets facilitate the efficient allocation of scarce financial resources by offering a wide variety of financial instruments with different risk and return characteristics. This competitive pricing of securities and the wide range of financial instruments allow investors to better allocate their funds according to their respective appetites for risk and return, thereby supporting economic growth.

Funding for the development of public services and infrastructure: Capital markets also provide equity, debt and infrastructure development capital that has strong socio-economic benefits through the development of essential public services such as roads, water, sewer, housing, energy and telecommunications, public transport, etc. projects are ideal for financing through the capital markets via long-term bonds and asset-backed securities.

Financing of Public-Private Partnerships, “PPP”: Capital markets encourage PPPs, thereby encouraging private sector participation in productive investments. The need to shift economic development from the public to the private sector to improve economic productivity has become inevitable as resources continue to dwindle. It helps the public sector fill the resource gap and complements its efforts to finance essential socio-economic development, by mobilizing long-term capital for projects.

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