WASHINGTON, DC – Ending extreme poverty and building shared prosperity across the developing world are noble goals; but they are also expensive, requiring financing on a scale far greater than what governments in developing countries, their donors, and local financial institutions are able to provide. 

Consider infrastructure. In Africa alone, delivering basic services like running water, electricity, and roads that connect communities to markets will require governments to spend an estimated $50 billion a year for the foreseeable future. The story is similar in Latin America and Asia, where infrastructure needs are expected to amount to some 7% of GDP.

Likewise, small and medium-size enterprises in emerging economies are starved for financing. In Latin America, they are in need of some $250 billion. In Asia, the figure is roughly $200 billion, and at least $100 billion in Africa.

Meeting those needs will require the type of financing that only capital markets can provide. If the proper conditions are created, capital markets can help to finance the growth of private firms, boost employment, and improve the lives of millions of people in Asia, Africa, and Latin America.

In 2013, the value of assets controlled by institutional investors in OECD countries was more than $92 trillion, and it has risen since. The world’s 300 largest pension funds control almost $15 trillion, and sovereign wealth funds have amassed about $6.5 trillion in assets. Meanwhile, domestic savings in emerging economies are growing rapidly. In Africa, pension funds own assets amounting to nearly $400 billion. The challenge is to channel these funds toward development and poverty alleviation in a way that is attractive to investors.

In other parts of the world, capital markets have proven to be effective intermediaries in allocating savings and other funds to national development priorities. They also serve as an alternative to the banking sector, mobilizing investments, driving economic growth, and helping to stabilize financial sectors by providing alternate sources of funding and different approaches to risk.

Capital markets in developing countries – many of which are still in their infancy – hold tremendous potential. Local bond markets, for example, have been growing in the last decade at a robust rate in some regions. The Asian bond market has grown more than fourfold since 2008, to $3 trillion, representing almost a quarter of GDP. In 2006, South Africa was the only country in Sub-Saharan Africa to have issued sovereign bonds. Today, more than $25 billion has been raised across the continent – $7 billion in 2014 alone.

And yet, although these figures point to a trajectory of rapid growth, they fall short of what is needed – as well of what well-functioning capital markets can provide. For markets to prosper, they need a place where buyers and sellers can meet, whether it be old-fashioned trading floors or cyberspace. Property rights must be clear and secure; those carrying out the transactions must have the legal right to control and transfer the items traded.

But, most important, well-functioning markets require trust. Investors need to know that markets are reliable and credible, which means that the information disclosed to them, and on which they base their trading decisions, is accurate, complete, and verified. Sellers need to be open and honest about potential conflicts of interest, risk profiles, and their business practices.

In modern capital markets – where trading is carried out anonymously over great distances – personal trust has been replaced by surrogates: best practices, securities laws, and regulations. Accountants and auditors provide the transparent and accurate financial reporting that underpins investor confidence. Credit rating agencies rebalance information asymmetries, by providing information about companies’ creditworthiness to lenders and investors. And law enforcement – whether public or private – ensures that the rules are obeyed. Without credible enforcement, even the best possible set of regulations is meaningless.

Policymakers in the developing world need to play a central role in creating and enforcing the regulatory framework that fosters trust. This can take time, but working in partnership with development organizations can accelerate the process by adapting global principles and standards to local conditions. The payoff is likely to be considerable. As capital markets in the developing world gain investors’ trust, their full power will be unleashed, with an immediate impact on prospects for economic growth and poverty reduction.

Ethiopis Tafara is Vice President for Corporate Risk and Sustainability and General Counsel at the International Finance Corporation.

Copyright: Project Syndicate