Equity market liberalization in emerging markets

EquityMarketLiberalizationinEmergingMarketsGeertBekaertGraduateSchoolofBusiness,ColumbiaUniversity,NewYork,NYNationalBureauofEconomicResearch,Cambridge,MA02138CampbellR.HarveyFuquaSchoolofBusiness,DukeUniversity,Durham,NC27708NationalBureauofEconomicResearch,Cambridge,MA02138ChristianLundblad∗KelleySchoolofBusiness,IndianaUniversity,Bloomington,IN47405January23,2003AbstractEquitymarketliberalizations,ifeffective,leadtoimportantchangesinboththefinancialandrealsectorsastheeconomybecomesintegratedintoworldcapitalmarkets.Thestudyofmarketintegrationiscomplicatedbecausetherearemanywaysonecanliberalizeandmanycountrieshavetakendifferentroutes.Tostudytheeffectivenessofparticularliberalizationpolicies,thesequencingofliberalizations,andtheimpactontherealeconomy,systematicmethodsmustbedevelopedto‘date’theliberalizationofemergingequitymarkets.Weprovideasynthesisofthecurrentmethods,andalsoshowtheimpactofliberalizationontherealsector.∗WewouldliketoexpressourgratitudetoXinHuangforexcellentresearchsupport.Forhelpfulcomments,wethankPeterHenryandtheparticipantsoftheSt.LouisFederalReserveBank’s27thAnnualEconomicPolicyConference,FinanceandRealEconomicActivity.Sendcorrespondenceto:CampbellR.Harvey,FuquaSchoolofBusiness,DukeUniversity,Durham,NC27708.Phone:[phone],E-mail:[e-mail].1IntroductionOneofthemostimportantnationalpolicydecisionsofthepast25yearshasbeenthefinancialliberalizationofequitymarketsacrosstheworld.Equitymarketliberalizationsgiveforeigninvestorstheopportunitytoinvestindomesticequitysecuritiesanddomesticinvestorstherighttotransactinforeignequitysecurities.Itisimportanttodistinguishbetweentheconceptsofliberalizationandintegration.Forexample,acountrymightpassalawthatseeminglydropsallbarrierstoforeignpartici-pationinlocalcapitalmarkets.Thisisaliberalization–butitmightnotbeaneffectiveliberalizationthatresultsinmarketintegration.Indeed,therearetwopossibilitiesinthisexample.First,themarketmighthavebeenintegratedbeforetheregulatoryliberalization.Thatis,foreignersmighthavehadtheabilitytoaccessthemarketthroughothermeans,suchascountryfundsanddepositoryreceipts.Second,theliberalizationmighthavelittleornoeffectbecauseeitherforeigninvestorsdonotbelievetheregulatoryreformswillbelonglastingorothermarketimperfectionsexist.Tostudyliberalizations,theymustbedated.Thisisdifficultbecausecountrieshavepursueddifferentliberalizationstrategies.Ourpaperbeginsbyanalyzingtheprogressthathasbeenmadeondatingliberalizations.Weexamineregulatorychanges,theabilityofinvestorstoaccessthelocalmarketviaproxieslikecountryfundsandthebehaviorofforeignportfolioholdings.Iftheliberalizationiseffective,itleadstomarketintegrationwhichhasafundamen-talimpactonboththefinancialandrealsectorsofdevelopingcountries.Ourpaperalsosummarizessomerecentresearchontheimpactofliberalizationontherealsector.2FinancialLiberalization2.1OfficialEquityMarketLiberalizationAsastart,BekaertandHarvey(2000)(BH)provideadetailedexaminationofthekeyeco-nomiceventsthatcouldpotentiallyimpactthefinancialliberalizationandreformprocessin1alargenumberofemergingcountries.1Further,toexploretheeffectsofforeignaccesstodomesticequitymarkets,BHdatean“officialequitymarketliberalization”foreachcountry;thatis,adateofformalregulatorychangeafterwhichforeigninvestorsofficiallyhavetheopportunitytoinvestindomesticequitysecurities,anddomesticinvestorstherighttotrans-actinforeignequitysecuritiesabroad.Asanexample,BrazilrewroteitsforeigninvestmentlawinMay1991.Resolution1832AnnexIVstipulatedthatforeigninstitutionscanownupto49%ofvotingstockand100%ofnon-votingstock.Similarly,January1992signifiedapartialopeningoftheKoreanstockmarkettoforeigners,afterwhichforeignerinvestorscouldownupto10%ofdomesticallylistedfirms.InTable1,wepresenttheBHofficialliberalizationdatesfor30emergingequitymarkets.Ascanbeobserved,manyliberaliza-tionsareclusteredinthelate1980sorearly1990s.BaseduponthechronologiespresentedinBH,Table2providesamoredetailedanalysisdescribingtheparticularregulatorychangethatoccuredattheBHofficialliberalizationdate.Generally,asintheexamplesprovidedabove,thesereformsinvolved(forthefirsttime)theremovalofforeignrestrictionsondo-mesticequityholdings.Further,thesedatesgenerallycorrespondtotheliberalizationdatesprovidedbytheInternationalFinanceCorporation(IFC);however,thereareother“equitymarketliberalization”datesprovidedinthisliteraturewhich,employingsomewhatdifferentcriteria,dodiffersignificantlyfromthoseprovidedbyBHforcertaincountries(seeHenry(2000a),KimandSingal(2000),andLevineandZervos(1998b)).Toillustratethedifficultyassociatedwithdatingmarketintegration,Table3presentschronologiesofmajoreconomiceventsfortwocountries,BrazilandKorea.Forexample,overthe20-yearperiodpresented,Brazil,showninPanelA,introducedinsidertradinglaws,undertookmacroeconomicreforms,employedseveraldifferentexchangerateregimes,andgraduallyallowedincreasedforeigndirectandportfolioinvestment.Additionally,theseeventswerenotone-directional,asexchangerateandtraderestrictionswerere-introducedoverthereformtime-line.Takentogether,thismulti-facetedreformeffortmakesthedating1Deta