Structuring Asian Bond Market From Demand

Sidecase study-PakistanMuhammad Arif

Joint Director/Head Money Market Operations

State Bank of Pakistan

March 25, 2006

Bangkok, Thailand

Contents

Why Bond Market Required? Pre requisites How to buildup Bond Markets ACD initiative regarding development of Asian

Bond Market Case Study

Pakistan

Why Bond Market Required?

Following Mexican and Asian crisis, the importance of local bond market came into limelight

These crises gave following lessons: Foreign exchange exposures can be devastating Foreign capital flows can be volatile The risk of liquidity and maturity mismatches can be very

acute and is a source of systemic risk These risks can be mitigated through the

development of financial sector and this goes hand in hand with the need for substantial mobilization of local savings, with key role for the local debt market and local stock market

Why Bond Markets? (continued) Development of local bond market provides:

Diversification of financial sector into equity, debt and bank financing

Effective allocation of capital competition in financial sector Supports infrastructure development, privatization,

securitization, and the rise of new institutional investors requiring long term assets to match long term liabilities

Reduces the currency, interest rate and funding exposures risks

Allows more efficient allocation of savings by reducing banks role that also reduces the element of political interference

Why Bond Markets? (continued)

Allows borrowers to use capital that is tailored to their assets and operations

Provides retail and institutional investors with several high quality and liquid domestic saving vehicles

Creates monetary policy instruments Provides most stable type of borrowing that a

country or corporation can engage in

Pre requisites

Following are the pre-requisites for the development of Bond Markets:

Credible and Stable Govt. Sound fiscal and monetary policies Sound exchange rate and capital account policies Effective Legal, Tax and regulatory infrastructure Smooth and secure settlement system Liberalized financial system with competing

intermediaries

How to Buildup Bond Market

More complicated then developing equity market as it needs

Supporting pricing infrastructure Money market and longer-term benchmarking Dealers and market makers which means creating

a new class of intermediaries that can take positions and manage their risks

How to Buildup Bond Markets (continued) Environment supporting bond markets

Macro and political stability Economic growth and low Inflation Sufficient number of issues Interest rate structures Tax policies Broader legal framework

Additional Factors supporting bond market Presence of government securities market Market yield curve Dealer community Well developed trading, clearing and settlement systems

ACD initiative regarding development of Asian Bond Market ACD bond initiative under Chiang Mai declaration is

to provide support to regional bond market in Asia to check outward flows and to create an avenue for investment by Central Banks as well as institutional/retail investors.

In this respect the challenges faced by ABF floated so far by EMEAP group are; Widening investors base Enhancing market liquidity, Raising price transparency, Improving market infrastructure. Removal of cross-border impediments. Credit ratings.

ACD initiative regarding development of Asian Bond Market

ABF expertise in PAIF and single market funds may be utilized for further development.

As next phase, when other ACD members will be considered to qualify for next Fund, ideas may be explored to structure it on two layered structure with Senior and subordinated structure where Senior segment may hold AAA rated securities and subordinated segment may have less than AAA rated securities. These segments will remain subject to rebalancing. This is one of the solution for moving forward and making all ACD members part of ACD initiative.

ACD initiative regarding development of Asian Bond Market The consensus among member countries is

essential to materialize followings;

Regional rating agency. Comprehensive communication mechanism, Cross border funds flow arrangements.

Key Indicators – Pakistan

  FY 02 FY 03 FY 04 FY 05

Gross Domestic Product (in billion PKR) 4,402   4,823 5,533  6,548

GDP Real Growth Rate at factor cost  3.1% 4.8%  6.4%  8.4%

National Savings (% of GDP)  18.6% 20.8%  18.7%  15.1%

Total Revenue (% of GDP)  14.2% 14.9%  14.3%  13.7%

Budget Deficit (% of GDP)  4.3% 3.7%  3.0%  3.2%

Inflation Rate (CPI) 3.54% 3.10% 4.57% 9.28%

Bond Market Data (as on June 2005) (%age of GDP)

Total Debt 63.9

Domestic Debt 32.5

External Debt 31.4

As of Feb 2005 (US$. in billion)

Market Treasury bills 10.00

Pakistan Investment Bonds

(Government Bond)5.00

Bond Market Data (as on June 2005)

As of Feb 2005 (US$. in billion)

Corporate Bonds 2.00

Commercial Papers .1

Status of Bond Market in Pakistan Tenors sovereign, quasi-sovereign and private sector bonds are

in place MTBs are of 3, 6 & 12 months Long term government securities i.e PIB’s are of 3,5,10,

15 & 20 years Tenors in Corporate bonds i.e TFC’s are 3,5,7 and 10

years Tenors in commercial papers are up to 9 months. Auction calendar is available in Market Treasury Bills on

monthly basis and in PIBs on quarterly basis

Status of Bond Market in Pakistan At present Auction is conducted manually which will be

done electronically after full implementation of RTGS/ Globus in this year

Govt. Bonds are of fixed nature while corporate bonds are fixed/ floating & collars

Participation of non-residents in the primary market is facilitated by Special convertible account and secured depository arrangements

Primary dealer system exists with 12 banks,1 brokerage house and 1 DFI for distribution of Government Securities. Their performance is measured periodically on given performance criteria.

Status of Bond Market in Pakistan Market making facilities are available through online dealing

systems at the well equipped treasuries of Primary Dealers KIBOR/KIBID rates appear on Reuters daily at 11.30 AM to

disseminate rates up to 3 years to the market participants. Above 3 years rates are also available on Reuters provided by the

Primary Dealers. Corporate Bonds rates are also made available by credible brokers. Short selling is allowed. OMOs as and when market conditions desire Captive source of Govt. Funding discontinued Govt. securities Outright/ Repo market well developed Securities settlement on Delivery versus Payment System

Status of Bond Market in Pakistan Regional and global investors are encouraged to

participate through Special Convertible Account facility All bonds are rated through local Rating agencies as well

Standard and Poors and Moody's. Retail investors are encouraged to invest through non

competitive bidding option For govt. securities SBP has issued all relevant

instructions whereas in corporate bonds, SECP has a system in place. Both coordinate on these matters on quarterly basis.

Securities Laws under Public Debt Act 1944 and Public Debt Rules 1946 exists whereas for Corporate Bonds SECP has full regulations in place.

Status of Bond Market in Pakistan State Bank acts as depository for Government

Securities, who has been declared eligible by New York based Global Custodian agency for making investment by American investors under section 17 of its SEC law.

For Corporate Bonds Central Depository Company act as depository

All Government/Corporate Bonds now exist in scripless form.

SBP and SECP are now actively working to list Government Securities on Stock exchange and to allow Strip trading against these bonds.

Status of Bond Market in Pakistan Fiscal Responsibly ACT 2005 is now in place that restricts

Government to over borrow above given threshold and to plan Government Debt under Public Debt Office on regular basis. This will check crowding out effect in the market.

In last three years GOP has accessed three times international bond market by floating its sovereign bond with oversubscription each time.

GoP is in contact with IFC and ADB to allow supranational Bonds flotation in Pakistan.

SBP and SECP are working actively to make Corporate Bond cost effective.

Three bond indices are now in pace that provide price discovery to the investors on daily basis on clean price/Total Return basis.

Revaluation rates are disseminated on Reuters daily to the tenors up to 20 years

Yield Curve

1998 Sovereign Yield Curve

12%

13%

14%

15%

16%

3 Month 6 Months 12 Months 3 Years 5 Years 10 Years

Tenor

Yiel

d

Yield Curve (cont.)

1999 Sovereign Yield Curve

8%

10%

12%

14%

16%

3 Month 6 Months 12 Months 3 Years 5 Years 10 Years

Tenor

Yiel

d

Yield Curve (cont.)

2004 Sovereign Yield Curve

0.00

2.00

4.00

6.00

8.00

10.00

12.00

3M 6M 1Y 2Y 5Y 10Y 15Y 20Y

Yield Curve (cont.)

2005 Sovereign Yield Curve

0.00

2.00

4.00

6.00

8.00

10.00

12.00

3M 6M 1Y 2Y 5Y 10Y 15Y 20Y

Pakistan Government Bond Indices

80.00

85.00

90.00

95.00

100.00

07-0

2-05

21-0

2-05

07-0

3-05

21-0

3-05

04-0

4-05

18-0

4-05

02-0

5-05

16-0

5-05

30-0

5-05

13-0

6-05

27-0

6-05

11-0

7-05

25-0

7-05

08-0

8-05

22-0

8-05

05-0

9-05

19-0

9-05

03-1

0-05

17-1

0-05

31-1

0-05

14-1

1-05

28-1

1-05

BMA PGBI J SPGBI FMA PGBI

Corporate Bonds

Term Finance Certificates (TFCs) is local name for corporate bonds.

Companies are trying to raise debt through TFCs. The CY 05 was relatively better in this regard as 14 companies issued corporate bonds at KSE worth Rs16.8bn, highest since 1995.

Out of 14 TFCs, 6 were issued by commercial banks for raising their equity levels.

In all issues of TFC’s during 2005, Kibor (Karachi Inter-bank Offered Rate) was used as a base rate. The range of spreads over Kibor was 150bps to 375bps. Before 2005 most of the issuer used SBP discount rate or PIBs as a base rate.

WAPDA Sukuk Certificates

Recently issued first quasi Sovereign Islamic instrument WAPDA Sukuk Certificates were launched on Nov 28, 2005. The initial offered amount is Rs. 8 billion, with semi annual

floating coupon, with reference rate as KIBOR and positive spread of 35 basis points.

The certificates are approved security for SLR for Islamic banks only.

The certificates are issued in denominations of Rs.5,000/-. The certificates are tradable in secondary markets, and prices

are updated on Reuter’s pages.

Conclusion

The Asian Bond Market Development will go a long way for the regional prosperity and progress.

Pakistan is looking forward to extend its complete support in this respect.

Thank You.