Monday, June 28, 2010

The Development of Debt Market in Pakistan

The article summarizes views of Mr. Khurram Baig, in his article, "The Development of Debt Market in Pakistan", which discuses the bond market of Pakistan and covers the issues and problems that it has been facing since years which are some of the leading factors hampering the overall debt market. The equity market, in contrast, has progressed all over the Asian region; but the debt markets in Asia, and in Pakistan, have not been able to develop.

Even though the size of the debt market in Pakistan is 43% of its GDP, much of the issues have been done by the government securities, which have not been able to set a good benchmark for other private corporations for launch a similar type of issues. Although the need for corporations and entities for a secure term financing is essential, the article mentions reasons such as lack of capital, expertise and trained staff, which is hampering these corporations to do so.

The demand for a debt market has emerged effectively now, considering the need to gather together the savings from retail, large individual and institutional investors for long term financing. However, there are some problems identified by prominent leaders, which are causing a slow growth.

One of the problems is that the short term bonds introduced by the government are causing problems in setting benchmark for the secondary market trading. It is not possible to place a consistent bid as a result of different profit payments. Another problem identified is the TFCs not being considered as an investment for banks while displaying list of investments for SLR to the State Bank.

In an attempt to liberalize and deregularize, the need to spread awareness to the retail investor regarding many saving schemes such as the NSS is important. Also, different schemes should yield different benefits in the form of returns to avoid clashes. The attempt to introduce foreign currency accounts for non-residents, and exemptions to it from zakat, and other taxes is a positive approach inn favor of the debt market.

However, there are some limitations specified in the article: the first being the small size of the market. For international investments, small markets are not a lucrative opportunity to invest. The fact that only a few private corporations are credible to issue bonds and the secondary market not being liquid enough makes it really a harsh environment for investment. Lack of regularity and a set framework for both issuers and investors in debt market is also a reason for its slow progress in Pakistan. With lack of proper accountability of companies within, it is difficult for the investor to trust issuers where the level of risk rises.

Another reason is also the lack of a credit rating system in place, and the mixture of Islamic and conventional mode of financing, which yields different returns and thus, causes problems for investors, with a varying/unclear benchmark for returns.

Apart from the problems specified, the country risk is also one of the major factors for lack of investment in the bond markets. With credit ratings below benchmark, Pakistan’s debt market is always skeptical because of low For-ex reserves. There is an option of hedge funds to invest in the discounted price bonds, but then the quick possibility of withdrawal of funds from the market make the situation tenser for Pakistan, considering low reserves. Also, the cost of capital has risen tremendously considering the servicing high interest rates.

With the removal of TAP systems, introduction of new debt instruments such as FIBs and STFBs, along with the initiation of secondary market for each, and also, the auctions for OMOs regularly in an attempt to further widen the secondary market, the opportunities for foreign investors have increased.

The risks to foreign investors include the currency risk, where a change in the exchange rate affects investments badly. Hence a profit earned by investing in a period of time has no real effect as it takes more rupees to buy a dollar in terms of devaluation. Apart from that there is inflationary pressure that makes the prices go up every often leading to interest rate risk. This eventually leads to a rise in the cost of doing business.

The role of State Bank to keep a check on the SLR position of banks is important since banks are the tool to implement the nation’s monetary objectives. The role of brokers in providing assistance to execution of capital market activities cannot be ignored in the overall scenario of monetary management.

With control of various problems identified such as the country risk, economic risk, which includes currency risk, inflation, weak secondary markets, lack of proper rules and framework mechanism, and the cost of doing business, Pakistan has the potential to strive back on its own. But the issues need to be addressed on an urgency basis to ensure prompt results.

Pakistan Capital Markets: Mobilizing for Growth

A Summerized form of article, with ideas generated by the speech of former State Bank governer (Ms. Shamshad Akhter) in 2006.

Pakistan’s financial sector has been transformed completely from the past during the recent years; which could more clearly be described as the “first generation of reforms”. Some noteworthy factors to discuss are firstly, the mobile cash flow in the economies of region after the East Asian crisis. Secondly, the change in the global financial flows of capital from the east to the west, against the previous west to east scenario. This situation is mainly because of the imbalances the US economy currently faces in the form of budget deficits. The situation however, is remarkable since the US $1.7 trillion reserves are sufficient enough for the East Asian economies to finance their economic needs, and also opens up new opportunities for developing economies like Pakistan to find for itself, new capital flows to financing its needs from what these countries have to offer. This could make a new beginning of financial flows which the speaker this is beneficial for Pakistan in the long run.

Thirdly, the incorporation of the financial world and the yet though, the imbalances that implicates as a result of the strong clan of the G8 countries and investments only in some parts of the world, that has lead to capital deficient countries, with exposure to currency risks. This as a a result has made some countries to tighten their monetary policies to make sure they are inline with the financial stability for the long term.

With careful macroeconomic policies along with measures to deepen the financial markets and institutions, along with framework of rules that nourishes the financial sector, Pakistan can achieve its target of future prospects. Pakistan, with 5% average economic growth and with private sector credit, although improved, but is not up to the mark with the Asian economies. This shows that Pakistan is far behind from the competition when compared from Malaysia, Singapore, Thailand and Korea in terms of dept of equity markets, bank assets and bonds outstanding. Therefore, the market currently faces “lack of depth, breath, and maturity”.

However, with the new system and reforms such as the CDC and UIN in place, Pakistan is set to cover all its problems. Privatization and consolidation of banks with strict abidance to the Prudential Regulations, and the increased role of corporate governance, Pakistan has been marked as just close to India in terms of finance and efficiency.

Considering the equity market, the lack price discovery mechanism with much speculation taking place makes the market inefficient in terms of determining stock prices, which hurts small investors that enter the market. The solution to this problem is to increase market depth and breadth by IPOs much more frequent and vibrant with implementation of rules and regulations that wipe of chances of risks.

Another aspect that has leaded to improve the image of Pakistani markets is the integration of banking sector with capital markets. The approval of banks to open subsidiaries for brokerage has lead to improvements in governance and systems and the way capital markets work. Incorporation of the asset management companies and banks, in order to provide open-ended and close-ended mutual fund benefits to small investors has also been helpful in designing a level playing field for everyone and has also provided rights to small shareholders.

With integration of both in the developed markets, it is seen that the risk transferring and sharing is much easier. It has also leaded to the creation of instruments such as derivatives and securitization, which has been an important tool for financial leveraging.

Taking examples from the US, Europe and Chinese economies and banking practices, Pakistan need to decide which option to go for, since it would be a important decision and a prerequisite for economies of scale.

Lastly, the emergence of derivates market in Pakistani capital market is a step towards increasing the depth and breadth of the economy of the country. The State Bank has allowed foreign currency options, forward rate agreements and interest rate swaps which is slowly but surely gearing itself in the market.

With the current scenario in place, Pakistan has tremendous growth opportunities by private capital flow due to the savings trend and gathering that is in the region. Much also needs to be done though in the form of expanding the capital market and the banking sector. In line with Basel II accord, and much experience to understand from in terms of international market, Pakistan should be able to decide the path that needs to be followed to form a framework of rules that are important to liberalize the market effectively.

Moiz Damani is currently a student at Shaheed Zulfikar Ali Bhutto Institute of Science and Technology, pursuing an MBA degree with specialization in Finance.