It's difficult to find an issue that the community of financiers agree upon. But one thing just about every top level decision maker on the market agrees is that the role of commercial banks is not to finance long term projects.
While most infrastructure and development projects in the country today seek funding from a consortium of commercial banks, each pitching in a small piece of the pie, they are merely filling in for the lack of a mature corporate debt market. Commercial bank advances are focussed towards big ticker multinationals or established family empires.
Around the world, hybrid models of debt and equity financing are employed when launching projects whose gestation periods extend beyond the short term. Taking the example of setting up an industry, commercial banks issue debt for the initial stages, but as cash flows start rolling in, the company issues debt to sustain longer term operations and goes for a public offering of its equity through capital markets.
Moreover, highly rated companies have the ability to use the strength of their balance sheets to go directly to the public and raise funds for investment projects.
In Pakistan, "when a large AA rated company needs financing, it goes to an A-rated bank and takes a loan. In the outside world, a high rated, a AA-rated company would take it as an insult to go to an A-rated bank and ask for a loan," Amjad Waheed, CEO of National Asset Fullerton Asset Management told BR Research in an interview earlier this year.
A well functioning bond market also serves as competition, for assets, to the banking system. When investors have the ability to seek other avenues to place their funds, outside of bank deposits, they are better able to match their risk and return profile.
In a 2006 research paper written for the Ministry of Finance, Farhan Hameed contends that a bond market offers a more efficient avenue for asset allocation. In an economy skewed towards banking, credit decision making is concentrated amongst a few individuals, and the risk of 'crony capitalism' allows toxic assets to remain on banks' balance sheets. "In contrast, bond holders immediately realize if a bond is not being serviced and can hold the issuer to account," writes Hameed.
Similarly, bank lending is typically of shorter term, a look at the banking system's credit advances the last year shows that almost one half of all advances are used for working capital requirements. Investment attracts less than half that proportion.
Comparatively cheaper than equity financing, long term bond issuances provide an efficient vehicle for long term project financing, such as dams, highways, fertilizer plants and so on.
Corporate bond markets also act as a stabilizing agent for the country's financial system. The flight of capital from equity to bond markets in the financial meltdown of 2008 is the most recent case. The lack of development of debt markets in Asia are cited as one of the reasons of the severity of the East Asian crisis of 1997. Since then, the economies of Korea, Malaysia, Thailand and Philippines have successfully encouraged companies to issue debt capital.
The development of debt markets in Pakistan is still in nascent stages. That being said, debt is not new to the markets. As early as the 1960s and 70s, prior to nationalization of financial institutions, debentures were listed on the stock exchanges with limited trading.
"The level of innovation in the financial sector in those early days attracted policy makers from all over Asia; that leadership is now almost non existent" Ali Raza, President of NBP, said in a recent interview for the Banking Review 2010.
Public sector companies, such as WAPDA, listed TFCs - bond equivalents in Pakistan - as early as 1988. The private sector stepped in with the issuance of a privately placed TFC by Packages Limited in February 1995.
Debt issuance took off in the first half of the last decade. In 2003, PIA launched the largest issuance with an outstanding amount of Rs15.4 billion. The average, though, remained around Rs660 million, according to SECP data. Issuances have been linked largely towards the 6-month Kibor in the absence of a long term benchmark rate in the secondary market.
Consequently, high interest rate environments have played a role in slowing the number of new issues since 2007. "Stable macroeconomic and political environment is a prerequisite for the development of debt markets then. Only then will companies move ahead with issuing debt instruments," an official at the SECP said in a recent chat with BR Research.
Among other factors cited as the hindrance to potential issuers are administrative hiccups that include prohibitively high costs of listing. Unlike many other countries, Pakistan imposes a stamp duty on the issuance and transfer of debt securities. "SECP has negotiated a lowering of stamp duty with the federal and provincial governments to more reasonable levels in an effort to encourage companies to issue their debt to the public," the SECP official added.
Liquidity, or the lack thereof, and the underdevelopment of a secondary market where investors have the opportunity to trade their assets over the counter are major issues. Industry experts suggest that while trading occurs at the institutional level, even if at low volumes, there is no central data collection organization that would enable better price discovery when calculating net asset values (NAVs).
An online bond trading system introduced by the KSE, Bond Automated Trading System (BATS), might not be enough to get fixed income traders on to the system since there is no compulsion in sharing the data on a daily basis at the moment. First steps in that direction are being taken in terms of collecting information by the SECP, but they are far from being effective just yet.
Choking liquidity from bond markets is the government's decision to allow institutional investors to invest in National Saving Schemes, a government sponsored saving scheme, which competes with private sector debt issues.
This had been disallowed in the early years of the last decade, a time which saw the highest number of debt issues in the history of the country, averaging 14 issuances per year from 2001 to 2004. At the same time, NSS funds are used for budgetary support, so private sector projects get elbowed out, due the risk free nature of government debt.
Long term sovereign debt, provides a benchmark rate for the industry to price similar securities in the private sector. Unfortunately, in Pakistan, interest rates on Pakistan Investment Bonds (PIBSs) are not entirely market driven. The government must take the lead in picking up its debt from the market instead of borrowing directly from the SBP.
"76 percent of government domestic debt is short term, partly because offer rates for PIBs in recent auctions were being rejected. So when there is no benchmark available for sovereign debt, it hinders the development of a market for long-term financing in the shape of a corporate bond." SBP Governor, Shahid Kardar told BR Research in a recent interview.
Despite the many issues that hinder private sectors from entering the fixed income domain, Engro Corporation has successfully led a debt issue that was directly offered to the retail investor. "We wanted to provide an alternative to depositors," said Hafsa Shamsi, who managed the launch of Engro Rupiya.
Rupiya offered a fixed rate of 14.5 percent for a three-year tenor and aimed to raise Rs2 billion, with a green shoe option of another Rs2 billion. To placate investor concerns, the company threw in a put option that allows investors to redeem their investments at a 98 percent of the face value.
"Interestingly, Engro is borrowing from the public at a cheaper rate than the government is borrowing for commodity finance from the commercial banks" SBP Governor commented when asked about corporate bond issues.
Even though the market was apprehensive, the launch was successful and Engro is now half way through funding the green shoe option. "The experience was very rewarding and we hope it will serve as a stepping stone for other companies to move forward," Hafsa told BR Research.
A well-structured product from a reputed company is definitely going to whet the appetite of the retail consumer. Leadership from policy makers in streamlining the issuance requirements and working towards a stable and predictable macro-economy will go miles in developing both investor confidence and the debt market of the country.
The writer can be reached at [email protected]
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Structure of Financial Systems in Selected Asian Economies (% of GDP)
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Bank Deposits Equity Market Bond Market
1990 2006 1990 2006 1990 2005
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China 75.6 177.8 1.4 60.4 5.9 34.1
India 31.4 53.2 10.4 76.2 19.8 33.0
Indonesia 30.0 34.7 4.4 30.4 0.1 20.3
Korea 32.6 66.1 48.2 88.2 44.3 102.0
Malaysia 80.6 115.9 100.7 141.0 69.9 90.5
Pakistan 23.6 34.0 6.7 35.8 29.0 29.7
Philippines 24.7 46.7 20.6 46.7 25.8 38.9
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Source: Infrastructure of Seamless Asia ADB
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