EDITORIAL: Pakistan and Asian Development Bank (ADB) have been development partners for the past five decades. Now ADB intends to increase its private sector operation in Pakistan. Currently, ADB's investment in Pakistan's private sector is largely confined to the power sector as the revenues in the sector are pegged to US dollar. ADB's inability to raise money in Pak Rupee impedes its objective to take exposure in other sectors.
The bank is in talks with the Pakistan government to come up with a mechanism to take exposure in domestic financing to private sector. ADB has proposed to issue local currency bonds to resident investors and offshore Pak Rupee-linked bonds for non-resident investors. Stakeholders in the government have consented to issuance of offshore linker bond (linked to Pak Rupee). Onshore issuance faces hiccups due to tax anomalies and limitations imposed by the Securities Act. Both Securities and Exchange Commission of Pakistan (SECP) and State Bank of Pakistan (SBP) have shown keen interest in local onshore accounts as this would help in developing domestic capital market.
Offshore bonds issue is capped at $200 million limit and may be issued only to non-resident investors and not funded via any sources from within Pakistan. The issue shall work differently from conventional Euro bonds. In case of Euro bonds, country's credit risk is covered in pricing, while for multilateral linker bonds there is no country risk involved. Since the issuer is ADB - a AAA rated agency - investors are not exposed to country risk. There is, therefore, no need for a country risk premium. However, investors will still face currency risk.
Pakistan is not the first country where ADB plans to issue such bonds. The bank has issued similar linker bonds in 13 economies where they are linked to respective local currencies. Salient examples include Masala Bond in India and Komodo Bond in Indonesia. In Pakistan, ADB may come up with a similarly catchy name - one idea is to name them after Pakistan's world-famous truck art.
These bonds enhance ADB's ability to take exposure in domestic private sector lending. These lending arrangements shall be similar to International Finance Corporation's (IFC's) commercial lending to the private sector. Linker bonds are cleared by international central securities depositaries and are listed on major stock exchanges. They are distributed exclusively to foreign investors and are not offered for sale to domestic investors. A wide array of investors including central banks, sovereign wealth funds, commercial banks, and institutional investors usually participate in them.
This is good for Pakistan as it creates another avenue of foreign funding for domestic businesses and can help reduce the balance of payment risk by increasing foreign inflows into the country. Moreover, this will provide flexibility to the ADB to enhance its own portfolio in financially underserved sectors. ADB can potentially invest in MSMEs, agriculture, and other sectors where the formal banking credit is scarce, and cost of funds is high.
Coupon payment on bonds shall be benchmarked to the prevailing interest rates in the country. Proceeds from the issuance shall be converted into Pak Rupee at prevailing forex spot rates. Repayment of principal and markup shall then be converted into forex spot rates. In this way, while investors will remain exposed to currency risk, they need not worry about country's credit risk. This is unlike Eurobond yields that incorporate country risk. This reflects itself in country risk disparities, such as similar maturity bonds issued by the US government at two percent, whereas those issued by the Pakistani government may offer a return of as much as 8 percent. Both the bonds are issued in same hard currency; the six percent difference in yield covers the country risk.
In case of ADB linker bonds, investors will receive prevailing domestic market interest rate and the returns shall be converted into foreign currency on spot rates. Currency depreciation could potentially dilute investor's returns while currency appreciation would enhance returns.
Offshore bonds shall help initiate direct lending by ADB to Pakistan's private sector in PKR. It will also help the debt capital market in the country to grow through issuance of onshore bonds. But for that to happen, SECP must make changes in the securities law as not all conditions applicable to the private sector for bond issuance are relevant to a multilateral such as ADB. In the 13 other countries where ADB has taken such initiatives, both onshore and offshore bond varieties exist. It is hoped that it won't take long before Pakistan's bonds become part of the same portfolio.
Copyright Business Recorder, 2020
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