602
Government Bond Market Development in Asia
13TAIPEI,CHINA
Li-Yen Paul Hsueh
Executive Summary
In the aftermath of Asian nancial crisis, bearish equity marketsmade it di¹cult for rms to raise equity funds, tight credit control lim-ited the availability of business loans, and a depreciated local currencyincreased the cost of o¬shore borrowing.The domestic bond market thus came increasingly to be seen as animportant alternative source of fund-raising for the private and publicsectors in Taipei,China.As in other Asian countries, the development of a domestic bondmarket in Taipei,China is only a recent phenomenon. or a long time,the stock market had played a dominant role in the nancial market,and commercial loans were the main source of funds for businesses be-sides equity. Direct nancing was rare, and liquidity in the secondarydebt market was low.The Government of Taipei,China began issuing treasury securitiesmore than 50 years ago. The bond market never developed in any mean-ingful way until a decade ago, however, when the Government switchedits scal policy to focus more on infrastructure developments, relyingmore on debt issuance as a funding source. The outstanding volume of government bonds before 1990 was less than New Taiwan (NT) $200billion, but had reached nearly NT$1.2 trillion (US$38 billion) by theend of 1999.As a percentage of gross domestic product (GDP), the amount of government bonds outstanding in Taipei,China is relatively low, cur-rently around 14 percent, compared with 60 percent in the US, 110percent in Japan, 97 percent in Singapore, and 30 percent in Hong Kong,China. This suggests that the government bond market still has plentyof room for further development. However, current budgetary laws put acap on the maximum size of government borrowing and total amount of debt outstanding.
Taipei,China
603
The rapid growth of the local economy, along with a favorableinterest rate environment, has also encouraged rms to aggressively tap thecorporate bond market. Direct nancing has replaced bank loans as themain source of funds for many businesses. Although small in size whencompared with its government counterpart, the corporate bond markethas also seen tremendous growth in recent years, with the outstandingvolume of corporate bonds surpassing NT$450 billion (US$15 billion)by 1999.A third component of the domestic debt market is made up of foreign bonds, which are currently issued only by supranational organi-zations such as the Asian Development Bank (ADB) and European Bank for Reconstruction and Development (EBRD). Their new issue volumehas increased steadily since 1995, with the total outstanding volumenow surpassing NT$80 billion. However, government bonds dominatethe domestic debt market with more than 70 percent of the market share.Corporate bonds account for a further 25 percent, and foreign bonds thebalance.The liberalization of the nancial market has played a major rolein overall nancial policy in recent years. Although the Asian nancialcrisis demonstrated the potential risks associated with such liberaliza-tion, especially for the nancial sector, the Governments longstandingpolicy of gradual opening has helped lessen the impact of the crisis.Having applied for World Trade Organization (WTO) accession, the Gov-ernment is modifying relevant laws and regulations to meet therequirements. The foreign ownership ceiling of local companies, for ex-ample, has been raised to 50 percent and will eventually be lifted alltogether. Repatriation of foreign investors principal capital and protshas also been abolished recently. Other limitations on foreign invest-ment are also scheduled for change in the near future, such as the securitiesand foreign exchange marketsmaking the local market even more at-tractive to foreign investors.The development of a deep and liquid domestic bond market hasbeen a priority for the Government. The issuance of government bondsin book-entry form was implemented in September 1997 and has nowbecome the mainstay of the secondary market. The Government is alsostudying various ways to modify the bond settlement/clearing system,and other issues relating to the development of an e¹cient bond market,such as lifting transaction tax on corporate and nancial securities, in-troducing bond futures and options, and enhancing the credit ratingssystem by means of qualied credit rating agencies.Since 1992, the issuance of government bonds has been conductedusing multiple-price sealed-bid auctions, a switch from the original xed-
604
Government Bond Market Development in Asia
price allocation. Short- and medium-term government bonds (two- toseven-year maturities) were issued in the early stages. In order to spreadout bond redemption dates and extend bond duration, longer-term gov-ernment bonds were gradually included. The rst 10-year governmentbond was issued in 1993, followed by a 15-year tenor in 1994 and a 20-year tenor in 1998.Only institutions with government security dealer status are al-lowed to participate in the primary bond auction. Individuals and otherinstitutional investors who wish to participate in the primary auctionmust do so through qualied dealers. Currently there are 71 governmentsecurity dealers in this market, more than twice the number of primarydealers in the US, where the Treasury market is almost 100 times larger.The outstanding government bonds in the market have a well-spacedmaturity range, providing a good basis for establishing a risk-free benchmark yield curve. However, inactive secondary market transaction (outrightbuy and sell), along with other market impediments, have degraded thebenchmarking function of the government bond yield curve in the market.Annual trading volume for government bonds in Taipei,Chinaaverages NT$50 trillion (with NT$1.2 trillion outstanding). This seeminglyhigh turnover rate is enabled by an immensely popular repurchaseagreement (repo) market. In fact, outright trading accounts for less than10 percent of the total market, with a daily trading volume of less than2 percent of outstanding volume (compared to nearly 16 percent in HongKong, China). This lack of liquidity can be attributed to a number of factors, including insu¹cient supply of government bonds, the lack of abenchmark yield curve, and commercial banks preference to hold bondsfor meeting their reserve requirements.The unique role of repos in the domestic market is mainly due tothe tax arbitrage incentive. A di¬erential tax treatment exists betweeninstitutional and individual investors. Individual investors are taxed ona cash basis, and hence tend to hold bonds between coupon paymentdates and sell them back to securities rms who are taxed on an accrualbasis. Consequently, individual investors essentially receive tax-free incomethrough repo transactions and security rms obtain low cost of fund tonance the security purchase. Because of this tax arbitrage in the repomarket, the government bond yield curve is depressed to an estimated75100 basis points (bps).The book-entry system was implemented in 1998 for governmentbonds, and these scriptless securities are cleared through a centralizedclearing system under the Central Bank of China (CBC). Currently,payments are transferred through the CBC Inter-Bank unds TransferSystem (CIS), which works electronically and can be on both a real-time
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