DEVELOPMENT OF BOND

MARKET IN PAKISTAN
(opportunities, hindrances
and suggestions)
Introduction of Bond Market
The bond market also known as the debt, credit, or fixed income market is a financial market where
participants buy and sell debt securities usually in the form of bonds.

Background
Bond markets play an important role in mobilization of capital. The investments are very necessary for
economic development of a country. A good market will help promote economic growth and reduce the
risk of financial crises. To improve the efficiency of the bond market what can be done is that financial
market regulation and supervision should be strengthened, market infrastructure should be enhanced,
new investments areas(products) for better mobilization of savings and improvement of investor bases.
((Developing Bond Markets in APEC - Toward Greater Public-Private Sector Regional
Partnership)))

The bond market is composed of Pakistan investment bonds, corporate bonds, Sukuks and commercial
paper. Overall this market is 5% of GDP at the moment which is very small as compared to other
economies. (((bond market development in Pakistan by Muhammad Arif 2007)))

Significance of Bond Market for Pakistan

Bond market is of great significance to a country that faces large budget deficits, like Pakistan.
Generally a well developed bond market is important for these reasons:

Increasing the competitiveness and efficiency of the financial system, which here is dominated by large
banks. At micro economic level development of securities market helps change the financial system
from bank-oriented system to multi layered system where capital markets can complement bank
financing.

Enhancing the stability of the financial system by creating alternatives to banks, that will reduce the
power of banks simply

It provides a resort for domestic funding and budget deficits other than by central bank
Bond market helps in the implementation of monetary policy, including achievement of monetary
targets or may be inflation objectives

The development of bond market can force the financial intermediaries to develop other products like
Repo, Structured finance and Derivatives.

Cost of debt servicing can be reduced through funding of Government Budget deficits on market-
oriented funds.

(((bond market development in Pakistan by Muhammad Arif 2007)))

Further I can say 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
• 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.
(((PeerPapers.com)))

Objectives of Bond Market

• To establish a free market that encourages the widest participation of ownership in enterprises
• A free market that regulates itself
• Enhance the democratization of wealth
• Promote the development of the capital market
• Protect investors
• Ensure full and fair disclosure about securities
• Minimize insider training and keep the market efficient up to the possible limit

Problem Statement
Mechanics of Bond Market

Development of bond market

Following are the essential areas which are necessary to be developed for realization of fixed income
market in Pakistan.

 Money market and Monetary operations

 Issuance strategy, market access and debt management framework
 Developing benchmark issues
 Investor base
 Primary market
 Secondary market
 Settlement infrastructure
 Legal and regulatory framework
 Taxation policy
 Linkages of sub national/Private sector bonds with government bond
market
 Sequencing of development

Plan for the development of bond market

There cannot be any doubt that financial system of Pakistan has a lot of potential, however, it is to be
searched and put in place. Another angle, which needs to be brought into the system, is to integrate it
with global financial system. The vision, which anybody can have in the market for the future financial
system of Pakistan, can be briefed as :

• It has to be market based

• The market should have its own policing system in addition to Regulatory framework.
• Development of new hedging products like derivatives.
• Updating of accounting/auditing and reporting system in line with the international standards.
• Fully automated financial system.
 • New Government Securities Act to replace out dated Public Debt Act 1944.
• Listing of Government Securities on Stock Exchange to widen investor base.
• Implementation of Real Time Gross System to mitigate systematic risk in fund settlement.
• Bond stripping to create liquidity in the bond market and to induct zero coupon yield curve.
• To foster growth of corporate Bond market in Pakistan by making it cost effective.
• To develop trading/Risk Management/Price dissemination mechanism for Corporate Bond
Market.
• Financial Institutions to have controls i.e. Clear Strategies of duties at all levels, Dual Controls,
Rotations of assignment of duties, Internal auditing of all operations, Audit programs for
external auditing, Operational reviews
• Development of newly inducted Islamic finance
• Development of investor base specifically Mutual Funds
• Development of Sub National Bond Market in Pakistan
• Development of Infrastructure/Mortgage Finance

Bond market in Pakistan

Current status and Overview
Liberalization of the financial system and the switch from credit planning to a market based monetary
policy has crated a secondary market for government bonds in Pakistan. Trading in treasury bills and in
short-term federal bonds provides the basis for open market operations of the state bank.
In 1991, the government with the consultation of World Bank, started issuance of two types of securities
—one of short-term maturity and the other of long-term maturity on the basis of auction through the
intermediation of primary dealers, i.e. treasury Bills (short-term) and federal investment bonds (long-
term). The salient features of the treasury bills are as under:

T-Bills
The bills are issued at a discount. The investors are required to quote the price at which they are willing
to buy t-bills of Rs.100 face value. Individuals, institutions and corporate bodies including banks/DFIs
are eligible to purchase the bills. The principal and profit accrued thereon is guaranteed by the
government. Principal and profit is payable on maturity. T-bills can be traded freely and are transferable
by endorsement and delivery.
Tax is deducted at source under the Income Tax Ordinance 1979.

Federal Investment Bonds

Bonds are of three different maturity periods viz. three years, five years and ten years. Short-term FIBs
have also been issued.
Individuals, institutions and corporate bodies including banks, irrespective of their residential status can
purchase bonds. There is no quantitative limit on purchases.
Bonds are redeemable at par on completion of their respective maturity period. In case cash is require
before the maturity date of the bond, the investor may approach his banker et his bonds converted into
cash at the market price. In the manner, the government bonds can be traded freely in the secondary
market before their maturity date. Each bank is required to display daily sale and purchase prices of
bonds at their main branches in major cities.
WAPDA, NDFC, BEL, PICIC, and some other firms have also issued non-government corporate bonds
and certificates. Trading is very limited. Investment banks which were expected to play a major market-
making role have not succeeded in doing so. Term Finance Certificate (TFCs) has been issued by
financial and manufacturing companies from time to time. 62 TFCs instruments have been issued on the
KSE during 1996-2003 (21 of these were issued in 2002-2003).
The secondary market is shallow and largely confined to the public debt sector. The range of financial
assets available is limited. The growth of the secondary market has been restricted by the expansion of
the national saving schemes (NSS), which are very popular with the public. Rates of return in the
secondary market are generally lower than those offered by the national saving schemes although rates
on these schemes have been drastically reduced during 2000-2002. The growth of the secondary market
is limited by the interventions of the government in the auctioning process to hold down interest rates.
Such intervention has been reduced since 1997, when the autonomy of the state bank was recognized
through the amendment of the State Bank of Pakistan Act 1962.
About Rs.5 billion worth of TFCs were issued during 1995-2000. There was major upsurge in 2002 but
the secondary market in TFCs is very undeveloped. Pakistan Investment Bond issues are significantly
larger (exceeding Rs.100 billion in 2001-2002 for example). A secondary market has not developed in
PIBs and PIBs are not regarded as a capital market instrument. The public is not informed of what the
government does with the money raised through Pakistan Investment Bond issues.

((money and banking in Pakistan, fifth edition, SA Meenai, oxford university press,2004))

Hindrances in development of Bond Market

• Fiscal and Trade Deficits
• Law and Order Problem
• Bad Governance, lack of accountability on the part of bureaucracy, Public and
Private Sector institutions.
• Ineffective Implementation of law and delay in adjudication
• Lack of market expertise
• Lack of awareness of new financial products
• Lack of infrastructure and automation
• Lack of stringent regulatory policies and their effective enforcement.
• Lack of self-policing system in the market.
• Lack of awareness of market ethical values.
• Political interference in the regulatory functions.
• Clear laws curtailing clear interpretations
 • Inconsistent supply and small size issues of Government Bonds.
• Corporate Bond market being not cost effective due to stamp duties levied by the
issuance and time taking procedure for their approval.
• Non issuance of sovereign Sukuk.
• Transaction cost as stamps duties on Commercial Paper making them non cost
effective.

Opportunities ????

Action plan for development of Bond Market of

Pakistan
o Create depth in money and securities market to improve the transmission channel

of monetary policy. This would facilitate investors/issuers to have better view of

interest rate movements. This includes introduction of SBP own instruments,
review of monetary policy execution framework to switch over to explicit interest
rate targeting, establishment of Market Stabilization Fund (an arrangement in
which government share the cost of monetary policy operations with central bank),
capacity building of DPCO, Projections of Government Cash flows.
o Building up institutional and market microstructure for developing Government
securities market in Pakistan i.e. developing distribution channel through market
makers and dealers having expertise in securities business.
o Keeping consistent supply of large size long-term government instruments for

creating liquidity and proper yield curve. To achieve this goal, reopening, stripping
and fundability need to be allowed
o Timely market information to he issuers as well to investor through data
dissemination.
o Diversifying the investor base. The steps include development of Asset
Management Firms/Mutual Funds/Discount Houses to diversify investor base
through legislative support.
o Containing crowding-out effect through reducing deficit financing for developing
Corporate Bond Market.
o Creating appetite for bond market by supporting Islamic Fund Industry, Mortgage
and Infrastructure Finance initiatives.
o Building Bench mark curves i.e. Revaluation, Clean, IRS, zero coupon curves.
o Aligning Sub National/local Governments/Public Sector requirements with
Government Bond Market by providing them same infrastructure.
o Reducing fees/Stamp duties on Corporate Bonds/Commercial papers to make them
cost effective.
o Allowing Supranational Bonds in Pakistan to create liquidity in Corporate Bonds
Market and to have best international practices through their presence.
o Attracting non-resident investors by providing them better opportunities to have
positive yields by extending some concessions like tax exemptions.
o New legislation aligned with current environment for Government as well
Corporate Securities Market.
o Creating tax base on equity providing level playing field to all investors.
o Allowing international depositories linked with domestic depositors for facilitating

international investors to invest in Pakistan.

o Establishing cross border settlement mechanism. This would reduce cost of doing
business in own and with others markets.
o Developing Derivatives market for facilitating investors/issuers to hedge the risks
on their portfolios.
o Developing Bond Market in sequenced manner i.e. from simple to complex
instruments/infrastructure.
 o For developing above Government as well regulators (central bank and securities
commission) to work together in devising policies and than coordination in their
implementation process.

(((bond market development in Pakistan, Muhammad Muavia Nov 2005)))