Local currency bond markets have more than doubled in nominal terms between 2011 and 2018.
A recent World Bank working paper has attributed this phenomenon to a benign global liquidity environment coupled with low interest rates, which has renewed investor interest in emerging market sovereign debt.
A deep and liquid debt market, especially in government securities, is crucial for efficient monetary policy transmission, infrastructure financing and financial deepening. Central banks have multiple interests in the development of government bond markets as they offer an avenue for financing the budget deficit in a non-inflationary way.
A key reason why local debt market should be developed and well-functioning is its specific role in efficient management of fiscal deficit and more generally, its role in efficient financial market functioning. In this regard, the regular issuance of sovereign debt can play a key role in the development of bond market by providing a base rate for the pricing of other financial instruments.
Debt markets make financial markets more complete by generating market interest rates that reflect the opportunity cost of funds at each maturity. This is essential for efficient investment and financing decisions. Pakistan sovereign debt Pakistan’s total debt has continued to grow over time with the latest data from the State Bank of Pakistan website exhibiting a growth of 7% in total debt in Q3FY21 relative to the same period of last year.
This increase is largely driven by an increase in government domestic debt, which forms a sizable proportion of 60% of the total debt. This growth in the domestic debt provides an opportunity for it to be actively issued and hence traded on local debt markets.
Currently, Pakistan has a very shallow debt market, which is limited to infrequent trading in government securities and corporate bonds. The corporate bond market remains negligible in the country. Furthermore, the government securities market does not provide efficient signals for pricing corporate debt securities.
Regulatory bodies such as the State Bank of Pakistan and the Securities and Exchange Commission of Pakistan (SECP) can play a key role in the development of a wellfunctioning debt market in Pakistan. A major shortcoming in the development of secondary market, as identified by the BIS, is that repo markets remain underdeveloped in most emerging economies including Pakistan.
For most economies, the interbank repo market tends to be very short-term in nature. Central banks can play an active role in repo markets, thus adding liquidity to the securities, which otherwise would be illiquid in the hands of banks. In terms of the SECP, complex procedures for the issuance of debt instruments such as Term Finance Certificates cause regulatory delays.
This results in prohibitive transaction costs, which impede the development of the local debt market. In addition to this, tax exemptions for investors of corporate bonds can also potentially contribute to the growth of corporate bond market in the country. Local currency bond markets provide a stable source of funding for emerging market sovereigns.
As economies witness the dampening economic impact of Covid-19, sources for obtaining concessional financing for Pakistan might be limited. In this regard, the development of a liquid and active debt market is imperative to provide an alternative source of funding.
Policymakers must play their role in providing a more supportive and consistent economic policy environment, and improving governance associated with the capital markets.
THE WRITER IS A DOCTORAL CANDIDATE AT THE BARTLETT, UCL