Integrating National Savings Scheme with capital market
It is a reminder of the inherent weak structure of the country’s least diversified capital market haunted by years-long monopoly of commercial banks, faulty structure of the National Savings Scheme (NSS) and the government’s overlapping monitory and debt management policies.
Nothing has changed on the ground, but one thing which is likely to attract government’s attention in the coming days is the latest report of the Securities and Exchange Commission of Pakistan (SECP) seeking implementation of the “Debt Capital Market Master Plan”.
Headed by SECP Chairman Razi ur Rehman, the 12-member Debt Capital Market Committee (DCMC) has analysed the market performance, and come up with recommendations seeking some fundamental changes in the present debt system.
The DCMC has already sent its report to the ministry of finance and the State Bank. The Master Plan envisages multiple reforms which seek easy debt availability to companies though Terms Finance Certificates (TFCs) and bonds and tries to avert the danger of a banking crisis in the near future.
A more efficient way of securing funds at competitive market rates is raising debt through capital market. This way, companies diversify their source of funding and do not have to go through the cumbersome process of obtaining funds from financial institutions and banks. But, at the moment, these banks enjoy a strong-footed monopoly over the lending business and credit pricing.
Compared with many emerging markets, Pakistan has lower international ratios of Financial Assets (FAs) as a percentage of GDP. Pakistan’s FAs add up to about 100pc of GDP. The global ratio of FAs to GDP averaged 315 per cent in 2005, up from 110 per cent in 1980. China, Chile, South Korea and Thailand have a ratio well in excess of 200pc. The Philippines and India stand at around 160pc.
The fastest growing global FA segment has been private debt (money market instruments and corporate bonds). Private debt has increased from 14 per cent of total FAs in 1980 to 27pc in 2005. On the other hand, banking assets have reduced from 45 per cent in 1980 to 27per cent in the same year. Private debt or TFCs in Pakistan remains under one per cent of GDP.
Pakistan is therefore relatively under-leveraged as an economy, which also points to under exploited resources to support economic growth.
At present, commercial banks seem unable to make significant contribution towards infrastructure and mortgage finance.. Both infrastructure financing and mortgages need fixed rates to develop.
Interestingly, banks are already operating at Asset/Deposit ratios that are close to the 75 per cent upper limit placed by the central bank.
The corporate sector also requires fixed interest rate loans to support plant and machinery investment. The borrowings on a floating rate basis or at fixed rates in foreign currency pose risks in a volatile financial market.. The current experience of the textile industry shows that floating rate borrowings for long-term investment can jeopardise profit margins in rising interest rate scenarios.
The Master Plan: The SECP committee on debt has given a number of recommendations to the government. It says the NSS instruments need to be integrated into the mainstream capital markets. One option is to convert the NSS instruments into existing market-based instruments i.e. Pakistan Investment Bond (PIBs) and T-bills, and pass them on to retail clients directly through the NSS network. The second option is to withdraw the policy of allowing redemption at zero penalties in order to make NSS instruments competitive with market instruments.
The NSS retail distribution network can be leveraged and its retail investor base made more resilient by allowing private sector mutual funds access to the platform for distribution of their investment products.
The government needs to turn to PIBs instead of NSS to fulfill its long-term investment needs, as PIBs would provide the Finance Ministry more control over its financing needs unlike the NSS, whose ‘on tap’ nature puts it outside the realm of government control.
The federal government, through the SBP, currently issues debt in two forms: Treasury Bills (shorter tenor with maturities three, six and 12 months) and IBs (longer tenor with maturities of three, five, 10, 15, and 20 years). T-Bill auctions are conducted by the SBP on a fortnightly basis, but PIB auctions are held on an ad hoc basis with an advance notice of at least two weeks. PIBs have been issued with an erratic frequency; for example, there were no issues from April 2004 to May 2006. The SBP has implemented a primary dealer (PD) system, instead of an open auction, for the distribution of government securities to the secondary market.
At present, 14 primary dealers are authorised to participate in auctions conducted by the SBP. In addition, the federal government borrows funds, via the Central Directorate of the National Savings (CDNS), directly from the retail sector through the National Savings Schemes (NSS). The NSS accounts for about Rs934 billion of the total domestic government debt of Rs2.3 trillion.
On the Corporate Debt front, there are two types of issues. Term Finance Certificates (TFCs), which can be listed or privately placed, and Commercial Paper. Privately placed TFCs can have short and long tenors. The investor base for privately placed TFCs includes commercial banks, DFIs and mutual funds. The issuance time is 30-45 days. These issues do not need approval from the SECP as prospectuses are not issued.
Listed TFCs currently have a five to eight year tenor (previously three to five year tenor), with the amount ranging from Rs1 billion to Rs3 billion. The investor base includes commercial banks, DFIs, employee benefit fund, insurance companies, and mutual funds. The issuance time is longer than that for privately placed issues, in the range of 3-4 months. Listed TFCs require approval of the SECP and relevant stock exchanges and also require a rating.
According to the SECP Master Plan, the government needs to ensure a more regular supply of government bonds to the market before bond distribution and secondary market trading can develop. With the present level of supply, and given that the statutory SBP requirements can be fulfilled by holding government bonds to maturity, there is little incentive for secondary market trading.
The government needs to move away from the principle of carrying on all its activities in the government bond market guided by the objective of cost-minimization.
Presently, the government conducts a price-driven auction instead of a quantity-driven auction, i.e. the government decides the cut-off yield for T-Bill and PIB auctions as opposed to letting the market determine the price. The SECP committee recommends that the pricing of TFCs needs to be reviewed with the objective of moving toward an efficient pricing structure.
Shelf registration procedures should be introduced along the lines of the US Securities & Exchange Commission rules. Shelf registration for corporate bonds is currently allowed by the SECP. However, due to resource constraints, the SECP requires a relatively long time for the approval process. If the onus of issuing certificates is placed on the lawyers and investment bankers, the process would be faster, albeit at higher issuance costs.
The government needs to improve regulation and incentives for the development of insurance and pension sectors to enhance demand for and investment in government bonds: There needs to be clarity regarding the regulation of the insurance industry. The exact sharing of responsibilities between the Ministry of Commerce and the SECP needs to be clarified, and ideally a single and empowered regulator needs to be established. The regulatory framework for pensions needs to be reviewed. The applicability of pension rules needs to be clarified. Rules have been put out by the SECP for provident funds, but it is not clear whether these rules are applicable to pensions.