CORPORATE DEBTS: OPTIONS FOR INVESTORS & ENTERPRISES

Escalation in the debt market serves as an encouraging development for the financial system and the economy at large.

MUNTAZIR HAIDER
Feb 19 - 25, 2007

Recent Global Trends: Today, the capital markets are comparatively deeper and more liquid, with Global Financial Assets (GFAs) growing faster than the GDP of the world. The GFAs are likely to exceed $200 trillion by the year 2010. This is leading a shift towards private debt securities, which are the largest and the fastest growing components of GFAs, from the bank deposits.

CORPORATE DEBT MARKET IN PAKISTAN

History: For the development of an emerging economy, it is important to have a well functioning corporate debt market. The local corporate debt market is underdeveloped and constitutes less than 1% of the GDP. The major components of the financial assets mixture in Pakistan are deposits and government bonds, while corporate debts are the least visible portion of it. The total outstanding issues of corporate debt in Pakistan are Rs.49.3 billion (0.64% of GDP) at the end of FY06. Countries such as Korea and Malaysia have this percentage up to 21.1% and 38.2%, respectively. The local corporate debt market was born in 1995 when the issuance of TFCs (Term Finance Certificates) was allowed.

The Government Schemes: Five years later, in the year 2000, Pakistan Investment Bonds (PIBs) were introduced, which created a bench mark for private issues; they were of 3, 5 and 10 years' tenors. National Saving Schemes (NSS) were introduced with tenors up to 10 years.

The Record Breaking Year: The year 2005 recorded the highest worth of TFCs (Term Finance Certificates) issued at the Karachi Stock Exchange, where 14 companies offered TFCs worth Rs.16.8 billion. This is an encouraging view of corporate debt market development, whereby, companies are favoring the issuance or IPOs (Initial Public Offerings) of TFCs as a source of financing.

CORPORATE DEBT MARKET IN PAKISTAN

The present scenario: TFCs are the substances that form the corporate debt market in Pakistan. A healthy growth has been witnessed at the same since the first TFCs issue of Packages Limited for Rs.232 million in February 1995. The total amount of outstanding TFCs as of March 2006 is estimated at Rs.57.99 billion (US$ 0.97 billion or 1.12% of the GDP). The TFC issuers include both non-financial and financial institutions as well as private and public firms. The coupon rate on the TFCs display a wide variety with different fixed coupons as well as floating coupons linked to various interest rates including the discount rate, PIB rates, and the Karachi Inter-bank Offer Rate (KIBOR). Despite the first TFC issue in 1995, the pace of issuance did not take off until 2001 when the number of new issues (17) equaled the total number of issues in the period 1995-2000. The sum of the new issues in 2001 was close to twice the total amount issued in the period 1995-2000. This sudden surge in TFC issues was partially a result of the government decision to bar institutional investors from NSS in March 2000. The largest ever TFC was issued by PIA for Rs.15.4 billion in February 2003, while the smallest issue was for Rs.100 million issued by Network Lease in October 2000.

Changes in Structure: The structure of the TFC market has changed drastically since 1995. A major change has been the shift in issuance from non-financial enterprises to mainly financial institutions (including leasing firms). The outstanding amount of non-financial TFCs has been stagnant since the mid of 2004. At the same time, the issuance o TFCs has increased particularly with banking sector issuing TFCs on a regular basis to increase their tier-II capital. Another change has been the movement from the fixed to floating rates. Until 1999, all TFCs were issued at fixed rates but starting 2001, most of the new TFCs were issued at floating coupons. The length of the tenors has also increased. In 2004, the range was 7.4-3.4 years, while during 1995-2002, the average was 5-7 years.

Critical Analysis of Economy Benefits: There have been extensive debates on the intrinsic worth of the development of corporate bond market. It has been considered a substitute to the banking system; Alan Greenspan refers it to as a spare tyre. The opposing argument states that the latter cannot be substituted since an overall decline in the economic and banking sector has a significant impact on the performance of bonds/TFCs. Escalation of the debt market serves as an encouraging development for the financial system and the economy at large. It helps in diversifying the nature of finance; reducing the dependency on banks and other financial institutions, as their monopolies often serve as an obstacle to efficient growth. At the same time, it provides organizations' access to more capital for long term financing. A well developed debt market can provide extensive competition to the banking sector, which in turn would be helpful in increasing their efficiency. Corporate require long-term loans, while bank loans are generally of short tenor due to their deposits being of the same nature. This leads to mismatch at maturity in the banks' asset and liability portfolios. Therefore, the long-term financing needs are fulfilled by a series of short term loans that are generally a regular roll-over. The roll-over often becomes difficult to settle for the borrower in case of a credit crunch. A developed debt market would help alleviate these difficulties and also facilitate better risk diversification as debt is spread across a large number of individuals as opposed to bank lending, and the corporate sector is able to raise longer term debt. This development can allow banks to concentrate more towards those enterprises that typically face credit constraints due to their small size, relatively new stage of development, or simply asymmetrical information.

OUTSTANDING DOMESTIC DEBT SECURITIES 
(IN PERCENTAGE OF GDP)

 

TOTAL OUTSTANDING DEBT SECURITIES

GOVT. SECURITIES

CORPORATE ISSUERS

FINANCIAL INSTITUTIONS

Pakistan

15.3

14.2

0.7

0.5

ASIA

China

31.9

20.3

0.9

10.7

India

36

35.4

5.4

0.2

Malaysia

102.8

43.6

43.4

15.8

Korea

81.1

24.2

24.8

32

Thailand

42.1

24.1

12.9

5

LATIN AMERICA

Argentina

17.3

6.7

6.6

4

Brazil

65

52

0.7

12.3

Chile

57

29.4

13.5

14.2

Colombia

33.1

32.5

0.6

0

Mexico

26.9

23.5

2.5

0.8

CENTRAL EUROPE

Czech Republic

63.4

55.8

4.1

3.3

Hungary

58

52.8

1.3

3.9

Poland

37.8

37.8

0

0

Russia

3.9

3.7

0

0

Turkey

60.9

60.9

0

0

MATURE MARKETS

Australia

61.8

16.4

17.8

27.6

Canada

83.2

61

10.5

11.7

Hong Kong SAR

28.8

10

3.4

15.5

Japan

189.5

145.1

16.9

27.5

Singapore

68.8

45.3

5.8

17.6

United States

169.5

49.1

23.4

97

Source: Luengnaruemitchai and Ong (2005) and SBP Statistical Bulletin. Pakistan data as of June 2006 and all other countries as of 30th September, 2004