THE DEVELOPMENT OF DEBT SECURITIES MARKET
COUNTRY EXPERIENCE OF PAKISTAN
PRESENTED BY
MS. UZMA KHALIL
STATE BANK OF PAKISTAN
SEACEN-WORLD BANK SEMINAR ON STRENGTHENING THE
DEVELOPMENT OF DEBT SECURITES MARKET
JUNE 08-JUNE 10, 2004
Introduction
The bond market in Pakistan is comprised of debt and debt like securities issued by a) the
Government; b) statutory corporations; and c) corporate entities. As of June 30th, 2003,
the size of the Pakistan’s bond market was approximately Rs. 1,892 billion equivalent to
USD 33billion. The bond market is clearly dominated by the Government, which
accounted for Rs.1,852 billion (or 98%) of total bonds outstanding as of June 30th, 2003
followed by corporate entities Rs. 25 billion (1.32%) and statutory bodies Rs.15billion
(0.79%).
The following table shows the outstanding position of bond market during the period
June 30th, 2003 as compared to June 30th, 1996.
Debt Instruments
FY2003
Amt Rs. in mn
Government Debt
1,852,391
FY1996
USD in mn
31,938
Amt Rs. in mn
USD in mn
901,402
15,541
Permanent Debt
427,908
223,788
Floating Debt
516,268
421,742
Un funded Debt
908,215
252,902
Corporate Debt
25,000
431.03
1,000
17.241
Statutory Corporation
15,000
258.62
13,400
231.03
2
The secondary market trading volume in the Government bond market as measured by
average daily turnover is approximately Rs. 20 bn which is 5% of the total outstanding
debt.
Government Debt Securities
The Government of Pakistan has run large fiscal deficits over the last two decades. This
has lead to the accumulation of a large domestic debt of Rs. 1,852 billion as at end June,
2003. Of this amount, permanent debt accounted for Rs. 427.908 bn (23 %), floating debt
for Rs. 516.268 bn (28%) and un funded debt (the various saving schemes) for Rs.
908.215 bn.(49%)
The large portion of floating and permanent debt has been raised through the auctions of
short term Government of Pakistan Market Treasury Bills (MTBs) and long term
Pakistan Investment Bonds (PIBs).
Characteristics of MTBs and PIBs
Market Treasury Bills (MTBs) are short-term instruments of Government borrowing
having the following features:

Zero Coupon bonds sold at a discount to their face values

Issued in three tenors of 3-month, 6-month and 12-months maturity

Purchased by individuals, institutions and corporate bodies including banks
irrespective of their residential status.
3

Can be traded freely in the country’s secondary market. The settlement is
normally through a book entry system through Subsidiary General Ledger
Accounts (SGLA) maintained by banks with State Bank of Pakistan (SBP).
Physical delivery could be affected if required.

Profit is taxable at 20%
As at end June 2003, outstanding amount in MTBs was Rs 516.268 bn (USD 8.901bn)
including MTBs created for replenishment of Govt. cash balances with SBP.
Pakistan Investment Bonds
After the suspension of auctions of the long term Federal Investment Bonds (FIBs) in
June 1998, there was no long term marketable government security that could meet the
investment needs of institutional investors. Therefore, in order to develop the longer end
of the Government debt market for creating a benchmark yield curve and to boost the
corporate debt market, the Government decided to launch Pakistan Investment Bonds in
December 2000. These bonds have the following features:

Issued in five tenors of 3, 5, 10, 15 and 20-years maturity.

Script less security managed through SGLA

Purchased by individuals, institutions and corporate bodies including banks
irrespective of their residential status.
4

Coupon and target amount announced by SBP in consultation with Ministry of
Finance

Payment of Profit on semiannual basis. Profit is taxable @10%.
As at end June, 2003 outstanding amount under PIB was Rs. 228.665 bn. Equivalent to
USD 3.94 bn.
Auction Mechanism
SBP is acting as an agent on behalf of the government for raising short term and long
term funds from the market. The MTBs and PIBs are sold by SBP to eleven approved
Primary Dealers through multiple price sealed bids auction.

The Auction for MTBs is held under a fixed schedule on fortnightly basis.

The Auction for PIB is held on quarterly basis. Since September 2003, the sale of
PIBs is done under Jumbo issuance mechanism under which the previous issues
are reopened in order to enhance the liquidity in the secondary market.
Corporate Bond Market
Pakistan’s bond market has seen increased corporate issuances following the
rationalization of interest rate structure of National Saving Schemes (various government
scheme to raise funds from non banks sources) in FY00. In addition to this, Government
has also barred institutional investors from investment in National Saving Schemes in
March 2000, which has substantially benefited the corporate debt market.
5
As a result of these measures, 48 new issues were launch during FY01 to FY03 whereas
previously only 13 issues were launched during the period FY95-FY00.
The size of Corporate bond market as at end June, 2003 was approximately Rs. 25bn
(USD 0.431 bn)
Role of Credit Rating Agencies
The Pakistan Credit Rating Agency (PACRA) was established prior to the first public
issue of Term Finance Certificate (TFCs). This agency was incorporated in August 1994
by IFC in collaboration with Fitch-IBCA Inc of UK and Lahore Stock Exchange, while
the second credit rating agency DCR-VIS Credit rating Co. Ltd was set up in 1997 to
improve transparency in capital market.
Recent Developments in Domestic Securities Market
Primary Dealer System

As a prerequisite for launching long term bonds, Primary Dealer System was
introduced in FY00 and seven banks were chosen by SBP on the basis of their
treasury expertise and infrastructure, past performance as market makers and
capital adequacy. Based on the experience with the Primary Dealers the Primary
Dealers rules were revised in FY03 in which the minimum paid up capital
requirements were relaxed to allow brokerage houses to act as primary dealers.
The Primary Dealers (PDs) are given explicit responsibility of developing an
6
active secondary market by supplying non-PDs and institutional investors with
PIBs.

In order to allow an effective price discovery mechanism each PD is allowed to
short sell 5% of the target amount before the auction.

Non competitive bidding upto 10% of the target amount in PIB was introduced in
FY03 in order to diversify the investor base and encourage participation from
retail investors.

With the view to enhance secondary market liquidity in long term bond market,
Jumbo issuance mechanism for the sale of PIB was introduced in September
2003. This step is expected to lessen the segregation in Government bond market
arising out of too many issues of different sizes and coupon rates trading in the
market. Also the announcement of quarterly sale target, helps market participants
in forming expectations about long term Government borrowing requirements.

In January 2004, PIBs of 15-year and 20-year maturity were introduced to provide
long term yield curve for corporate sector, housing finance and infrastructure
projects.
Corporate Bond Market

In order to develop the corporate bond market, several initiatives have been taken
by the Government to remove the anomalies in interest rate structures for
government saving schemes. In this respect, the rates on Government National
7
Saving Schemes (NSS) been linked with the yields on market based instrument
i.e. PIB of different maturities.

In addition, the Govt. has also barred institutional investors from investment in
NSS in March 2000, which has substantially benefited the corporate debt market.

On the investment side, commercial and investment banks are main investors in
private sector TFC’s. In 1997, listed TFC’s became “ approved securities” for the
purpose of meeting statutory liquidity requirement (SLR) for NBFI’s.

As an important step, Government has progressively liberalized the investment
restrictions on institutional investors. According to the new Insurance Ordinance
the minimum requirement of investible funds of life insurance companies in
Government securities has been lowered to 40%. Immediately prior to the
promulgation of the ordinance, the minimum requirement was 50% while in 1997
the requirement was 60%.

The investment cap was raised for provident funds to invest in stocks and listed
fixed income securities from 10% to 30%.

Furthermore the Government has reduced stamp duties and taxation including
withholding tax on profits of TFCs.
Implementation of Monetary Policy.
The financial sector reforms initiated in late 1980’s started to reform the financial
markets rapidly from FY91. One of the objectives of these reforms was the reorientation
8
of Monetary Policy away from direct controls towards indirect controls through marketbased instruments. This reorientation triggered two important changes. First is the
increasing assertiveness of the SBP in initiating and implementing its monetary policy,
albeit within the framework of Annual Credit Plans, and second is the significant
alteration in monetary policy transformation mechanism.
With respect to the monetary transmission mechanism, prior to reforms it was largely
determined by the instruments of direct control such as high SLR, bank-by-bank credit
controls and directed lending. After the initiation of reforms following indirect instrument
are relied upon for the successful implementation of monetary policy.
Open Market Operations (OMOs)
After the abolishment of Credit to Deposit ratio in 1995, OMOs are being used as a major
tool for the conduct of Monetary Policy. Regular OMOs are being conducted since
January 1995. Effective from July, 2001 OMOs are conducted under a flexible schedule
on as and when required by market conditions prior to that OMOs were conducted under
a fixed schedule. The Government Market Treasury Bills created for replenishment of
Govt. accounts are used as instruments.
SBP 3-day Repo Facility
The 3-day Repo facility is one of the main instrument of SBP. Changes in it shows the
direction and stance of monetary policy. Cash accommodation is usually provided for
9
overnight, however transaction period can be extended to 3-days or more to cover
occasionally long week ends.
Cash Reserve Requirements
All scheduled banks in Pakistan are required to maintain a balance-non-remunerated with
SBP upto 5% of their demand and time liabilities. Effective from July 26, 1997 banks
were advised to maintain average balance of 5% of DTL on weekly basis with a
minimum of 4% on daily basis.
Swap Desk
The Foreign Exchange Swap Desk was established in September 2001 to manage the
liquidity in both the FX and Money Market.
Coordination between Monetary and Fiscal Policy
The SBP is managing the public debt on behalf of the Government. There exists a close
coordination between Ministry of Finance and SBP as a result of which fiscal and
monetary policy are closely coordinated to achieve the objective of high sustainable
growth rate and low and stable inflation rate. To achieve this task the National Credit
Consultative Council meet annually to formulate the Credit Plan for the year which is
reviewed on semiannual basis.
10
Key Challenges facing the Development of Debt Securities Market
Enhancing Secondary Market Liquidity
This is obviously the most critical area for improving the efficiency of secondary market.
In this respect the Primary Dealers have to play a more effective role in enhancing their
market making abilities by quoting two-way prices for large volumes.
In addition to reduce fragmentation in the long term bond market, Jumbo issuance
mechanism has been introduced in September, 2003 to by which previous benchmark
issues are reopened to provide greater liquidity to the market. Further efforts are
underway to introduce Coupon stripping in long term bonds.
Diversifying the Investor base
Presently, in the long term bonds are largely held by the banking system. As on April 30,
2004 banks held 59.65% of total outstanding PIBs whereas Non-banks held 40.35%. The
high percentage of holdings by banks is exposing them to interest rate risk as their
liabilities are short term whereas assets are long term. To help diversify the investor base
SBP is maintaining close liaison with banks and recently guidelines on Risk Management
are issued so as to guide the banking system in their efforts to develop effective Risk
management system. In addition to encourage retail participation in long term bonds,
non-competitive bidding upto 10% of the target amount was introduced in 2003.
11
Creating Awareness among Investors
One of the problems in long term bond market is that most institutional investors appear
to lack proper professional skills and infrastructure to gauge market sentiments. This
makes it difficult for institutional investors to quote prices and thus most of them have
adopted a buy and hold strategy. In this respect SBP has held several joint meetings with
Primary Dealers and institutional investors to assess the problems faced by institutional
investors and have encourage Primary Dealers to hold seminars for creating awareness
among institutional and individual investors.
12