Development of Domestic Debt Securities Market
I.
Recent Development of Domestic Debt Securities Market
1. Creation of the securities market
During the pre-transition period the Government owned almost all social wealth.
However, since Mongolia has adopted the new Constitution, Civil Code and other laws to
allow existence of private wealth, the Government had to be directly involved in such
economic relations which are arranged by stock exchange markets. An issue pertaining to
stocks is important to all social spectrums from political parties, government, and policy
makers to the public at large. The process of introducing new and never-used-before
financial instruments into today's distinctive economic environment is underway
currently.
Upon the set-up of the MSE on 18th January of 1991, the stock exchange market has
developed. The legal environment for the operation of the stock exchange market was
established by adopting the Privatization Law on 22nd May of the same year. The primary
goal of the MSE operations or the establishment of Stock Exchange was to privatize
state-owned factories, which had been inherited from the centrally planned economy. In
the framework of its operation, it was decided to set up 474 public companies on the
basis of these factories and to privatize them. Thus, upon the start-off of the privatization
of the state factories, true understanding about stocks has been established alongside with
an emergence of these companies.
The instrument for the privatization was privatization voucher. The privatization voucher
is the blue color coupon, which was distributed to the citizens so that they could buy
stocks of above mentioned 470 companies. Altogether, investment certificates with the
value of 0.35 billion US dollars were distributed to 1989.9 thousand citizens and citizens
were allowed to buy company stocks using these certificates.
The development of the securities market can be divided into the following periods.
-
The primary market (1992-1995)
-
Start of cash trading (after 1995)
Taking into account specifics of the primary market in order to evaluate development and
trend of Mongolian securities market, let's only look over the period of cash trading or
secondary market. Investors' interest to participate in securities trading was weak because
of artificial equilibrium of demand and supply, investors had no knowledge of securities,
and there was no cash trading during the primary market period.
Primary market
The first trade, which took place at the Mongolian Stock Exchange on 7 th February of
1992, is regarded as a start-off of the operation of the securities market. Since then till
August 8, 1995, the privatization of state factories or primary market operation took
place. During this period total of 900 trading were held and privatization vouchers or blue
colored coupons traded 96 million shares of 474 companies. Within three and half years
of period, 1.1 million shares owned by individuals and vouchers with value of 47 million
US dollars /20 billion tugrugs/ were traded. At that time, company's shares were
classified as common and preferred stocks. Preferred stock was sold to their employees at
its nominal cost. At that time, nominal prices of shares of all 470 companies were the
same 0.2 US dollar /100 tugrugs/. The following table shows data of this trading.
Table 1. Number of common stock sold to individuals through the Stock Exchange
Years
Number of Number of stocks
companies
/in thousand/
1992
1993
1994
1995
Total
205
155
70
40
470
35995.72
22318.6
22374.18
12685.13
93373.64
Total
/in thousand
dollars/
99280
7515.12
3513.49
1280.27
21588.9
Average rate
US / in US dollars /
2.08
0.34
0.16
0.10
067
Table 2. Number of Deferred stock sold
Years
1992
1993
Number of Number of Total
Average rate
company
stocks / in /in million /in US dollars/
/in tugrugs/
thousand/
US dollars/
101
1921,14
4.8
2.5
100
45
677,17
0.17
0.25
100
1994
1995
Total
20
13
179
341,02
65,80
3005,13
0.08
0.01
4.99
0.24
0.21
0.71
100
100
100
Depending on Mongolia's economic characteristics, the country's primary securities
market had the following features. These included:
-
Artificial equilibrium of demand and supply of stocks
-
From one side individuals with privatization vouchers, from another side state owned
factories with the same cost stock
-
Nominal costs of all companies were the same.
-
Investors had no experience to participate in the securities market operation
Companies couldn't accumulate financial resources, as there was no cash trading
Secondary market
The specifics of Mongolian secondary market operation are associated with a fact that it
was distributed free of charge to individuals or traded at no cost. Till August 1995, there
was no cash trade in the primary market. Individuals couldn't trade their securities as the
securities weren't traded in cash or distributed in investment certificate.
On August 28th, 1995, first cash trading was held at the Mongolian Stock Exchange. This
period is called as a beginning of secondary securities market. This enabled investors to
sell and purchase their securities.
Such trading has been held till now and totally shares of 53.95 million US dollars and
bonds of 126.7 million US dollars were traded through 1900 trading. This shows amount
of money flown into investment. It can only be said for Mongolia's case. The trades on
the secondary market operation meant only re-trading of shares that were acquired
through privatization vouchers.
Money market
Till 1996, money market or short term securities had not been traded in the Mongolian
securities market. Short-term securities market or money market operation has started as
Mongolian Government Bond was traded first time on October 25th, 1996. Government
bond was sold as discounted security and 0.21 million US dollars securities were sold
through the Stock Exchange in the first trade.
Since then, during 2000-2002, Government and corporation bonds were traded. In 2001,
corporation bond was traded first time at the Mongolian Stock Exchange. This process
was the primary base of developing money and debt market. From the following table,
data of Government and corporate bond can be seen.
Central Bank, the Government and commercial banks have been main participants in the
money market operations with their activities being regulated in an open and transparent
manner.
2. Current situation of securities market
A decade passed since the Mongolian Stock Exchange (MSE) established. Almost a half
of the period were years of hyper and high inflation pushing businesses and individuals
away from financial assets due to its negative yield on holding. Since the MSE
established only over 30 companies issued its share in the capital market not including
shares traded in exchange of privatisation vouchers. This indicates that companies in this
country do not want to finance its business expansion by issuing equity. On the other
hand, non-participation of the institutional investors, such as insurance and pension
funds, limits market expansion itself. The absence of institutional investors affect to the
quality of information and it disclosure so public investors intention or decision collared
by the brokers information or perhaps some other middleman who's incentive may
diverge from those of investor's. And perhaps, it is slowing the pace of the capital market
development in turn.
In last few year the opportunity to upgrade capital market functioning have been
increasing with a low and stable inflation relative to previous years, and public interest on
financial saving is recovering.
Operation of securities market of this period is the most important time to determine
development of previous and future trends of Mongolian securities market. To determine
the conditions of Mongolian securities market at this period let's evaluate indicators
separately.
Now let's determine conditions of Mongolia's securities market. In order to do so, the
following indicators have been analyzed.
Table 4. Information on Mongolian securities Market /1996-2003/, end of period
1996
1 Number of listed 449
companies
2 Number of trading
companies
3 Listed stocks /in
millions
of
1997
435
1998
430
1999
418
2000
410
2001
400
2002
403
2003
402
302
203
125
88
134
117
226.4
261.0
273.5
274.3
657.3
1124.6
4
5
6
7
8
9
number/
Market capitalization /in million/
in US dollar
25.9
53.2
Trading amount /in million/
in US dollar
6.3
15.0
Sold stocks /in 24.1
33.7
billion/
Daily average
Total amount /in 26.5
59.2
million of $/
Sold stock /in 102
133
billion/
Trading bond /in billion $/
Government bond
0.2
Corporate bond
TOP-75 index /in US dollar/
Upper
0.39
0.48
Lover
0.22
0.16
Average
0.30
0.31
Closing
0.39
0.44
39.8
32.1
36.9
37.5
31.9
42.4
11.9
33.1
3.1
21.4
2.7
35.4
1.6
15.9
1.2
9.8
0.8
8.1
47.1
12.1
10.7
6.2
4.8
3.1
130.7
85.1
138.9
62.3
38.6
32.3
10.2
27.9
1.1
37.1
2.6
18.6
2.6
0.46
0.24
0.33
0.43
0.87
0.44
0.59
0.74
1.29
0.71
1.00
0.83
0.89
0.49
0.66
0.77
0.45
0.25
0.26
0.26
0.26
0.18
0.21
0.24
Regarding these indicators till 1997-1998 most of the indicators were reached at the top
level and since then these have continuously been declining. From these indicators, even
TOP-75, Government bonds and corporation bond were increasing, while other indicators
including market rate, trading volume, and intensity were decreasing. From last years'
trading, it can be seen that there was no trade at all except trading of major few
companies' securities and Government bond. Moreover, companies do not issue securities
in the capital market. From above indicators Mongolian securities market is now in
stagnant condition.
II.
The Implications of Domestic Bond Market for Central bank Policy
A financial market consists of money and capital market. The money market is the
market for securities up to one year; they are named as short-term securities or short-term
debt instruments. In contrast the capital market is the market for longer maturity debt
instrument. Although the instruments of these markets are not an emphasis in this short
essay, one might worth noting. All instruments in both markets are differing by its
maturity, risk and consequently its yield but among all debt instruments special attention
drawn to the government securities. There is common believe that the Government will
not default on its debt, and therefore the demand on different type of Government
securities in both capital and money market is high, so investors treat them as lowest risk
instrument.
The most important use of those is the investors' opportunity to diversify non-market risk,
related to other debt instruments. In addition to this the Government securities used as
reliable signal for market condition, when uncertainty increases due to increased
volatility of prices of other securities the demand for the government securities increases.
One important role of the Government securities is the role of key instrument for
enhancing market relations at initial stage of both financial and money market
development in developing economy. In this country we see that the Central Bank Bills
(CBB) plays similar role for money market development. The main objective of the Bank
of Mongolia shall be to ensure stability of the tugrug. In order to implement its
objectives, the Bank of Mongolia shall formulated and implemented of monetary policy
by coordinating money supply in the economy.
In order to execute monetary policy, to influence price developments through controls
over the reserve money and money supply as a whole, and to indirectly manage excess
reserves within the banking system, the Bank of Mongolia has issued CBB. The CBB is
the main policy tool of the Central Bank, at discounted prices (selling at a discount, i.e. a
price below par value, while repaying the buyer at par value). This has been done in
accordance with international standards.
Although both CBB and Government securities are financial instruments, they differ in
principle by their ultimate objectives. As for the TB, it is issued for implementing fiscal
policy and Government debt management, and as for the CBB it is issued for maintaining
domestic price stability. Because of their different influence on macro-economy, certain
conflicts of interest may arise during implementation of fiscal and monetary policies. For
instance, issuance of the Government securities leads to an expansion of money supply,
and in contrast, issuance of the CBB leads to a decrease of base money.
In the most countries participants of the money market is limited. Typical participant of
the market is the commercial bank. So, the money market in reality a wholesale market
for money. Thus the commodity sold here is money and price for money is cheaper than
otherwise. The default risk in the money market is low maybe because of short maturity
of the contracts negotiated. A transaction in the money market transfers money from one
intermediary to another. Its size and price is the space monetary policy. In contrast the
capital market serves genuinely for and opens to the public. Products sold in this market
vary widely but they cannot be used as a payment instrument. The market attracts public
interest to invest because of its tax convention, wide range of efficient flexible investment
and an opportunity for diversification of the risk. It is very rare for any central bank to be
actively involved in this big market where concludes many different financial contracts.
So, the capital market is not a direct space where monetary policy operates. However, it
is important enough for consideration from a monetary policy point of view, because of
its relevance for achieving a goal of the policy.
The capital market increases efficiency of the monetary policy
Development and stable operation of the capital market is important for the monetary
policy implementation by two major reasons.
1. The capital market is a part of the monetary policy transmission mechanism.
2. The capital market contributes for the financial stability because it provides an
alternative for an investment opportunity.
If there is a change in a money supply and/or in a short-term interest rate for monetary
policy consideration then in one side it will induce change in the price for financial
assets. On the other hand it will create an additional flow of funds between markets. In
both cases these shocks stimulate flexible investment opportunity revealing most
productive sectors/industries and reallocate financial resources. Through these
adjustments ensure the achievements of the goal of the monetary policy. Although this is
just an additional channel to transmit a policy effect when it enables the efficiency of the
policy is improved substantially. The effect of this channel depends upon development
and capitalisation of the capital market, popularity and habitual pattern of the use of
financial instruments and public intention to invest in the market and of cause
Government policy on deepening of the capital market.
The role of the capital market is to channel a saving to the business, creating investment
opportunity in the real sector and provides continues valuation of the listed companies.
Apart from this the capital market can provide an opportunity to business entities and
individuals to proper locate their liquidity when instability facing in the money market
and conditions of the banks and non-bank similar institutions is worsening. Therefore
when a financial intermediation falls, hence an investment and saving opportunity lacks
the market offsets deterioration of the intermediation reducing a negative impact of it.
Furthermore well functioning capital market may prevent the negative impact above
mentioned to extent to the financial crisis. So, enhanced stability of the financial sector
ensures successful implementation of the monetary policy. Since a monetary policy is
based on the stable relationships of the monetary side of economy, and if any negative
shock to the money market spreads and causes loss of the latter relationship then changes
in the instruments may result unexpected, perhaps, damaging effects. This is enough for
the central bank to pay attention to the development of the capital market and to be an
active observer of the market. From the development of the capital market there are some
aspects worth noting. The specific of the market can be characterised as an information
intensive, not easy to understand for a general public, methods of diversifying risks are
require sophisticated technique. Perhaps, therefore with the development of the academic
research in this direction and an improvement in information processing, dissemination
mechanism the market capitalisation increases. However, the information is an expensive
and it has property of a common good after the disclosure. In other words, when
company invests in private information to increase its profit they have no opportunity to
avoid the situation where other investors follow the decision taking by the firm and as a
result initial expected profit will be reduced due to common good inefficiency.
However, with the increasing number of participants the common good problem may be
reduced. But, to encourage potential investors to participate the role of big investors
(including institution investors), who can facilitate information availability and quality is
crucial. The history shows institutional investor such as insurance and pension funds are
plaid role for stimulators for quality information and made important base investment in
information business. On the other hand with increased availability of the quality
information general public invests in the market more, not only for profitable investment
but to seek a capital gain.
The incentive of the participants focused on the capital gain also gives signal to the listed
companies about its rating and market value for the share as performance criterion.
Indeed, companies carry a decision to increase its business issuing equity depending on
the price of its share. Because classic economists are believed that monetary policy may
influence to the market value of the company (change of the Tobin's q as an example) the
capital market plays crucial role to promote investment via monetary policy.
III.
Key Challenges In Developing Domestic Debt Securities Markets
In order to use the opportunity fully there are needs to put effort on broad advertisement
of the usefulness of Stock Exchange, take measures to increase its credibility, improve
transaction efficiency of the institution. The market efficiency will improve with
achievements in the information quality and dissemination efficiency.
Apart from above introduction of the new instruments will impact market size positively
and may force its deepening as you can observe from recent activism of the Government
security in the market. The volume of the Government security increased substantially
since 2000 and housing bond introduced from 2001. These new instruments will
contribute to upgrade capital market and gave investors a new alternative for investment.
Perhaps, widen market space through introducing less risky and more liquid assets. At
this stage our capital market is not developed yet to attract investor for a profit from
capital gain. So, capital market is not ready to operate as monetary policy transmission
mechanism today.