The government of Pakistan has awarded mandate for the issuance of Pakistan’s sovereign bond to JP Morgan and Deutsche Bank as lead-manager, and ABN Amro Bank as co-lead manager, few days ago. For the last few months, both local and international print media have been publishing news items/commentaries on the issuance of Pakistan’s sovereign bond.

Through these publications they have been drawing the attention of the global bond investors about Pakistan’s re-entry into the international capital market after the laps of six years.

There has been a general appreciation about Pakistan’s endeavour to re-appear on the radar screen of the global capital market. Still some people may be wondering about the rationale for going to capital market when Pakistan’s foreign exchange reserves are as high as $11.5 billion or raising capital from international market when the international financial institutions (IMF, WB, ADB etc.) may be providing the same at a relatively cheaper rate. Attempt is made in this article not only to provide rationale for going to the capital market but also to discuss the objectives of issuing bond, the timing for going to the market, and the use of the money so raised from international markets.

After discussing briefly the background which prompted the authorities to go to the international capital market I discuss the points mentioned above.

Background: Pakistan has lived through an era of severe macro-economic imbalances in the 1990s, owing mainly to the persistence of large fiscal and current account deficits. These imbalances vitiated stable macro-economic environment. Such a state of affairs had a far reaching impact on the country’s economic well being. Indeed, Pakistan witnessed its economic growth slowing down, investment rate decelerating, the country’s debt burden reaching alarming proportions, foreign exchange reserves poised on knife’s edge, exports stagnating relations with international financial institutions in disarray, and credit rating deteriorated to the level of selective default (SD).

To address the issue of severe macro-economic imbalances and place the economy on a path of sustained higher growth, financial stability, and improved external balances, a concerted effort was launched some four years ago. Restoration of a stable macro-economic environment was therefore found to be absolutely vital for improving investment climate and taking the economy at a higher growth path on sustainable basis. A reduction in fiscal and current account deficit was considered to be the key element of restoring macro-economic stability, slowing the pace of accumulation of public and external debt and laying the foundation of strong growth on sustained basis with a view to reducing poverty.

These macro-policies were needed to be complimented by undertaking wide-ranging structural reforms to improve the supply side response by removing impediments to private sector development. Over the last four years a concerted effort was made in Pakistan to improve the country’s macro-economic environment through prudent fiscal, monetary and exchange rate policies. At the same time, a wide ranging structural reforms were introduced to lay the foundation of a high sustained growth and consequent decline in poverty.

Despite series of domestic and external shocks such as unprecedented drought, the events of 9/11, the regional tensions and rising uncertainties in the run-up to war in Iraq, Pakistan’s economy has made significant progress during the last four years. The economy is now more stable; economic policies are transparent and predictable; confidence of the private sector is restored to a larger extent; expatriate Pakistanis are brining their capital back; external balance of payments are in comfortable position. Foreign exchange reserves are close to $11.5 billion and are sufficient to finance 11-12 months of imports; exchange rate is stable; inflation and interest rates have never been so low; domestic and external debt have declined; fiscal deficit has been lowered and current account balance is in surplus for two years in a row; Pakistan has now reached to a position where it is pre-paying more than $ 1.0 billion expensive external debt; tax collection is growing; exports have picked up even in the midst of difficult external environment, and Pakistan’s credit rating in international capital market has improved considerably.

Having achieved a modicum of stability and taking the economy to a take-off stage, Pakistan has decided to graduate itself from a dole economy to a market-based borrowing economy. It is in these perspectives that Pakistan has already informed the IMF authorities that the current ongoing PRGF Programme is going to be the last programme, ending in November, 2004. There is all the more reason now to diversify its funding sources from primarily International Financial Institutions to international capital markets.

This does not mean that Pakistan will not be borrowing from the World Bank, the Asian Development Bank, etc. Pakistan will continue to borrow at concessional rates. Accordingly, Pakistan has been sounding out the international capital market of its intention to make a strategic move to issue a sovereign benchmark bond. This possibility has been enthusiastically received by sophisticated bond investors and top global investment banks, especially in the backdrop of robust appetite for emerging market debt.

Objectives: Why Pakistan wants to go to the international capital market to raise capital when it is already holding a foreign exchange reserve of $11.5 billion? The objectives of going to the international capital markets are manifold. First, Pakistan has been out from the international capital market for the last six years, therefore the first and the foremost objective is to re-enter international capital market and established a benchmark.

Second, by reaching out to a wide and diversified pool of international investors Pakistan will be able to show its economic turnaround and re-introduce itself to the international investor community. Third, a benchmark issue will serve as a gauge of the economic and financial health of the country for a range of investors. Fourth, a benchmark of global bond can be a “beacon” for other investments into issuing country. Fifth, Pakistan’s recent economic performance has been impressive - not only in relation to its past but also in comparison to many better rated peers, especially on the external front. The favourable dynamics generated by the strong economic rebound provides an ideal opportunity to greatly expand international awareness of Pakistan’s remarkable progress and improving credit fundamentals.

The wide dissemination of Pakistan’s credit story is of particular importance given the interruption to country’s access to international private capital that occurred in the late 1990s as a result of severe external payment pressures. Sixth, capitalizing on a confluence of favourable developments, Pakistan can smoothly prepare to graduate from an IMF Programme. Of the 39 countries on a PRGF Programme as of end-July 2003, most are economically fragile and graduation from the IMF programme will reinforce the positive international perception regarding Pakistan, translating into greater access and potentially lower cost of borrowing. Seventh, a widely held liquid sovereign bond will establish a pricing benchmarks for all borrowers from Pakistan. Finally, it will demonstrate Pakistan’s ability to raise capital from the market and reduce its dependence on multilateral institutions.

Why Now?: The timing appears opportune because the global interest rate environment has never been so conducive during the last 45 years. At the same time Pakistan has a credible story to tell about its economic health. Furthermore as opposed to six years ago when Pakistan issued sovereign bond with a position of distress and one of necessity, it is now going to the international market with a position of strength and not one of necessity.

Six years ago Pakistan was desperate to raise capital from international market because of its extremely fragile balance of payments. Today, Pakistan is planning to go to the market with strong balance of payments, and certainly not for raising capital but for establishing a benchmark. This is a fundamental difference between the two issuance. Thus the combination of low global interest environment and strong economic fundamentals of Pakistan provides an excellent opportunity to make a strategic re-entry into the international bond market.

There are many countries around the world holding enormously large foreign exchange reserves and yet they have continued their presence in the international capital market through issuance of sovereign bonds. For example, China with foreign exchange reserves of almost $ 400 billion is a frequent issuer of the sovereign bond. Similarly, Korea with a reserve of $ 130 billion; Malaysia and Thailand with $ 37 billion each are the frequent issuers of sovereign bonds. Even the oil rich Bahrain has been in the market for quite some time.

Financially strong economies like UK, Italy, Spain, Finland, Austria and Poland are also frequent issuers of sovereign bond. Thus, maintaining presence in international market is nothing to do with the size of the foreign exchange reserves. It is in this background that Pakistan sounded out the international capital market of its intention to issue a sovereign benchmark bond. With recent further improvement in its credit rating by Moody’s, Pakistan expects a tight pricing and global distribution of its bond.

Use of money: By the end of the 1990s, Pakistan’s external debt had reached unsustainable level. Over the last four years a large sum of expensive debt has already been paid to our creditors. In fact, over the last four years Pakistan has paid approximately $19 billion for its debt servicing. The total external debt and liabilities stood at $35.47 billion at end-June 2003 __ down by $2.5 billion over the last four years. The government has prepared a strategy to pre-pay these expensive debts in phases. In the first phase, $1.078 billion will be prepaid during the current fiscal year. Money so raised from the international capital market will be used for pre-paying expensive external debt.

Pakistan’s return to the international bond markets will mark an important milestone. More than a funding exercise, the issue will re-introduce Pakistan to the international investor community (debt, equity, FDI) given that it has been sometime since Pakistan last tapped the international bond markets. This will also provide an opportunity to raise the international profile of Pakistan and highlight the recent achievements on economic front to the international community. The return to international capital market should not be one-off exercise. What is needed is the continued presence of Pakistan in international bond markets.

(The writer is the Director General, Debt Office, and Economic Adviser, Ministry of Finance.)