The government reportedly is negotiating with foreign banks to underwrite the issue of $500 million jumbo bonds, and 12 banks have submitted the expression of interest in this regard. This is an effort to innovate new mode of financing after the conclusion of the arrangement with the International Monetary Fund next year on the one hand and to mop-up the excess liquidity in the financial market at the lowest-ever interest rate, on the other.

The funds to be generated through the issuance of the Eurobond would be used for retiring some of the expensive foreign loans. The move is being criticized in some sections of the press without taking into consideration its significance in diversification of debt profile and to lay the foundation for the development of secondary markets in the country. The opponents are of the view that the foreign exchange reserves of the country had exceeded $11 billion at the moment and what is the rational for seeking new foreign loan by floating bonds in the presence of substantial foreign exchange reserves.

Borrowing from the international market is a norm rather than an exception for almost all countries including the developed and the developing ones. There are different sources of financing available in the market like the bilateral loans, multilateral loans, and commercial loans. The bond floating is yet another source of borrowing like any other source and this has advantages and disadvantages vis-a-vis other sources of financing. Its pros and cons can be debated and analyzed. The borrowing target achieved through diversification lends stability and helps insulate against external shocks and contagion. The countries like China, South Korea and Malaysia with huge foreign exchange reserves, continually go to the bond market.This implies that its correlation with the foreign exchange reserves is not well established. South Korea is in fact the greatest bond market in Asia. It is always better for the countries to look for cheaper sources of financing. The availability of capital at minimal cost is always helpful in laying the foundation of development in capital-starved countries like Pakistan. The Capital Asset Pricing Model tells us that the government bonds represent risk-free asset in the capital market and are part of an overall portfolio of investments.

Various analytical studies conducted on the efficacy of amassing funds through bond floating generally highlight the benefits of the government bond markets and maintain that bonds can provide an alternative, non-inflationary source of financing for the governments around the world, fostering a healthy capital market, and improve the functioning of the financial system. Moreover, active government bond markets can have indirect benefits through better monetary management, enhanced transparency, a widening of investment opportunities, easier benchmarking of corporate sector claims, and a more efficient determination of the time value of money. The accountability and transparency effect is crucially important for countries like Pakistan because political expediency always dominates the rational decision-making. Once you are in the bond market, analysts keep an eye on the efficiency of economic policies of your country. But it is not always easy to amass money through bonds for a developing country. The Eurobonds are important to assess the market-based benchmark price. Bond pricing reflects the underlying premiums expected by the foreign investors from a specific country. There are indeed institutional determinants of the government and corporate bond markets and the experience of developed countries shows emphasis on the importance of proper debt management and other institutional requirements.

The governments may create a “captive” demand by requiring financial institutions to purchase and hold the government securities (and often at below-market interest rates). The mandated investment demand results in resource inefficiency and competitive distortions between the market participants. In an open market the demand for debt securities is supplemented by the domestic demand for financial assets. Both domestic and foreign investors are motivated by the economic benefits. Domestic investors are becoming increasingly more sophisticated and make rational decisions.

Foreign investors require a high level of transparency, legal certainty and good market practices as well as a certain threshold of development before investing. Structural factors that have been important in building demand include deep and efficient secondary and derivatives markets, efficient clearing and settlement systems, and a sound legal and accounting framework. Pakistan has no such infrastructure to develop the domestic market and it has to rely upon the secondary markets, elsewhere. There are many enabling factors that support the demand like market-based economic policy, strong banking sector, safe-haven characteristics and standardization and consolidation.

Pakistan first entered into the Eurobond market in 1994 by launching first sovereign Eurobond of $150 million with the 5-year maturity at 385 basis points above the 5-year US Treasury rate. The response from the investor-community was good enough because Pakistan’s access to the bond market was fully backed by the boom in our stock markets and the Pakistan’s stature as a darling of foreign investors in the region at that time. In 1997, Pakistan floated another $300 million bond, but the follow-up developments evaporated all the hard-earned gains. In 1998, Pakistan was ranked among the 25 worst performers worldwide with more than 50 per cent of the projects and commitments at the risk. With approximately $111 million expenditure on the Political Risk Insurance (PRI) cover, Pakistan was caught into the failed-state syndrome and the foreign investment reached its lowest ebb by 2000-01.

In December 1999 in a last ditch attempt to avoid the default, Pakistan exchanged three existing Eurobonds worth about $610 million on more favourable terms (3 years grace period, 6 years maturity and 10 per cent coupon rates), after agreeing with the Paris Club for a flow rescheduling deal that extended the comparable treatment to private creditors for the first time. As noted in the IMF’s annual report (2000, p.136), “The restructuring of a country’s external debt is a serious step and something most sovereigns only do as a last resort.” In particular, seeking the restructuring of payment terms is likely to entail significant costs in terms of market access and output losses, albeit costs are not as large as those following a default. Pakistan managed to restructure obligations even under the contract that required the unanimous approval of all the borrowers. However, the presence of the collective action clauses (CACs) has smoothed the process of obtaining the creditors’ agreement to carry out a voluntary bond exchange (rather than a restructuring of the existing bond contract).

Pakistan would pay back $155 million of outstanding payments of the Eurobond before floating a new bond in the international market. Since the existing bonds would be repaid, as the agreed schedule, there would be no other instrument that could allow the stakeholders to have a market assessment of Pakistan. The rebound in Pakistan’s economic performance is well anticipated on the international arena. The prices of the Eurobond have skyrocketed in recent months, in response to the developments of the last two years that helped the country to build up a reserve level of $11 billion plus on the back of a strategic role as a frontline ally in the US-led war against terror.

Notwithstanding the massive reserve build-up, Pakistan is still a heavily indebted country, albeit far distant from meeting the criterion of being awarded Heavily Indebted Poor Country (HIPC) status. Pakistan’s total external public and publicly guaranteed debt stood at $33 billion, or 47 per cent of the GDP at the end of 2002-03, and is expected to decline to 44 per cent of the GDP by 2004-05. Debt service as a share of exports of goods and services is estimated to fall from 30 per cent in 2000-01 to 24 per cent by 2004. The present value of long-term public and publicly guaranteed external debt to exports reached 230 per cent at the end of 2003—almost double the indicative level of sustainable debt (150 per cent) for the HIPC countries. This puts severe pressure on the balance of payments. The share of multilateral claims is also high in comparison to other countries. For example, the share of multilateral claims in the long-term debt is over 10 percentage points higher than that for the HIPCs as a group.

In terms of the liquidity, Pakistan’s risk has substantially improved due to the huge build-up of reserves. But Pakistan’s exports and the overall GDP growth remain highly dependent on the agriculture sector, adding further volatility to its debt servicing capacity. In terms of investment, although the Eurobond was presently traded at a premium, its usefulness as a proxy for the investment climate was limited due to the narrow base of the bondholders (bulk purchased by the Pakistani financial institutions), restricting its trade in the secondary market. Interest charges of the government bonds are likely to put extra burden on the budget which should not be at the expense of the development expenditure. Instead, in addition to the need to maintain a reasonable level of development expenditure and to provide the needed budgetary support for the poverty reduction programmes, our budget must be able to cover the interest cost of the government bonds. Our capacity to service these new liabilities is dependent on two major factors: (1) the improvement of macro economic condition, particularly the level of market rate of interest, market confidence and the investment climate; and (2) the improvement of domestic revenues. The sustainability of our macroeconomic performance crucially hinges upon our ability to improve the domestic revenue, while improvement of domestic revenue is also influenced by our success in improving the macroeconomic performance, reflecting a complex relationship between many critical variables.

In the backdrop of Pakistan’s rescheduling of the Euro bonds in 1999, it was hard to expect the re-entry of Pakistan in the global bond market, but the change of events since September 2001, had helped Pakistan in improving its external sector of the economy, as well as the sovereign credit rating. Since the capital market could play a crucial role in mobilizing the domestic and foreign resources, the government had also made several efforts to strengthen the regulatory framework and infrastructure for these markets. Beginning from the financial liberalization of 1989, through the boom and bust of 1990s, the stock market had been under an extended bull-run since the last year and the KSE index is approaching 5000 points against the previous highest-ever standing at 2700 points in 1990s.

Now in 2003, with the external sector strength, the large current account surplus, much better net external debt ratio and a booming stock market, and on top of it better relations with the US and western countries, as well as the international financial institutions, could help Pakistan to tap international financial markets for the greater benefit of the country. Pakistan fortunately has a professional watchdog in the shape of the Debt Policy Coordination Office (DPCO) to monitor the developments in bond market. This is the most suitable time for Pakistan to go into the bond market with strong economic fundamentals supported by buoyant stock market and massive reserve build-up. Pakistan’s comfortable balance of payments can pay dividends in this regard.

These bonds could be important in offsetting the budget deficit and mobilizing the capital for development. Only thing the government can do on its part is improve the effectiveness of the national financial markets, improve the legal framework on issuing, listing as well as trading of the government bonds, encourage the development of financial intermediaries, set up policies to establish and strengthen the bond market and enable trading bonds on the OTC (over the counter).

The development of full range of bonds can play pivotal role in capital attraction for the investment and savings, increase in the GDP and prevention from issuing money to offset the budget deficit. The bond market has many parallells like well-developed financial and capital markets, investment funds, insurance market and investor’s confidence. Thus these are the areas where the government should focus while making economic policies.