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EDITORIAL: The Asian Development Bank (ADB) has approved a $300 million loan for capital market development in Pakistan. It's a policy loan which is linked to certain reforms to be undertaken at the Securities Exchange Commission of Pakistan (SECP) in general and debt capital market in particular. It's said to be a part of ADB's continued efforts to deepen the local capital market. ADB's efforts towards strengthening the capital market regulations go a long way - back in the days, it was the Bank's loan conditions that had pushed the Corporate Law Authority to become the Securities Exchange Commission of Pakistan (SECP). The banning of institutional investments in National Savings Schemes (NSS) in the past was also on the advice of ADB. That had helped the debt capital market to take baby steps towards developing long-term sustainable operations. The current loan is a continuation to build on the same foundation.

There are four key areas ADB is keen on developing in Pakistan. One is the market stability where certain amendments in the SECP Act took place to bring operational autonomy of the commission. The other is to strengthen the SECP audit oversight board to bring in checks and balances. Then there are some demand and supply side measures which would deepen the capital markets such as financial contracts netting and to transit from price-based auctions to volume-based auctions of government bonds. The idea is that these measures will facilitate the market and help in creating a vibrant debt capital market. With these changes, the practice of scrapping of auctions would be done away with. The government would carefully design auction targets and would be accepting 90 percent of bids or auction targets, whichever are lower, in a year. A long-term debt capital market plan is also being developed.

A major drawback and gap in our financial market is the virtual absence of the debt capital market segment except for government issued bonds that attract participation from treasuries of a few big banks in the primary market. With far too few players in the arena it is a misnomer to call it a market at all. Recent Sukuk issuance and changes sought under pre-conditions of this loan would go a long way towards building a true market.

Since the government is hard pressed to get the resources to finance its fiscal deficit and to build the foreign exchange reserves base, the reforms process is to be expedited under the guidance of ADB. The objective should be and perhaps is to align the government's short-term objective with ADB's long-term development focus.

For a successful outcome of this initiative, the government and its regulatory machinery have to be fully on board with the ADB's objective. Let's hope the government will exhibit a relentless commitment towards the true implantation of reforms because the cost to the economy of a weak financial market is immense. For instance, the intermediation cost of banks is much higher than international norm that makes their loans expensive for trade and industry. Even in the case of State Bank of Pakistan's (SBP's) concessionary financing, banks are charging 3-4 percent as an intermediation cost for processing loans of corporates. Banks haven't acquired these funds from their depositors to justify charging intermediation cost based on their administration expense. Furthermore, nowhere in the world do such high intermediation costs exist. The other problem is that banks are the prime buyers of government securities. A major chunk of incremental deposits in the last decade or so are routed towards investment in government bonds by banks. This leaves less space for private sector credit, which is shrinking in terms of ratio of GDP. The big wigs in the private sector very rarely raise capital directly from the debt market; they rely on bank financing. This leaves little for commercial segment, SMEs and consumers that usually are the main players of borrowing from banks. In better markets, insurance companies, retirement funds, mortgage and infrastructure companies are buyers of government and private sector debt. There is dearth of such companies in Pakistan. The need is to develop these markets to end the banks' virtual monopoly in the debt capital market. There are gaps in the whole chain of financing. SECP is just one part of it. There are taxation issues and work is required at SBP to boost the market.

Until the whole documentation element is improved, overall interest rate environment is conducive, courts' decisions on corporate cases are swift, breakup value issue of private equity (pass through effect) is dealt with, insurance companies are brought out of the ambit of commerce ministry, development of debt capital market will remain elusive; each bottleneck will have to be removed. The recent reforms and efforts in government debt office can help in developing the long-term yield curve. And it is imperative to have indicative yield curve for the issuance of market-based instruments. Implementation of long-term capital market plan under this loan would fulfill a common objective of both; the government and ADB to bring about long-term sustainability in the debt capital market.

Copyright Business Recorder, 2020

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