An interview with Ali Sultan, Group Head, Global Treasury and Capital Markets - Bank Alfalah Ltd.

'Structural reforms and liberalisation key in opening up debt market'

Ali Sultan is responsible for Treasury & Capital Markets at Bank Alfalah Limited as its Group Head. He is a seasoned banker with over 25 years of experience in the financial sector, bringing an important regional and international perspective to treasury markets, investment banking and fund management in Pakistan. Ali Sultan represented Bank Alfalah as Chairman of the Board of Directors for Alfalah GHP Investments for 5 Years. He was also nominated by SECP to represent it on the board of Pakistan Mercantile Exchange (PMEX).

He is a certified member of Pakistan Institute of Corporate Governance (PICG). Presently, he is also serving as a member of Listing Committee at Pakistan Stock Exchange (PSX) and Member of Capital Market Development Committee (formed by SECP).

Ali Sultan holds a Master's Degree in Applied Mathematics and has attended management and leadership program from INSEAD. He has made valuable contributions towards developing policy initiatives on capital markets and debt from regulators and agency platforms, and has collaborated with multi-lateral agencies like the IMF, IFC and ADB on the development of Pakistan's financial markets. Following are the edited excerpts of the conversation Ali Sultan had with BR Research regarding portfolio investment and capital markets:

BR Research: Portfolio investment coming in Pakistan is a hot topic these days; unlike others, you have divergent views. Why?

Ali Sultan: First of all, I would like to clarify that these are my personal views and do not reflect the views of my institution. Foreign Portfolio investment from overseas is a very passionate topic for me and there is no divergence in my views on this. However, there are lot of market players and some senior economists who believe that investment coming from overseas investors in local currency debt market (LCDM) will distort domestic market, monetary policy aspect and consider it as hot money. I respect their point of view but from my perspective, I am a big supporter of opening of market for foreign investors. In fact, I might go as far as to add that diversity of investor base results in lowering of asset price volatility and improves investor confidence.

BRR: Foreign investors are taking interest in investing in local currency debt market (LCDM) and we are witnessing that the amount is increasing after every auction. What are the reasons that are triggering foreign investors to participate in LCDM?

AS: We have observed that foreign investors specialising in Emerging Markets assets, are taking keen interest in the local currency debt market (LCDM) and have bought T-bills amounting to USD711 million through special convertible rupee account (SCRA).

These Emerging Markets asset managers are mostly located in the US and the UK. From an operational perspective, Pakistan is one of the few markets in the region with a complete spectrum of traded local currency government debt that allows a free flow of inward and outward capital movement and complete repatriation of profit/interest without any limitation on amount through the SCRA account. Equity investors have been frequent users of the SCRA since the last 2 decades and the regulator has recently carried out road shows and has engaged in conversations with debt market foreign investors.

From a commercial perspective, subsequent to the monetary tightening by 750 basis points, currency adjustment lower by 35 percent against the USD in the current cycle, SBP's statement that the exchange rate regime is market based, has resulted in significant shrinking in current account deficit, which has started to appeal the foreign investors. In my opinion, the investment by foreign investors will gain even further traction as the interest rates peak out and currency volatility is expected to remain low since Pakistan has entered into the IMF program.

BRR: So what has been keeping foreign portfolio investment from coming in all these years?

AS: Pakistan's regulations for foreign portfolio investors compared to the region are relatively liberal. However, the investment flow towards LCDM has been negligible. One reason for this has been the lack of proper marketing. The world of global investors has no idea about the depth and spectrum of government debt market, despite the fact that State Bank's regulations for non-resident investors and blanket permission for these investors to hedge currency risk, if they so desire, have been in place for decades.

Secondly, there have been some issues and tax anomalies that have now been resolved but could have been resolved earlier. For example, there is lack of clarity on capital gain tax on treasury bills and bonds that was taken to the Economic Coordination Committee (ECC). The ECC has approved a simplified tax regime to facilitate foreign investors to invest in LCDM and by doing that we would now be comparable with most of the peer group markets. Simplification of tax structure has primary been possible due to the efforts of SBP & FBR.

Recent investments by international investors in local currency debt have validated our view that local market has sizable trading liquidity and depth. A foreign investor who wants to invest in local currency can execute and trade $100-500 million ticket with any one counterparty on a given trading day. When you tell this to the outside world, they are awe-struck. This fact has not been communicated well in the past, and Pakistan has had a general perception of being a shallow market. Now that the investors have been made aware, portfolio investment is flowing into Pakistan.

Also, SBP's website caters to investors' need for data. The breadth, depth and timeliness of data, is unmatched, among Pakistan's peers, and has led to investors' confidence. This should also be highlighted.

BRR: But there is this perceived risk of foreign portfolio investment as hot money by many market players. How do you respond to that?

AS: Some market participants might view opening up of equity market to foreign portfolio investors as the real hot money. But the country has been receiving portfolio investment in equities for the last 25 years. On the high side, we have seen portfolio investment in equities touching close to $10 billion and in period of risk aversion this amount dropped to below $ 1billion, and currently the investment of foreign portfolio investment is an excess of $3.25 billion.

Globally central banks used the concept of sterilisation to neutralise the impact of investment or disinvestment by foreign portfolio investment.

In Pakistan, portfolio investment is done via SCRA - Special Convertible Rupee Account which the foreign investor can open under certain conditions and convert his currency into PKR that he can use to buy equity or debt securities and the profits can be repatriated immediately on liquidation of investments. Since SCRA is denominated in PKR, the amount remitted from abroad undergoes currency conversion on the day money arrives for credit to account.

The issue is not with the procedure. People consider the money coming into debt securities from foreign investors as hot money, whereas I consider it as an investment confidence, opportunity, deepening of the market, and a part of liberalisation of the markets. When new money comes in, domestic money will face competition, which will eventually reduce one of the key challenges that the country is facing i.e. reduce cost of borrowing for Ministry of Finance (reduction in debt servicing cost). Structural reforms and liberalisation are the key in opening up debt market.

BRR: Globally, a recession is perceived when the yield curve is headed down. Whereas in Pakistan, this is being taken positively. Why this dichotomy?

AS: Yield curve inversion is taken as a sign of upcoming recession. When short term yields rise above the long term yield, it also impacts borrowing costs of the businesses in the short term. As a result, cost of doing business increases, economic activity slows and the economy contracts in near future. This is the same abroad and in Pakistan as well. Following different measure taken by the government to control aggregate demand, our economy has slowed down considerably.

The GDP is around 3 percent right now. Inflation has been reducing gradually. Both IMF and SBP have revised inflation for FY20 downwards from the initial target levels. These developments have led the market participants to believe that monetary easing is about to start soon and this is a source of optimism for longer dated investments.

BRR: The Governor State Bank said that he wishes to have a proper yield curve that unfortunately doesn't exist right now for market deepening. For that he recommends profit pricing on all pockets. Can you explain this?

AS: The idea is to buy back illiquid issues and convert them to jumbo issues so that every maturity has a price determined. Another thing is to reopen the previous issues till a time they become big enough. This is to make these issues liquid as that is one key factor what investors look for, i.e. he is able to buy and get out of the position at will. So yes, every maturity point on the yield curve should be liquid. Unfortunately, today this is not the case. We are hopeful that things will get better as both the central bank and the Ministry of Finance are working on this.

BRR: How we can broaden our market regulation for foreign investors?

AS: I would like to mention that the regulations in Pakistan are relatively flexible among its comparable markets. This should invariably be highlighted in road shows and along with equity market; debt market should also be promoted. However, this is called a short term approach.

Long term approach should also be adopted where Pakistan strives to become part of global bond index. Of course, adding a new member to a global bond index has set criteria like issue size, rating, market deepening and liquidity. Then there are also country criteria for emerging market countries like no capital control, no hard forex peg as well as instrument criteria like a) >13m maturity; b) sufficient size ($1.5bn first bond, $1bn subsequent bonds); c) sufficient liquidity and turnover (no quantitative criterion, but dependence on surveys of market conditions).

So there is a set process where the ministry and the central bank needs to be aligned. At the same time, we should start working on how we can enter in Global bond index and also establish a road map to be part of the Euroclear or Clearstream.

Once the benchmarking is completed, the country is part of a voting process of global fund managers' committee. Pakistan has a very high chance of being part of this voting process because of market depth and regulatory framework. Ministry of Finance and the State Bank should be aligned together in order to move both in the global bond index and facilitate local debt security settlement via Euroclear and to give comfort to the foreign investors.

BRR: What are the comparable markets for Pakistan in LCDM investments?

AS: Comparable markets are Egypt, Ukraine, Nigeria, SriLanka, Mexico and Philippines.

BRR: How much do you think our investment flows would increase if Pakistan becomes part of a bond index?

AS: My assessment could be wrong but I think our market has a potential to attract funds of around $10-15 billion dollar.

BRR: The investment has come in only on 3-month paper. Why is that?

AS: Investors are testing the market. And I believe this is the way to go about it, because they are testing how quickly they can come in and leave. Once Pakistan becomes a part of global bond index and Euroclear, then we foresee the significant foreign investors who invest more into high duration bonds and rather than focus on carry trade.

BRR: Our government debt market is well developed. What are the challenges for our corporate debt market in your views?

AS: All around the world, debt and fixed income markets are much bigger than the equity markets. Unfortunately, there has been a clear gap in the understanding of these in Pakistan. Even banks have not played their part in developing the debt market. Today, equity market is developed and so is government debt market; but corporate debt market is hardly developed. Corporate bonds, TFCs, commercial papers, perpetual papers and tier two capital of banks should be up for listing. Some of it started back in 2008 before the financial crisis, but unfortunately, crisis wasn't managed properly in the TFC context and the investor lost interest.

I would like to highlight a fundamental issue, which is not because of the issuer or the investor but the system. Advance to Deposit Ratio (ADR) has been the key issue that the system faces till today. Our ADR is around 55 percent, whereas the rest of it goes for reserve requirement and government securities. However, in countries where ADRs are around 90 percent e.g. in Turkey, the banks have little choice to lend from its deposits, and hence corporates have to raise financing through capital markets.

Also, before we talk about foreign investors in the debt market, we have to ensure we have domestic investors to build the market. Engro Rupiya and K-Electric Certificates was a good attempt particularly from a retail investors' perspective, but nothing came after that. On the other hand, government securities market in Pakistan compared to the regional market is much sophisticated and developed because government is the biggest borrower.

BRR: So have you been involved in any sort of discussions with the regulators on how to deepen the debt market?

AS: We have been working very closely with the State Bank and the SECP, and one of my suggestions on record, which the government should have undertaken to list the Rs144 billion Neelum Jhelum and Rs110 billion Dasu; government guaranteed long term project financing papers. Even today, they can go for technical listing of these project financings and that can be sold in the secondary market via PSX towards mainly the non-banking sectors like NBFIs, insurance companies, employee funds, which will give depth to the market.

Another suggestion has been to list all the Sukuk tranches coming in for the circular debt from day one, and providing a level playing field to asset management companies and non-banking sector to invest in these. This will create competition for the banks and the issuer will benefit from lower price of the issue. This is what the ministry of finance should do.

BRR: Do you think that we have now moved to a market-based approach for the currency? There are still perceptions that it is being managed. What is your view on the currency?

AS: I have been loud and clear that full credit goes to the central bank for taking the currency to a market-based approach. I think they have done a marvelous job. Previously, there was market distortion due to lack of information. It is now the responsibility of every treasurer to compile and share the data for inward and outward flows of import/export and remittances and dividends every day. This has fixed the cash management at the central bank's end.

The central bank has time and again mentioned its monetary policy statements that it will intervene only when it sees unwarranted volatility. The gist of this is that you cannot leave a thinly traded market on its own. Credit also goes to the treasurers of banks for behaving responsibly in all this.

Currency has been depoliticised and the message is clear to the exporters and importers that currency is market determined.

Demand and supply is the right way to manage currency. Plus, the concept of fear of floating is already over.

There are various benchmarks to predict currency. Of course REER is one of those. However, there are other factors also like NIR, demand, behaviour of regional currencies etc. Major adjustment in the currency has been made. Now any movement up or down will be market-based and will be considered healthy as it will be a play of demand, supply and all other factors. A stock market movement is a typical example of a market-based approach. Any major change in the market's external or internal perspective however, will affect the currency.