Continuing our Friday's coverage of debt management reforms (See: Dec 18, 2015 column titled: Ideas to fix national debt problem), today's column would shed light on some ideas to fix the debt capital market. On the supply side a host of problems haunt the market. The first of these is the absence of long term yield curve. In order for a debt capital market to function properly, price discovery is of paramount importance. But how can one have efficient price discovery when you don't have a consistent supply of long term papers. The government therefore needs to gradually phase out its average maturity from its current concentration in relatively shorter term to a much longer term.

Moreover, the transparency of government fiscal accounts, which includes the transparency in all kinds of debt and liabilities (their size, payback schedules, etc), is imperative to give the right signal and direction to the market. On that note, regular market guidance seems to be a missing element; the pulse from the market is that it wants to be periodically informed of the government's view on duration and ancillary affairs.

Recall also that until recent past, the government used to play around with the market and give wrong signals. For instance, its auction calendar might say that it will pick up Rs50 billon but it eventually picks up Rs300 billion leaving the market players with bad rates. This practice has somewhat subsided now, after market players - mostly bankers - raised hue and cry about it. But to date no mechanism or regulation exists that prevents the government from falling back to its old habits again.

On the demand side, a combined strategy is needed to be worked out by the Finance Ministry, the SECP and the central bank. Without spelling out the details to avoid naming and shaming, currently the parties seem to be working in silos, with little sense of coordination.

At its end, the central bank is trying to increase the non-bank participation in treasury auctions by means of non-competitive bids, and by asking banks to open individual portfolio accounts. A few years ago the SBP had also introduced the Electronic Bond Trading Platform (EBND) to help bring better price discovery. SBPs evaluation criteria for the selection of primary dealers (PD) includes that each PD should ensure that at least 50 percent of its trading with other PDs is done through the EBND, whereas each PD should also have a minimum portfolio of 250 IPS accounts and shall ensure minimum 15 percent increase in its IPS accounts during the preceding year.

Sources in the central bank say that as a result of these efforts, retail investor participation has increased in T-Bill/PIB auction via non-competitive bids from 1-2 percent of total auction size when it started, to about 10 percent nowadays. However, since the specific PD regulations mentioned above are not a requirement per se with any sanction assigned to it, they are not followed by the market, and therefore the fruits of SBPs efforts have been growing frustratingly slow.

To that end, the SBP would do well to go on a media campaign aimed at improving retail participation in government papers. The SBP also needs to sit down with the banks and work out an incentive structure that gives banks all the more reasons to attract retail investors in government papers. Currently, bankers' remuneration and career growth is tied to the size of deposits they bring and not to the size of investments in government papers. How then, can bankers be expected to push investments when their growth is pegged to deposits?

The central bank and the SECP also need to sit down and figure out how to phase out the held-to-maturity (HTM) category of treasury bills, and indeed weed out the very HTM mindset. Treasury sources say that buy and hold seems to be a mindset problem, as traders don't really want to take a punt, without which trading activities naturally remain muted.

Any effort to build a vibrant debt capital market (DCM) will also require a corporate debt market. To that end, SECP sources have told BR Research that the regulator is currently exploring options to develop a third party bond pricing agency ala Malaysia and Thailand to help bring confidence into the market. That seems to be a healthy development in the light of not so recent corporate debt defaults. However, the SECP also needs to explore the possibility of having the provincial stamp duty and WHT removed from debt instruments (at least for retailers) to help develop the DCM.

Be that as it may, building a corporate debt market seems to be long haul since Pakistani corporations usually raise money from bonds when they don't have any internal resources left of their own or when they have maximized their lending limits from banks. Case in point: Engro and KE in recent years.

The alternative therefore could be to develop an efficient government debt market which could take different shapes. What could be some of the contours of those reforms, will be discussed tomorrow in our last leg of the discussion on debt. But in the meanwhile, it is suffice to say that no debt market reform can be brought about with sorting out the NSS.

The NSS is indeed the elephant in the room; it's a much costlier debt to the government, yet the government keeps it, perhaps for populist reasons. The high returns on the NSS - hence higher debt costs to the government - is also the reason why retail bond investors don't have any incentive to get any direct or indirect exposure into debt capital markets.

In order to reform debt market and develop the DCMs, the NSS instruments need to be integrated into the mainstream capital markets, where one idea catching dust since 2007 is to convert the NSS instruments into market-based instruments such as PIBs and T-bills, and pass them on to retail clients directly through the NSS network.

Debt capital markets aren?t only needed to reduce the cost of government debt and create a culture of savings. DCMs - as Dr Vaqar Ahmed of SDPI said at Prime Institute's National Debt Conference earlier this month - are also important to bring a sense of social responsibility into debt. And that in itself is a worthy objective on its own.