Bond Sector of Pakistan

ASIGNMENT # 1
Bond Sector of Pakistan
Fixed Income and Derivative Analysis
Name :

Daood Abdullah
Fozia Asghar
Farah Islam

14209003
13109002
13119001

Submitted To:
Sir Faisal Munir

School of Accounting and Finance

Gujranwala

Table of Content

1
Assignment 1

Bond Sector of Pakistan

1. Introduction of Bond Market............................................................................ 3

1.1 Background....................................................................................................... 3
1.2 History of Bond Sector....................................................................................... 3
1.3 Significance of Bond Market for Pakistan...........................................................4
2. Bond market in Pakistan................................................................................... 5
2.1 Current status and Overview.............................................................................5
2.2 Government Bond Market.................................................................................6
2.2.1 T-Bills........................................................................................................... 6
2.2.2 Federal Investment Bonds...........................................................................6
2.3 Corporate Bond Market............................................................................................. 7
2.4 Sukuk Market:........................................................................................................ 8
2.5 Commercial Paper:................................................................................................... 8
3. External Bond Market................................................................................................. 9
3.1 Dollar Dominated and Eurobonds................................................................................. 9

2
Assignment 1

Bond Sector of Pakistan

1. Introduction of Bond Market

The bond market also known as the debt, credit, or fixed income market is a
financial market where participants buy and sell debt securities usually in the
form of bonds.

1.1 Background
Bond markets play an important role in mobilization of capital. The
investments are very necessary for economic development of a country. A
good market will help promote economic growth and reduce the risk of
financial crises. 1
The bond market is composed of Pakistan investment bonds, corporate
bonds, Sukuks and commercial paper. Overall this market is 5% of GDP at the
moment which is very small as compared to other economies.2

1.2 History of Bond Sector

In Pakistan, the development of bond market was commenced in late 1990s
after the liberalization reforms; however, Pakistan's bond market has
established at a slow speed as compared to other states. Pakistan bond
market is at its initial phase and has a very slow pace of development, just
1% of GDP, as compared to other countries. Like other developing markets,
most of the debt financing is done through bank borrowings. According to
State Bank of Pakistan (SBP) and Securities and Exchange Commission of
Pakistan (SECP) the domestic bonds outstanding were 30 percent of the GDP,
equivalent to PKR 5.8 trillion as of June 2012. This consists mainly of
government bonds, as the corporate market is yet to develop. Government
bond market gained momentum after the introduction of Pakistan
Investment Bonds (PlBs) in 2000, which helped to rationalize the auction of
Government Securities and to develop secondary market for the Government
instruments. SBP introduced selective Primary Dealer System (PD) in 2000.
In 2001 KlBOR/KIBlD rates were introduced to provide inter-bank call money
arch. Outstanding T-bills are roughly PKR 2.4 trillion as of June 2012 out of

1 Developing Bond Markets in APEC - Toward Greater Public-Private Sector Regional

Partnership
2 bond market development in Pakistan by Muhammad Arif 2007
3
Assignment 1

Bond Sector of Pakistan

which banks hold 75 percent worth of short term paper. Outstanding PIB
amount is PKR 974 billion, out of which 52 percent of holding are with banks.3

1.3 Significance of Bond Market for Pakistan

Bond market is of great significance to a country that faces large budget
deficits, like Pakistan. Generally a well-developed bond market is important
for these reasons:
Increasing the competitiveness and efficiency of the financial system, which
here is dominated by large banks. At micro economic level development of
securities market helps change the financial system from bank-oriented
system to multi layered system where capital markets can complement bank
financing. Enhancing the stability of the financial system by creating
alternatives to banks that will reduce the power of banks simply it provides a
resort for domestic funding and budget deficits other than by central bank
Bond market helps in the implementation of monetary policy, including
achievement of monetary targets or may be inflation objectives. The
development of bond market can force the financial intermediaries to
develop other products like Repo, Structured finance and Derivatives. Cost of
debt servicing can be reduced through funding of Government Budget
deficits on market-oriented funds.4
Further development of local bond market provides:
Diversification of financial sector into equity, debt and bank financing

Effective allocation of capital competition in financial sector

Supports infrastructure development, privatization, securitization, and

the rise of new institutional investors requiring long term assets to
match long term liabilities

Reduces the currency, interest rate and funding exposures risks

Allows more efficient allocation of savings by reducing banks role that

also reduces the element of political interference

3 Nazir (2010) .Future and Prospects of Bond Market Development in Pakistan: A

Review
4 Arif (2007).Bond market development in Pakistan
4
Assignment 1

Bond Sector of Pakistan

Allows borrowers to use capital that is tailored to their assets and

operations

Provides retail and institutional investors with several high quality and
liquid domestic saving vehicles.

2. Bond market in Pakistan

2.1 Current status and Overview
With the partition of subcontinent, the stock market and SBP starts to
perform its operations. At that time financial system of Pakistan was very
weak. Then with the passage of time private sector starts to develop that in
1970s acquired by government. This trend increases in period of 1970-1990s
when private sector was almost shrunk and government took control.
Then post 1990s time period consists of financial liberalization reforms that
were initiated to reduce the Government deficit.
At that time with the privatization reforms, Government started to issue fixed
income securities to pool funds form public for reduction of government
deficit. Government borrowed on tap instruments having predetermined
rates. Captive Finding was provided by SBP that was restricted later on by
increasing the statuary liquidity requirements and cash reserve
requirements. So as whole fixed income market for government securities
was not properly developed that could provide benchmark yield for corporate
securities.
The first long term bond issued in 1992 thus giving an opportunity to
corporation to issue a bond by taking that long term yield curve as a bond.
Hence a series started in 1995 when the first term Finance Certificate was
sold in market then later on in 2000 and Pakistan Investment bonds are sold
by Government. But due to the limited supply of government s securities a
representative long-term yield curve had not formed which constrained the
development of corporate bond market.5
Liberalization of the financial system and the switch from credit planning to a
market based monetary policy has created a secondary market for
government bonds in Pakistan. Trading in treasury bills and in short-term
federal bonds provides the basis for open market operations of the state
bank.
5 Nazir (2010) .Future and Prospects of Bond Market Development in Pakistan: A
Review
5
Assignment 1

Bond Sector of Pakistan

In 1991, the government with the consultation of World Bank, started

issuance of two types of securitiesone of short-term maturity and the other
of long-term maturity on the basis of auction through the intermediation of
primary dealers, i.e. treasury Bills (short-term) and federal investment bonds
(long-term).
Market Treasury Bills (MTB) is short term debt issued by the government to
raise funds for less than 1 year at a risk free rate. These securities can be
sold in the secondary market. In addition to it, government of Pakistan had
launched Pakistan Investment bonds in 2000 for long-term financing. These
bonds are issued for the tenor of 3, 5, 10, 15 and 20 years of maturity. There
also exists secondary market for these securities. Government has started
national saving schemes for retail investors. Another one is term finance
certificate. TFC are issued by corporation for a specified time period at both
fixed and floating interest rates by both financial and non-financial
institutions. Returns in these securities are changed with the maturity and
credit risk of the issuer.

2.2 Government Bond Market

2.2.1 T-Bills
The bills are issued at a discount. The investors are required to quote the
price at which they are willing to buy t-bills of Rs.100 face value. Individuals,
institutions and corporate bodies including banks/DFIs are eligible to
purchase the bills. The principal and profit accrued thereon is guaranteed by
the government. Principal and profit is payable on maturity. T-bills can be
traded freely and are transferable by endorsement and delivery.Tax is
deducted at source under the Income Tax Ordinance 1979.

2.2.2 Federal Investment Bonds

Bonds are of three different maturity periods viz. three years, five years and
ten years. Short-term FIBs have also been issued. Individuals, institutions
and corporate bodies including banks, irrespective of their residential status
can purchase bonds. There is no quantitative limit on purchases. Bonds are
redeemable at par on completion of their respective maturity period. In case
cash is require before the maturity date of the bond, the investor may
approach his banker et his bonds converted into cash at the market price. In
the manner, the government bonds can be traded freely in the secondary
market before their maturity date. Each bank is required to display daily sale
and purchase prices of bonds at their main branches in major cities.

6
Assignment 1

Bond Sector of Pakistan

WAPDA, NDFC, BEL, PICIC, and some other firms have also issued nongovernment corporate bonds and certificates. Trading is very limited.
Investment banks which were expected to play a major market-making role
have not succeeded in doing so. Term Finance Certificate (TFCs) has been
issued by financial and manufacturing companies from time to time. 62 TFCs
instruments have been issued on the KSE during 1996-2003 (21 of these
were issued in 2002-2003).
The secondary market is shallow and largely confined to the public debt
sector. The range of financial assets available is limited. The growth of the
secondary market has been restricted by the expansion of the national
saving schemes (NSS), which are very popular with the public. Rates of
return in the secondary market are generally lower than those offered by the
national saving schemes although rates on these schemes have been
drastically reduced during 2000-2002. The growth of the secondary market is
limited by the interventions of the government in the auctioning process to
hold down interest rates. Such intervention has been reduced since 1997,
when the autonomy of the state bank was recognized through the
amendment of the State Bank of Pakistan Act 1962.
About Rs.5 billion worth of TFCs were issued during 1995-2000. There was
major upsurge in 2002 but the secondary market in TFCs is very
undeveloped. Pakistan Investment Bond issues are significantly larger
(exceeding Rs.100 billion in 2001-2002 for example). A secondary market
has not developed in PIBs and PIBs are not regarded as a capital market
instrument. The public is not informed of what the government does with the
money raised through Pakistan Investment Bond issues.6
Main features of government bond market in Pakistan are as under:
Bonds are issued in 3, 5, 10, 15, 20, and 30 years tenors.
Bonds are issued through auction system in which only Primary Dealers
(PDs) can participate.
Issued at Par.
Coupon payments are made semiannually.
Bonds are issued in the form of un-certificated bonds and are maintained in

6 SA Meenai (2004) .Money and banking in Pakistan, fifth edition, oxford university press
7
Assignment 1

Bond Sector of Pakistan

SGLA maintained by the SBP.

Bonds are SLR eligible securities and individuals, institutions and corporate
bodies including banks can purchase, irrespective of their residential
status.
Bonds are tradable in secondary market.

2.3 Corporate Bond Market

Foundations of the corporate bond market were laid in 1995 with the first issue of Term
Finance Certificates. Since then issuance of listed TFCs has totaled approximately PKR
80 billions.
Amongst those were de-regulation of the banking sector, lower interest rates, availability of
benchmarks for both fixed and floating rate debt, active inter-bank trading markets in
government securities, coming of age for mutual funds, etc.
Corporate bond market in Pakistan is smaller in comparison to many equivalent rated economies
(less than 1% of GDP) although the situation is improving. The reduction in interest rate
volatility during 2005 brought life back into issuers. Issuers appear less perturbed by higher rates
than by volatility. Hence, 2005 and 2006 remained good years in terms of the number of issues
and volume of issuance.
Main features of the corporate bond market in Pakistan are as under:
1. The corporate bond in Pakistan is in form of Term Finance Certificate (TFC).
2. TFCs are based on legislation enacted in 1984, which authorize issuance of redeemable capital
securities. As a debt instrument TFC is slightly different from the corporate bond because it was
specifically designed to comply with Sariah law. The key difference is that the TFC substitutes
the words expected profit rates for interest rate.
3. TFC issuers include both NBFIs as well as public and private firms.
4. The coupon rates on the TFCs display a wide variety with different fixed coupons as well as
floating coupons linked to various interest rates including the discount rates, PIB rates and the
KIBOR.

2.4 Sukuk Market:

Sovereign Sukuk market does not exist in Pakistan, though GOP has floated a Sukuk in the
international market in 2005 that fetched US$ 600 million at 6 months Libor+220bps. The
concept used in this issue was Ijarah (Leasing). SBP in this regard has proposed a product for the
domestic market based on Ijarah concept. Moreover, to fulfil the needs of short-term instrument

8
Assignment 1

Bond Sector of Pakistan

having T-Bill features, a hybrid product (Combination of Ijarah and Murhabah concepts) has
been proposed to the GOP.
Immense growth in Islamic banking industry during the last four years has necessitated for
emergence of Sukuk (Shariah complaint instrument) market in Pakistan. However till this day
only three issuances have come into the market and that too from the corporate side. GOP Sukuk
has yet to be issued that is being awaited as it would in-fact provide yield curve for future Sukuk
issuances.
2.5 Commercial Paper:
Commercial Paper (CPs) is an unsecured tradable instrument used by highly rated corporate
entities to raise short term working capital. It is usually sold to cash rich financial institutions
which have an appetite for short term MM instrument. CPs are discount instrument like T-Bill
and are issued in the form of promissory note. They can even be traded in the secondary market;
however secondary CP market is not yet developed in Pakistan.
SBP and SECP issued guidelines for their issuance. The tenor of commercial papers is 3, 6 and 9
months. The Corporates can issue CPs on attaining criteria i.e. equity of the corporate is not less
than Rs 100 million, minimum credit rating for short term CP should be A- and for long tenor A,
it should have clean credit information Bureau (CIB) report and as per the latest ended balance
sheet report the company maintains a minimum current ratio of 1:1 and a debit equity ratio of
60:40. CP market is at very nascent stage in Pakistan. Packages Ltd was the first company to
raise working capital through CP.

3. External Bond Market

On external sector GOP floated three of its Sovereign Bonds including one Sukuk to make its
presence on the radar of international debt market. The significant achievement on this front is
successful auction of 30 years bonds at competitive price. This has paved the way for Corporate
sector in Pakistan to access international debt market. Pakistan floated its bond for the first time
in 1994 and then in 1997 to the amount of USD 610 million (US$ 150 million on 22-12-94 at
11.5%, US$ 160 million on 26-2-97 at 6% & US$ 300 million on 30-5-97 at 6 Month Libor+395
bps) however in 1998 on detonation of atomic bomb Pakistan was left with no position to repay
them on their maturity. So they were restructured at high premium i.e. 10% interest rate with
final repayment in December 2005.
Pakistan reverted back to the international capital market in 2004 with better credit rating
emanating from its improved macroeconomic indicators. Currently its Sovereign rating by
Standards and Poors is B+ (Foreign currency) and B for short term and BB for long term
9
Assignment 1

Bond Sector of Pakistan

(Local Currency). This process seems likely to continue to keep Pakistans presence in the
international Capital Market for developing its domestic bond market as well.

3.1 Dollar Dominated and Eurobonds

Pakistan Earlier, in March 2014, has raised $2 billion by floating five and ten year dollardenominated bonds at interest rates ranging between 7.25% and 8.25%. In the second attempt,
the government issued five-year $1 billion Ijara-Sukuk bonds at 6.75%.
On April 08, 2014 placed USD 1,000.0m in bonds with a 8.25% coupon, maturing in 2024. The
bond was priced at 100% to yield 8.25%. Bank of America Merrill Lynch, Barclays Capital,
Citigroup, Deutsche Bank arranged the deal.
Pakistan on November 26, 2014 placed USD 1,000.0m in bonds with a 6.75% coupon, maturing
in 2019. The bond was priced at 100% to yield 6.75%. Bookrunner: Citigroup, Deutsche Bank,
Dubai Islamic Bank, Standard Chartered Bank arranged the deal.
Pakistan in last week of September 2015 has issued a new 10-year bond of $500 million in the
international Euro bond market at a coupon rate of 8.25 per cent.
Pakistan initially wanted to raise $500 million through Eurobonds, but the offering of over 7.2
per cent return attracted unexpectedly very high amount of investment of up to $5 billion. The
government has reportedly raised $2bn.
Experts in the financial sector, bankers and analysts noted with enthusiasm that Pakistan quickly
made inroads to the international financial market and got the response much bigger than their
expectations.
According to available information, the government has raised $1bn in five-year bonds at a fixed
rate of 7.25pc 558 basis points (bps) above benchmark five-year US Treasury and $1bn in
10-year bonds at a fixed rate of 8.25pc 556bps above benchmark 10-year US Treasury.
Experts see multiple positive impact of Eurobond launching, particularly while the government
is struggling to improve the countrys image tarnished by the terrorism and poor law and order
situation.
Bankers said the issuance of Eurobonds would help improve balance of payments and, more
importantly, the image of Pakistan. They said the bond issue would go a long way in restoring
investor confidence.

10
Assignment 1