Key Takeaways from Omar Soomro’s Global Debt Markets Webinar
Global Bond Markets are hugely important for any economy, but especially for those with twin deficits (fiscal deficit and current account deficit).
Pakistan’s fiscal deficit is currently being financed by commercial banks, and the current account deficit is currently being financed solely by the International Monetary Fund (IMF).
When the fiscal deficit goes up, the government issues more bonds; as a result bond yields spike significantly. However, global bond markets can play a major role in ameliorating this situation by absorbing the increased bond supply.
Resultantly, bond yields (and the subsequent interest payments) will not rise as sharply. This will help the government avoid being stuck in a vicious cycle of perpetual fiscal deficit.
Global bond markets can also intervene to lessen the severity of the current account deficit by adding a huge pool of new buyers of Pakistani bonds.
Resultantly, there would be a lesser depreciation of the Pakistani Rupee, and SBP would not have to rely as heavily on a contractionary monetary policy (rate hikes), which would otherwise lead to a heavier interest payment burden.
Global bond markets are not a panacea, however. They won’t resolve the structural and economic problems of Pakistan.
The aim of participating in global bond markets, for any government, is to be able to consistently finance itself at lowest possible long-run cost of borrowing.
Pakistan can only afford to spend a small portion of its annual budget on services and infrastructure because debt servicing (including interest payments) takes up a large chunk of the budget. By participating in global bond markets, Pakistan could significantly drive down the interest costs incurred, which add up to about 25% of all services costs.
Positives for foreign investors looking to invest in Pakistan include:
Liquid market for Market Treasury Bills (MTBs)
A well-functioning auction schedule – transparent and easy-to-access
Extremely detailed auction statistics, relative to the rest of the emerging markets
Negatives that discourage foreign investment in Pakistan include:
Limited liquidity in (Pakistan Investment Bonds) PIBs
No game plan from policymakers with regards to the debt markets (could have saved $200 million by issuing Euro-bonds in a timely fashion, which did not happen)
Successful emerging markets do not struggle as much as Pakistan does with hot money inflows/outflows, predominantly because:
Brazil, Turkey, South Africa, and Indonesia all have presence in bond indices, which incentivizes foreign investors to stay, even during challenging economic times
All of the aforementioned markets also have a local, diversified investor base – Pakistan does not have a pension-fund industry or a large-enough asset-management industry to support local bonds. This means that longer-dated bonds lack liquidity.
Passive inflows may often prove to be a gateway for foreign investors to invest in other assets in a country. Therefore, bond market inclusion may encourage international investment in Pakistani corporate credit, equities, and even SMEs.
Pakistan should be first and foremost aiming to achieve bond index inclusion, seeing as it is very achievable as things stand. It would ensure that a large portion of foreign investment is sticky, and remains in the country even during an economic downturn.
There are two main hurdles to Pakistan getting bond index inclusion:
An unconsolidated debt market – no bonds outstanding worth more than $1 billion.
Lack of liquidity from local participants.
Pakistan could conquer these hurdles by:
Issuing PKR Euro-bonds, as a short term solution.
Developing the PIB markets – so that when investors come in (even if they are speculative), longer-term and lower-risk assets will encourage sustained investor interest.
Getting inclusion into an index not only helps finance the twin deficits at a significantly lower rate, but it also means that the currency does not need to be depreciated, nor do the interest rates need to be hiked as much.
There is ample evidence to suggest that long-term foreign exchange management has proven unsuccessful. However, short-term foreign exchange management may actually reduce currency devaluation, and the amount of capital leaving an economy.