Download Opportunities in Emerging Corporate Bond: Chapter Bangladesh

Opportunities in Emerging Corporate Bond:
Chapter Bangladesh
Md. Shahriar Parvez*
Abstract:
Purpose: A corporate bond is a bond issued by a corporation. It is a bond that a corporation
issues to raise money in order to expand its business. The term is usually applied to longerterm debt instruments, generally with a maturity date falling at least a year after their issue
date. The study focuses on Bond market development in Bangladesh, an emerging market.
The policy environment for bond market development in Bangladesh is studied with the
initiatives by various sectors over the past decade (2001 – recent year). This paper also aims at
understanding the hurdles Bangladesh is facing in developing its own local currency bond
market over last decade.
Design/ Methods: The study uses published secondary data from various relevant sources
and the researchers have used personal observation and experience regarding the country’s
socio economic and political background and their impact on the bond market.
Findings: Developing bond markets is more complicated than developing equity markets. They
operate best when they have money market and longer-term benchmarks. Numerous factors
suggest that Bangladesh could not develop an active, local-currency, and fixed-income market.
The obstacles include improper regulations, unwilling investors and borrowers, lack of market
confidence and ineffective infrastructure. The market participants in Bangladesh are skeptical
whether the government can succeed in this endeavor.
Practical Implications: Because of large quantum of long-term fund requirement with the
liberalization of the energy and communication sectors, major infrastructure sectors like oil &
gas, power, telecommunications, shipping, airlines and port development, the government
financing for such sectors would be lesser in the days to come. Existing financial system of the
country does not have either the capability or the instruments to support these sectors. The
rational alternative appears to be the Capital Market, and it our country there is only one Capital
Market is known that is debt market which is not sufficient to cover these types of financial
need. Bangladesh must drive to local currency bond market development.
Originality: Viewpoint/ general review/ Finance/ Economics.
Key words: bond market, capital market, economic development,
intermediaries & Market forces
_____________________________
*Lecturer, Department of Business Administration, City University, Bangladesh.
E mail Address: [email protected]
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INRODUCTION
Developing a local corporate bond market is a relatively new activity for many
emerging economies, and insights form experiences are very limited.
Development of local bond markets has become much talked about topic for
decades in countries like Vietnam, Srilanka, Pakistan and Bangladesh. The
current emphasis on local-currency bond market stems mainly from its riskmanagement benefits. A growing number of emerging market countries around
the globe are looking into the prospects of building local bond market to reduce
the currency, interest rate, and funding exposures. But building a bond market
is difficult, it takes a lot of time and not every country those persuaded was able
to develop an active market. The reason lies on the fact that bond markets
grow from participation by issuers, investors and intermediaries – not just from
building the market infrastructure. Participation results when a fairly
comprehensive range of economic, technical, as well as political and
“behavioral” factors come together. Unfortunately, many of these factors, by
definition, are not well developed or are in inappropriate level in emerging
markets. In most of them the financial market is controlled by the parts of the
government those may care little about developing bond markets, which further
complicates the process.
In the starting this paper conceptualizes the market forces those play significant
role in developing a bond market. It identifies the key success factors behind
the development and the stages of bond market development. The paper
critically evaluates the bond market development process in Bangladesh. At the
concluding part this paper summarizes the major obstacles seen the
development process of a bond market as Bangladesh has experienced.
Purpose
In Bangladesh there are huge scopes of bond market. Capital market here is
based on the debt market, and there are no proper infrastructures in the bond
market. Only few companies are trading their long term debenture in the bond
market. But a good capital market is a mixed basket of debt and bond, if only
the debt market is boost up then an inequality in the country’s capital market
emerges which is not good for improvement of a country’s financial structure.
Bangladesh must think about the bond market development as large quantum
of long-term fund requirement with the liberalization of the energy and
communication sectors, as well as the liberalization of government policies,
major infrastructure sectors like oil & gas, power, telecommunications,
shipping, airlines and port development are now open for the private sector,
including international participation. This implies that government financing for
such sectors would be lesser in the days to come. Existing financial system of
the country does not have either the capability or the instruments to support
these sectors. The rational alternative appears to be the capital market, and the
country’s capital market is dominated by equity securities which is not sufficient
to cover these types of financial need. For this reason Bangladesh must boost
up the bond market in the capital market sector which might bring a huge scope
for the country’s financial development.
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This paper aims at understanding the hurdles Bangladesh is facing in
developing its own local currency bond market over last decade.
Methodology
The study uses secondary data collected mainly from the office folder of Capital
Market Service Limited (Now NDB Capital) a full-fledged merchant bank an
enlisted company of Dhaka Stock Exchange (DSE) Bangladesh and the
information colleted form the central bank Bangladesh Bank including its’
websites, monthly journals, and annual reports. In addition to this the
researchers have used personal observation and experience regarding the
country’s socio economic and political background and their impact on the bond
market.
ROLE OF BOND MARKET IN THE ECONOMIC DEVELOPMENT
Developing economies heavily rely on foreign investments and debts for
maintaining the pace of GDP growth. Foreign investment is clearly a plus for
economic development but it does create certain risks. Since financial sector
crises will never be eliminated and at least for many years to come, flows into
emerging markets will be large in relation to the markets in which they are
investing, any rapid outflow will create serious problems for the borrowing
country. Emerging market countries must find ways to manage the risks, and
hence benefit from international capital flows. They need to be able to reduce
exposures to foreign-currency borrowing and also absorb the associated
shocks and volatility, so that small problems will not escalate into broadly
based social catastrophes, harming people who were in no way directly
involved in the markets.
Borrowers want to rely on short-term, foreign currency funding because when
their economy and local currency is strong, such borrowing creates a double
benefit to their net worth: the borrower’s liabilities fall while its assets and
revenues rise. The turn over side is that when times turn bad, borrowers get a
double hit on their net worth: liabilities rise and assets fall, causing strains and
in some cases defaults. The solution to this problem is to use funding
structures that have a neutral effect on net wroth, as in the case of bonds. The
difficulty lies in convincing borrowers that good time many turn bad, and in
getting them to incur the potential opportunity cost from locking instable funds
and rates.
Issuing bonds can reduce the types of interest rate, foreign exchange, and
refunding exposures and can help ensure that emerging market borrowers
have more shock absorbers – more tools – to limit impact of those exposures.
Local-currency bonds dampen the effect of crises created by international
capital flows by locking in interest rates and local-currency funding. This allows
borrowers to hold on to their funds and positions.
Emerging market countries have been developing local bond markets for the
past 5 to 10 years, though at a slower, less focused pace. Any count that is
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liberalizing and growing economically needs diversified financing tools beyond
just banks and equity market. Banks often cannot provide the size or structure
of financing needed. In many countries today, banks are increasingly
constrained from financing longer-term, large-scale projects because they are
trying to improve the quality of their operations. Pressure from international
agencies to contain credit extension (for example, via legal lending limits or
provisioning for non performing assets) is limiting lending as well. Issuing new
equity is not always an option, as it is costly and dilutes ownership. Local bond
markets also support major trends that stem from economic and financial
sector growth. For issuers, infrastructure development is creating demands for
large-scale, longer-term funds that banks cannot often provide.
Privatization, securitization (particularly for housing finance), and
decentralization of governments are all creating new financing demands. On
the investor side, many countries are now rich enough for insurance and social
security are creating institutional investors that need long-term assets. They
want to keep their interest rate (fixed), reinvestment (long term), and local
currency risks to manageable levels, with macroeconomic stability increasing in
many countries, issuers and investors alike are more willing to lock in rates.
Local bond markets also strengthen the financial sector by encouraging greater
transparency. Pushing companies to disclose in public markets and forcing
them to better understand themselves and in turn improve their management.
Bond markets create competition with the local banking sector, which can
reduce lending rates. Ideally, countries should try to build both primary and
secondary markets for bonds. Primary markets reduce the three risks noted;
secondary markets, by adding liquidity and broadening the investor base help
reduce funding costs. As mentioned earlier, many countries are not yet creating
secondary markets, and some will find it hard to develop public primary
markets. Whatever the situation, reducing one or two of the three financing
risks is worthwhile. Getting local-currency, fixed-rate, and long-term funds in a
private placement may cost more than a publicly traded issue but it might be all
that a country can do, and will reduce the issuer’s risk, and allow the investor to
lock in an asset.
BUILDING BOND MARKETS
Developing bond markets is more complicated than developing equity markets.
Bond markets need supporting pricing infrastructure. They operate best when
they have money market and longer-term benchmarks. Bond markets simply
cannot grow as quickly as equity markets can because investors need to be
sure that issuers have the cash flow to make interest payments and redeem
principal.
Furthermore, bond markets need more sophisticated market
participants including dealers and market makers, which means a new class of
intermediaries who can take position and also mange their risks.
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Participation of market forces
The three parties of bond market- issuers, investors, and financial
intermediaries actively participate in a market when they see an economic
benefit of themselves. Willingness (have the right attitudes) and ability (have
the skills, regulations), and are structured set up of the industry enhance the
active participation. The three elements of need, willingness, and ability drive
on each another. And there are many factors which weaken and put obstacles
to participate.
If the benefits of participation are clear and substantial, participants will be
more willing to involve in activities like analyzing and disclosing information. If
better skilled, they will be less fearful and more willing to enter the market.
Market participation cannot be commanded or forced, but a facilitating
environment can encourage it, and it can be discourage by an “un-enabling”
environment.
Around, across and inside the market factors
Kviback (2000) identified three types of interactive factors which may influence
the bond market; they are around the market factors, across other parts of the
financial system, and inside the market factors.
Around the market: These factors affect the market form outside and in
general they portray the macro economic features of the country. Around the
market factor includes a conducive environment consisting of macro and
political stability, strong economic growth, moderate controlled inflation and a
stable interest rate, debt encouraging tax policies, and a firm and wide legal
coverage (e. g., securities law, bankruptcy protections, uniform codes,
negotiable instruments, financial crime etc.) that substantiate debt market.
Across other parts of the financial system: These factors are part of the
market but they are based on other sectors of the economy. The risk free
governmental debts must be present to build a benchmark yield curve and a
dealer community. Risk free bonds are also important to design a portfolio and
diversify risk. Regular induced savings in the form of insurance and retirement
benefit plan contribution ensures a steady inflow to the market and brings into a
long run perspective to it. Well developed equity and money market, supported
by efficient stock exchanges and seedy clearing mechanism help to boost bond
market. Strong securities dealers bring confidence and make it familiar to the
general investors. The banking sector as whole is a vast cross market set up
that play very important part to the market as it takes many role in various
capacities as investor, issuer and intermediary.
Inside the market: Regulators are the most important inside factors to support
and develop the market. Trading, clearing, and settlement systems determine
the overall success of a bond market. Credit rating system, financial protection,
debt protection laws influence the market’s attractiveness to an issuer, investor,
and intermediary.
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The Key Success Factors Around, Across and Inside the
Market
The success of developing a market depends on some key factors from inside
the market and around it. The inside factors are appropriate participation by
issuers, investors and intermediaries, and the commitment by the government.
The around market factors are macro economic stability and successful
taxation system. For the most of the developing countries, the deficient issuers
and investors are the main stumbling block to develop a market. If a country
has sufficient issuer and investor base, stable macro-environment, and firm
governmental commitment yet the bond market development may be
constrained for the lack systems across the financial system like inefficiency
the government debt market, banking sector, and equity markets.
Market Participants: An active bond market needs diversified borrowers with
varied credit risks representing different economic sectors. Investors should
also be diversified and composed of institutions like pension funds, insurance,
companies, mutual funds, and other foreign investors interested in diversified
credit risk and economic sectors. Active intermediaries are needed to get
issuers and investors together. They will make money from the business with
the ability to take and manage the risks, and must be able to perform in the
long run. There should be a good number of firms to create a competition but
the number will not be that big so that the market dampens and it becomes
difficult to make enough money. The industry dominance should be taken by
several independent securities firms and not by banks as they can constrain
the operations for their credit performance.
Government commitment: The government needs to take the lead role to
make regulators (SEC and others) committed to build the market by bringing
together key market players. It is also a prime role of the government to build
systems mechanisms and lobbying with outside regulators and leaders. The
level of commitment determines the pace of the market growth and in the
absence of an inside governmental commitment, the market is least likely to
grow.
Macroeconomic stability: Stable macro and political environment is essential
for a bond market to grow. Without a healthy GNP growth, high savings and
investment rates the economy might not provide the issuers and investors
needed to warm up the market. Inflation and interest rates should be
predictable and affordable. High interest rates can slow issuance by creating an
unaffordable cost. Volatile rates may stop issuers and investors from locking
into a rate.
.
Taxation: Taxation is a well-known for its potentiality to destroy a market by
directing financial flows or by changing relative costs of different types of
borrowing. Bonds do not need to get preferential treatment, but they cannot
operate at a disadvantageous situation as compared with alternative products
such as bank loans and equity. Taxation can also take other names like stamp
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duties, transaction taxes; and income taxes on the cost of issuing, investment
returns, and intermediation of profits.
Government debt market: The government debt is an important ingredient for
the corporate bond market. It provides benchmark for the yield curve and helps
in promoting dynamic, profitable fixed-income dealer class. Without adequate
governmental borrowing at a fixed rate, the interest rate structures tend to be
undernourished, particularly for the instruments with long term maturities, and
very much limited high-quality credit alternatives exist. Government debt also
provides dealers exposure in trading fixed-income securities and a fair
possibility of earning profits. It is essential in obtaining a better priced financing
from banks and financial markets.
Equity and money market: A full fledged equity market is essential for bond
market development. It is important for the new comers to the market to be
confident that the country has a “capital markets culture” with all the supporting
institutions. With functional stock markets in the economy, issuers are familiar
with disclosure challenges, investors have general understanding about the
meaning of investing in securities. In such an environment money markets can
provide short-term pricing benchmarks rates which provides dealers less risky
trading experience.
Banking System: Commercial banks support bond issuance indirectly, when
their lending is constrained like capital inadequacy, legal conditions, sector
limits, and so on. Banks also participate directly by acting as issuers, investors,
and intermediaries. Commercial banks dominate in forming markets as
frequent investors. They can enhance market development buying and holding
securities. Banking system can halt the pace of bond market if there are
preferential tax treatments for banks and special regulatory network is offered
to protect them from bond market competition.
Credit-Rating Agencies: Credit-Rating Agencies (CRAs) need to be credible,
independent, and able to obtain information. They also need to be profitable
otherwise they will not survive. To survive CRAs need enough deal flow or they
will have to charge high fees. Both the approaches may affect bond market
adversely. It is crucial to have sufficient CRAs with having minimum cost and
other adverse impact on the market
Market development stages
No two countries have the same condition in inside and out the market but in
general the bond market development takes three stages:
First stage: The first stage consists doing one-off transactions – where an
issuer needs local-currency loan for long-term funding. This is matched up with
the investor need of a long-term investment in a limited private placement
market. It is generally characterized with limited number of issuers and
investors, unskilled intermediaries, and relatively underdeveloped capital
markets. In the first stage markets the government securities are essentially
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undeveloped and underutilized. Setting prices would be a problem, as there will
be no benchmarks. The issuer and investor want to limit the bond maturity and
use floating rates because both the parties are afraid to lock in fixed rates in
absence of a benchmark. The bond transaction is more expensive than a public
share offering but it is the only way to obtain longer-term local-currency loan for
the time being. It reduces some refunding and currency risk but retains interest
rate risk.
Second stage: The bond markets of second stage involve building a good
primary market for public and privately placed issues. It takes place in a county
having quite a lot of attractive issuers, a growing but still inadequate investor
base, developing stock markets, and a fair macro-political environment. The
country of stage two needs public company supports and disclosure
regulations. A credit-rating agency support in trading is highly sought. Having a
benchmark, even a limited one, is useful for pricing bonds with longer
maturities.
Third stage: Third stage involves lunching secondary markets dedicated for
bonds. The country must have sufficient issuers and investors and skilled
intermediaries, with a supportive macro-political environment. An established
government debt market is in force that provides a foundation for pricing new
issues, and other elements of the financial market.
BOND MARKET DEVELOPMENT IN BANGLADESH
The macro economic condition of Bangladesh was fairly strong over the last
two decades with growth rates averaging a respectable 5% and inflation
averaging a modest 9-10%. The first decade since its independence in 1971
was marked by slow growth and food insecurity. But till than it has shown many
significant improvements. The primary fiscal deficit during the past five years
has averaged about 5.5% of GDP, which has generally been within sustainable
limits. (However, the consolidated public deficit, taking into account losses
incurred by state-owned enterprises, is much higher and underscores the need
for improved fiscal management, although foreign exchange reserves have
become more stable recently owing to impressive export performance specially
man power exports and reduced imports). Heightened foreign investor interest
in the country’s natural gas sector has opened up tremendous fund flow
possibilities. The following table-1 of Foreign Direct Investment (FDI) from 1972
to 2006 easily portrays the possibilities in Bangladesh.
Table 1: Historical Information of FDI in Bangladesh
Period and political regime
Allowed Amount of FDI in Bangladesh
(Amount is considered by US Dollar($) in Million}
1972 - 1976
14.11
1977 - 1981
9.48
1982 - 1986
58.27
1987 - 1991
195.86
1992 - 1996
297.78
1997 - 2001
1675.39
2002 - 2006
2388.15
Source: Board of Investment (BoI), Bangladesh Government
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The domestic capital market
Numerous factors about Bangladesh today suggest that Bangladesh could not
develop an active, local-currency, and fixed-income market. Economic and
financial transactions are highly regulated, and till today the economy does not
provide a sufficient number of appropriately structured and skilled issuers and
investors. Although the government began privatizing selected state-owned
companies and deregulating the financial market for more than a decade, the
progress is slow. It leaves the market participants skeptical whether the
government can succeed in this endeavor.
Bangladesh with its drive to make a lively stock market could benefit form
having a local-currency, fixed-securities market like other emerging-market
countries. At present, the major fixed income instruments are bank deposits,
bank loans (fixed deposits), government savings certificates, term loans,
treasury bills, government bonds and corporate debt. In general the corporate
debt market is still very small compared with the equity market and it is
dominated by syndicated loans via private placement and debentures.
Table 2: Instruments Available in Bangladesh
Investments
Nominal Amount
(Taka billion)
682.00
717.00
170.00
Relative size
(%)
38.98 %
40.98
09.72
Bank Loans
Deposits
Government Savings
Certificate
Government Bonds
40.00
02.29
Treasury Bills
76.00
04.34
Equity (market value)
64.00
03.65
Debentures/Bonds
00.67
00.04
Source: Bangladesh Bank, National Saving Bureau & Dhaka Stock Exchange Report (20052006).
(Provide by CMSL, merchant bank, Now NDB Capital)
The equity market: Despite the limited role of capital market in the economic
development, the equity market in Bangladesh has shown a upward trend over
last decade. Bangladesh has two well known stock markets which are getting
popular among the investors, namely Dhaka Stock Exchange (DSE) and
Chittagong Stock Exchange (CSE). The Market capitalization of these two
similar markets amount nearly 20% of the country’s GDP (the market
capitalization 2008 is 964.9 billion taka and GDP in 2008-9 is 6149 billion taka),
(Bangladesh Bureau of Statistics).
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Table 3: Indicators of Capital Market Development
Securities Market (DSE)
Number of listed securities *
Issued equity and debt (billion
Tk)
Market capitalization (billion Tk)
Turnover (billion Tk)
General price index
Listed Mutual Funds
Number of mutual funds
Market Capitalization (billion
Tk)
Bond Market
Number of listed bonds
Government
Corporate
Debenture
Market Capital (billion Tk)
20032004
40042005
20052006
20062007
20072008
20082009
60
36.1
267
46.8
259
52.8
277
64.7
281
83.7
294
109.0
69.2
30.6
830
142.4
24.8
1319
213.0
74.1
1713
205.3
46.0
1340
412.2
164.7
2149
964.9
543.2
3001
10
.05
11
0.8
12
1.3
13
1.2
14
3.3
14
9.5
8
8
-08
0.5
-08
0.5
26
18
-08
12.2
34
26
-08
20.6
52
44
-08
80.2
93
84
1
8
178.9
Note: * includes debentures but excludes government bonds. Of the total number 231 are listed in CSE as
well. Only four securities are listed in CSE but not in DSE.
Source: Monthly Review, various issues Dhaka Stock Exchange
The above table portrays that despite of a reasonable growth in the equity market, the
performance of debt and bond market is quite sluggish.
Government initiatives in developing a bond market
Government of Bangladesh has taken a number of initiatives over the last few
years to develop an active secondary bond market, as a part of its Capital
market development plan. Considering the current situation in Bangladesh,
while there is not even an active primary market, such an initiative is quiet
challenging. The major steps taken by the government during the past decade
includes:
SEC Registration of CDBL: Central Depository of Bangladesh Limited
(CDBL), the long hibernating proposed depository system conceived to initiate
script less securities trading, succeeded to obtain a conditional registration from
the Securities and Exchange Commission, such a depository system was of
urgent need for an efficient secondary market. The system reduces the chance
of fraud or duplication of securities and thus provides infrastructure support as
well as keeps investor confidence.
Approval of Country’s First Credit Rating Company: The SEC has
approved country’s first credit rating agency named Credit Rating Information
and Services Ltd (CRISL) in November, 2001, a long demand for an efficient
secondary market. A reputed and trusted credit rating agency helps in
maintaining the investors’ confidence, provides valuable information about risk
factors associated with a particular company or issue and make the investors’
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base broader. It also assists in calculating the risk premium and thus helps the
issuers as well as investors to determine the coupon rate structure.
Axing of Interest rate on Saving Certificates: Government massively
slashed the interest rates on some savings certificates by 1.5 to 2% annually
with a hope that a decline in the income in nontransferable government
securities will encourage the investors to invest more in commercial fixed
income securities, which in turn will increase the demand for commercial
bonds. This will ensure high bond market participation. .
Divestment of State owned enterprises : The government has divested the
state owned enterprises(SoEs) held
under three corporations namely
Chemical Industries (BCIC), Sugar and Food Industries (BSFIC) and Steel
Engineering Corporations (BSEC). So far 115 SoEs have been divested out of
a total list of 228 SoEs (Bangladesh Bureau of Statistics). These enterprises
were mostly financed through loans form National Commercial Banks even
though many of them were loan defaulter. The divestment procedure required
that the enterprises to go for public and thus, the supply of securities in the
market increases. The increase in the supply of securities also strengthens the
secondary market activities.
Repurchase Agreement (REPO) Permission: The central bank of
Bangladesh has introduced the much awaited money market instrument,
Repurchase Agreement (REPO) in mid 2002. This allows commercial banks
and financial institutions to sell treasury bills brought from the central bank. The
REPO is expected to strengthen a secondary money market ultimately and
ensure a better liquidity management. In absence of effective money market
mechanisms liquidity crunch often disturbs the banks and financial institutions
and they were forced to dispose securities at discount rates to the central bank
to overcome temporary liquidity problems. With the introduction of REPO, they
will now be able to sell securities at market rates and lend to smaller banks
without risking the principal.
T-Bill auction opened for public: In a landmark move the central bank has
opened the treasury bills of various terms ranging from 28 days to 5 years to
resident individuals and institutions (Bangladesh Bank Bulletin OctoberDecember 2002). Apart from banks and financial institutions, any individual or
institution through their respective banks can take part in the weekly auctions.
Besides, institutional investors will also be allowed to put their provident funds
in long-term treasury bills (2 to 5 year). Provident funds have earlier been
barred from investing in government saving instruments from 01 July 02
(Bangladesh Bank Bulletin October-December 2002). This could very well be a
prelude to the establishment of a secondary market of government securities
and help to develop of a long-term yield curve.
DSE moves to activate secondary bond market: The country’s premier stock
market has recently formed a four member committee, which is planning to sit
with primary dealers to persuade them into putting price quote on the
secondary market. Since the launch of debt securities on the DSE in 2005, only
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one Treasury bond has so far been transacted on the secondary market. Even
the market sees no price quotation of such bonds. The main reason behind this
situation is that the primary dealers are holding the bonds are statutory liquidity
reserve (SLR). Presently the financial institutions have to keep 13 percent of
their total deposits as SLR (Bangladesh Bank Bulletin January-March 2009).
Sonali, Janata, Agrani, Prime, Uttra, Jamuna, Southeast and NCC banks and
IDLC are the primary dealers of the treasury bonds. In 2006, the DSE held a
number of meetings to persuade the primary dealers into taking active role in
the secondary market for bond transactions through the DSE. However, the
DSE could not motivate the primary dealers much to place two-way quote for
bond in the exchange system.
A total of 49 government treasury bonds have so far been listed on the DSE.
Listed bonds are of three categories having five year maturity period with 7.5
percent interest rate, ten year maturity period with 8.5 percent interest and
fifteen year maturity period with 14 percent interest rate (The New Nation
October28, 2007).
MAJOR OBSTACLES TO BOND MARKET DEVELOPMENT
The obstacles towards bond market development in Bangladesh can be seen
into three broad categories as Kviback (2000) identified: those around, across
and inside the fixed-income markets:
Around the market obstacles
Bangladesh, since its inception almost forty years back, is not enjoying political
stability. Governance and accountability are lacking in certain areas, and there
are elements of inefficiency in the financial system, mainly concerning the
state-owned banking sector. In addition, certain commercial and financial
regulations are outdated in that they tend to focus on institutions rather than
functions. Although the government is aware of these problems, it has been
slow to improve governance and develop strong institutional capacity. The
problems are created by these weak institutions are compounded by an
increasingly confrontational political environment. The obstacles in this group
stems from the political situation, the macroeconomic situation, legal framework
and the broader financial system.
The revengeful and overcharged political situation: The politics of
Bangladesh has been highly polarized into two of its past leaders’ image. One
group believes in secularism and other group believes in nationalism but also
rejects secularism. So the political deviation is clearly visible in almost every
sector in the country and all actions taken by the government. Though there are
other small political parties and ideologies they are yet to take any significant
power in the politics of the country. Like other small countries the third power,
which is always in the lime light, is the armed forces of Bangladesh. Powerful
governments’ preference of few foreign countries and their diplomatic mission
in Bangladesh also become the decisive factor since liberation. All these
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aspects often come into force together at once and the country looks at a
random walk where the long term vision is either absent or fainted. It is a
serious stumbling block for having an own successful capital market with active
players for the country.
Macroeconomic failure in capital formation: The economy of Bangladesh
continues to be agriculturally based; agriculture accounts for nearly 19% of the
country’s GNP (CIA, World Fact book), and more than 60% of labor force is
engaged in agricultural activities (Center for Policy Dialogue (CPD) survey).
The industry and service sectors contribute 28.7% and 52.3% respectively
(CIA, World Fact book), but compared with landholdings, the average size of
industrial and commercial enterprises is rather modest. Bangladesh’s macro
economy was fairly strong since the 1990’s with growth rates averaging a
respectable 5% and inflation averaging a modest 9-10% (Economic Trends,
September 2009). The primary fiscal deficit during the last decade has
averaged about 5.5% GDP (Economic Update, April 2010), which has generally
been within sustainable limits. The consolidated public deficit, taking into
account losses incurred by state-owned enterprises, is much higher and
underscores the need for improved fiscal management, although foreign
exchange reserves have become more stable recently owing to impressive
export performance specially the non traditional exports and service exports.
To foster market development Bangladesh is trying to bring more competition
into the financial sector through deregulation and privatization. With the hope
that deregulation of interest rates and privatization of state-owned enterprises
will enhance the demand for public fund and thereby, will create more
opportunities for investment. But the pace of change is very slow and their
impact on the market is very hard to see. The problem intensifies due to per
capita income and poor saving as well as investment rate. The country’s per
capita income is too low compare to world standard. According to the World
Bank Global per capita investment is about $1350 (approximately in 20042005) while Bangladesh reached to only $7(Economic trends 2009). For a
country having such a poor investment capacity it very hard to improve the
speed of capital market installation and it is the toughest barrier for a local
market. .
Outdated legal protection and regulations: Bangladesh’s laws represent a
mixture of codified British common law and legal principles from various
religious heritages. Although the court system derives from a common law
tradition, Bangladesh courts are limited in their ability to function effectively.
Most of the laws of the country are inherited by the British rule or slightly
modified version of that, which are grossly inadequate for a country in this
dynamic environment. The law and legal sector reform was in the agenda for
long time but with no or little success. The legal system can move only so fast
in amending the laws and enacting new ones, but implementation is not
happening. Even though the government acknowledges the need for such
changes, the contract laws and commercial codes seem to be fair, but ensuring
that they are observed is difficult because of a weak adjudication system. This
fragile legal system very hardly provides any legal security or protection for the
13
borrower and especially to the lender. As a result the citizens of Bangladesh
become very skeptic over market lending and borrowing rather they prefer to
surrender to a banker.
Across the market obstacles
The three important ingredients across the market are money market,
governmental securities market and, financial system as whole. Among them
the financial sector is dominating in Bangladesh where the commercial banks
play a vital role.
Sate dominated banking sector: Banking system is controlled the stateowned nationalized commercial banks (NCBs). It has created two serious
problems for a local corporate bond market. First, the system provides low cost
loans to state owned enterprises compare to their credit risks, which account
for a large part of the corporate sector. This undermines development of the
corporate bond market, because other financial institutions are unable to
compete with these “under-priced loan”. Indeed, the state-owned enterprises
constitute a large part of the NCBs business. To complicate matters,
development financial institutions also provide low-costs loans, priced at a
small percentage over bank deposits for similar maturities. Second, the banking
sector is faced with a substantial number of bad loans; non-performing assets
account for about 32% of total assets (Scheduled Banks Statistics, OctoberDecember 2009). Although these non-performing assets can be said to create
a need for an active bond market, to the extent that banks are constrained in
new lending and thereby cannot meet the funding needs of corporate
borrowers, they also rob the bond market of needed investors. Despite of the
effort made by the past three governments over last two decades the stateowned banks just keep on making bad loans.
Imperfect non-banking sector: The non-banking portion of the financial
sector consists of two small stock exchanges (Dhaka and Chittagong), both of
which have still not recovered form the bull market problems of 1996, which left
the public suspicious of corporate institutions because it is hard to get them to
disclose their figures. At that time, the stock exchange experienced a heavy
run-up in prices owing to a large inflow of funds from retail investors. This
inflow, drawn by the prospect of easy money, was a new experience for the
Bangladeshi people, but it lasted only the second half of 1996 in those six
months the index soared from 500 to 3500 and the market came crashing down
to about 600. In the period 1996-2005 while the global stock markets have
taken a beating due to the economic recession, both the DSE and CSE has
performed reasonably well. According to Bloomberg, the New York-based
prestigious information services company, the DSE was the fourth best
performing exchange in the world on a currency adjusted basis in 2008.
According to the 23 world indices, the Dhaka Stock Exchange has performed
the best in comparison with the other important stock exchanges (Annual
Report, Dhaka Stock Exchange 2007-2008). The index has in early 2010
crossed 5000 mark (www.dsebd.org) with an average daily turn over of 20
billion taka (the local currency, 70 taka = 1 USD). But this success is not
14
helping to form confidence in the market because the rates and transaction
volume are always fluctuating with the suspicious moves by few large investing
houses. It is widely believed that the stock prices are manipulated here on
purpose and the market imperfection is very high. In sum, the non-banking
sector has not evolved in a way that would allow it to pay an active role in the
financial system. Nor is it prepared to play an active and skilled leadership role
in developing and participating in an active fixed income market.
Inadequate government securities market: The government securities
market in Bangladesh is relatively small, does not provide much of a yield curve
to support a corporate bond market, and does not provide intermediaries with
skills and a profit base to support the corporate bond market. The different
“Saving Schemes” has become a major source of fund for the government.
They are open ended and have gained enormous popularity among the middle
income bracket, due to flexibility in matching the savings and expenditure
pattern of the middle class and the high rate of interest being offered.
Government savings certificates (GSCs) range in maturity from three to eight
years. Government savings certificates are offered to different types of
investors in the retail sector (but small corporate are allowed to invest). The
types of investors are mostly individuals and families but also include charity
and provident funds. Government savings certificates are issued in series
through the year. The holder may redeem them at par at any time. Threemonth interval profit-based savings certificate offer as high as 11.50% effective
rate which has reduced from 14.20%. Savings certificates with half-yearly,
quarterly and monthly interest payments also have received tremendous
response. The Wage Earners’ development bond is also popular with the
expatriate Bangladeshis.
Inside the fixed-income markets obstacles
Bangladesh finds it difficult to move forward for several reasons: weak
governance at the institutional and market levels; high non-performing assets
among the nationalized commercial banks (NCBs); poorly defined and
overlapping responsibilities and objective of the Bangladesh Bank, Securities
and Exchange Commission, and Ministry of Finance; and the lack of incentives
and private initiative to drive market developments. These are the principal
obstacles to the development of bond markets in Bangladesh.
Overlapping regulators and inadequate regulations: One hurdle at the
regulator and regulation level is the overlapping objective between the two
financial market regulators, the central bank of the country Bangladesh Bank
(BB) and the Securities and Exchange Commission (SEC), has no clearer
jurisdiction over the fixed-income market. In general, BB regulates the
commercial banks and their activities, while the SEC regulates the NonBanking Financial Institutions i.e., the two stock exchanges and the capital
market. However the SEC has no authority to issue rules and regulations, other
than direct secondary securities dealings and the procedure as whole is ling
and drawn out. As a result, although the SEC requires listed companies to
15
meet international standards on accounting and auditing, accounting
information appears to be of doubtful quality and reliability, it has not proposed
any regulations for the issuance of bonds or debentures. All the rule proposals
must first be submitted to the Ministry of Finance for approval and then passed
on for approval form Ministry of Law. Furthermore, potential issuers have to
look at various sets of regulations and follow a long and cumbersome
procedure.
The Securities & Exchange Act of 1993 confers vast regulatory authority on the
state, and is regarded as a constraint on capital market development. There is
a board of policymakers. Three of its members are appointed the state, another
is from the Ministry of Finance and one from the Central Bank, and the
chairman is appointed by the government.
Inefficiency in central market infrastructure: In the absence of a secondary
market in fixed-income securities, no effort has been made to build up a central
market infrastructure to support it. Bangladesh only has a telephone market for
T-Bill trading and central market infrastructure at the stock exchange for trading
equities and debentures. In the T-Bill market, the counterparts call each other
and settle transactions without any transparency in real time for other
participants in the market. At the stock exchange, the debenture market is fully
automated. The debentures market has a some what more transparent ordermatching system in that bids and offers are entered in the computer and then
matched automatically.
Absence of reliable credit rating system: Country’s first credit rating
company, Credit Rating Information and Services Ltd (CRISL) obtained
approval from SEC in November 2001, after long six years of procrastination
and wrangling of the regulatory body, which led to litigation. But this
organization is not famous yet and unfortunately, even after nine years of
establishment, the agency hasn’t yet been active. It implies that companies are
not willing to get their credit rating, most probably because of their poor credit
quality that may be exposed to the investors. Thus the credit rating agency is
facing hard time to be profitable. Market participates are still referred to other
media, such as the daily financial newspaper, and thus experience a delay in
obtaining essential economic information. According to some participants even
that the information is often unreliable.
Issuers: The foremost impediment here is that Bangladesh lacks a significant
number of potential, good-quality issuers. Most private sector enterprises are
small and owner-run; many are of cottage size and most are in the garment
industry, which depends largely on short-term bank loans for financing. These
enterprises could benefit from longer-term funding but are neither large enough
nor well known enough to issue bonds. Most of the large-scale industrial units
and commercial enterprises are sate owned. Their shares are not listed, and
they do not offer debentures since their financing needs are met by the
government or by the state-owned NCBs. These state-owned firms generally
stay out side the capital market. The privatization program for state-owned
companies is works too slowly to influence the market.
16
For ensuring sound financial condition of the company prudent businessman
often design their capital structure with a reasonable mix of debt and equity
capital. If a company uses too much borrowed capital, it becomes vulnerable to
financial risk. It appears that many listed companies did not issue bonds
because thy preferred equity capital and their share issue was enough to meet
their funding needs. Among the other reasons were- the bond issue would
impose too much of an interest burden on the company, the bank loans are
more attractive and easier than bond issues, company policy does not permit to
issue bond and they do not need to issue bond.
Although Bangladesh has a small debenture market, to date only a small
numbers of well-known issues have used the market. The liquidity in those
debentures at the stock exchange is insignificant because of the small number
of investors and their buy and hold mentality. The investor community does not
seem to find this market too attractive owing to weak disclosure by the issuers
which in turn reduces credibility and investor confidence.
CONCLUSION
Although there is not meaningful base for a secondary market of corporate
bond today, the Bangladesh economy may well grow at an attractive rate in the
future, and if it does, capital-intensive industries such as gas and telecom will
invest heavily. Thus Bangladesh will eventually need an efficient capital market
that came mobilize domestic and foreign resources for investment. For the time
being, however, Bangladesh should focus on creating a well regulated, and
attractive primary market in both public and private placements.
Like Bangladesh most of the developing countries are facing numerous pieces
missing for building their bond markets and want to know what steps they
should take to build their market, not just where they need to end up. This
discussion made is about some of the impediments to the development of
fixed-income market in Bangladesh and some ways to remove them. Clearly, a
market needs issuers and investors. As obvious as this sound, a surprising
number of countries have pushed forward to build markets despite the lack of
these players. Steps are hard to map out, since no two countries will have the
same combination of pluses and minuses and political and behavioral
conditions. Few emerging market counties provide extensive examples yet. A
reform is necessary in Bangladesh for all the across the market, inside the
market and around the market factors. A regulatory reform must be taken to get
the borrower-investor trust. Further study is essential to portray some specific
guidelines to ensure those reforms which ultimately enhance the market
participation and foster the development a local currency bond market.
17
References
Kviback, Mikael, 2000, “Bangladesh Survey: Issues in Local Bond Market
Development”, Harwood Alison, Building local Bond Markets: An Asian
Perspective, IFC, International Financial Corporation 2121 Pennsylvania
Avenue, NW Washington, D.C. Chapter 14 pp 254-266.
Bangladesh Quarterly Economic Update ,March 2007, The Asian Development
Bank, Bangladesh Quarterly Economic Update, Economics Units of the
Bangladesh Resident Mission, Asian Development Bank, Sher-e-Bangla
Nagar, Dhaka-1207, Bangladesh. Publication Stock No: 010401.
Economic Trends ,September 2009, Bangladesh Bank. Monthly Economic
Trends ,Publications, source website. www.bangladesh-bank.org
Scheduled Banks Statistics ,October- December 2008, Bangladesh Bank,
Scheduled Banks Statistics ,Publications, source website. www.bangladeshbank.org.
Annual Publication, 2006, 2005, Bangladesh Bank. Annual Publication,
Publications, source website. www.bangladesh-bank.org.
Weekly Market Review, 2001-2007,Asset & Investment Management Services
of Bangladesh. Year 2001 – 2007, Weekly Market Review source website.
www.aims.bangladesh.com.
Annual Publication of Bangladesh Economic ,2007, 2008, Bangladesh Bureau
of Statistics. Source website: www.bbs.gov.bd, provided by CMSL, Merchant
Bank.
Major Economic Indicators: Monthly Update ,April 2010, Bangladesh Bank,
Major Economic Indicators: Monthly Update, Monetary Policy Department
Bangladesh Bank, Volume 04/2010
Monetary Policy Review , July 2009 , Statistics Department, Bangladesh Bank,
Monetary Policy Review.
“Annual Report 2007 -2008 Dhaka Stock Exchange Limited” available at:
www.dsebd.org, www.dse.com.bd accessed 12 May 2010.
The New Nation, 2007, “Activating the secondary bond market” October 28,
2007, available at: http://nation.ittefaq.com/issues/2007/10/28/all0512.htm
accessed 07 June 2010.
18
Appendix A
Bangladesh Economy
The economy has grown 5-6% over the past few years despite inefficient stateowned enterprises, delays in exploiting natural gas resources, insufficient
power supplies, and slow implementation of economic reforms. Bangladesh
remains a poor, overpopulated, and inefficiently-governed nation. Although
more than half of GDP is generated through the service sector, nearly twothirds of Bangladeshis are employed in the agriculture sector, with rice as the
single-most-important product. Garment exports and remittances from
Bangladeshis working overseas, mainly in the Middle East and East Asia, fuel
economic growth.
GDP:
GDP growth rate:
GDP per capita:
GDP composition by
sector:
$208.3 billion (2007 est.)
6.3%
$1,400
agriculture: 19%
industry: 28.7%
services: 52.3%
Labor force:
66.6 million
note: extensive export of labor to Saudi Arabia, Kuwait, UAE, Oman, Qatar, and
Malaysia; workers' remittances estimated at $1.71 billion in 1998-99
Labor force by
agriculture: 63%
occupation:
industry: 11%
services: 26%
Unemployment:
2.5% (includes underemployment)
Budget:
revenues: $5.993 billion
expenditures: $8.598 billion
Industries:
cotton textiles, jute, garments, tea processing, paper newsprint, cement, chemical
fertilizer, light engineering, sugar
Electricity production fossil fuel: 93.7%
by source:
hydro: 6.3%
nuclear: 0%
other: 0%
Agriculture:
rice, jute, tea, wheat, sugarcane, potatoes, tobacco, pulses, oilseeds, spices, fruit;
beef, milk, poultry
Exports:
garments, jute and jute goods, leather, frozen fish and seafood
Export partners:
US 24.2%, Germany 13.2%, UK 10.6%, France 6%
Imports:
machinery and equipment, chemicals, iron and steel, textiles, foodstuffs, petroleum
products, cement
Import partners:
India 14.7%, China 14.6%, Kuwait 8%, Singapore 6%, Japan 4.4%, Hong Kong
4.1%
Economic aid
$1.575 billion
recipient:
Currency:
taka (BDT)
SOURCES: The CIA World Fact-book, U.S. Department of State, Area
Handbook of the US Library of Congress
19