• 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.