Possibilities of revamping the bond market

Shahiduzzaman Khan

Although thousands of people are associated with the stock market in Bangladesh, the bond market
remains conspicuously unattractive. Unfortunately, the country's stock market remains volatile now as
serious efforts to salvage it by the government and the private sector, are proving to be futile.

The government is exploring the possibilities of revamping the country's capital market. The bond
market can be a suitable alternative in this respect. But the point is that the people are less familiar
about the behaviour of this market and they are not sufficiently accustomed to bond market trade.

The bond market is a financial market where participants can issue new debt, known as the primary
market, or buy and sell debt securities, known as the secondary market, usually in the form of bonds.
The primary goal of the bond market is to provide a mechanism for long term funding of public and
private expenditures. As of 2009, the size of the worldwide bond market with its total debt outstanding
is an estimated $82.2 trillion.

Indeed, a vibrant domestic bond market can reduce a country's dependence on short-term foreign
currency borrowing and also help the country accelerate its economic activities. One of the problems in
Asian countries is that they are too dependent on short-term foreign currency borrowing which is
dangerous. Development of a domestic bond market should be a priority of the country. A proper
domestic bond market can speed up financial development of a country like Bangladesh.

Yet non-iquid nature and lack of knowledge make bonds less popular among potential investors. There
are of course some complexities. One cannot sell bonds easily like shares on the market. It is also
difficult to calculate bond price as coupon payment is made in future while principal amount is given at
the end of maturity. Value of money decreases due to inflation and a person without very good
knowledge about finance cannot calculate the prices of bonds.

The central bank sells treasury bills and bonds to overcome short-term cash crunch of the government.
The mature periods for such bill are 28-day, 91-day, 182-day and 364-day. The treasury bonds are sold
to meet budget deficit and long-term government financing. The mature periods are 5 years, 10 years,
15 years and 20 years. The central bank holds auction for treasury bonds every week and anybody can
bid for it through any bank. The auction committee fixes bond interest rate and it is applicable
throughout the bond's life, which means that buyers will get interest payment at the rates fixed by the
committee. Any individual is allowed to buy government bonds, which pays interest or coupons after
every six months and it is of Tk 0.1 million denomination or its multiplier, from the primary or secondary
market through any bank.

There is a secondary bond market for sale and purchase of bonds. Yet this market remains dysfunctional
since its inception in 2005, depriving the capital market of the gains and benefits expected from it. Since
its inception at the Dhaka bourse, there had been negligible transactions at the secondary market. IBBL
Mudaraba Perpetual Bond, the only one corporate bond issued by Islamic Bangladesh Bank Limited
(IBBL), however, showed some good performance. No capital market can reach maturity without a
strong bond market. Once the government bond market becomes vibrant, only then the private sector
bond market will grow.

Meantime, Bangladesh Bank (BB) is contemplating to make bond market vibrant and attractive to
investors by putting pressure on nine primary dealers to play a more active role. Despite offering higher
returns on investment than long-term bank deposits, the bond market failed to get desired response
from potential investors. The BB partly blamed the financial institutions engaged as primary dealers
(PDs) for the poor response. Since bonds are not easily convertible like other assets, investors might
have been less enthusiastic about them.

It appears that the PDs are not considering the bond market as another earning window. These financial
institutions have so far taken little initiative to lure investors into bond trading although it offers return
ranging between 10.5 and 12.88 per cent in five to 20 years' time. There is an allegation that PDs of
treasury bonds show unwillingness to offer government bonds for sales in the secondary market, rather
they hold bonds as reserve requirements.

However, the PDs have denied this allegation. In fact, the PDs do not find investors who want to buy
treasury bonds at the secondary market. Unattractive yields on bonds, tax on interest incomes from
treasury bonds and high per-unit value of treasury bonds made the bond market unattractive to
investors. General investors also do not have much confidence in the private sector as few corporate
debentures are in default without any legal or moral recourse to the investors. The market requires
more private sector bonds from banks and non-bank financial institutions to make the secondary bond
market active.

Reports say the Japanese are making money from the stock markets shifting themselves from the
banking instruments. Some years ago, the Japanese invested in a bigger way in the Chinese stock
markets followed by investing in the Indian and Vietnam stock exchanges. Now they are looking for the
next destination. Eventually, Bangladesh can be Japan's next investment target.

In a recent circular, Bangladesh Bank issued a directive to the effect that the companies must take
permission from the Securities and Exchange Commission (SEC) before launching bonds or debentures.
Banks were so far allowed to invest any amount in the financial instruments to give the bond market the
much-needed boost. The new central bank circular has also limited investment of the commercial banks
in bulk purchase of bonds. Compliance for single borrower exposure also limits bank loan to 15 per cent
of its capital to a single client. It means that if a company floats Tk 1.0 billion bonds and approaches a
bank to buy all of them, the regulation will prevent the bank from doing so and leave a wider investment
scope for small investors.

Undeniably, the country's stock market is very small and existing bond market very tiny. The
government and the private sector need to issue more bonds. In Vietnam, the bond market is worth
about 5.0 billion US dollars while Bangladesh's existing bond market is only about one billion dollars. The
country's capital market needs to be more mature and liquid. There should be provision for foreign
investment in the domestic bond market. Like China and India, Bangladesh rules do not also allow
foreign investment in domestic bond market. The country also needs to build a proper domestic capital
market with adequate infrastructure, right financial instruments like government bonds and corporate
bonds. If such requirements are fulfilled, the five-billion-dollar capital market can be expected to turn
into a 20-billion-dollar market very soon.