Pak­istan in the in­ter­na­tional bond mar­ket

Enterprise - - Contents - By Dr Ash­faque H. Khan

Pak­istan has made a suc­cess­ful re­turn to the in­ter­na­tional bond mar­ket for the first time in over seven years. Ini­tially tar­get­ing to raise $ 500 mil­lion, Pak­istan raised the trans­ac­tion size to $ 2 bil­lion at the back of the strong de­mand of its pa­per by high qual­ity and di­ver­si­fied in­ter­na­tional in­vestors re­sult­ing in mul­ti­ple time over- sub­scrip­tion. Pak­istan has sold a $ 2 bil­lion dual tranche note on April 9, 2014, di­vided into five and ten year tranches of equal size ($ 1 bil­lion each).

This trans­ac­tion is Pak­istan’s largest in­ter­na­tional sov­er­eign bond of­fer­ing to date and at­tracted sig­nif­i­cant in­ter­est from global in­vestors, es­pe­cially from the US. Pak­istan’s 5 and 10 year bonds’ yields are 7.25 per­cent and 8.25 per­cent re­spec­tively which are priced at 558 ba­sis points ( bps) and 556 bps above the cor­re­spond­ing bench­mark rates of US Trea­sury 5 and 10 year, re­spec­tively.

Why do coun­tries go to the in­ter­na­tional bond mar­ket? There are two types of coun­tries that launch their sov­er­eign bonds. The first type in­cludes coun­tries des­per­ate to raise fund to meet debt pay­ment obli­ga­tions or build their for­eign ex­change re­serves to pro­vide sta­bil­ity to their ex­change rates. Such set of coun­tries do not hes­i­tate to of­fer high yield on their pa­pers in act of des­per­a­tion. For yield- hun­gry global in­vestors, such set of coun­tries is con­sid­ered earn­ing par­adise.

The sec­ond type of coun­tries is those who are not in­ter­ested in money, rather they want to showcase their grow­ing eco­nomic strength to global in­vestors. They are fre­quent is­suers of bonds with the sole pur­pose of re­main­ing in touch with mar­kets and in­vestors. For ex­am­ple China, with over $ 3.5 tril­lion re­serves, is a fre­quent is­suer of sov­er­eign bonds in or­der to showcase its im­prov­ing credit fun­da­men­tals to the rest of the world.

There could not be a bet­ter time for Pak­istan to go to the in­ter­na­tional bond mar­kets. The global mar­ket is flooded with liq­uid­ity as a re­sult of con­tin­ued Quan­ti­ta­tive Eas­ing pol­icy pur­sued by the United States. Even to­day, the Fed­eral Re­serve is pump­ing $ 75 bil­lion per month to re­vive US econ­omy. As a re­sult, the in­ter­est rates are at an all- time low and global in­vestors are anx­iously look­ing for high yield bonds to park their oth­er­wise cheap money. There­fore, Pak­istan chose the best time to go to the mar­ket to raise funds.

It was in­deed coura­geous on the part of the gov­ern­ment to un­der­take 144A/Reg S trans­ac­tion which en­abled it to hold a road show in the US mar­ket. Pak­istan’s cur­rent credit rat­ing is be­low seven notches of the in­vest­ment grade ( caa1) by Moody’s and six notches be­low (B-) by Stan­dard & Poor’s. Such a poorly rated coun­try sel­dom takes risk in en­ter­ing the US mar­ket for a road show. But Pak­istan went to the US mar­ket, at­tracted enor­mous de­mand for its pa­per and ac­cord­ingly of­fered more than half to the US in­vestors. This is in­deed a great suc­cess for the fi­nance min­is­ter.

There are three stake­hold­ers of this trans­ac­tion – the gov­ern­ment, the global in­vestors and the lead man­agers (Bar­clays, Cit­i­group, Deutsche Bank and Mer­rill Lynch). While all the stake­hold­ers are win­ners and ben­e­fi­cia­ries of this trans­ac­tion, the only loser is per­haps the coun­try. By look­ing at the size of the trans­ac­tion, Pak­istan gave the im­pres­sion of be­ing a des­per­ate bor­rower to the global in­vestors. Ini­tially tar­get­ing to raise $ 500 mil­lion, when Pak­istan saw such an over­whelm­ing re­sponse from global in­vestors, it raised the size of the trans­ac­tion by four times ($ 2 bil­lion).

Pak­istan needed dol­lars badly to meet gross in­ter­na­tional re­serves tar­get of the IMF pro­gramme. There­fore, it did not even bother to pay such a high spread over the bench­mark US trea­sury rates. With this trans­ac­tion, Pak­istan has set its new bench­mark for five and ten year pa­pers with spread of 556 bps and 558 bps, re­spec­tively. The last bond the coun­try floated in May 2007, amount­ing $ 750 mil­lion for a ten- year ma­tu­rity, at­tracted a spread of 200 bps.

The new pric­ing bench­mark is cer­tainly ex­pen­sive and will have a far- reach­ing ad­verse im­pact on pri­vati­sa­tion in de­ter­min­ing the bench­mark price for the item to be pri­va­tised, GDRs ( Global De­pos­i­tory Re­ceipts) and for bor­row­ing by the pri­vate sec­tor in in­ter­na­tional mar­kets.

Given Pak­istan’s cur­rent debt pro­file, bor­row­ing such a heavy amount at a rel­a­tively high cost in the midst of pay­ment to pre­vi­ous and cur­rent bor­row­ing from the IMF, short- term bor­row­ing from the Is­lamic De­vel­op­ment Bank, Stan­dard Char­tered Ban­kled con­sor­tium of com­mer­cial banks and re­pay­ment of the thus far resched­uled Paris Club loan start­ing 2016, will cause se­ri­ous debt ser­vic­ing dif­fi­cul­ties. The new bor­row­ing ($ 2 bil­lion) will en­tail in­ter­est pay­ment of $ 155 mil­lion per an­num in the next five years and $82.5 mil­lion per an­num in the re­main­ing five years.

If I were in the Min­istry of Fi­nance, I would have ad­vised the fi­nance min­is­ter not to take more than $ 500 mil­lion and tighten the spread, work with rat­ing agen­cies to im­prove rat­ing, re­turn to the mar­ket at the back of a grand suc­cess in the next three months, fur­ther tighten the spread and con­tinue to build upon the suc­cess. Per­haps, dur­ing the next one or two years Pak­istan’s spread would have come down to 350-400 bps and to 200-250 bps in the next three to four years.

The sec­ond stake­holder is the global in­vestors. In­un­dated with liq­uid­ity, the yield- hun­gry global in­vestors look­ing for a high yield bond re­sponded over­whelm­ingly to Pak­istan’s pa­per, of­fered be­tween $ 5 bil­lion and $ 7 bil­lion and fi­nally parked $ 2 bil­lion-$ 1 bil­lion each at 7.25 per­cent and 8.25 per­cent. There can­not be a bet­ter in­vest­ment than park­ing liq­uid­ity with Pak­istan at such won­der­ful rates.

The third ben­e­fi­ciary/ win­ner is our lead man­agers. While they have done an ex­cel­lent job in build­ing the size of the book, invit­ing qual­ity in­vestors across all re­gions and mak­ing the road show a grand suc­cess, they should have ad­vised the min­is­ter to not take more than $ 500 mil­lion as ini­tially en­vis­aged. I as­sume they did not ad­vise the min­is­ter ac­cord­ingly. Nev­er­the­less, they earned their fee four times more than what they could have earned with $ 500 mil­lion trans­ac­tion. Not a bad deal ei­ther for the bankers.

A coun­try like Pak­istan can­not move far ahead on bor­rowed re­sources. There is no sub­sti­tute for good macroe­co­nomic poli­cies and solid struc­tural re­forms. The IMF pro­gramme has pro­vided breath­ing space. Pak­istan should use this space for far- reach­ing struc­tural re­forms in vi­tal ar­eas in­clud­ing the much needed tax and en­ergy re­form.

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