The Emerging Asian Bond Market

The Emerging Asian Bond Market

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(c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market

The Emerging Asian Bond Market

© 1995 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing December 1995 Printed on recycled paper Design by Patricia Hord Graphik Design The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. Ismail Dalla, principal author of The Emerging Asian Bond Market, is a US national and past principal financial specialist in the World Bank's East Asia Country I Department. He is currently President of Washington Asset Management, Inc., Washington, D.C. The Emerging Asian Bond Market by Ismail Dalla, Deena Khatkhate, D.C. Rao, Kali Kondury, Kwang Jun, and Terry Chuppe. ISBN 0−8213−3487−5 Library of Congress Cataloging−in−Publication Data Dalla, Ismail, 1948− The emerging Asian bond market / by Ismail Dalla. p. cm. Includes bibliographical references. ISBN 0−8213−3487−5 1. Bond market—East Asia. 2. Monetary policy—East Asia. I. Title. HG4651.D35 1995 332.63'23'095—dc20 95−48236 Delivered by The World Bank e-library to: 000000 0000000000 CIPbreak IP : 000.000.00.00 000, 00 000 0000 00:00:00

The Emerging Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market

Foreword The economic performance of East Asia has been a remarkable story spanning several decades. The region has enjoyed macroeconomic stability, consistent growth, low inflation, increasing openness to international flows of trade and private capital, and a steady reduction in poverty and improvement in living standards. Along with rapid expansion of productive capacity and extensive structural changes in their economies, the financial sectors of these countries have also developed vigorously. The region now has a well−developed banking system, and boasts four of the top twenty stock markets in the world. However, East Asia's bond markets are relatively small and at an early stage of development. The combined size of its bond markets at US$ 338 billion, or 22 percent of GDP at the end of 1994, was only one−third of the size of the region's equity markets. This report has been prepared by World Bank staff and is based on studies of bond markets in China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand. These studies have been carried out in a collaborative effort between Bank staff and institutional counterparts in these countries. These studies are circulated separately as background papers. The main objectives of the report are to provide a comprehensive survey of the East Asian bond markets, identify the best practices that have fostered development of these bond markets, and present a broad agenda for reforms that would further contribute to their development in the region. The report finds great diversity among these markets in their size, sophistication, regulatory framework, and infrastructure. Each of these countries has taken significant steps in recent years to improve the functioning of its bond market. In some countries, the results are already apparent and the bond markets have begun to grow. In others, more concerted efforts are required. However, it is clear that most of these markets are poised for growth and, in most cases, the institutional prerequisites either are already in place or are being put in place. Market development is essentially an organic process, but one that can be aided by appropriate supportive actions by governments. The World Bank hopes that this report will facilitate a dialogue between key market participants, regulators, and officials responsible for promoting market development on specific measures that are required for each country. With the right measures, we expect the bond markets in these countries to grow very rapidly and become a major source for financing investments in industry and infrastructure that are essential to sustain rapid development in the world's most dynamic region. break

GAUTAM S. KAJI MANAGING DIRECTOR THE WORLD BANK

Acknowledgments Delivered by Theeffort World Bank e-library to: Bank staff and the counterparts in eight East This study has been carried out in a collaborative by the World 000000 0000000000 IP : 000.000.00.00 Asian countries over a period of nine months. This report has been prepared by a team headed by Ismail Dalla 000, 00 000 0000 00:00:00 (Principal Financial Specialist). The team included Deena Khatkhate, D.C. Rao, Kali Kondury, Kwang Jun, and

Foreword

2 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Terry Chuppe. Subir Lall and Gary Kleiman made important contributions to the report. The Asian bond market team would like to express its gratitude to Gautam Kaji, Managing Director, for invaluable guidance and continued support; Russell Cheetham, Regional Vice President, for full support; Vinod Thomas and Ishrat Husain, successive Chief Economists in EAP, for getting the study off the ground and for bringing it to a successful completion; Callisto Madavo, Pamela Cox, William McCleary, Vineet Nayyar, and Khalid Siraj for providing guidance and resources to carry out this regional study from the EA1 Department; and Francis Colaco, Gary Perlin, and Hans Rothenbuhler for providing constructive comments on the draft report. The team would like to express its appreciation to Joseph C.K. Yam, Chief Executive of the Hong Kong Monetary Authority (HKMA), and Andrew Sheng, Deputy Chief Executive, for full support and for providing a platform to disseminate the study; Loretta Wong of the HKMA for her total dedication in ensuring the administrative arrangements for the Hong Kong conference; Cosmas Robless for guidance and providing the resources to carry out a parallel study on India; Roger Hall for statistical support; and Amy Mendez, Joyce Rompas, Muriel Greaves, and Patricia Hord for their valuable contributions in the production of the report. Joost Polak edited the report. The study would not have been complete without the support and close cooperation of our counterparts in these countries. We would like to thank Dato Malek Merican, Advisor/Director, the Arab Malaysian Merchant Bank, for valuable guidance for the Malaysian study; Ekamol Kiriwat, Secretary General, Securities and Exchange Commission of Thailand, for full support and guidance for the Thailand study; Koh Beng Seng, Deputy Managing Director, Monetary Authority of Singapore, for valuable comments on the Singapore study; Roland Young, President, All Asia Capital, Philippines, for agreeing to put together the final report on the Philippines; Priaswijanto Sabrawi of the Institut Pengembangan Analisis Finansial, Indonesia, for the Indonesian report; Insup Lee of the Korea Securities Research Institute for the Korean study; Priscilla Chiu of the HKMA for valuable contribution to the Hong Kong report; Anjali Kumar of the World Bank for producing the China report; and N. J. Jhaveri, Chairman of ICICI Securities and Finance Company, Ltd., India, for agreeing to participate in the study and producing the India report on a compressed schedule. break

ISMAIL DALLA TASK MANAGER, ASIAN BOND MARKET STUDY

Table of Contents Executive Summary

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1 Introduction

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2 The Emerging Asian Bond Market

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Bond Markets in Selected Industrial

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Size and Composition of the East Asian Bond Market

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Table of Contents

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The Emerging Asian Bond Market Investors

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The Primary Market

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The Secondary Market

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Benchmarks

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Role of Credit Rating Agencies

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Derivatives

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Taxation

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Summary and Conclusions

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3 Regulation of The Emerging Asian Bond Market

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Introduction

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Securities Market Regulatory Systems

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Government Oversight and Self−Regulation

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Regulation of Securities Markets, Private Issuers, and Intermediaries

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Regulation of Government Securities and Intermediaries

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Regulation of Investment Companies

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Summary and Conclusions

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4 Internationalization of the Emerging Asian Bond Market

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Role of Foreign Portfolio Investment

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Bond and Equity Market Opening in East Asia

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International Bond Market Access by East Asian Developing Countries

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Summary and Conclusions

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5 Bond Markets and Monetary Policy

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Introduction

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Indirect Monetary Controls in Selected Industrial Countries

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Indirect Monetary Instruments and Monetary Policy in the East Asian Countries

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Summary and Conclusions

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Table of Contents

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The Emerging Asian Bond Market 6 Looking Ahead

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The East Asian Economy in 2004

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Issuers

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Investors

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Summary and Conclusions

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Annexes A Bond Market—Statistical Profile

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B The Industrial Country Experience

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Endnotes

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Selected Bibliography

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Tables in Text 1.1 East Asia: Selected Economic Indicators, 1993

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1.2 FDI Flows into East Asian Countries, 199094

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1.3 Equity Portfolio Flows and Bond Issuance to East Asia

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1.4 Relative Position of Banking Assets, Equity, and Bonds, 1994 link 2.1 Size of the Emerging East Asian Bond Market, End−1994

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2.2 Size of the Emerging East Asian Bond Market, 199094

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2.3 Main Sectors of the East Asian Bond Market

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2.4 Size of the National Government Bond Sector

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2.5 Size of the Central Bank Bond Sector

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2.6 Size of the State Enterprise Bond Sector

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2.7 Size of the Corporate Bond Sector

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2.8 East Asia: Investors in Bonds, 1994

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2.9 Net Issuance of Bonds in Selected Industrial Countries, 198093

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2.10 Withholding Tax for US−Based Institutional Investors

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2.11 Indicative East Asian Bond Tax Rates

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3.1 Asian Bond Markets: A Profile of Regulatory Systems

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4.1 Private Capital Flows to All Developing Countries: 198993

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4.2 Capital Flows to East Asia, 198594

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4.3 4.4

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Table of Contents

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The Emerging Asian Bond Market 4.5 Bond Issues in International Markets by Issuer Type in Selected East Asian Countries

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4.6 International Bond Issues by Selected East Asian Countries by Instruments

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4.7 Average Maturity

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4.8 Ratings of Sovereign Foreign Currency Debt, March 1995

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6.1 GDP and Gross Domestic Fixed Investment, 19942004

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6.2 Capital Structure in Selected East Asian Countries

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6.3 East Asia: Indicative Financing Plan of Projected Investment

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6.4 Indicative Size of the East Asian Bond Market

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6.5 Indicative Investment Requirements in Infrastructure, 19952004

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6.6 Asset Size of East Asian Institutional Investors

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6.7 Total Pension Assets in Selected Countries

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Figures in Text 1.1 GDP Growth, 198093

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2.1 Relative Position of Bank Assets, Equities, and Bonds

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2.2 Bond Market as a Percentage of GDP

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2.3 East Asia: Secondary Market Trading in Bonds, 1993

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2.4 Yield Curves in Selected East Asian Markets

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4.1 International Bond Issues in Selected East Asian Countries

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5.1 Instrument Mix and Operation for Selected Countries

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5.2 Indirect Monetary Policy Instruments in the East Asian Countries

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6.1 Composition of the East Asian Bond Market in 2004

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Boxes 2.1 Cagamas

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2.2 Singapore International Monetary Exchange (SIMEX)

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List of Abbreviations ADB

Asian Development Bank

AGSD

Accredited Government Securities Dealers

BDC

Bond Dealers Club

BIS

000000 0000000000 Bank for International Settlements IP : 000.000.00.00

BNM

Bank Negara Malaysia

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List of Abbreviations

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The Emerging Asian Bond Market BOK

Bank of Korea

BRI

Bank Republic Indonesia

BSP

Bangko Sentral ng Pilipinas

CMU

Central Money Market Unit Service

CPF

Central Provident Fund

EGAT

Electricity Generating Authority of Thailand

EPF

Employee Provident Fund

GDFI

Gross Domestic Fixed Investment

GDP

Gross Domestic Product

GHK

Government of Hong Kong

GOS

Government of Singapore

GOI

Government of Indonesia

GOK

Government of Korea

GOM

Government of Malaysia

GSIC

Government of Singapore Investment Corporation

GSIS

Government Service Insurance System

HKMA

Hong Kong Monetary Authority

IDR

Indonesian Rupiah

KLSE

Kuala Lumpur Stock Exchange

KDEI

Indonesian Depository and Clearing Agency

LAF

Liquidity Adjustment Facility

MAS

Monetary Authority of Singapore

MGS

Malaysian Government Securities

MSB

Monetary Stabilization Bonds

MTRC

Mass Transit Railway Corporation

POSB

Post Office Savings Bank

RAM

Rating Agency Malaysia

REPO

Repurchase Agreement

RTG

Royal Thai Government

SEC

Securities and Exchange Commission

SEHK

Stock Exchange of Hong Kong

SET

Stock Exchange of Thailand

SSS

Social Security System

TRIS

Thai Rating and

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List of Abbreviations

7 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market

Currency Equivalents China Year−end 1994 Average 1994

US$ 1.00=Yuan 8.45 US$ 1.00=Yuan 8.49

Hong Kong Year−end 1994 Average 1994

US$ 1.00=HK$ 7.74 US$ 1.00=HK$ 7.73

Indonesia Year−end 1994 Average 1994

US$ 1.00=Rupiah 2200 US$ 1.00=Rupiah 2197

Korea Year−end 1994 Average 1994

US$ 1.00=Won 788.70 US$ 1.00=Won 791.86

Malaysia Year−end 1994 Average 1994

US$ 1.00=Ringgit 2.56 US$ 1.00=Ringgit 2.56

Philippines Year−end 1994 Average 1994

US$ 1.00=Pesos 24.42 US$ 1.00=Pesos 24.15

Singapore Year−end 1994 Average 1994

US$ 1.00=S$ 1.46 US$ 1.00=S$ 1.53

Thailand Year−end 1994 Average 1994

US$ 1.00=Baht 25.09 US$ 1.00=Baht 25.10

Executive Summary Introduction The World Bank Group has been engaged in financial market studies in many East Asian1 countries as an integral part of its ongoing operations. The information gathered and the insights gained from these studies, especially on Korea, Thailand, the Philippines, Indonesia, and China, have enabled the Bank to make an important contribution to the formulation of financial sector development policies in its member countries. Most East Asian countries now have efficient banking systems and robust equity markets. However, future efforts lie beyond the banking system, and the focus will shift to capital market development, especially the bond market. Therefore, the Bank, in consultation with its member countries and market participants, has undertaken a study of the East Asian bond market. The study was carried out over October 1994−May 1995 by a Bank team in collaboration with Delivered by The World Bank e-library to: 000000prepared 0000000000by consultants in these countries are issued separately counterparts in member countries. Country studies IP : 000.000.00.00 from this report. 000, 00 000 0000 00:00:00

Currency Equivalents (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market The study concludes that the East Asian bond market is poised to grow rapidly during 19952004 and is expected to become an important segment of the financial markets in East Asia. The emergence of the bond market will complement the growing equity markets of the region and lead to more complete financial markets in these countries. Vibrant bond markets would facilitate financing of massive investment needs of the region, especially for long−term private fixed investment required to sustain the high levels of projected economic growth—average annual growth of 7.7 percent—over the next decade. Moreover, well−functioning bond markets will allow policymakers and market participants to manage their risks better, improve liquidity, and reduce intermediation costs relative to comparable instruments like bank deposits and equities. The development of bond markets would also encourage new risk management products such as interest rate futures and options. Furthermore, well−functioning bond markets with a broad range of instruments would enable central banks to carry out indirect monetary policy through open market operations. The past financing patterns of the corporate sector, with heavy reliance on bank financing and internally generated funds, are likely to change over time. The share of bank financing is expected to decline steadily and be substituted by bonds. Bond instruments would become a more acceptable asset class in the portfolios of both institutional and individual investors. A significant change in the region's corporate finance patterns is already taking place because large infrastructure and capital−intensive industrial projects require long−term, fixed−rate debt capital. Projects with long gestation periods are increasingly being undertaken by the private sector, and their financial viability depends on achieving acceptable rates of return which, in turn, depends on an appropriate capital structure. Infrastructure projects, for example, are highly lever−aged, with typical debt to equity ratios of 3 to 1. This trend is likely to accelerate due to institutional and policy changes in these countries' domestic economic and financial sectors, and their growing international linkages. Concerted efforts have been made by policymakers and regulators during recent years to implement the regulatory and financial sector reforms essential for robust bond markets. These reforms are at an advanced stage in economies such as Hong Kong, Korea, Malaysia, and Thailand, but have just begun in the Philippines, Indonesia, and China. If recent trends continue, the size of the East Asian bond market would most likely cross the trillion dollar mark by 2004, from about US$338 billion at the end of 1994.break

Macroeconomic Context of the East Asian Bond Market

East Asia has emerged as a major economic powerhouse. With a population of 1.6 billion and a combined GDP of US$1.3 trillion in 1993, the region accounted for 6 percent of global output, or 27 percent of the total GDP of low− and middle−income countries as a whole. East Asia's GDP is larger than that of France, Italy, or the United Kingdom, and almost one−fifth of US GDP. The region's output grew more than 2.6 times over 198093, with an average annual growth of 7.8 percent, or more than twice the rate of global output growth during this period. Per capita incomes have also doubled. Sound macroeconomic management and a stable political climate, combined with low−cost and highly skilled labor, have attracted corporations from the industrial countries to invest in the region. Most of this direct investment has been in export−oriented industries. East Asia's export performance over the past quarter century has been impressive, with exports of goods and services rising more than thirtyfold to about US$850 billion; they now account for about 22 percent of world exports. As a result, East Asia has been able to accumulate massive foreign exchange reserves amounting to US$204 billion at the end of 1994. East Asia's rapid growth has been propelled by high levels of saving and investment. From around 22 percent of GDP in 1965, its savings rate has risen sharply to 35 percent, roughly 60 percent more than the average for industrial countries. In 1993, China, Hong Kong, Korea,to:Malaysia, Singapore, and Thailand had Delivered by TheIndonesia, World Bank e-library 000000 0000000000 savings rates exceeding 30 percent of GDP. Over the past 25 years, investment rose by about 11 percent annually IP : 000.000.00.00 to reach 35 percent of GDP. The net flow of000, foreign saving into East Asia during the period amounted to only 0.3 00 000 0000 00:00:00 percent of GDP. Macroeconomic Context of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market The growth of East Asian financial markets during this period has been equally impressive. Table 1 shows the key indicators of the East Asian financial markets for 1993. Financial markets of most East Asian countries have been dominated until the late 1980s by banks, which served as the main corporate funding source. Since then their equity markets have grown dramatically. Hong Kong, Singapore, Malaysia, and Thailand are now among the world's 20 largest stock markets. At the end of 1994, total market capitalization of the eight East Asian stock exchanges amounted to about $1.1 trillion, or 71 percent of GDP, compared with total assets of the banking system of $1.4 trillion, or about 92 percent of GDP. This growth wascontinue Table 1: Key Indicators of the East Asian Financial Markets, 1993 (Amount in US$ billion) M21

Bank Assets1

Equity Market2

Bond Market3

US$

% of GDP

US$

% of GDP

US$

% of GDP

US$

% of GDP

519

88

547

128

41

9

47

11

Hong Kong4 119

109

200

182

385

352

6

5

Indonesia

69

48

85

59

33

23

13

9

Korea

139

42

229

69

139

42

138

42

Malaysia

54

88

60

93

220

342

35

54

Philippines

22

42

28

51

40

74

24

43

Singaporeb

51

92

92

167

133

240

38

70

Thailand

98

79

118

95

130

104

10

8

Germany

1,184 65

2,766

145

463

24

1,587 83

Japan

4,633 111

6,338

150

3,000 71

2,887 68

United Kingdom

885

96

2,101

223

1,152 122

311

United States

4,013 64

3,471

55

5,224 83

6,993 112

Chinaa

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a/ Specialized financial institutions only. b/ Deposit Money Banks only. Sources: 1/ International Financial Statistics. 2/ Emerging Markets Database, International Corporation. Delivered by Finance The World Bank e-library to: 000000 0000000000 3/ Country Reports and World Bank staff estimates. IP : 000.000.00.00 000, 00 supply 000 0000 and 00:00:00 4/ Hong Kong Monetary Authority. HK$ money banking assets.

Macroeconomic Context of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market brought about, to a large extent, by increased foreign portfolio investment attracted by East Asia's booming economies, mostly open capital accounts, and relatively stable exchange rates. The East Asian bond markets, in contrast, have grown more slowly. At the end of 1994, total value of the East Asian bond market amounted to US$338 billion—less than a third of the equity market capitalization. The East Asian Bond Market

East Asian bond markets have grown slowly relative to the region's equity markets. At the end of 1994, the total market capitalization of the East Asian bond markets amounted to US$338 billion, or 22 percent of GDP—less than one−third the size of the equity markets. At the end of 1994, the size of the East Asian bond markets represented a mere 2.1 percent of the world bond market. In the context of emerging markets, however, East Asia is at the forefront of bond market development. The total outstanding value of emerging market bonds was estimated at about US$800 billion at the end of 1994, with East Asia accounting for nearly 43 percent. At the end of 1994, the individual size of the East Asian bond2 markets measured as a percentage of GDP was as follows: Singapore (72 percent), Malaysia (56 percent), Korea (43 percent), Philippines (39 percent), Thailand (10 percent), Hong Kong (9 percent), China (7 percent), and Indonesia (6 percent), compared with bond markets in developed countries such as the United Kingdom (35 percent) and Japan (74 percent). In absolute terms, the major markets were Korea (US$161 billion), Singapore (US$45 billion), China (US$33 billion), Malaysia (US$40 billion), and Thailand (US$14 billion). Although the absolute size of the East Asian bond market is small, the growth of this market has been impressive. At the end of 1989, the total face value of all outstanding East Asian bonds stood at about US$167 billion. By the end of 1994, this market had doubled to about US$338 billion. In comparison, the total size of the bond markets of the United States, Japan, Germany, and the United Kingdom grew by 70 percent. At the country level, the bond markets in China, Korea, the Philippines, and Indonesia have more than doubled; the markets of Thailand and Malaysia have grown by more than 35 percent. The Hong Kong bond market had grown to a sizable US$12 billion in 1994 from a very low base in 1990. The East Asian financial markets can be broadly categorized into three groups: Hong Kong and Singapore as regional financial centers with sophisticated markets; Malaysia, Thailand, and Korea as countries with relatively well−developed financial markets; and the Philippines, Indonesia, and China, which have carried out substantial reforms but need to further build or strengthen institutional infrastructures that exist in economies with sophisticated financial markets. The present bond markets in these economies generally track the stage of development of their economies and financial markets. Singapore's bond market, at 72 percent of GDP in 1994, was the largest in East Asia. Although the value of bonds listed on the Singapore Stock Exchange is larger than the equity market, about 98 percent are the Asian Dollar Bonds (currencies other than the Singapore Dollars). While there exists a relatively large primary government securities market in Singapore, its main purpose has been to absorb the savings of the Central Provident Fund (CPF) and the Post Office Savings Bank. The proceeds of the issues are then converted into hard currencies and invested overseas by the Government of Singapore Investment Corporation (GSIC). The primary government securities market is the mechanism for providing a guaranteed return for the contributors to the CPF and depositors with the Post Office Saving Bank and then passing on the asset allocation and investment decisions to the GSIC, with the Government of Singapore (GOS) assuming the exchange risk. Although the Monetary Authority of Singapore (MAS) manages to influence domestic liquidity and interest rates by varying the net amount of Treasury bills auctioned weekly, open market operations in the domestic market are supplementary to interventions in the foreign exchange market. Given Singapore's unique situation, GOS's efforts are directed toward developing the country as a major regional bondBank market andto:a center for bond market infrastructure such Delivered by The World e-library 000000 0000000000 as a regional bond insurance company. IP : 000.000.00.00 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market Hong Kong is the other major financial center in the region. At the end of 1994, the Hong Kong stock market ranked eighth in the world in terms of market capitalization (US$269.6 billion) and eleventh in terms of volume of stocks traded (US$129.2 billion). The development of the domestic bond market has lagged substantially behind, with bonds outstanding issued by Hong Kong private issuers representing about 9 percent of GDP However, the Hong Kong bond market has grown rapidly since 1993, due in large part to the role played by the Government of Hong Kong (GHK) and, in particular, by the Hong Kong Monetary Authority (Monetary Authority). The experience of Hong Kongcontinue

provides an interesting example of how, in a relatively free market economy, concerted public policy actions can greatly facilitate capital market development. The development of a Hong Kong dollar bond market was constrained by several factors, including the lack of a market−based benchmark, bank dominance in the financial sector, the absence of a bond rating agency, limited institutional investors such as government−mandated employee retirement or provident funds, and the absence of key institutional infrastructure (central custody, an efficient clearing and settlement system, and market makers, etc.). Furthermore, the ability of market makers to perform their function was constrained by lack of liquidity. In the view of many market practitioners, the profits tax on interest and the stamp duty also acted as deterrents to the use of the Hong Kong dollar debt market by private issuers. Unlike Singapore, Hong Kong has allowed the internationalization of its currency and permitted foreigners to issue bonds in Hong Kong dollars. The Hong Kong dollar is linked to the US$; therefore, the Monetary Authority needs monetary instruments in the domestic market to conduct its monetary policy of maintaining exchange rate stability. To this end, the government launched the Exchange Fund Bills and Notes Program in 1990 to provide a tool for monetary management. The maturities of Exchange Fund Bills and Notes have been gradually lengthened to five years, and these instruments have provided a benchmark for the issuance of debt instruments with longer maturities. The proceeds of the bills and notes offerings are not used to fund government spending, but are instead invested prudently by the Exchange Fund in international markets. To further lengthen the maturity structure of debt instruments, the government has supported the issuance of debt by supranational organizations in Hong Kong by granting tax exempt status to Hong Kong dollar denominated bonds issued by the World Bank, the Asian Development Bank, the International Finance Corporation, and other multilateral lending institutions. The benchmarks currently provided by these instruments are widely followed by market practitioners, and efforts to strengthen this market will contribute to the further maturation of the Hong Kong dollar bond market. Hong Kong is one of the few financial centers in the region with an active secondary market in government bills and notes. With average daily turnover of about HK$22.3 billion in 1994, secondary market trading represents more than half of the total debt outstanding of HK$40.2 billion. The Monetary Authority has facilitated liquidity in the debt market by allowing Mass Transit Rail Corporation (MTRC) and Airport Authority debt instruments to be used for repurchase agreement (REPO) transactions. REPOs can facilitate debt market development by providing a relatively economical source of funding for dealer inventories in securities and a source of interest income (or the equivalent thereof) to the counterparties to the REPO transaction. In March 1994, the scope of eligible REPO securities for discounting under the Liquidity Adjustment Facility (LAF) was extended beyond Exchange Fund Bills and Notes. In addition to paper issued by MTRC and the Airport Authority, HK dollar debt instruments are, in principle, qualified if they: (a) are lodged with and cleared through the Central Money Market Unit Service (CMU) operated by the Monetary Authority; (b) have a minimum credit rating of A3 (Moody's) or A− (S&P) for a bank issuer, and A2 (Moody's) or A (S&P) for a non−bank issuer; (c) are marketable; and (d) have an issue amount greater than HK$1.0 billion. Debt instruments, regardless of their ratings, will not be accepted as REPO securities if they are issuedbyby REPO counterparty, its subsidiary, or its holding company. Delivered Thethe World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 transactions in 0000 bills00:00:00 and notes

The Monetary Authority conducts its in the secondary market only through recognized market makers. The Monetary Authority will also make a bid to market makers for bills and notes that The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market they may offer. It will also act as a last resort supplier and lender of bills and notes to market makers subject to the availability of bills and notes held in reserve or bought in the secondary market. Market makers are permitted to incur short positions so long as the net market value of all long and short positions in bills, notes, and government bonds is positive. The Monetary Authority also may sell short in any issue so long as its net positions in bills, notes, and government bonds are positive. The Monetary Authority has established a cost−effective computerized book−entry clearing system to reduce settlement risk and facilitate secondary market trading in Exchange Fund Bills and Notes. This service was extended to other Hong Kong debt instruments with the start−up of its CMU. The CMU performs the role of central custodian and clearing agent for Hong Kong dollar debt instruments issued by private sector issuers, including certificates of deposit, commercial paper, and bonds. The transfer of title is in book−entry form so that physical delivery is not required.break

Although no limits are normally set on the size of REPO transactions that individual counterparties may enter under LAF, the Monetary Authority reserves the right to set limits, if it deems appropriate, when the REPO securities are other than the Exchange Fund Bills and Notes or government bonds. To ensure the marketability of the issue and facilitate its daily valuation, the Monetary Authority requires that there should be at least two institutions acceptable to the Monetary Authority prepared to make every effort to quote from time to time and at the request of the Monetary Authority make a firm bid price of reasonable size in the issue. These institutions are also required to provide price information to the Monetary Authority on a daily basis. Structured issues (i.e., other than ''plain vanilla" products) are not normally accepted as REPO securities. Further, the issue size should not be less than HK$1 billion. Hong Kong's corporate bond market is very small but growing. Most corporate bonds are listed on the Stock Exchange of Hong Kong (SEHK), while the bulk of trading takes place over the counter. This market practice is typical in most countries. Investors in corporate bonds are primarily institutional investors, including banks and pension funds. Individual investors are not active in the corporate bond market, and seem to prefer the risks and rewards associated with the more volatile stock market. Moreover, the returns available in the equities market have been quite high in recent years, with the Hang Seng Stock Index more than doubling in 1993. As in other Asian countries, individual investors in Hong Kong are perceived to have a very short−term investment horizon. However, this may change as the populace ages. In light of this, many fund managers in Hong Kong expect that there may be a shift in emphasis from wealth creation to wealth preservation in the years ahead. Unlike Singapore, the infrastructure requirements of Hong Kong are very substantial. MTRC has estimated that it will cost HK$23 billion to construct a 34−kilometer railway linking Central and Kowloon with Northern Lantau Island and Hong Kong's new airport. More importantly, there is a long−term need to develop the bond market to facilitate the financing of China's infrastructure. As a regional financial center, Hong Kong is well positioned to intermediate in bonds for the East Asia region. The second largest bond market in the region, measured relative to GDP, is that of Malaysia. At the end of 1994, the size of the Malaysian bond market was about RM101.1 billion (US$40 billion), or about 56 percent of GDP The main components of the bond market were government (73 percent), corporate (12 percent), state enterprises (10 percent), and the central bank (5 percent). The Government of Malaysia (GOM) started issuing bonds to meet the investment needs of the contractual savings sector, the Employee Provident Fund (EPF), and to partially fund the budget deficit of the Federal Government. Since 1988, the GOM and the Bank Negara Malaysia (BNM) have made concerted efforts to further develop the bond markets and create a yield curve. A dealer network has been in place since 1988 and consists of 23 principal dealers (commercial merchant banks, and discount houses) Delivered by The World Bank e-librarybanks, to: 000000 0000000000 Securities (MGS), which are auctioned. MGSs that underwrite the primary issues of Malaysian Government IP : 000.000.00.00 000, 00are 000 only 0000 00:00:00 issued with original maturities of up to 10 years offered to principal dealers, while longer−term MGSs are issued at predetermined coupons and sold at par to selected institutional investors. BNM also introduced an The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

13

The Emerging Asian Bond Market electronic book−entry system for the transfer of securities and to facilitate the transfer of funds. However, the supply of MGSs has declined in recent years because of the comfortable fiscal position of the GOM. As a result, MGSs are no longer an effective benchmark. Securities issued by the Cagamas Berhad (the National Mortgage Corporation), which are considered to be corporate bonds, are often used for this purpose. The corporate bond market was launched in 1987 with the establishment of the Cagamas Berhad. In 1994, the amount of corporate bonds issued was RM8.4 billion, compared with RM1.8 billion in 1988. Cagamas purchases housing loans from mortgage originators such as banks, other financial institutions, and the government, and issues unsecured mortgage−backed securities to fund its mortgage portfolio. These securities qualify as liquid assets. In a relatively short time, Cagamas has established itself as a major player in the domestic bond market. Since its inception, Cagamas has issued RM11 billion worth of bonds, representing about 45 percent of the total corporate bond market. Both fixed rate bonds with maturities of 3, 5, and 7 years and floating rate bonds pegged to the 6−month Kuala Lumpur Inter−Bank Offered Rate are issued. Cagamas is broadly owned by the financial institutions in Malaysia, including the central bank, and has been profitable since its inception. The corporate bond market in Malaysia has grown rapidly since 1988. In the past, the bond market was confined to government bonds issued to meet the invest−soft

ment needs of institutional investors such as the EPF and the insurance companies. The mandate shifted to the private sector with the launching of the Privatization Master Plan. Since then, the GOM has been actively privatizing telecommunications, electricity supply, highways, and other utility sectors. This policy change had a major impact on the corporate bond market. Malaysia has very large institutional investors. The EPF, the Social Security Organization, the Armed Forces Fund, pension funds, and insurance companies are the major investors in the bond market. The EPF is by far the largest, with total assets of RM82.6 billion at the end of 1994, and is to remain as the major source of long−term funds. It is required by law to invest at least 50 percent of its annual investable funds in MGSs and it is not permitted to invest in unsecured corporate bonds. However, it has recently financed large infrastructure projects such as the independent power plants, the Light Rail Mass Transit, and the new Kuala Lumpur International Airport. It is estimated that private capital requirements in Malaysia over the next 25 years will be about RM6.3 trillion (US$2.5 trillion). Traditional borrowings and equity financing are unlikely to satisfy this massive level of investment. Therefore, most corporations are likely to resort to bond financing. Malaysia has built most of the basic infrastructure, including credit rating and tax incentives, to support the development of a robust bond market. The main shortcomings are: (a) the multiple regulatory regime; (b) an inactive secondary market except for Cagamas bonds; and (c) the absence of a mechanism to provide liquidity support to the market makers. The bond market in Thailand is small but growing rapidly. At the end of 1994, the total size of the bond market was Baht 344.6 billion (US$13.7 billion), or only 10 percent of GDP The main sectors of the bond market were state enterprise bonds (55.3 percent), corporate bonds (25.5 percent), and government bonds (19.2 percent). In Thailand, government bonds were issued primarily for open market operations to control liquidity in the financial system and, to a lesser extent, to fund the budget deficit. Government bonds were mainly purchased by financial institutions to meet their statutory requirements. Given that the Royal Thai Government (RTG) has been running fiscal surpluses for the last few years, there has been no need to issue bonds since 1990. As a result, there has been no need to set up an auction system. Delivered by The World Bank e-library to: 000000 0000000000 Similar to Malaysia, the RTG has decided to increase the role of the private sector in financing the massive IP : 000.000.00.00 000, to 00 sustain 000 0000 00:00:00 infrastructure investment that will be required the high projected growth of the Thai economy. Fourteen large public utilities and other state enterprises such as Thai Airways will be corporatized, and their shares are to

The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market be issued to the public in small installments. These enterprises are encouraged to raise funds to meet their investment requirements from domestic financial markets. This has led to a dramatic increase in the state enterprise bonds, which did not exist until 1990. The corporate bond market in Thailand is relatively new but growing rapidly. Historically, the few bonds issued by private firms were mostly short−term promissory notes and bills of exchange, guaranteed by commercial banks. Prior to 1990, only public companies and companies listed on the Stock Exchange of Thailand (SET) were allowed to issue bonds and consequently the number of private sector issues was quite limited. However, following the enactment of the Securities and Exchange Act in May 1992, limited companies were allowed to issue debentures and many qualified companies have begun to do so. The volume of new issues by the corporate sector rose twelvefold over 199294, surpassing state enterprise bond issuance. Thai bond markets have developed rapidly because of the conscious decision made by the RTG to develop the market to meet the need of the real sector. The regulatory framework was streamlined to enable issuance of bonds on a competitive basis with other debt instruments. The Securities and Exchange Commission (SEC) of Thailand has been given the mandate by the Ministry of Finance and the Bank of Thailand to be the champion of the bond market. SEC has played the dual role of a promoter and regulator very well. Tax disincentives on bond investment have been removed to a large extent, and additional measures are being taken to simplify administration of bond taxes on the secondary market. A credit rating agency, the Thai Rating and Information Services (TRIS), was set up in 1993. To help stimulate the growth of the secondary market, the Association of Securities Companies formed the Bond Dealers Club (BDC) in November 1994. Membership in the BDC includes securities companies and financial institutions with bond trading licenses. There are now 62 dealers, and they make market in 37 corporate bond issues. However, the average daily trading volume was only US$5.0 million.break

The investment financing requirements of the Thai economy over the next decade are very large. Since Thailand does not have a large contractual savings sector like Malaysia or Singapore, its state enterprises and corporate sector will need to rely on the domestic debt market, equity, and foreign borrowing. At the end of 1994, total size of the contractual savings sector was less than Baht 125 billion (US$5 billion), including 757 provident funds, social security funds, and life and non−life insurance companies. To accelerate development of the bond market in Thailand, there is a need to take several additional actions including an accelerated development of the contractual savings sector; creation of a benchmark; provision of liquidity support to all accredited dealers through the REPO market, which is currently limited to the banks; and inclusion of state enterprise bonds for trading through the BDC, which is currently restricted to corporate bonds. Vigorous efforts are being made by the RTG, SEC, and market participants to address these issues. The Korean bond market is the largest among East Asian bond marketsat the end of 1994, the volume of outstanding bonds stood at Won 127 trillion (US$161 billion). However, at 43 percent of GDP, it was smaller than Malaysia. The main sectors of the bond market were: corporate (37.8 percent), state enterprises (23.3 percent), central bank (20 percent), government (17.3 percent), and the state government (1.7 percent). The Government of Korea (GOK) has followed sound fiscal policies, and most bonds issued by the government are administratively determined and distributed to financial institutions in the country. The Bank of Korea issues a large amount of Monetary Stabilization Bonds (MSBs) to absorb liquidity from the market. Until 1994, MSBs were administratively allocated to the banking and nonbank financial institutions. Starting in early 1994, about 30 percent of MSBs were auctioned through a network of dealers. There is an active secondary market in MSBs, and they could serve as a benchmark in Korea. However, the maturity of MSBs is generally limited to two years. Until recently, new issues of corporateDelivered bondsbywere brought the market often at administratively determined The World Bankto e-library to: 000000 0000000000In essence, Korean bond issues can be viewed as yields, and issue timing was also administratively governed. IP : 000.000.00.00 000, 00 sense. 000 0000Prior 00:00:00 loan packages instead of bonds in the traditional to 1981, there existed regulatory guidance over the maximum coupon rate on corporate bonds. Currently, corporate issuers are free to select suitable coupon rates. The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

15

The Emerging Asian Bond Market However, the coupon rate has to be within a band of 2 percent of the base rate. Korea has three credit rating agencies, but none of them has matured into an effective institution because all bonds were guaranteed by the banks and there was no room for differentiating credit risks. This is likely to change in the future with the increase of non−guaranteed bonds, which have been allowed since 1993, and other financial deregulation measures implemented as a part of Korea's financial sector reform programs. Korea has in place most of the basic infrastructure for a robust bond market. It has a large number of corporate issuers with a strong appetite for investment funds. Korea also has a large and growing institutional and individual investor base. There is also a strong interest from foreign investors in Korean bonds. Korea is expected to complete all its announced financial sector reforms, including full capital account opening, by 1997. This should provide a major impetus for its bond market development. Indonesia is the smallest bond market in East Asia. At the end of 1994, total size of the bond market was US$9.1 billion, or 5.8 percent of GDP The main issuers of the bonds were the central bank (75 percent), state enterprises (17 percent), and corporations (8 percent). The Government of Indonesia (GOI) is precluded by its constitution from issuing bonds in domestic markets. Since most bonds issued by the central bank are money market instruments, the bond market in Indonesia is essentially limited to the state enterprise and corporate bond segments. The first private sector bond issue was brought to the market in 1988. To date, there have been 26 private issuers of listed bonds and an estimated 50 in the private placement bond market. A total of close to IDR 1.4 trillion (US$636 million) has been issued in corporate bonds since 1988. Corporate bond issuance has been hampered by several regulatory requirements such as guarantees and sinking funds, and by a lengthy and cumbersome issuing process. The capital markets law also places limitations on maturity—a minimum of 3−year maturity is required. The high cost of issuing bonds and lengthy issuance procedures discourage corporations from issuing short−term bonds. Another impediment to corporate issuers is the high all−in cost in the domestic market compared with the cost of raising funds in international markets. For this reason, many Indonesian corporations prefer to raise funds in international capital markets and swap the proceeds into Indonesian Rupiah.break

Indonesia is clearly at an early stage of bond market development. To develop the bond market, additional efforts will be required by policymakers in addressing both policy and institutional infrastructures. These will include creation of a market−based benchmark, a strong dealer network, a simplified issuance procedure, and an efficient clearing and settlement system. In this connection, a credit rating company was set up in early 1995, and a scripless clearing and settlement system is under preparation and is likely to be in place in late 1995 or early 1996. The Philippine bond market is dominated by government issues to finance the deficits of both the national government and the central bank during the last decade. At the end of 1994, the total size of the Philippine bond market was Peso 612.5 billion (US$25.1 billion), 39 percent of GDP Almost the entire domestic debt market consists of debt issues by the national government, government corporations, and government−owned financial institutions. Since the bulk of outstanding bond issues carry maturities of less than one year, the Philippine bond market is essentially a money market but is treated as a bond market for completeness in this study. The government now issues treasury bills with maturities of 63, 91, 182, and 364 days. Government securities (treasury bills and notes) in the Philippines are issued via competitive auction. The current auction system and dealer network were established in 1986 based on the US model. The Government Securities Department of the central bank is responsible for managing the auction on behalf of the national government. The auction is conducted on a weekly basis. The primary dealer network has expanded from 20 dealers to the current 30, which includes the large commercial banks and investment houses in the Philippines. Only Accredited Government Securities Dealers (AGSDs) can participate in the auctions as competitive bidders. All treasury auctions Delivereddirectly by The World Bank e-library to: 000000 0000000000 are conducted on a yield basis. The auction committee ranks the competitive bids from the lowest yield to the IP : 000.000.00.00 000, 00 000 0000 00:00:00 highest. The Philippines has put in place a relatively well−functioning primary market in government securities.

The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Corporate debt issues in the Philippines are generally limited to a handful of blue−chip corporations and are usually short−term commercial paper maturing in less than one year. Long−term commercial paper (maturities of up to three years) is also occasionally issued. Corporate bond issuance is limited because of the Philippines Corporation Law, which requires that bond issuance be approved by two−thirds of the shareholders, while commercial paper issues only require approval by the board. Corporate issuers get around this restriction by issuing long−term commercial paper which is, in effect, a bond issuance. With a non−investment grade sovereign rating, the corporate sector, in general, has limited access to international financial markets. However, blue−chip corporations such as the Philippines Long Distance Telephone Company and San Miguel Corporation have been able to tap foreign capital markets, mainly through equity issues. Similar to Malaysia and Singapore, the Philippines has a relatively large contractual savings sector which has mobilized a substantial amount of long−term resources. The Social Security System (SSS) and the Government Service Insurance System (GSIS) together had total investable resources of Peso 147 billion (US$6 billion) at the end of 1994. Both institutions have been the major investors in government securities. However, both institutions have played a limited role in capital market development, and their investment policies also restrict them from investing in relatively risky projects. The size of private pension funds is quite small (about US$1 billion), and the bulk of their funds have been invested in equity market and real estate. Although the size of the Philippines bond market is relatively large in relation to the GDP, its market is at an early stage of development. The Philippine market suffers from a lack of long−term fixed rate instruments, difficulty in establishing benchmarks for long−term fixed rate instruments because of a lack of macroeconomic stability in the past, absence of a rating agency with broad−based ownership, and lack of an efficient clearing and settlement system except for the accredited dealers in the primary market. Secondary market infrastructure needs to be developed. Liquidity support for the accredited dealers will foster the growth of the secondary market. However, the most important of all in the case of the Philippines is the discriminatory tax against bonds at the primary and secondary levels. Bonds are also subject to relatively high documentary stamp duties. Considerable efforts are required to develop the bond market beyond the primary market in government securities. The bond market in China is in transition from a centrally planned and administratively controlled credit allocation mechanism toward a competitive market−driven system. At the end of 1994, total size of the Chinese bond market was estimated at Yuan 281.6 billion (US$33.3 billion), or 7 percent of the GDP. Thecontinue

market consists of two main sectors: government (73 percent) and the state enterprise (27 percent). Since 1984, the volume and variety of debt issue in China have grown rapidly. Total debt issues increased from Y48.7 million in 1981 to Y65.6 million in 1985, and to Y113.3 billion in 1994. New issues planned for 1995 are Y150 billion. Government debt in China is issued primarily by the Ministry of Finance (treasury bonds), and the part of this used for general budgetary purposes is referred to as treasury bills. Since 1994, there has been a significant increase in the volume of treasury bills issued, primarily due to the government's decision to cease to finance its deficit through borrowing from the central bank. Government debt issues, at over Y113 billion, increased threefold over 1993. Planned issues for 1995 are higher still, at Y150 billion. Enterprise bond issues, meanwhile, were reduced. Until 1990, all debt securities in China were placed administratively and on a mandatory basis. Since then, the government has recently experimented with different methods of issue for treasury bills. These included underwriting by primary dealers, sales via local finance departments, direct placement with institutions, and certificates allocated by Peoples' Bank of China to the headquarters of the specialized banks for sales to individuals through their branches. Government bonds Delivered by The Worldare Bankissued e-libraryatto:par and the majority carry a predetermined 000000 0000000000 coupon. There is no auction process to determine the yield in the primary market. Coupons are administratively IP : 000.000.00.00 000, 00 000 0000 00:00:00 set at a margin above deposit rates of comparable maturity, without reference to the secondary market yield on issues of comparable maturity. Most government issues are of three years or more in maturity and since 1992, The East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market have had a coupon related to the inflation rate. Only two treasury bills pay an annual coupon: the five−year 1993 issue and the scripless issue of 1994. All other bonds pay a redemption amount consisting of principal plus accumulated simple interest estimated on the basis of the coupon at issue. A drawback of the primary issue process for government securities in China is that treasury bills typically have been offered in a small number of issues, in the first half of the year, rather than in several offerings spread over the year. Bond issuance generally takes several months and has effectively been an on tap market. The sale of scripless treasury bills aimed at wholesale investors in 1994 was a step in the right direction which permitted a much shorter issue period. In addition to the drawbacks discussed above, China's bond market faces several other constraints. Efforts to establish benchmark securities are hampered by interest rate controls, and the accounting system is at an early stage of development. Benchmarks will be hard to establish without the deregulation of the financial markets, especially interest rates. The contractual savings sector is very small and institutional investors are few. The State Planning Commission plays an important role in the bond market by issuing an annual securities plan. The regulatory framework is evolving, and several institutions are involved in regulating and supervising the issuance of bonds. Disclosure requirements are rudimentary and will be meaningless unless financial statements are prepared in accordance with generally accepted accounting principles. Market makers and intermediaries are at an early stage of development. Development of a bond market in China is likely to be slow unless the authorities decide to address the abovementioned constraints. Nonetheless, the Chinese bond market will grow in size because of the need to finance government deficits and for massive investment requirements in infrastructure. Looking Ahead Investment Requirements

East Asia is expected to continue its rapid pace of growth over the next decade. Under the World Bank's baseline growth scenario, regional output is projected to grow at an annual average rate of 7.7 percent, similar to that of the past 15 years. Financing this growth will require the mobilization of massive amounts of resources for corporate investment in capital−intensive manufacturing, upgrading existing infrastructure stock and expanding services, and housing. Based on the projected investment rates by the 1995 Global Economic Prospects, regional gross domestic fixed investment (GDFI) is expected to average about 36 percent of GDP, which translates into a cumulative investment of US$8 trillion over the 19952004 period. Private gross domestic fixed investment alone is expected to account for about US$5.0 trillion. The bulk of projected GDFI will be in China (US$3.3 trillion), Korea (US$2.1 trillion), Thailand (US$931 billion), Indonesia (US$681 billion), and Malaysia (US$449 billion). The manufacturing sector, as the largest sector in most East Asian economies, will account for the lion's share of this investment, but infrastructure projects and the housing sector will also be important claimants on investment funds.break

Given the decision taken by many governments to encourage the private sector to undertake infrastructure investments, raising funds for these projects will become a major source of growth for bond markets. The current level of infrastructure investment of about 5 percent of GDP in some East Asian countries is not adequate to satisfy current levels of demand, let alone meet future needs. A recent Bank study estimates that this investment level will need to increase to about 8 percent of GDP, which translates into an infrastructure investment of some US$1.4 trillion between 1995 and 2004.3 In Thailand alone, infrastructure investment over the next decade is Delivered by The World Bank e-library to: estimated to be well over US$100 billion, dominated by the 14 state−owned utility companies. In Malaysia, 000000 0000000000 IP : 000.000.00.00 private investment requirements under the Seventh Malaysian Plan (19962000) are RM 350 billion (US$136 000, 00 000 0000 00:00:00 billion). The main factors making for a dramatic increase in demand for infrastructure services are (a) East Asia's Looking Ahead

18 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market rapid industrialization, with a growing accent on capital−intensive industries, which will require more power and other physical infrastructure; and (b) a large and growing backlog of demand for services, from telephones to water supply and mass transport, for the region's rapidly growing urban population. In addition, there will be need for large investments in housing. With East Asia's urban population growing from 19 percent of the population in 1970 to 52 percent in 1991, financing of urban housing has acquired renewed urgency. Assuming a coverage ratio of 25 percent and an average cost of US$25,000 per house, demand for housing finance will be roughly US$160 billion in 2004, or about 5.3 percent of GDP Limited housing finance is now provided by commercial banks, and they will find it increasingly difficult to cope with future demand unless mortgage−backed securities are developed. Malaysia is the first country in the region that has taken the lead in this area by establishing a mortgage−backed securities market in 1986 through Cagamas. Additional institutional infrastructure for mortgage−backed securities markets, such as mortgage insurance, would further facilitate growth in this market. The region is likely to witness a new trend of increased reliance on domestic debt financing brought about by the confluence of four major factors: (a) the need to mobilize massive amounts of resources to finance infrastructure investments and housing, both of which require long−term, fixed rate debt capital; (b) structural changes in the economy from predominantly laborintensive manufacturing to capital−intensive industries that require long−term debt financing; (c) the advent of risk−based capital adequacy requirements instituted by the Bank for International Settlements (BIS) which has strained the banking system's ability to meet long−term financing needs; and (d) increased demand for longterm fixed income investment vehicles from the region's institutional investors. In most industrial countries firms tend to finance expansion through debt rather than equity financing, both because it allows them to retain greater control over corporate decisionmaking, and large investment requirements cannot easily be satisfied by bank finance, rights issues, or internally generated funds. Although the commercial banking system played a vital role until recently in financing public and private enterprises in East Asia, its ability to carry out the term transformation required for new investment has been constrained by asset−liability maturity mismatches and the severe constraints placed on banking operations by the BIS−instituted capital adequacy norms. Thus, the past modes of financing will no longer be able to cope with the task of future financing needs. Therefore, greater reliance will be placed on financing through fixed−income debt instruments in the future. Issuers

East Asian bond markets with the exception of China and the Philippines are expected to be dominated by the corporate and state−owned enterprise sectors in the coming decade. In 1994, East Asian governments were the major issuers of bonds and accounted for 45 percent of all bond issues, followed by the corporate sector (23 percent), the state enterprise sector (18 percent), central bank securities (14 percent), and state governments (1 percent). This profile is likely to change dramatically during the next decade. The government bond sector is expected to decline to about 33 percent by 1999 and to about 23 percent by 2004. The governments of Malaysia, Thailand, Indonesia, and Korea are expected to have fiscal surpluses. Hong Kong and Singapore have already accumulated large surpluses and will continue to do so in the future. Governments will be the main issuers of securities only in China and the Philippines. The fastest growing sector of the bond market will be the corporate sector. Bonds issued by the corporate sector are projected to grow from US$77 billion in 1994 to more than US$500 billion by 2004. The sector's share will increase from 23 percent in 1994 to about 42 percent in 2004. The major issuers of corporate bonds will come from Malaysia, Korea, and Thailand. The second largest group of issuers will be state enterprises, which are incontinue Delivered by The World Bank e-library to:

the process of being corporatized as a prelude 000000 to full0000000000 privatization. Most of the issuers in this category will be IP : 000.000.00.00 from Thailand, Malaysia, and Korea. 000, 00 000 0000 00:00:00

Issuers

19 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Although the contractual savings sector across East Asia has mobilized large amounts of long−term resources, its role in capital market development has thus far been fairly modest. In the past, these provident funds were used to meet government funding requirements, leaving their managers limited freedom in asset allocation. However, most East Asian countries have recently moved toward making the contractual savings sectors more autonomous by lifting controls on their investment policies. The Singapore authorities are opening the CPF to professional managers and allowing more freedom in investment strategies, and Malaysia's provident fund managers are now required to invest no more than 50 percent of their assets in government securities. The driving force behind the change in the asset allocation and investment policies of these pension plans is the fiscal surpluses of these countries, especially Singapore, Malaysia, and Thailand. With new−found freedom in asset mix and investment decisionmaking, these institutional investors are now seeking to maximize risk adjusted returns, for which longterm fixed−income instruments are the most logical choice. Investors

Malaysia, the Philippines, and Singapore have relatively large institutional investors, mainly the contractual savings sector. Indonesia, Korea, and Thailand are at an early stage of development. China has a very small contractual savings sector. At the end of 1994, the total size of domestic institutional investors—mainly central provident funds, social security organizations, and mutual funds—was about US$109 billion, with Malaysia and Singapore accounting for about 70 percent. At the end of 1994, total assets of the CPF in Singapore stood at S$55.5 billion (US$38 billion), while the EPF in Malaysia had accumulated RM84 billion (US$33 billion). The RTG started funding its civil servant pension plan in August 1994, by introducing a new plan that combines defined−benefit and defined−contribution plans. This plan will be funded and it is expected to start with an asset size of US$2 billion to US$3 billion in 1996. With the increase in income and aging of populations, most East Asian countries have adopted or are in the process of adopting social security programs. Indonesia and Thailand have developed social security organizations and are in the process of strengthening their operations. The Thai social security fund is likely to grow exponentially, with the coverage increasing from the current one million to about five million members within the next ten years.4 Social security funds in East Asian economies are projected to grow rapidly over the next decade because of the demographics of the region, and will be a major source of long−term funds for industry. The other main segment of the contractual saving industry, insurance, is not yet well developed, but it is likely to flourish with the deregulation of the financial sectors in countries such as Korea and Thailand.5 The mutual fund industry is also expanding rapidly in East Asia. At the end of 1994, the size of the mutual fund industry was roughly US$20 billion. Hong Kong, Malaysia, and Thailand have been at the forefront of developing their mutual fund industries. With the deregulation and the licensing of new fund managers, the size of the Thai mutual fund industry expanded tenfold to about US$10 billion over 199294.6 In Malaysia, unit trusts have experienced dramatic growth, while Indonesia and Korea are in the early stages of developing mutual funds. Assuming that East Asia can maintain its growth rate of 7.7 percent over the next decade and financial sector reform programs are not drastically reversed, the size of the institutional investors (government−sponsored pension plans, social security organizations, and mutual fund industries) is estimated to increase to nearly US$400 billion by year 2004. Since the supply of government securities in all countries except for China and the Philippines will be limited, these institutions will have to seek out other investment opportunities. Malaysia and Singapore have already taken the lead in enabling their contractual savings institutions to diversify their portfolios and to a limited extent allowed them to invest overseas, initially within East Asia. These institutions are therefore likely to emerge as major investors in long−term debt instruments and would provide a major boost to the development of corporate bond markets. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Investors

20 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market International Investors

As discussed in Chapter 4, East Asian issuers have raised large amounts in the international bond markets in recent years. Between 1991 and 1993, Asian issuers other than Japan floated US$25.7 billion in fixed income securities in foreign markets, far more than these firms raised through share offerings.7 Addition of convertible bonds issued during this period brings the total issues to some US$32.7 billion. Until recently, issuance of bonds in domestic markets was rather cumbersome and costly compared to issuing bonds abroad. The investor basecontinue

was also limited. This is likely to change with the regulatory reforms introduced in the East Asian countries and the changes in investment policies of domestic institutional investors. The rapid growth in East Asia's equity markets has been influenced to a large extent by the increase in foreign portfolio investment, especially by institutional investors mainly from the United States. Most of these investments have been limited to first−tier companies, and in many countries, they have already reached the limit permitted for foreign ownership. In fact, the availability of first−tier shares has become a constraint in Hong Kong, Thailand, and Korea. To address this problem, several East Asian countries have permitted the issuance of convertible bonds. With the robust macroeconomic environment in most East Asian countries and partial or full convertibility on their capital accounts, the East Asian fixed income securities offer an attractive alternative investment opportunity for foreign investors. However, access to most of these markets has been limited (Chapter 4) because large markets such as Korea are reluctant to permit foreign portfolio investment in bonds because of the impact on the exchange rate. There are currently five markets (Hong Kong, Indonesia, Malaysia, the Philippines, and Thailand) which are completely open for foreign portfolio investment. However, this is likely to change with the accelerated implementation of financial sector reforms in China and Korea. The composition of East Asian capital markets, however, is expected to change dramatically over the next decade. In the more mature markets of the region (Hong Kong, Korea, Singapore, and Thailand), growth in equity market capitalization is expected to be similar to that of mature economies, while in the developing markets such as China and Indonesia, the equity markets will grow, but valuation will reflect the fundamentals of these markets. Bond issuance, especially in corporate, infrastructure, and housing sectors, however, will surge in the light of the need for long−term debt financing. Analyses conducted for this report indicate that the size of the East Asian bond market could grow from US$338 billion in 1994 to over US$1 trillion by the end of 2004 (Chapter 6). The total size of the market relative to GDP will still be much lower than that of industrial countries such as the United States (over 100 percent of GDP in 1994). However, unlike the industrial countries where the bond markets are dominated by government securities, those in East Asia will be centered on the private sector and state enterprises in transition to privatization. Most investors are likely to be institutional investors within the region, especially the contractual savings institutions. The projections indicate that by 2004, Korea will emerge as the largest bond market (in dollar terms) in the region followed by China, Thailand, and Malaysia. The ranking by percentage of GDP in year 2004 shows the following order: Korea (90 percent), Malaysia (68 percent), the Philippines (59 percent), Thailand (35 percent), Indonesia (14 percent), and China (13 percent). However, the fastest growing markets are likely to be Malaysia and Thailand. Agenda for the Future

The projected rapid growth in the region's bond markets is contingent upon continuation of sound macroeconomic Delivered by The World Bank e-library to: management and policy and institutional reforms. Although 000000 0000000000many countries in the region have taken bold steps to IP : 000.000.00.00 boost their bond markets, the necessary and000, sufficient conditions for robust bond markets are not yet fully in 00 000 0000 00:00:00 place. Financial sector reforms, regulatory reform, building of supporting institutional infrastructure such as credit International Investors (c) The International Bank for Reconstruction and Development / The World Bank

21

The Emerging Asian Bond Market rating agencies, efficient clearing and settlement systems, bond insurance, and market intermediaries require further development. The growth rate of the East Asian bond market will depend to a large extent on these countries' efforts to systematically build the market. Some of the key building blocks are discussed below. Financial Sector Reforms

Bond markets develop most rapidly in stable economic environments and deregulated financial markets. East Asia is known for its stable macroeconomic environment. Most countries in the region have also moved decisively in recent years to deregulate their financial sectors and reduce government intervention (Chapter 5). Malaysia and Thailand have definite plans to carry out the final stages of deregulation. Korea is set to complete its announced financial sector reforms by 1997. The Philippines has completed most of the financial sector reforms. Indonesia has made substantial progress, but its financial markets are still at an early stage of development. China has a great challenge ahead of it to transform its financial markets to the level of other East Asian countries. A major ingredient of these liberalization programs until now has been the freeing of interest rates on assets and liabilities of banks, but the coverage of reforms is being extended to other debt instruments such as government securities, private corporate bonds, and money market instruments.break

Open market type operations, if not full−fledged open market operations, are currently pursued in Indonesia, Korea, Malaysia, the Philippines, and Thailand. These take the form of sale of government bonds or central bank securities, purchase or reverse purchase of bills, and recycling of bank deposits by the central bank and vice versa. In Hong Kong and Singapore, money market intervention by the monetary authorities is carried out through buying and selling treasury bills, foreign exchange swaps, lending in interbank markets, and repurchase agreements in government bonds. In Hong Kong, Exchange Fund Bills and Notes are used. In general, open market type operations are limited by the thinness of the market and a lack of eligible government paper. To get around these problems, central banks in Indonesia, Korea, Malaysia, and the Philippines have issued their own debt instruments. Most transactions occur in the primary market, while open market transactions in the secondary market are extremely limited, though arrangements are being made to broaden the scope of the secondary market in these countries. Using auctions to issue government or central bank paper in the primary market is bringing their yields to the level of market interest rates.8 Indonesia, Korea, Malaysia, the Philippines, Singapore, and Thailand have phased out the use of subsidized central bank discount facilities to strengthen monetary control. The third type of indirect monetary policy instrument, reserve requirements, requires portfolio adjustment among commercial bank assets, and has been used less frequently with the increasing resort in recent years to more flexible open market operations. The reserve requirements level has been kept to the minimum in Indonesia, Korea, and Malaysia, but remained high in the Philippines until 1993 because of the ineffectiveness of open market operations in conditions where central bank losses were large and it could not undertake open market operations; this constraint has now been removed. Implementation by East Asian countries of the remaining financial sector reforms will facilitate development of the bond market. Regulatory Reforms

In addition to completing financial sector reforms, it is essential to build a sound and cost−effective regulatory environment. In most East Asian markets, regulatory bodies perform the dual functions of fostering the development of the market and regulating the market. In building an effective regulatory system, several factors need to be taken into consideration. It is critical to establish a regulatory framework that fits the unique needs of each emerging market. Factors that should be taken into account in building a regulatory framework include the by The World Bank e-library to: extent of financial sector developmentDelivered and reform, legal framework, the mission of the regulatory body, and 000000the 0000000000 IP : 000.000.00.00 types of intermediaries comprising the financial sector. Finally, it is critical that the regulations recognize the 000, 00 000 0000 00:00:00 economic function of a capital market: capital mobilization and the allocation of capital to its most productive Financial Sector Reforms (c) The International Bank for Reconstruction and Development / The World Bank

22

The Emerging Asian Bond Market uses. In the long run, this requires the development of a regulatory system that is designed to regulate rather than control or manage the market and market participants. At an early stage, a proactive regulatory system may be essential to facilitate market development. The level and type of regulatory model adopted will also depend on the stage of development of supporting institutional infrastructure, including the laws and ability to enforce such laws, the prevailing accounting system and the accounting standards, the sophistication of investors and issuers, and a disclosure−based regulatory system. Hong Kong and Thailand have most of the institutional infrastructure in place and have made notable progress in implementing regulatory reforms that are essential for bond market development and are moving toward a disclosure−based system. Malaysia has all the required infrastructure and has carried out substantial regulatory reforms but needs to streamline its regulatory system by centralizing the approval process and development function in a single agency. Korea needs to review its bond market regulatory system in line with its plans for financial market deregulation and capital account opening. China and Indonesia are at an early stage of bond market development and regulatory reforms, while the Philippines needs to make its regulatory system more developmental and move toward a disclosurebased system. In general, a single regulatory body for a bond market will be desirable, as it provides a major impetus for bond market development and will bring other advantages, including a more clearly defined regulatory framework and better coordination, to develop the market. Alternatively, a joint task force could be set up to oversee market development. It is also important that the regulatory agencies be self−funded. This will enable them to attract and retain qualified staff. The securities commissions in Hong Kong and Malaysia are financially independent, and their experience should be reviewed by other countries. Institutional Infrastructure

It is also necessary for both private and government policymakers to focus on the development of institutional underpinnings for thecontinue

bond market, including credit rating agencies, efficient clearance and settlement systems, bond insurance, and development of strong networks of intermediaries that will facilitate primary and secondary trading. Malaysia and Thailand now have relatively well−functioning rating agencies, while Indonesia's PEFINDO has just commenced operations. Rating agencies in these countries will need time to further build their organizations and develop staff to gain full acceptance of market participants. In the case of Korea, the rating agencies have been in place for some time but have not been functioning as rating agencies because of the regulatory requirement that all bonds must be guaranteed by financial institutions. Full deregulation of financial markets will provide a new lease on life to these agencies. In China, a concerted effort seems to be needed to build two or three rating agencies at the national level to set the standards for the rest. In the case of the Philippines, a new rating agency, with broad−based ownership is required to service bond market participants, as the present rating agency suffers from its ownership structure and the appearance of potential conflict of interest. There is clearly no need for Hong Kong and Singapore to have local rating agencies, given the presence of the major international rating agencies. To further increase the efficiency of the rating agencies, serious consideration should be given to making the rating function voluntary, and additional rating agencies should be permitted in markets such as Malaysia and Thailand, where the bond markets are likely grow rapidly. One of the important parameters in bond market development is a market−based benchmark that enables market participants to price bonds in both primary and secondary markets. Authorities should seriously consider creating such benchmarks. These may include Delivered securities issued by a national mortgage corporation, state enterprise bonds, by The World Bank e-library to: 0000000000 or repackaging of existing debt issues of major000000 government−owned entities (Chapter 2). Except for Hong Kong, IP : 000.000.00.00 no East Asian countries have market−based000, benchmarks for maturities beyond two years. Malaysia has made an 00 000 0000 00:00:00 excellent start through MGS securities and Cagamas. State enterprise bonds in Thailand could be used as Institutional Infrastructure (c) The International Bank for Reconstruction and Development / The World Bank

23

The Emerging Asian Bond Market benchmarks if they were issued by major enterprises such as the Electricity Generating Authority of Thailand on a regular basis across maturities. In the case of the Philippines, the government should consider issuing three− to five−year fixed rate instruments to create a yield curve. Korea has a good short−term benchmark, based on the MSBs. Creation of a long−term yield curve of government bonds should be considered in connection with restructuring of policy loans.9 All East Asian markets except for Hong Kong suffer from a lack of liquidity in the secondary market which impedes secondary market trading. Since bond dealers operate on a small margin, a large trading volume is essential to stay in business. Without an access to funding, bond dealers are generally not in a position to make market or carry a large inventory of bonds. The experience of Hong Kong should be reviewed by the other countries. The Monetary Authority has provided liquidity in the bond market by allowing MTRC and the Airport Authority debt instruments to be used for REPO transactions. Thailand currently allows only banks to participate in the REPO market. Extension of this facility with appropriate safeguards to members of BDC should enhance liquidity in the secondary markets. Malaysia should consider expanding the participation in the REPO markets, by including nonbank dealers which meet the eligibility criteria. The same applies to the Philippines, which limits REPO transactions only to banks. China and Indonesia do not currently have any mechanisms to enhance liquidity in the secondary market. Consideration should be given to enhancing liquidity in these markets. The availability of centralized sources of information will also facilitate trading activity. An important factor that affects bond market development is taxation. In general, tax treatment should be the same for both stocks and bonds. The after tax risk adjusted return on bond investments should be competitive with other investment vehicles. In many East Asian countries, the tax treatment of bond instruments, both interest income and capital gains, is not uniform. In many countries, there is no capital gain tax on equity investments and dividend income is taxed at low rates. Capital gains from bond trading, however, are taxed at both the corporate and individual levels. For example, in the Philippines, interest income from bond investments is subject to a withholding tax of 25 percent. Furthermore, unlike stocks, bonds are subject to documentary stamp duty, which increases transaction costs and retards secondary market trading. Investors in Korean bonds are exempt from a 0.35 percent transaction levy which applies to equities while non−residents pay interest and capital gains tax at 25 percent which can be lowered through tax treaties. Hong Kong has no withholding tax, but profits are taxed at 17.5 percent. However, Exchange Fund Bills and supranational bonds are exempt from taxation. Singapore does not tax capital gains, although dividends are taxed at thecontinue

marginal 27 percent corporate income tax. Hong Kong, Malaysia, and Thailand have taken the lead in removing tax disincentives on bonds. Other East Asian countries should follow suit in eliminating discriminatory taxation of bonds to remain competitive. Consideration should also be given to the removal of differential taxation between domestic and foreign investors. Finally, a robust bond market requires well−informed investors, issuers, market professionals, and regulators. Each of these key participants needs to have a sound understanding of new financial instruments as they are introduced to the market, trading mechanisms, procedures for clearance, settlement, and safekeeping of securities. This task will become more onerous with the introduction of more sophisticated financing techniques such as repurchase agreements and derivatives. Therefore, it is important that the government and the private sector develop training programs to meet the needs of market participants, government regulators, and self−regulators. Conclusion

East Asian economies have made remarkable progress developing Delivered by The Worldin Bank e-library to: their economies and financial markets, 000000 0000000000 especially the banking system. If East Asia is to sustain rapid growth over the next decade, investment in IP : 000.000.00.00 capital−intensive manufacturing, infrastructure, housing will need to expand tremendously. Financing of 000, 00and 000 0000 00:00:00 investment of this huge magnitude will require substantial mobilization of resources on a large scale. Given the Conclusion

24 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market region's high saving rate, the investment can be financed mostly from within the region. However, this will call for major efforts by the governments and regulators in close collaboration with market participants in the private sector to accelerate development of domestic capital markets, especially bond markets, so that intermediation of long−term savings and long−term investments can be performed efficiently. Most East Asian countries have undertaken major policy reforms during recent years. These reforms will need to be accelerated. In addition to undertaking the policy reforms in the financial sector, there is a need to further develop institutional infrastructure (credit rating, clearing and settlement, custody, liquidity, benchmark, taxation market makers, and bond insurance agencies) to foster growth of East Asian bond markets. Organization of the Report

This report is organized into six chapters. Chapter 1 provides an introduction and rationale for bond market development. Chapter 2 discusses the size and composition of the East Asian bond market in depth. The size and structure of bond markets in eight economies and the main sectors of these markets (i.e., government, central bank, state enterprise, and private bonds) are discussed. An overview of each country's bond market is presented. The organization of the primary and secondary bond markets is examined, focusing on how these markets are organized in each country and the supporting institutional infrastructure such as primary dealers, market makers, liquidity supports, credit rating agencies, benchmarks, and clearing and settlement systems. A survey of the status of secondary markets is presented, and policy measures that contributed to the development of these markets, and factors impeding their growth, are identified. Regulatory policies affecting bond markets in these economies are discussed in Chapter 3 in an effort to identify the essential elements of a desirable regulatory framework. Chapter 4 examines the impact of the internationalization of the East Asian bond markets. The role of foreign portfolio investment and its impact on bond markets and regulatory and other factors that facilitate or impede participation in international bond markets are discussed. The extent to which government issuers, state−owned enterprises, and private corporations have been able to raise funds in international capital markets is also presented. The relationship between off−shore markets and the development of local bond markets is explored and country risk considerations are discussed. The use of bond markets in the conduct of monetary policy is detailed in Chapter 5. The importance of a robust bond market in conducting efficient open market operations is discussed, and the experience of selected countries is examined to draw lessons for developing countries of East Asia. An assessment of the prospects for bond market growth in East Asian countries and an agenda for bond market development are presented in Chapter 6.break

1— Introduction With a population of 1.6 billion and a combined GDP of US$1.3 trillion in 1993, East Asia1 is now a major economic powerhouse. In 1993, these eight countries accounted for 6 percent of global output, or 27 percent of the total GDP of low−and middle−income countries as a whole. East Asia's GDP is larger than that of France, Italy, or the United Kingdom, and almost a fifth of US GDP. The region's GDP grew more than 2.8 times over 198093, with an average annual growth of 7.8 percent (Figure 1.1); this was more than twice the rate of global growth. The region's 1994 economic growth is estimated at 9.3 percent. Per capita incomes also doubled, and their growth is expected to accelerate as continuing economic progress is bolstered by falling population growth.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

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25

The Emerging Asian Bond Market

Figure 1.1 GDP Growth, 198093 (Average annual growth; percent) Source: World Bank. East Asia's rapid growth has been propelled by high levels of saving and investment. From around 22 percent of GDP in 1965, its savings rate has risen sharply to 35 percent, roughly 60 percent more than the average for industrial countries. In 1993, China, Hong Kong, Indonesia, Korea, Malaysia, Singapore, and Thailand had savings rates above 30 percent of GDP (Table 1.1). Over the past 25 years investment rose at above 11 percent a year to reach 35 percent of GDP. The net flow of foreign savings into East Asia during the period amounted to only 0.3 percent of GDP. The Philippines, which has lagged behind the other countries in this group, seems to have turned a corner in 1994 at its GDP grew 4.3 percent. Table 1.1: East Asia: Selected Economic Indicators, 1993 Percent of GDP GNP Per GDP Capita (US$B) (US$)

GDP Growth 198093 (Percent)

Gross Domestic Savings

Gross Current Domestic Account Investment Balance

490

426

9.6

40

41

2.7

Hong Kong 18,060

110

6.5

31

27

—

Indonesia

740

145

5.8

31

28

1.4

Korea

7,660

331

9.1

35

34

0.1

Malaysia

3,140

64

6.2

38

33

3.3

Philippines

850

54

1.4

16

24

6.1

Singapore

19,850

55

6.9

47

44

3.7

Thailand

2,110

125

8.2

36

40

5.5

China

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Source: World Bank.

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The Emerging Asian Bond Market East Asia's success is not limited to growth in production—export performance has also been outstanding. Over the past quarter century, the region's exports of goods and services rose more than thirtyfold to about $850 billion, and now account for about 22 percent of world exports. Sound macroeconomic management led by conservative fiscal policies and a stable political climate combined with low−cost and highly skilled labor have attracted corporations from the industrial coun−soft

tries to invest in the region. Most of this direct investment has been in export−oriented industries. As a result, the region has been able to accumulate large foreign exchange reserves amounting to $203.9 billion, or 16.5 percent of the world's foreign exchange resources. East Asia's share of global foreign direct investment (FDI) was about 14 percent in 1980; by 1990, it had increased to 44 percent. East Asia is now the largest recipient of FDI flows, surpassing Latin America, accounting for 57 percent of the total. Historically, the United States and Europe were the major sources of FDI flows to East Asia. Since the late 1980s, however, Japan and the newly industrialized economies of East Asia have become the dominant sources of these flows. China and Malaysia have been the major beneficiaries of these inflows in recent years (Table 1.2), but the Philippines and Korea will be sought out for profitable investment opportunities as they relax, and ultimately eliminate, the remaining restrictions on their capital accounts. Table 1.2: FDI Flows Into East Asian Countries, 199094 (US$ billion) 1990

1991

1992

1993

1994

China

3.5

4.4

11.2

25.8

33.0

Indonesia

1.1

1.5

1.8

2.0

2.5

Korea

0.7

1.1

0.5

0.5

0.7

Malaysia

2.3

4.0

4.5

4.3

4.8

Philippines

0.5

0.5

0.2

0.8

1.0

Thailand

2.4

2.0

2.1

2.4

3.0

Total

10.5

13.5

20.3

35.8

45.0

Source: World Debt Tables, World Bank. East Asia's success in attracting foreign capital flows has not been limited to direct investment. While the region's export orientation and low−cost and highly skilled labor have attracted vast amounts of FDI, its capital markets have come of age and East Asia is now a major recipient of foreign portfolio investment. Indeed, equity portfolio investment increased more than elevenfold, while foreign investment in East Asian bonds surged twelvefold over 199093 (Table 1.3). While a portion of these portfolio flows has been due to the low interest rate environment of the early−1990s in the OECD countries, the robust growth in the region's equity markets, together with the strength of East Asian currencies, has enhanced the region's attractiveness for portfolio investment. The growth of East Asian financial markets during this period has been equally impressive. The financial sector in these countries was dominated until the late 1980s by banks, which served as the main corporate funding source. Since then their equity markets have grown dramatically. Hong Kong, Singapore, Malaysia, and Thailand are now DeliveredAt by The Bank e-library to: market capitalization of the eight East Asian among the world's 20 largest stock markets. the World end of 1994, total 000000 0000000000 IP : or 000.000.00.00 stock exchanges amounted to about $1.1 trillion, 71 percent of GDP, compared with total assets of the banking 000, 00 000 0000 00:00:00 system of $1.4 trillion, or about 92 percent of GDP. This growth was brought about to a large extent by increased Organization of the Report (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market foreign portfolio investment attracted by East Asia's booming economies, mostly open capital accounts, and relatively stable exchange rates. The East Asian bond markets, in contrast, have grown more slowly. At the end of 1994, total market capitalization of the East Asian bond market amounted to $338 billion or 22 percent of GDP—less than a third of the equity market capitalization (Table 1.4). break Table 1.3: Equity Portfolio Flows and Bond Issuance to East Asia (US$ million) Equity Flows (Net)

Bond Issuance (Net)a

1990

1991

1992

1993

1990

1991

1992

1993

China

0

653

1,194

2,278

48

24

201

2,056

Indonesia

312

0

119

1,836

26

381

156

8

Korea

518

345

3,045

6,029

342

3,020

2,876

3,694

Malaysia

293

0

385

3,700

3

377

754

290

Philippines

0

1

333

1,082

395

124

51

688

Thailand

449

41

4

3,117

87

78

548

1,747

Total

1,572

1,038

5,080

18,042

631

3,848

4,082

7,903

a: Bond offerings in international capital markets. Source: World Bank.

Table 1.4: Relative Position of Banking Assets, Equity, and Bonds (1994) Bank Assets

Stock Market Cap

Bond Market

US$

% of GDP

US$

% of GDP

US$

% of GDP

China

388

76

44

9

33

7

Hong Konga

257

195

270

205

11

9

Indonesia

90

57

47

30

9

6

Korea

283

75

192

51

161

43

Malaysia

70

100

199

283

40

56

Philippines

34

54

56

87

25

39

Singapore

115

186

135

217

45

72

Thailand

153

110

132

94

14

10

Total

1390

92

1073

71

338

22

Germany

3255

169

471

25

1719

90

Japan

7106

152

2257

216

Delivered by The World Bank e-library to: 0000000000 3443 3720 00000080 IP : 000.000.00.00 000, 00 000 0000 00:00:00

1210

116

366

74 35

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The Emerging Asian Bond Market United Kingdom United States

3620

54

5082

75

7429

110

a: Includes only HK$ denominated assets. Source: World Bank. Although fixed income securities have been less popular than equities as financing instruments and a medium for holding savings, this has begun to change, with East Asian corporations now floating growing amounts of debt securities in international and domestic markets. The number and size of East Asian firms are growing rapidly, and larger firms find it advantageous to increase the proportion of debt to equity in their financing mix. In East Asia, this is likely to be even more so because of the ongoing privatization of state enterprises, which will require long−term debt to finance their investment programs as the banking system will not be able to provide loans on such a large scale. On the demand side, new institutional investors, such as pension funds, are emerging in the region on a larger scale than in the past, creating a new market for debt instruments of medium− and long−term maturities. East Asian issuers have raised very substantial amounts in the international bond markets in recent years. Between 1991 and 1993, Asian issuers other than Japan floated $25.7 billion in fixed income securities in foreign markets, far more than these firms raised through share offerings.2 With convertible bonds issued during this period, the total would rise to some $32.7 billion. The solid economic performance of the East Asian economies has prompted international rating agencies to raise their sovereign debt ratings (except for the Philippines) to investment grade, further increasing their attractiveness to foreign investors. Most East Asian governments are corporatizing and then privatizing their state enterprises, especially major public utility companies. Since the objective in this transition phase is not to shed majority ownership, the enterprises are being encouraged to raise funds from domestic markets by issuing bonds to meet their investment requirements. This has been dramatized in Thailand, where corporations issued bonds on a scale that made them the largest segment of the domestic bond market. The experience of the industrial countries shows that expanding firms tend to favor debt to equity financing, both because debt allows owners to retain greater control over corporate decisions and because massive investment requirements cannot be met by bank finance or rights issues. The attractiveness of debt finance is also likely to increase as East Asian stock markets mature and valuation is based more on fundamental factors than on sentimental and technical considerations. While the commercial banking system has played a vital role in financing the needs of public and private sector enterprises in East Asia, its ability to carry out term transformation faces increasing constraints as the region's appetite for capital grows. Most bank deposits have short maturity, and too much long−term lending results in asset−liability maturity mismatches. The advent of risk−based capital adequacy requirementscontinue

instituted by the Bank of International Settlements is further limiting the commercial banks' ability to finance corporate expansion. The corporate sector is thus turning to bonds of medium− and long−term maturities as substitutes for bank loans. For all the impressive record of the region in the areas of poverty alleviation and human resource development, infrastructure development has lagged. It is estimated that in some countries of East Asia in the 1980s, there may by The World Bank e-library to: have been a shortfall of infrastructureDelivered investment of 0000000000 as much as 2 to 3 percent of GDP.3 Despite spectacular 000000 IP : 000.000.00.00 growth in per capita incomes, unsatisfied demand for infrastructure services remains high in East Asia. For 000, 00 000 0000 00:00:00 example, in 1990, just 69 percent of the region's population had access to safe drinking water and about 77 Organization of the Report (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market percent to sanitation, leaving some 400 million people without basic amenities. Telecommunications coverage ratios are even lower: in the Philippines there were only 10 telephone main lines per 1,000 people in 1990. And demand has been growing exponentially—in 1993, the waiting period for a telephone connection was 2.6 years in Indonesia and over 10 years in the Philippines. Addressing infrastructure bottlenecks will be crucial to sustaining East Asia's growth performance. In East Asia—as in other developing regions−the public sector has traditionally provided infrastructure services, financing them from tax revenues and, to a lesser extent, loans from multilateral organizations such as the World Bank and the Asian Development Bank, and from bilateral sources. This pattern is changing with increasing private sector participation, especially in power and transportation. The resources required to meet East Asia's rapidly increasing demand for infrastructure will be enormous; the World Bank projects a level of about $150 billion a year;4 financing of these massive levels of investment can be greatly facilitated by developing domestic bond markets as long−term funding sources—which will also serve as a source of funds for newly privatized enterprises. The local currency−denominated revenue streams of infrastructure projects dictate that financing be arranged in domestic debt markets, apart from the fact that raising capital on international bond markets encounters difficulties from the lack of liquid swap markets in exotic currencies. With East Asia's urban population growing from 19 percent of total population in 1970 to 52 percent in 1991, financing urban housing has acquired a new urgency. While most housing finance is now provided by commercial banks, they will find it difficult to cope with future demand. Continued dependence on the banking sector for mortgage loans can cause problems due to mismatches in asset−liability structures unless mortgage−backed securities are developed. Malaysia is the first country in the region to have taken the lead by establishing a mortgage−backed securities market in 1986 through Cagamas Berhad—National Mortgage Corporation—which issues mortgage−backed bonds that now constitute about 9 percent of the bonds outstanding in the Malaysian market. The phenomenal growth in East Asia's equity markets has attracted vast amounts of foreign portfolio investment. US institutional investor allocations to these markets have quadrupled from 3 percent in early 1980 to 12 percent in 1993. These portfolio inflows have contributed to the rapid growth of the East Asian economies and the development of their capital markets, as documented in a recent World Bank report.5 This high level of portfolio investment is generally confined to first−tier companies, and in many countries, it has already reached the limit permitted for foreign ownership. In fact, the availability of the first−tier shares has become a constraint in Hong Kong, Thailand, and Korea. To address this problem, several East Asian countries have permitted the issuance of convertible bonds. These bonds carry low coupon rates and are typically convertible into shares at a premium of 20 to 25 percent within a specified period. Korea, Thailand, and Hong Kong have been the pace setters. As of December 1993, the size of the Asian convertible bond market, excluding Japan, was estimated by Euromoney at about $7 billion. With partial or full convertibility on the capital account, there is now a greater interest in East Asian fixed income securities. Indeed, in 1993, at least 20 funds were floated in the US market with the main objective of investing in fixed income securities in East Asian markets. Further development of domestic bond markets will offer a wider range of investment vehicles to foreign investors. The 1980s saw the emergence of new institutional investors such as pension and provident funds and insurance companies in several East Asian countries. This new class of investors has accumulated vast amounts of funds totaling over $80 billion. These provident funds were initially used to meet government funding requirements, leaving their managers limited freedom in asset allocation. However, most Asian countries have recently moved toward making the contractual saving sector more autonomous by lifting controls oncontinue Delivered by The World Bank e-library to: 000000 0000000000 their investment policies. The Singapore authorities are opening the Central Provident Fund to professional IP : 000.000.00.00 000, 00 000 0000 00:00:00 and Malaysia's provident fund managers are now managers and allowing more freedom in investment strategies, required to invest no more than 50 percent of their assets in government securities. The driving force behind this

Organization of the Report (c) The International Bank for Reconstruction and Development / The World Bank

30

The Emerging Asian Bond Market change is the fiscal surpluses of these countries, especially Singapore, Malaysia, and Thailand. With new freedom in investment decision−making, these institutional investors are now seeking long−term fixed income instruments that will minimize their asset−liability mismatches, opening a new field for fixed income securities. The mutual fund industry is also making rapid strides in East Asia, and in the coming years this class of investors will constitute an important segment of the fixed income investor universe. Thailand and Malaysia have been at the forefront in developing their mutual fund industries. With the deregulation of the mutual fund industry and the licensing of new fund managers, this industry expanded tenfold from 1992 to about $10 billion in 1994.6 In Malaysia, unit trusts have experienced dramatic growth, while Korea and Indonesia are in the early stages of developing mutual funds. Insurance companies are another class of potential fixed income investors. Given the pace at which East Asian countries have been deregulating their financial sectors, private insurance companies will mushroom in the next few years, requiring fixed income securities of longer maturities. Together, these three categories of institutional investors (pension funds, mutual funds, and insurance companies) are expected to generate enormous demand for fixed−income investment vehicles. With financial liberalization in an advanced stage in the East Asian countries, reliance on direct instruments of monetary policy, such as interest rate ceilings and directed credits, has been steadily receding. Monetary authorities in East Asia are moving toward using market−based monetary policy instruments, such as open market operations and on−demand rediscount operations, that indirectly influence the prices of financial assets and, therefore, interest rates. These indirect mechanisms can only work if there is a market for government bonds and short−term commercial paper. The East Asian countries are fully cognizant of the winds of change in the financial climate and have moved in recent years to build the infrastructure for bond market development, including setting up sound regulatory structures, credit rating agencies, and clearing and settlement systems.break

2— The Emerging Asian Bond Market This chapter presents a broad overview of East Asian domestic bond markets, their major sectors, functioning of primary and secondary markets, and supporting institutional infrastructure and identifies the key issues that need to be addressed by policymakers, regulators, and market participants to foster the development of vigorous bond markets in the region.1 This discussion is prefaced by a brief review of the experience of the bond markets in four leading industrial countries—the United States, Japan, Germany, and the United Kingdom—to provide a comparative perspective and draw some broad conclusions that the East Asian countries can use as the basis for further developing their bond markets. The experiences of France and Spain, which have built their bond markets in recent years, although not covered in this study, should also be of interest to the policymakers in these East Asian economies. Bond Markets in Selected Industrial Countries At the end of 1993, the outstanding dollar volume of 21 major industrial country bond markets stood at about US$17 trillion—more than three−quarters of global GDP during that year. Of this, almost three−fourths is accounted for by four industrial countries—the United States, Japan, Germany, and the United Kingdom. The United States bond market, which has almost a pioneer status, is the largest, and has the most developed and sophisticated issuing techniques, secondary markets, transaction transparency, diversity of instruments, regulatory apparatus, and innovations. Though there are broad similarities in the patterns of bond market development across these four countries, there are significant differences in the organization and path of bond market development. Delivered by The World Bank e-library to: The role of government in the development of000000 bond 0000000000 markets varied according to the institutional imperatives and IP : 000.000.00.00 stages of financial sector development in each country. At one end is the United States, where bond market 000, 00 000 0000 00:00:00 development has been autonomous, responding to profit incentives and a desire to minimize the borrowing costs 2— The Emerging Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

31

The Emerging Asian Bond Market of financing. Japan represents the other extreme, with the government assuming an active role in shaping the profile of bond market development to make it conform to its overall strategy of economic development. As bond markets evolve, however, techniques of issuing bonds, market orientation, and international linkages seem to converge. The broad features of the bond markets in these four industrial countries are discussed in this section, while comprehensive details, together with the related statistics, are contained in Annex B. Bonds form a significant segment of the market for financial assets in these four industrial countries. In the United States, bonds and stocks were 110 and 75 percent of GDP in 1994, respectively, almost at the same level as in Japan. The German market for bonds was a little less than four times the market for stocks, while the UK stock market was almost three times the market for bonds. Total bank assets as a proportion of GDP were highest at 216 percent in the UK, followed by Japan (152 percent), Germany (169 percent), and the United States at 54 percent (Figure 2.1). The high ratios of bonds to GDP in Japan and Germany reflect the fact that banks in those countries raise a large proportion of their resources in the bond markets. The relative size of bond markets in these countries since 1970 is presented in Figure 2.2. Total face value of all outstanding bonds in the US market increased from 48 percent of GDP in 1970 to 110 percent in 1994. The Japanese bond market recorded an increase from 23 percent in 1970 to 74 percent of GDP in 1994. The German and UK bond markets have been of more mod−soft

est dimensions. German bonds stood at 90 percent of GDP in 1994, but in absolute terms were less than half the value of the Japanese bond market. The UK's bond/GDP ratio, on the other hand, remained more or less constant at about 35 percent, despite a sixfold rise in the amount of bonds outstanding between 1970 and 1993.

Figure 2.1 Relative Position of Bank Assets, Equities, and Bonds (End−1994; Percent of GDP) Source: International Finance Corporation, International Monetary Fund, and Salomon Brothers. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

2— The Emerging Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

32

The Emerging Asian Bond Market

Figure 2.2 Bond Market as a Percentage of GDP Note: Face value of all outstanding bonds as a percent of GDP. Source: Salomon Brothers, Inc. International Monetary Fund. Government securities have been the mainstay of the bond markets in all four countries. In 1993, they were the highest as a proportion of GDP in the United States (45 percent) and lowest in Germany (29 percent), the reason being the large fiscal deficits in these countries. In the aftermath of World War II, most of these governments ran large and continuing budget deficits, first to finance the restructuring of their economies and then to sustain social welfare activities. As a result, the ratio of government debt to GDP rose sharply to about 43 percent in 1980. Some industrial countries, including Japan and the United Kingdom, have scaled down their fiscal deficits, but countries with bigger deficits such as the United States and Germany, in the wake of the heavy fiscal burden of unification, have not been able to do so. This rapidly growing debt raised the stakes for governments trying to minimize their borrowing costs. Municipalities and local governments have been prominent issuers of bonds only in the United States because of their tax exempt status. Corporations have been the largest issuers of bonds after governments in the United States and, to a lesser extent, in Japan. Within the categories of corporate bonds, bank bonds—alternatively called bank debentures—are important in Germany and Japan, while the main issuers of bonds in the United States were non−financial corporations. This difference in issuer profiles reflects the active role of Japanese and German banks in financing private investment. The US corporate sector has relied on debt financing more than the other three countries because interest expenses are tax−deductible while dividends are not; this makes it more attractive for corporate treasurers to take on increased leverage. Tax deductibility of interest payments is a relatively recent development in Japan, Germany, and the United Kingdom. Indeed, some 17 percent of private fixed capital formation is financed through bond issues in the United States, in contrast to only 2 percent in the UK and 4 percent in Japan.2 The US bond market has been the most innovative among the industrial countries. Two of the most prominent innovations in recent years have been mortgaged−backed and asset−backed securities, which dominate the US bond market. There have not been comparable developments on the same scale in the other three countries, though there are indications that they will soon follow the trends in the US bond market.break Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Mortgage−backed securities (MBS) emerged in the United States during the 1980s as conduits to channel funds 2— The Emerging Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

33

The Emerging Asian Bond Market from investors to mortgage borrowers. These are securities backed by a pool of mortgages—which are in turn loans secured by specified real property. The United States mortgage market is the largest in the world and also one of the largest components of the US debt market, and has benefited the most from government policies. It offers an instructive case of public policy fostering the development of capital markets. Asset−backed securities are collateralized securities. They are created with underlying collateral as varied as automobile vehicle loans, credit card receivables, house equity loans, accounts receivable, boat loans, recreational vehicle loans, and other types of loans. Asset−backed securities are small compared to mortgage−backed securities, but a fast growing segment of the US bond market. All four bond markets have been increasingly exposed to international bond issues—both foreign bonds (those issued by foreign entities in the host country) and Eurocurrency bonds (bonds issued in host−country currency, outside of its borders). In terms of outstanding amounts, the largest international issue of bonds is in the United States, followed in descending order by Japan, Germany, and the United Kingdom. Industrial Country Experiences

East Asian countries can draw important lessons from how the bond markets in these four industrial countries progressed to their present stage of development, the sources of their strength, their characteristics, and the policy framework in which the markets developed. In particular, the industrial country experience provides insights that can be used by the emerging Asian countries in determining a mix of successful practices they can adopt in developing their bond markets. These are discussed below: • The development of equity and bond markets depends on the overall development of the economy and its financial sector. • Bond markets in Japan and Germany are dominated by banks. This is mainly because of the historical legacy of heavy reliance on the banking system to finance growth and, to some extent, due to the institutional relationship between private enterprises and the universal banking system. The significance of this characteristic of the bond market may be more relevant to China in view of the close involvement of its banks in financing industrial development. • The frequency and regularity of government bond issues and the methods used in the primary markets differ among the four countries. Regular issuance cycles support deeper markets and broaden interest, which are crucial for those governments with sizable borrowing programs. However, varying the size and timing of issues can allow governments to capture favorable market conditions. All four countries have gradually moved away from direct syndication to market−oriented auctions as their bond markets matured. Within the auctions, both uniform and discriminatory pricing of bonds are prevalent. • The basic principle governing the operation of primary markets in these four countries is similar with minor variations. Markets for government bonds are organized by setting up networks—groups of financial firms acting as primary dealers in government securities which usually function on a quid pro quo basis; in exchange for certain privileges, they agree to bid for primary issues and to make secondary markets in government debt, subject to rules and regulations governing their operation. In details, however, the procedures vary among countries. In Japan, for example, the syndicate has no role in the secondary market or central bank monetary policy implementation. In broad terms, the procedures adopted in market organization are variants of the ones that evolved in the United States, and their essence lies in achieving the objective of maintaining two−sided liquidity in secondary markets (and thus depth Delivered in primary markets) and supervising and monitoring their operations by The World Bank e-library to: 000000 0000000000 continuously and closely to maintain stability in the bond markets. IP : 000.000.00.00 000, 00 000 0000 00:00:00

• Most of the transactions in the secondary markets are over the counter (OTC) except in the UK. Industrial Country Experiences (c) The International Bank for Reconstruction and Development / The World Bank

34

The Emerging Asian Bond Market • The ability to engage in repurchases—or REPO—agreements facilitates management of both long and short positions by securities dealers, and thus reduces the cost of market−making and increases liquidity in the markets. The largest REPO market is in the United States; this market is hampered in other industrial countries by regulatory restrictions or taxes, though efforts are being made to minimize the rigor of these impediments, if not to eliminate them.break • An important requisite for efficient functioning of the secondary market is the presence of benchmark securities, which are commonly represented in all four countries. There are variations in the practices adopted in designating benchmark securities, however. In the United States, the yield on 30−year bonds is used as the key benchmark, while in Japan, government bonds with an original maturity of 10 years are considered to be the benchmark securities even though they may not be the most recently issued. • There is no uniform system for clearing and settling government securities across four countries. Only the US and the UK settle transactions in long−term government bonds by the next day. Book−entry and the related netting systems help minimize risks and reduce the volume of transactions to be recorded. Eurobonds are settled in a seven−day period during which the bonds are held in a clearing system such as Euroclear or Cedel. Here again there is divergence. In Japan, for example, normal settlement occurs on a predetermined cycle rather than at the discretion of the trading parties. • The investor base for government bonds is important from the point of view of the functioning of secondary markets. The experience in these four countries amply demonstrates that if bonds are held by institutional investors such as pensions and provident funds, mutual funds, and insurance companies rather than retail investors—individuals and households—there is likely to be greater turnover, imparting liquidity and lengthening the maturity structure. One trend with implication for the East Asian bond markets is that the proportion of bonds held by the banking system has revealed a secular declining trend. Another aspect of the investor base of government bonds in industrial countries is the growing domination of foreign holders of bonds. While broader markets can help reduce borrowing costs, they also connote a growing interdependence amongst financial markets that can make it difficult to implement domestic goals. • Municipal bond issuance methods are different in the United States, Japan, and Germany. The UK has virtually no market in municipal bonds. In the US, the volume of municipal bond issuance has been high due to their tax−exempt status. Prospectuses need to be filed and credit rating is considered essential by most investors. In Japan, the procedure in regard to issuance of municipal bonds is the same as in respect to government bonds. In Germany, municipal bonds are sold on request and are kept on offer until the desired amount is reached. The secondary market in municipal bonds is less active than that in government and corporate bonds. • There are differences in corporate bond issuance methods. In the US, such bonds are distributed to the public or placed with institutional investors through underwriting syndicates arranged by investment banks, often on a competitive basis. All publicly issued corporate bonds have to be registered with the Securities and Exchange Commission. Germany follows the issue methods for corporate bonds which are similar to those used for international bonds. In the UK, public issuance of corporate bonds follows the same procedures as that for government bonds. Thus, there is a wide choice of methods for the issuers of private bonds. • Secondary market trading in corporate bonds is mostly in the OTC markets in the US, though they are often listed on stock exchanges. In Japan, on the other hand, there is no active secondary market in corporate and bank bonds as these bonds are mostly held by individual investors who hold them to maturity. In Germany, a three−tiered trading of corporate bonds—official regulated market, and unofficial markets—prevails. Delivered by Thetrading, World Bank e-library to: 000000 0000000000 While official and regulated markets are confined to the stock exchange, unofficial transactions are carried out by IP : 000.000.00.00 00 000 0000 00:00:00 telephone throughout the country and across000, borders.

Industrial Country Experiences (c) The International Bank for Reconstruction and Development / The World Bank

35

The Emerging Asian Bond Market • Clearance and settlement of corporate bonds varies across the four countries, not so much in basic structure and format as in procedural details. In the United States, the central clearing house performs multilateral netting of transactions for its members, while the depositories provide book−entry transfer systems to achieve delivery against payment for securities. In Japan, government and corporate bond settlement procedures are the same. The German system requires payment and delivery of securities on the second trading day following the day of trade. The UK uses a seven−day settlement for trades in corporate bonds. It is thus clear that there are no uniform and universally accepted rules governing the bond markets in these industrial countries. The overarching principle is that the market should operate transparently, fairly, andcontinue

efficiently in consonance with risk/reward considerations and to the full satisfaction of both the issuers of and investors in bonds. The East Asian economies may therefore prefer an eclectic approach to further developing their bond markets, combining those practices and procedures that have succeeded well in industrial countries, taking into account the stage of their financial market development, the availability of local institutional infrastructure, and other constraints. Size and Composition of the East Asian Bond Market At the end of 1994, the size of East Asia's bond market was around US$338 billion, representing a mere 2 percent of the bond markets in 21 major industrial countries,3 but it constituted about 40 percent of the bond market of the emerging economies, estimated to be about US$800 billion. The size of the East Asian bond market was small in comparison to the region's equity market capitalization of US$1.1 trillion (71 percent of GDP). As a percentage of GDP it is small compared to those in the major industrial countries (United States, Japan, Germany, and the United Kingdom). However, the growth in East Asian bond markets has been impressive. Over 198994, these markets grew at an average annual rate of 20 percent, more than twice as fast as the bond markets in these four industrial countries. Bond markets in China, Hong Kong, Indonesia, and the Philippines have experienced rapid growth, but the size of their bond markets is relatively small. The phenomenal growth in this group of countries is characteristic of a nascent market. The relatively mature bond markets of Korea, Malaysia, and Singapore have registered considerably lower growth rates, although they exceeded those in the industrial countries. Table 2.1 provides an overview of the East Asian bond market by country and by sector as of end−1994. Bond markets in East Asia have been slow to develop in part because of prudent fiscal policies that limited government debt issuance; and in part due to the heavy reliance of the corporate sector on equity markets and banks to finance their investments; tightly regulated financial markets with extensive government controls on interest rates; dominance of banks; lack of adequate regulatory framework to protect the investors; inadequate institutional infrastructure; and barriers to capital flows. A bond market profile of the eight East Asian economies is provided in Annex A. Among the East Asian bond markets, the major markets are Korea (US$161 billion), Singapore (US$45 billion), China (US$33 billion), Malaysia (US$40 billion), and Thailand (US$14 billion) (Table 2.2). Table 2.1: Size of the Emerging East Asian Bond Market, End−1994 (US$ billion)

China

National Govt.

State Govt.

State Central Enterprises Bank

24.4

0.0

9.0

0.0

0.0

Hong Kong 0.1

Corporates Total

Delivered by The World Bank e-library to: 000000 0000000000 0.0 0.0 IP : 000.000.00.00 000, 00 000 0000 00:00:00

6.8

4.7

33.3 11.5

Size and Composition of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

36

The Emerging Asian Bond Market Indonesia

0.0

0.0

1.5

6.8

0.7

9.1

Korea

27.9

2.7

37.4

32.1

60.8

161.0

Malaysia

29.0

0.0

3.7

2.0

4.9a

39.5

Philippines

24.8

0.0

0.1

0.2

0.0

25.1

Singapore

42.3

0.0

0.0

0.0

2.5

44.9

Thailand

2.6

0.0

7.6

0.0

3.5

13.7

Total

151.0

2.7

59.3

47.9

77.1

338.0

a: Includes Cagamas bonds. Source: The World Bank. The East Asian bond market comprises five main sectors: national government bonds, state government bonds, state enterprise bonds, central bank securities, and corporate bonds (Table 2.3). At the end of 1994, government bonds constituted the largest segment—almost one−half—of the East Asian bond market (Table 2.4). Corporate and state enterprise bonds were the next largest segments, representing 23 and 18 percent, respectively. Central bank securities accounted for another 14 percent and the remaining 1 percent was issued by state governments. The importance of these segments varies across countries depending on the stage of development of their bond markets and their governments' fiscal policies. East Asia represents a counter example to industrial country trends in that its governments are downsizing their roles as primary issuers of bonds due to fiscal surpluses. Hong Kong, Singapore, Malaysia, and Thailand are leading the way in this respect. Corporate issuers have begun to make their mark as the remaining impediments to bond issuance are being removed. Infrastructure finance, where enhanced private sector participation is in the offing, is already accelerating the growth in this sector (see Chapter 6). In the past few years, many East Asian countries have moved to privatize their state−owned enterprises (SOEs), though the modes of privatization have been different. Most countries have adopted a partial divestiture policy—which is similar to corporatization—where parts of SOEs have been privatized, while majority shares have been retainedcontinue

Table 2.2: Size of the Emerging East Asian Bond Market, 199094 (US$ billion) 1990

% GDP

1992

% GDP 1993

% GDP 1994

% GDP

China

23.6

6.7

40.4

9.6

47.4

11.1

33.3

6.5

Hong Kong

1.0

1.3

3.0

3.1

6.0

5.5

11.5

8.7

Indonesia

1.7

1.6

11.4

8.9

13.3

9.2

9.1

5.8

Korea

88.2

34.8

121.5

39.5

138.1

41.7

161.0

42.8

Malaysia

27.1

63.3

32.0

55.2

35.1

54.5

39.5

56.0

Philippines

8.7

19.6

20.5

38.7

23.7

43.5

25.1

39.3

Singapore

24.8

68.1

37.4

77.1

38.4

69.6

44.9

72.4

13.7

9.8

338.0

22.3

Delivered by The World Bank e-library to: 0000000000 7.6000000 10.3 8.2 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Thailand

8.4

9.9

8.4

Total

183.6

18.4

274.6

22.5

312.3

23.8

Size and Composition of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

37

The Emerging Asian Bond Market Germany

1,141

70.0

1,420

72.1

1,587

83.1

1,719

89.5

United Kingdom

257

26.4

247

23.6

311

33.0

366

35.1

Japan

2,116

72.2

2,487

67.9

2,887

68.5

3,443

73.7

United States

5,168

94.1

6,389

107.6

6,993

111.7

7,429

110.2

Note: Source: The World Bank and Salomon Brothers, Inc. Figures for industrial countries exclude Eurobonds. Table 2.3: Main Sectors of the East Asian Bond Market, 199094 (US$ billion) 1990

1991

1992

1993

1994

National Government

102.2

112.3

135.5

146.6

151.0

State Government

1.2

3.2

4.5

2.1

2.7

State Enterprises

22.2

32.5

45.6

58.9

59.3

Central Bank

23.2

26.8

41.4

48.4

47.9

Corporation

34.8

43.0

47.6

56.3

77.1

Total

183.6

217.8

274.6

312.3

338.0

(In Percentage Shares) National Government

55.7

51.6

49.3

46.9

44.7

State Government

0.6

1.5

1.6

0.7

0.8

State Enterprises

12.1

14.9

16.6

18.9

17.6

Central Bank

12.6

12.3

15.1

15.5

14.2

Corporation

19.0

19.7

17.4

18.0

22.8

Total

100.0

100.0

100.0

100.0

100.0

Source: The World Bank. by the governments. Also, with increasing urbanization and rising incomes, demand for housing is escalating and Delivered by The World Bank e-library to: mortgage finance is fast becoming an important segment of these markets. Malaysia's Cagamas Berhad (National 000000 0000000000 000.000.00.00 Mortgage Corporation) is a case in point. 000,IP00: 000 0000 00:00:00

Size and Composition of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

38

The Emerging Asian Bond Market At the end of 1994, the size of central bank securities was about US$48 billion, accounting for about 14 percent of the total East Asian bond market (Table 2.5). Korea accounted for about 67 percent of this sector. The Bank of Korea (BOK) has been issuing large amounts of the Monetary Stabilization Bonds (MSBs) as part of its sterilization policy. Until recently most MSBs were issued at below market rates mainly to nonbank financial institutions. In Indonesia, the central bank issues large amounts of short−term notes to regulate money supply. The Hong Kong Monetary Authority has initiated the issuance of bills of varying maturities as part of its plan to develop the domestic bond market. The state enterprise sector is perhaps the fastest growing sector of the East Asian bond market. At the end ofcontinue

Table 2.4: Size of the National Government Bond Sector (US$ billion) 1990

% GDP

1992

% GDP

1993

% GDP

1994

% GDP

China

17.1

4.8

22.3

5.3

28.7

6.7

24.4

4.7

Hong Kong

0.0

0.0

0.4

0.4

0.5

0.4

0.1

0.1

Indonesia

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Korea

19.2

7.6

25.3

8.2

25.8

7.8

27.9

7.4

Malaysia

24.9

58.2

27.6

47.6

26.8

41.6

28.9

41.0

Philippines

8.5

19.2

17.4

32.8

22.5

41.4

24.8

38.8

Singapore

24.8

67.9

37.4

77.1

38.4

69.6

42.3

68.2

Thailand

7.7

9.0

5.2

4.7

3.9

3.1

2.6

1.9

Total

102.2

10.3

135.5

11.1

146.6

11.2

151.0

10.0

Source: The World Bank. Table 2.5: Size of the Central Bank Bond Sector (US$ billion) 1990

% GDP

1992

% GDP

1993

% GDP

1994

% GDP

China

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Hong Kong

1.0

1.4

2.6

2.7

3.6

3.3

6.8

5.2

Indonesia

0.8

0.8

10.0

7.8

11.1

7.7

6.8

4.3

Korea

21.3

8.4

25.7

8.3

29.9

9.0

32.1

8.5

Malaysia

0.0

0.0

0.0

0.0

2.7

4.2

2.0

2.8

Philippines

0.1

0.2

3.1

5.8

1.0

1.8

0.2

0.3

Singapore

0.0

0.0

0.0

0.0

Thailand

0.0

0.0

0.0

0.0 by The0.0 0.0 0.0 Delivered World Bank e-library to: 000000 0000000000 0.0 IP : 000.000.00.00 0.0 0.0 0.0 000, 00 000 0000 00:00:00

Total

23.2

2.3

41.4

3.4

48.4

3.7

47.9

0.0 3.2

Size and Composition of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

39

The Emerging Asian Bond Market Source: The World Bank. Table 2.6: Size of the State Enterprise Bond Sector (US$ billion) 1990

% GDP

1992

% GDP

1993

% GDP

1994

% GDP

China

6.6

1.9

15.4

3.7

18.7

4.4

9.0

1.8

Hong Kong

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Indonesia

0.8

0.8

1.3

1.0

1.7

1.2

1.5

1.0

Korea

13.0

5.1

23.8

7.7

30.9

9.3

37.4

9.9

Malaysia

1.1

2.6

2.0

3.4

2.2

3.4

3.7

5.2

Philippines

0.1

0.2

0.1

0.2

0.1

0.2

0.1

0.2

Singapore

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Thailand

0.7

0.8

3.0

2.7

5.3

4.2

7.6

5.4

Total

22.2

2.2

45.6

3.7

58.9

4.5

59.3

3.9

Source: The World Bank. Table 2.7: Size of the Corporate Bond Sector (US$ billion) 1990

% GDP

1992

% GDP

1993

% GDP

1994

% GDP

China

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Hong Kong

—

—

—

—

1.9

1.7

4.7

3.6

Indonesia

0.1

0.1

0.1

0.1

0.5

0.3

0.7

0.4

Korea

33.6

13.2

44.9

14.6

49.4

14.9

60.8

16.1

Malaysia

1.1

2.6

2.5

4.3

3.4

5.3

4.9

7.0

Philippines

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Singapore

—

—

—

—

—

—

2.5

4.0

Thailand

0.0

0.0

0.2

0.2

1.0

0.8

3.5

2.5

Total

34.8

3.5

47.6

3.9

56.3

4.3

77.1

5.1

Source: The World Bank. 1994, total size of this sector was about US$59 billion (Table 2.6). Korea had the largest share, about 63 percent, followed by China and Thailand. As the state enterprises were corporatized, the issuance of the SOE bonds increased dramatically in recent years, especially in Thailand. The funding requirements of the state enterprises, especially utilities, are massive and growing. Malaysia is in a similar situation, but has opted for full privatization of its state enterprises. China's policy on state enterprise bonds is currently under review by the government. Delivered by The World Bank e-library to: 000000 0000000000 In East Asia, the commercial banking system remains the single largest lender to the corporate sector. In dollar IP : 000.000.00.00 000, 00 000 0000 00:00:00 steadily. However, the corporate bond market has terms, commercial banks' outstanding assets have been growing finally come of age. At the end of 1994, the total size of the corporate bond market in East Asia amounted to

Size and Composition of the East Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

40

The Emerging Asian Bond Market US$77 billion, an increase of 37 percent over 1993. The fastest growing corporate bond markets have been those in Thailand, Malaysia, Korea, and Hong Kong (Table 2.7). The size of the corporate bond market will be boosted as state enterprises are privatized and the private sector becomes a major player in meeting infrastructure requirements of East Asian countries. Investors The bulk of East Asian bonds are held by three major classes of institutional investors: the contractual saving sector,4 pension funds, and financial institutions. Bond holdings of individual investors are negligible except in China where individuals are major holders of government bonds. The extent to which each of these investor classes dominates the bond markets, however, varies from country to country (Table 2.8). In Malaysia and Singapore, the contractual saving sector comprising government−sponsored compulsory saving institutions such as the Central Provident Fund (CPF) in Singapore and Malaysia's Employee Provident Fund (EPF) is the largest single segment of the investor universe. Financial institutions are the largest investors in Korea, Thailand, and the Philippines. The third institutional investor class, pension funds (for example, GSIS and SSS in the Philippines and Civil Servant Pension Plan and Social Security Organization in Thailand), is the next largest investor in bonds. With a total investment of US$83.0 billion in bonds in 1994, the contractual savings sector was the major investor in these markets. Table 2.8: East Asia: Investors in Bonds, 1994 (US$ billion) Contractual Saving Institutions

Private Pension Funds

Financial Institutions

Others

Total

China

n.a.

n.a.

4.6

28.7

33.3

Hong Kong

n.a.

n.a.

11.5

n.a.

11.5

Indonesia

2.8

0.1

1.8

4.4

9.1

Korea

15.0

39.7

37.6

68.7

161.0

Malaysia

22.7

n.a.

5.5

11.3

39.5

Philippines

4.0

0.5

10.6a

10.0

25.1

Singapore

38.0

n.a.

6.8

n.a.

44.8

Thailand

0.5

n.a.

12.2

1.0

13.7

Total

83.0

40.3

90.6

124.1

338.0

a: Banko Sentral ng Pilipinas. Source: World Bank staff estimates. The Primary Market In many countries, the impetus for bond market development stems from governments' need to finance their fiscal deficits. Indeed, at the end of 1993, central government bonds represented 40 percent of all publicly issued bonds outstanding in a sample of 21 major bondcontinue Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

markets.5 As can be seen from Table 2.9, the net issuance of government bonds has consistently outstripped that Investors

41 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market of corporate bonds over 198093. In East Asia, the organization of primary markets, the range of issuers and investors, the instruments available, and bond issuance methods vary substantially across countries. At one end of the spectrum, countries such as Hong Kong and the Philippines issue bonds in a competitive auction market where prices are truly market determined, while at the other end, Chinese bonds are placed via administrative allocation mechanisms and are often priced at below−market yields. Table 2.9: Net Issuance of Bonds in Selected Industrial Countries, 198093 (US$ billion) 1980

1985

1990

1991

1992

1993

49.0

164.8

153.6

212.9

215.2

178.3

Corporate Bonds 36.8

106.8

85.1

156.3

109.8

103.9

13.6

50.6

46.3

87.9

117.3

14.2

93.8

92.4

71.6

92.7

14.6

16.8

13.8

32.8

68.7

0.4

2.1

1.3

1.7

3.1

64.0

18.4

37.5

40.0

69.5

5.4

16.4

17.7

15.9

32.5

United States Government Bonds

Japan Government Bonds

1.7

Corporate Bonds 20.5 Germany Government Bonds

32.2

Corporate Bonds 0.7 United Kingdom Government Bonds

67.5

Corporate Bonds 2.5

Source: Based on data from Salomon Brothers. The rest of the East Asian countries are in the middle. In Indonesia, pricing of bond issues often does not reflect the true cost of capital, as they are priced off deposit rates of state−owned banks, which are government controlled. In Malaysia, government bonds used to be sold on a subscription basis with pre−announced coupon rates. This practice, however, has changed and government bonds are now competitively priced, although government securities with maturities of longer than 10 years are issued at par and at predetermined coupon rates to the EPF and the national pension fund. The Singapore government issues bonds exclusively for the CPF at administratively determined yields. The variance in country practices, however, has been declining in the past two years, as most countries of the region are converging towards transparent and market−driven issuance practices. The following section describes the country−specific practices in East Asia's primary markets. Government Bonds

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 were issued primarily for open market 000, 00 000 0000 00:00:00

In Thailand, government bonds operations to control liquidity in the financial system and, to a lesser extent, to fund the budget deficit. Given that the Royal Thai Government (RTG) Government Bonds

42 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market has been running fiscal surpluses for the last few years, there has been no need to issue bonds since 1990. As a result, there has been no need to set up an auction system. However, the Government of Malaysia (GOM) started issuing bonds to meet the investment needs of the contractual saving sector, the EPF, and to partially fund the budget deficit of the Federal Government. In 1988, GOM appointed 18 principal dealers—4 commercial banks, 7 merchant banks, and 7 discount houses—to underwrite the primary issues of Malaysian Government Securities (MGS), which were auctioned. The principal dealer network was expanded in 1990 to include 5 more commercial banks, bringing the total to 23. MGSs are issued with original maturities of more than one year. MGSs of maturities of up to 10 years are only offered to principal dealers while longer−term MGSs are issued at predetermined coupons and sold at par to selected institutional investors. In Malaysia, prior to 1989, the MGSs were issued at par on a subscription basis with pre−announced coupons. Since then, MGSs of maturities up to 10 years have been issued through the best price tender auction process. Malaysian Treasury Bills (MTB) are issued on a discount basis through tenders submitted by the principal dealers. The 91−day MTBs are issued weekly, the 182−day MTBs are issued fortnightly, and the 364−day MTBs are issued monthly. The development of the primary debt markets in Hong Kong was greatly facilitated by the introduction of the Exchange Fund Bills and Notes Program in 1990 and the creation of a central clearing and custody system for the debt market. Prior to the issuance of the Exchange Fund Bills and Notes, the government had issued securities only on an occasional basis. In fact, there was only a single issue of government debt brought to the market during the entire 1980s. Since the government normally operated in fiscal surplus, it was able to accrue large cash reserves. Following the successful introduction of three−month bills in March 1990, the government launched the six−month bills program in October 1990. Tenders are accepted only from recognized dealers who are permitted to submit bids at the competitive auction. Each recognized dealer must maintain at least two accounts with the Monetary Authority: one account for a dealer's own holdings and a separate account for clients. Recognized dealers must comply with regulations issuedcontinue

by the Monetary Authority. Two−year Exchange Fund Notes were introduced to the market in May 1993 by the Monetary Authority to replace government bonds as they matured. Singapore has normally operated at a fiscal surplus and has accumulated massive cash reserves. Thus the aim of issuing government securities is to absorb the surplus of the CPF and to develop the domestic capital markets. The primary market for government securities in essence acts like a financial intermediary by which the task of risk management is passed from the contractual saving sector to a government investment corporation, GSIC. Subsequent to the restructuring of the issuance market in May 1987, GOS regularly issues varying amounts of securities, which are auctioned to the public through primary dealers and carry market determined interest rates. Government securities are auctioned and non−competitive bids are allotted at the weighted average price and yield of the successful competitive bids. Currently, seven primary dealers are committed to making two−way quotes in all government securities and ensuring liquidity in the market under all conditions. GOS now issues 91−day, 182−day, and 364−day treasury bills, and 2−, 5−, and 7−year bonds. Long−dated bonds are issued primarily to cater to the needs of the CPF, but often at administratively determined yields that are usually below market rates. Primary markets in the Philippines are dominated by government issuance. Almost the entire domestic debt market consists of debt issues by the national government. The government issues treasury bills with maturities of 63, 91, 182, and 364 days. Government securities (treasury bills and notes) in the Philippines are issued via competitive auction. The current auction system and dealer network were established in 1986. The Government Securities Department of the central bank is responsible for managing the auction on behalf of the national government. A committee with representatives from theBank National Department of Finance, and the Delivered by The World e-libraryTreasury, to: 000000 0000000000 central bank decides the amount of securities offered at each auction, taking into account the financing needs of IP : 000.000.00.00 000, 00 000 0000 00:00:00 the government and the open market operation requirements of the central bank. The auction is conducted on a weekly basis. The primary dealer network has expanded from an earlier 20 to the current 30 and includes Government Bonds

43 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market commercial banks and investment houses. Only Accredited Government Securities Dealers (AGSDs) can participate directly in the auctions as competitive bidders. All treasury auctions are conducted on a yield basis. The auction committee ranks the competitive bids from the lowest yield to the highest. What is worth noting in this regard is that the government has put in place a system of screening and selecting dealers in government securities who can serve as market−makers and thus foster a liquid and efficient market in government securities. Primary markets in China can best be characterized as markets in transition from a centrally planned and administratively controlled credit allocation mechanism toward a competitive market−driven system. A myriad of bonds are issued in China. Since 1984, the volume and variety of debt issue in China have grown rapidly. Total debt issues increased from Y48.7 million in 1981 to Y65.6 million in 1985, and to Y113.3 billion in 1994. New issues planned for 1995 are Y150 billion. Government debt in China is issued primarily by the Ministry of Finance (treasury bonds), and the part of this used for general budgetary purposes is referred to as treasury bills. Since 1994, there has been a significant increase in the volume of treasury bills issued, primarily due to the government's decision to cease to finance its deficit through borrowing from the PBC. Government debt issues, at over Y113 billion, increased threefold over 1993. Planned issues for 1995 are higher still, at Y150 billion. Enterprise bond issues, meanwhile, were reduced. Historically, all debt securities were placed administratively and on a mandatory basis. However, the Ministry of Finance in 1991 used an underwriting syndicate to launch a bond issue for the first time on an experimental basis. The syndicate was entrusted with the issue of Y2.5 billion, out of a total of Y19.9 billion of the treasury bond quota issue for that year. In 1993, underwriting failed to sell the desired quantity of treasury bills, due to competition from the booming equity and property markets and higher (unauthorized) returns on enterprise debt. Since then, the government had reverted to mandatory administrative allocation. With some revival in the bond market in 1994, the government experimented with four different issuance methods for treasury bills, representing a compromise between those who desired more market−oriented issuing procedures and those who doubted the effectiveness of the underwriting system in China. These methods included: (a) Y13 billion of six−month and one−year scripless treasury bills via underwriting agreements. The underwriters (many of whom were designated primary dealers) were given a week to place the debt, after which it was listed on the Shanghai stock exchange; (b) placement ofcontinue

Y28 billion of two−year bearer treasury bills via local financial departments, which applied for allocations. The balance of the year's planned issue then become available for distribution via other channels. The local finance departments signed ''underwriting agreements" with financial institutions at the local level, which then sold the securities to individuals and others; (c) direct placement of Y2 billion of five−year bearer treasury bills with institutions; and (d) allocation of Y70 billion, certificates of three−year maturity by PBC to the specialized banks for selling through their branches. Government bonds are issued at par and the majority carry a predetermined coupon. There is no auction process to determine the yield in the primary market. Coupons are administratively set at a margin above deposit rates of comparable maturity, without reference to the secondary market yield on issues of comparable maturity. Most government issues are of three years or more in maturity and since 1992, have had a coupon related to the inflation rate. A drawback of the primary issue process for government securities in China is that treasury bills typically have been offered in a small number of issues, in the first half of the year, rather than in several offerings spread over the year. Bond issuance typically takes several months and has effectively been an on tap market. The sale of scripless treasury bills aimed at wholesale investors in 1994 was a step in the right direction which permitted a much shorter issue period.Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Government Bonds

44 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Corporate Bonds

The corporate bond sector is the fastest growing segment of the East Asian bond market. The Thai corporate bond market is relatively new but growing rapidly. Historically, the few bonds issued by private firms were mostly short−term promissory notes and bills of exchange that were guaranteed by commercial banks. Prior to 1990, only public companies and companies listed on the Stock Exchange of Thailand (SET) were allowed to do so, and consequently the number of private sector issues was quite limited. However, after the enactment of the Securities and Exchange Act in May 1992, limited companies were allowed to issue debentures and since then qualified companies have begun to do so. The volume of new issues by the corporate sector rose twelvefold over 199294, surpassing the state enterprise issuance. Public offerings of bonds in Thailand have to meet several requirements, and the issue process is cumbersome. The issuer has to satisfy SEC criteria, which are intended to ensure that the issuer has experience in the business and the business is financially viable. The issuer, assisted by a financial advisor, must file for permission to issue bonds and obtain a credit rating for the issue. The issuing process for a public offering generally takes about 60 days. Procedures for private placement of bond issues are much simpler than those for public offering. The issuer of an unsecured debenture only has to register with the SEC and comply with the regulations for selling/transferring the issue. For secured and subordinated debentures, the issuer files a request to issue with the SEC. If the SEC does not object to the issue within seven working days, permission is considered granted. The issuing process for a private placement typically takes about 1015 days. As a result, the private placement market for corporate securities in Thailand has been growing rapidly. Private placement accounted for over 50 percent in 1993 and by 1994, this proportion has risen to 60 percent of total corporate bond issuance. Until 1988, the corporate sector in Malaysia was not an active issuer of bonds. Corporate bond issuance included long−term private bonds which can be redeemable, non−convertible, secured, or unsecured; short−term bonds such as Revolving Underwriting Facilities (RUFs) and Note Issuance Facilities (NIFs); and Islamic debt securities. RUFs are popular instruments in the Malaysian bond markets and are issued mainly to finance corporations' working capital requirements. The underwritten rate is usually set between 75 to 100 basis points above KLIBOR (Kuala Lumpur Inter−Bank Offering Rate). NIFs are similar to RUFs except that they are not underwritten. Most corporate bonds are issued on a bought deal basis where bonds issued are fully subscribed by a primary subscriber which in turn sells these bonds to eligible investors. Eligible investors are those that qualify under Section 38(1B)(c) of the Companies Act of 1965. Thus, the primary subscribers—usually financial institutions—in effect, act as underwriters. Merchant bankers play an important role in structuring the deal. In 1986, the Malaysian government helped launch Cagamas Berhad, the National Mortgage Corporation, in an effort to provide liquidity to financial institutions that provide housing loans and to ensure a continuous supply of mortgage funds. In a relatively short time, Cagamas has established itself as a major player in the domestic bond market. Its volume of bond issues has more than quadrupled over 199294 (see Box 2.1).break

It is estimated that private capital requirements in Malaysia over the next 25 years will be about RM 6.3 trillion (US$2.5 trillion). Traditional borrowings and equity financing are unlikely to satisfy this massive level of investment and therefore bond issuance will have to increase dramatically. Another driving force for bond issuance is privatization of state enterprises. Over the last several years, GOM has been actively promoting privatization: telecommunications, electricity supply, highways, and other utility sectors are being privatized. In the future, these newly privatized enterprises will become major issuers of bonds. Corporate issuance in the PhilippinesDelivered is generally limited toe-library a handful by The World Bank to: of blue−chip corporations and are usually 000000 0000000000 short−term commercial paper maturing in less than one year. Long−term commercial paper (maturities of up to IP : 000.000.00.00 three years) is also issued, although to a lesser Corporate 000, extent. 00 000 0000 00:00:00 bond issuance is almost non−existent because of the Corporation Law which requires that bond issuances be approved by two−thirds of the shareholders while Corporate Bonds

45 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market commercial paper issues only require approval by the board. Corporate issuers get around this restriction by issuing long−term commercial paper which is, in effect, a bond issuance. With a non−investment grade sovereign rating, the corporate sector in general has limited access to international financial markets. However, blue−chip corporations such as the Philippines Long Distance Telephone Company and the San Miguel Corporation have been able to tap foreign capital markets, mainly through equity issues.break Box 2.1: Cagamas Cagamas Berhad—Malaysia's National Mortgage Corporation—was formed in 1986 with Bank Negara Malaysia (the central bank), commercial banks, finance companies, and merchant banks as shareholders, with BNM holding a 20 percent share. The board of directors, charged with the responsibility of formulating the company's policies, comprises nominees of BNM, the Association of Banks in Malaysia, the Association of Merchant Banks, and the Association of Finance Companies in Malaysia. The Governor of BNM serves as the chairman. Cagamas performs the vital function of providing liquidity to financial institutions by purchasing their mortgage portfolios, although with recourse, and ensures a continuous supply of mortgage funds. Cagamas purchases housing loans from mortgage originators, such as banks, other financial institutions, selected corporations, and the government, and it then issues unsecured mortgage−backed securities to fund its mortgage purchases. Proceeds from the sale of housing loans to Cagamas can be used freely by the originator in granting new housing loans or in other more attractive investments. With high marketability of its bonds, Cagamas has been able to raise low−cost funds, thus lowering mortgage rates. Since its inception, Cagamas has issued RM 9 billion worth of bonds representing about 45 percent of the total corporate bond market. Both fixed rate bonds with maturities of 3, 5, and 7 years and floating rate bonds pegged to 6−month KLIBOR (Kuala Lumpur Inter Bank Offering Rate) are issued. Short−term discount notes of maturities less than one year have also been issued. Cagamas bonds are issued by way of tenders through the 23 principal dealers who are obliged to submit bids and those with the lowest yields are allocated the appropriate amount of paper. The yields on these bonds are very close to those of government bonds of similar maturities and as low as yields on government bonds when bonds are in short supply. Occasionally, private placements or special issues are made to nonbank institutions. Cagamas has established itself as the dominant player in the Malaysian bond markets and has been profitable. The company enjoys certain concessions from the authorities such as exemption from stamp duties on its purchase of mortgage loans. In addition no prospectus is needed for any of its issues and Rating Agency Malaysia has so far accorded AAA and P1 for all its paper. Although its operations are highly leveraged, Cagamas maintains an 8 percent capital adequacy ratio, similar to other financial institutions.

Box Table: Cagamas Bond Issues, 19901994 (RM million) Issue Year

Fixed Rate Bonds

Floating Discount Islamic Total Rate Bonds Delivered Notesby The World Bonds Bank e-library to:

1990

400

—

—

1992

750

1,365

—

000000 0000000000 — IP : 000.000.00.00 000, 00 000 0000 00:00:00

—

400 2,115

Corporate Bonds

46 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market 1993

980

670

—

—

1,650

1994

4,730

—

560

30

5,320

Total

6,860

2,035

560

30

9,485

Source: The World Bank.

The popularity of these bonds stems from the fact that they qualify as liquid assets and provide a safe haven for investors as these bonds have recourse, which means that these bonds are on par with bank−guaranteed bonds. This has aided the rapid development of an active secondary market in these securities. Trading volume accelerated fivefold over 199294. With rapidly rising income and increased urbanization, demand for housing finance will no doubt continue to increase. The impressive performance of Cagamas thus far, is expected to be further strengthened with increased securitization of mortgages. The outstanding stock of housing loans in the Malaysian market is estimated at about RM 4550 billion, of which only 15 percent has thus far been securitized. Although the existing mortgage purchases are with recourse, Cagamas is planning to purchase them without recourse in the future.

Local bond issuance by Hong Kong companies is hampered by the profits tax on interest earned and the stamp duty. There have been only five domestic corporate bond issuances to date. In recent years, the number of international bond offerings and foreign bonds listed on the Hong Kong Stock Exchange (HKSE) has increased dramatically. The Hong Kong government has granted tax concessions to investors in the bonds of multilateral development institutions (i.e., the World Bank, IFC, and Asian Development Bank) by forgoing the stamp duty tax and the payment of the profits tax on interest payable on the Hong Kong dollar debt offered by these institutions. In 1993, the value of international bond offerings denominated in Hong Kong dollars increased to US$37 million, a fivefold increase from 1992. In the same year, five local companies issued Hong Kong dollar bonds in the local market. The Korean bond market is the largest among East Asian bond markets—at the end of 1994, the volume of outstanding bonds stood at US$161 billion, or 42.8 percent of GDP However, new issues are brought to the market often at administratively determined yields and the issue timing is also administratively governed. In essence, Korean bond issues can be viewed as loan packages instead of bonds in the traditional sense. Corporate bond issues are underwritten by a syndicate comprising securities companies, merchant banks, investment trust companies, and other financial institutions. Corporate securities are floated by commercial banks, merchant banks, and stock−broking companies. Public issue of new bonds requires the publication of a prospectus along the lines of the prospectus requirements of the Companies Act. The issuing corporation must submit a securities report and a preliminary prospectus to the Korea Securities Supervisory Board. Although interest rates on corporate bonds with maturities of more than two years have been liberalized, the underwriters usually absorb the bulk of the issues since it is generally difficult to sell these bonds to the public. Also, the issuance amount each month is controlled by the Corporate Bond Coordinating Committee of the Korea Securities Dealers Association, even though the corporate bond issuance is, in principle, liberalized. Prior to 1981, there existed regulatory guidance over the maximum coupon rate on corporate bonds. Currently, corporate issuers are free to select suitable coupon rates. However, the coupon rate has to be within a band of 2 percentage points from the base rate. Delivered by The World Bank e-library to: 000000 0000000000 IP was : 000.000.00.00 bond issue brought to the market 000, 00 000 0000 00:00:00

In Indonesia, the first private sector in 1988. Since 1989, there has been an increasing trend of private bond issuance. To date, there have been 26 private issuers active on the listed bond Corporate Bonds

47 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market market, and an estimated 50 in the private placement bond market. A total of about IDR1.4 trillion has been issued in corporate bonds since 1988. Corporate bond issuance has been hampered by several regulatory requirements such as guarantees, sinking funds, and by a lengthy and cumbersome issuing process. If an issuer cannot post sufficient collateral, the bond issue needs to be guaranteed. In practice, however, it is a defacto requirement that all non−state sector issuers have sufficient collateral backing their bond issues. Even though regulations are not clear on who can act as a guarantor, in practice, the only acceptable guarantors have been the state banks. The market perceives state banks to be highly creditworthy by virtue of the fact that they are owned by the government. If the BAPEPAM (Capital Markets Supervisory Agency) deems that the collateral offered by the issuer is sufficient, bond issues do not have to be guaranteed. Bond issues that are not guaranteed require a sinking fund. However, the sinking fund is not structured in a conventional way so that bonds are redeemed prior to maturity by lottery. The regulations require that sinking funds be set up in the form of deposits kept with a designated state bank at below market rates, which increases the cost for the issuer. The capital markets law also places limitations on maturity—a minimum of 3−year maturity is required. The high cost of issuing bonds and the lengthy issuance procedures discourage corporations from issuing short−term bonds. Another impediment to corporate issuers is the high all−in cost in the domestic market compared with the cost of raising funds in international markets. For this reason, many Indonesian corporations indeed raise funds in international capital markets and swap the proceeds into Indonesian rupiah. In Singapore, corporate securities are floated by commercial banks, merchant banks, and stock−brokering companies. Public issue of new bonds requires the publication of a prospectus along the lines of the prospectus requirements of the Companies Act. Where bonds are structured and issued pursuant to a trust deed, they must comply with the trust deed requirements of the Companies Act. For a foreign issuer, suitable arrangements must be made for a paying agent to be situated in Singapore as long as the bonds are quoted on the exchange, to enable bond−holders in Singapore to be paid promptly. The bond issuancecontinue

markets in Singapore are dominated by Asian dollar bonds—at the end of 1993, about 98 percent of all outstanding bonds were Asian dollar bonds. State Enterprise Bonds

Unlike other East Asian countries, Indonesia represents a unique case in that the government has been altogether absent from the primary market. The balanced budget law adopted in 1967 precluded the government from issuing debt securities in domestic markets. State−related agencies are able to issue debt securities and they dominate the market. Of the 47 bond issuers to date, 21 have been state−related agencies, accounting for about 73 percent of total debt issued to date, and another three have state−owned entities as minority shareholders. For the first five years of the bond market, from 1983 to 1988, three state sector issuers, led by Jasa Marga, accounted for all issuance of fixed income securities. In Thailand, the government stopped issuing securities in 1990. In early 1990, the RTG decided to increase the role of the private sector in financing massive infrastructure investment that will be required to sustain Thailand's high growth rates. Fourteen large public utilities and other state enterprises, such as Thai Airways, Electricity Generating Authority of Thailand, and Telephone Organization of Thailand, will be corporatized and their shares are to be issued in small installments. These enterprises are encouraged to raise funds in domestic markets through bond issuance. As a result, the size of the state enterprise bond market increased dramatically from US$700 million in 1990 to US$7.6 billion in 1994. The Secondary Market

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 market not only requires sound policy 000, 00 000 0000 a 00:00:00

A well−functioning secondary framework but also needs efficient supporting institutional infrastructure such as market−based benchmarks, well−capitalized market makers, State Enterprise Bonds (c) The International Bank for Reconstruction and Development / The World Bank

48

The Emerging Asian Bond Market efficient clearing and settlement systems, credit rating agencies, liquidity supports, and central information systems. East Asian countries are in the process of building such a market infrastructure. However, secondary market trading thus far has been sporadic in East Asia (Figure 2.3). Hong Kong and Korea have relatively more advanced market infrastructures, and trading in these markets has been somewhat more active with turnover rates of 58 and 57 percent, respectively, in 1993. In industrial country bond markets, daily trading volumes typically run into billions of dollars (see Annex A). However, it is important to realize that the most frequent transactions in the industrial country bond markets occur in benchmark government securities. Investor familiarity with these securities, their risk−free status, and market determined prices, together with highly sophisticated supporting infrastructure, facilitate trading. In emerging Asian bond markets, secondary market trading in a given issue is typically active shortly after offering, with spreads widening quickly. Hence, secondary market activity rises and falls with primary market activity.

Figure 2.3 East Asia: Secondary Market Trading in Bonds, 1993 (Average turnover ratios; percent) Note: China: Data are for 1992; Indonesia: OTC trading; Malaysia: MGS trading. Source: World Bank. In East Asia, as in industrial countries, most of the trading takes place on over−the−counter markets, although bonds are in general listed on exchanges in these countries. Exchange listing is largely viewed as a requirement to widen the investor base and enhance the acceptability of bonds as institutional investors are prohibited from investing in unlisted securities. The predominance of OTC trading is mainly due to the relative ease of trading, such as no set minimum trading amounts, less restrictive trading times, and faster settlement. For example, virtually all trading in Korea takes place on the OTC market—99.9 percent of total trading in 1993—even though more than 80 percent of the bonds outstanding are listed on the Korea Stock Exchange (KSE). In Malaysia, trading takes place on the Kuala Lumpur Stock Exchange (KLSE) and on the OTC market. Bond trading on the KLSE has been thincontinue

because only 24 corporate bonds are listed while government bonds are not listed. Cagamas bonds are traded over the counter. In the Philippines, government securities are traded on the OTC market run by 24 accredited government dealers, most of whom are universal banks, some investment houses, and a government−owned development bank. In Indonesia trading is confined to the OTC market. Since bond certificates are bearer securities, there is no compelling reason to trade through thee-library exchange, even though there is no charge for bond Delivered by The World Bank to: 000000 0000000000 trades. IP : 000.000.00.00 000, 00 000 0000 00:00:00

State Enterprise Bonds (c) The International Bank for Reconstruction and Development / The World Bank

49

The Emerging Asian Bond Market Impediments to Secondary Market Trading

The institutional and policy impediments in the way of robust secondary market trading are elaborated below. Insufficient Supply of Bonds

Lack of a sufficient number of issues and relatively small issue sizes make it difficult for market participants to actively engage in secondary market trading. In secondary bond markets of the industrial countries, trading is facilitated, to a large extent, by the availability of a critical mass of government securities and a continuous supply of new securities. In contrast, the East Asian governments (except China and the Philippines) are downsizing their borrowing programs due to fiscal surpluses, and in some countries like Thailand, government bond issuance has ceased. The lack of government securities has been substituted by the increasing amount of corporate bond issues, but they have not yet reached the threshold required for secondary market trading. The supply constraint is rooted in several related issues such as narrow definitions of entities eligible to issue bonds, lengthy prospectus and issuing procedures, the absence of a streamlined regulatory framework, and discriminatory taxation on bonds. To facilitate bond issuance and to expand the issuer base, it is critical that these issues be addressed as part of the bond market development plan of these countries. In general, the issuance decision should be left to the market participants as long as they meet the compliance requirements. In several countries, the number of issues and total funds that can be raised are controlled by regulators. In addition, bond issuers have to follow the same lengthy procedures for each new bond issue, which increases transaction cost. In industrial countries, especially the United States, the introduction of shelf registration has greatly facilitated bond issuance. East Asian regulators should seriously consider adopting such procedures. At present, Korea is the only East Asian country with a shelf−registration facility, which provides blanket approval for continuous issuance. Buy−and−Hold Investors

Institutional investors such as the contractual saving sector, pension funds, and social security schemes are the dominant classes of investors in bonds. In East Asian countries, all of these investor classes tend to be buy−and−hold investors who minimize mismatches in maturity of their assets and liabilities. Contractual saving institutions such as the CPF in Singapore and the EPF in Malaysia invest in long−term bonds for the express purpose of holding the bonds to maturity. Singapore's CPF holds about 80 percent of government securities and is essentially a buy−and−hold type investor and does not engage in trading, while Malaysia's EPF holds 50 percent of total outstanding bonds and is also a buy−and−hold investor. Social security schemes and pension funds (for example, the SSS and GSIS in the Philippines and the Social Security Organization in Thailand) also tend to be buy−and−hold investors due to their long investment horizons. Of late, this situation has, however, been changing and contractual saving institutions are being given more flexibility in their asset allocation. For example, under the provisions of the new EPF Act, the proportion of annual investible funds required to be invested in Malaysian Government Securities was reduced from 70 to 50 percent, provided that the outstanding amount of MGS does not fall below 70 percent of EPF's cumulative investible funds. In Singapore, the government has initiated efforts to open the management of CPF funds to private professional managers with increased autonomy in investment decisionmaking. Lack of Market Makers

Market makers are essential for active secondary market trading. Two issues are of importance in this regard. First, liquidity supports must be provided for market makers; and second, market makers should be required to maintain a minimum capital base. Typically, bond dealers run highly Delivered by The World Bank e-library to: leveraged operations and their inventory 000000 0000000000 usually represents a large multiple of their capital base. To finance these large inventories, dealers rely on IP : 000.000.00.00 000, 00 000 0000 repurchase contracts or REPOS and to a lesser extent on 00:00:00 borrowings from banks at dealer rates. In industrial country bond markets, market makers are provided liquidity through REPO markets or central bank rediscounting Impediments to Secondary Market Trading (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market windows. But in almost all East Asian markets, there has been a void in this regard as most of the dealers are not market makers due to the lack of dealer financing facilities. Clearing and Settlement Systems

Effective bond trading depends on reliable and expeditious clearing, settlement, and payment systems. In some East Asian countries, this market infrastructure is not yet fully incontinue

place and traders run a variety of risks such as counterparty risk, fraud, and multiple trades of the same security. Mechanisms such as delivery−versus−payment, payment−versus−delivery, and central depositories which form an important element in the settlement arrangement are also essential for secondary market trading activity. For clearing and settlement systems to function successfully, it is essential that safeguards be in place. Safeguards built into any system for handling investors' securities, either in transfer or safekeeping, are important to the maintenance of public confidence in the debt market. It is essential that customers' debt instrument holdings be segregated from the proprietary holding of the financial institutions, or dealers with whom investors are doing business. It is also important that the safekeeping arrangements have proper checks and balances built into the system. Several East Asian countries have been taking steps to establish organized central clearing and settlement systems. In Hong Kong, the liquidity of the Exchange Fund Bills and Notes Program was aided by the development of an efficient system for clearance and settlement by the Monetary Authority in 1994. As of September 1994, 158 financial institutions had become members of the Central Money Market Unit System (CMU). Membership in the CMU is open to all members of the Hong Kong Capital Markets Association, authorized institutions in Hong Kong, and exempt dealers in securities under the Securities Ordinance. This service was extended to other Hong Kong debt paper by the Monetary Authority with the introduction of CMU. The CMU performs the role of a central custodian and clearing agent for Hong Kong dollar debt instruments issued by private sector issuers, including certificates of deposit, commercial paper, and bonds and is operated by the Monetary Authority. The transfer of title to the instruments is in book−entry form so that physical delivery is not required. The transfer of title is effected through a computerized book−entry system. Transfer is effected by the matching of instructions from buyers and sellers. The CMU register is updated with the receipt and matching of transfer instructions from participants in the system. Position reports are issued monthly, and members are provided information concerning their day−end accounts in the event that their accounts have a transaction on a particular day. Paying agents of the issuer are advised by the CMU of the details of holders of its debt instruments for the purpose of payment of interest and redemption of principal. In addition to establishing international linkages, the CMU plans to develop, in consultation with the Hong Kong Capital Markets association, a securities lending program for the private sector instruments lodged in the CMU. This is intended to increase the market liquidity of the private sector CMU instruments and this will help activate secondary market transactions. Finally, the CMU plans to develop a real time delivery−versus−payment system in 1996. This is a longer−term objective for eliminating settlement risk, which can be effected once the inter−bank payment system moves into a real−time gross settlement system. Malaysia has two clearing systems—the Kuala Lumpur Stock Exchange (KLSE) and SPEEDS, which consists of Inter−Bank Funds Transfer System (IFTS) and Scripless Securities Trading System (SSTS). IFTS is used to transfer funds in the inter−bank money market while the SSTS was developed for electronic bookentry for transferring scrips. Clearance on the KLSE operates on a physical delivery basis where scrips of loan stocks or Delivered by The World Bank e-library to: bonds are physically sent to the clearing house000000 through the brokers who execute the trades. Clearing and 0000000000 IP : 000.000.00.00 settlement of government bonds, Bank Negara Malaysia (BNM) bills, and Cagamas bonds occurs on SPEEDS. 000, 00 000 0000 00:00:00 The IFTS transfers funds between banks as well as between banks and the central bank. The SSTS, on the other Clearing and Settlement Systems (c) The International Bank for Reconstruction and Development / The World Bank

51

The Emerging Asian Bond Market hand, completes book entries electronically on the transfer of scrips. The scrips, however, remain physically parked in the central bank. With the introduction of the SSTS, the lodgment, custody, recording, and transfer of government bonds, Bank Negara bonds, and Cagamas bonds all occur in scripless form. Each principal dealer or approved dealer maintains two separate accounts with BNM—its own securities account and an aggregate customers' account for securities held on behalf of its clients. In addition, a cash settlement account is also maintained with BNM for the settlement of securities traded, including REPO transactions. Settlement is affected automatically on confirmation of trade for SSTS participants. The advances made in the clearing and settlement area by the introduction of SPEEDS and scripless trading not withstanding, the absence of an organized and central bond clearing house is hampering secondary market trading. It would be advantageous to form a central clearing house sponsored by the KLSE or a private organization. Alternatively, a privatized SPEEDS should be considered to assume this function. Thailand has developed scripless clearing and settlement systems for both equity and bond trading. Settlement is done by the Association of Securitiescontinue

Companies, which acts as the market center that links all dealers with its on−line computers to form a bond−trading network. The settlement is a T+2, scripless, net−clearing balance system through the SET's depository facility. Prices quoted daily on the secondary market are intended to reflect true demand and supply of bonds on that day. Indonesia is in the process of introducing a computerized clearing and settlement system to replace its manual system. The majority of bonds are traded in the OTC market, and settlement takes place on a one−to−one basis between the parties involved and follows a payment−versus−delivery system. Payment is made by check or bank transfer, and bargains can be struck for settlement anywhere between the day of trading and ten days after payment is made based on accrued interest to the payment date, but the lack of convention gives rise to problems when orders are filled through multiple trades. The delivery of bearer paper for settlement entails two risks: the risk of theft/loss during transport and the risk of forgery. Market participants have been known to hire reputable carriers to ensure the safe delivery of parcels of physical bearer securities. Insurance is available on amounts of around US$1 million and is also offered in conjunction with blanket banking business insurance policies. The Indonesian Depository and Clearing Agency (KDEI) came into existence in 1993 under sponsorship of the seven state banks and the Jakarta and Surabaya stock exchanges, and has been practicing netted settlement services for shares since the middle of 1994. Scripless trading will be introduced in late 1995. The same agency is expected to start centralized clearing and netted settlement of bonds by end−1995. Initially, only issues quoted on the BPI will be included, and this will serve as a stimulus for issuers to list there. In the first instance, bond trading will still be based on unregistered bearer securities, but they would be immobilized, meaning that to trade the securities they have to be lodged with the KDEI, and brokers can trade through their KDEI accounts. Other matters that have to be addressed are whether to adopt a registered/bearer system and how to settle off−exchange trades. Safe custody services are offered by roughly 15 large banks that form part of the custodians' association, and a number of other banks operating the service on an adhoc basis. Brokers offer free safe custody services for their clients, a service mainly used by private individuals. All large institutional investors have a designated custodian. Many foreign investors are, by statute, barred from investing in physical bearer securities, while domestic investors carefully select a custodian for their bearer paper. A number of custodians have taken out special insurance against the loss of bearer bond certificates. Such Delivered by The World Bankinsurance e-library to: provides cover for up to around IDR 2 000000 0000000000 billion (about US$900,000) per transaction, and requires certain procedures to be followed during delivery. IP : 000.000.00.00 000, 00 000 0000 00:00:00

Clearing and Settlement Systems (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Securities listed on the Philippine Stock Exchange are cleared through two clearing banks. Brokers are required to operate within a four−day settlement period. In 1993, 31 banks operated as transfer agents for the issuance of certificates to new owners and the cancellation of certificates sold. Since 1989, government securities have been issued in book−entry form by the central bank. Starting in 1996, all equity and debt instrument transactions will be cleared through a new clearing system being established with financial assistance from USAID. A central depository will also be put in place in the second half of 1995, and an oversight committee, the Philippine Central Depository, was recently formed. Information Sources

Robust secondary market trading hinges on the availability of centralized information to all market participants so that brokers and dealers can provide blind quotes. In most East Asian countries such information infrastructure is not yet in place and, if in existence, is rudimentary. In industrial countries, centralized information sources such as Reuters and Bloomberg ensure a level playing field in that all market participants have access to the same information at the same time. East Asian regulators should encourage the formation of such centralized sources of information to facilitate trading activity. Reserve Requirements on Banks

Commercial banks have been a major investor class in bonds throughout the region as they can use their bond holdings to satisfy statutory liquidity reserve requirements. Therefore, banks do not trade bonds for yield maximization. The impact of these impediments may abate in the future as East Asian countries reduce their mandatory requirements on banks. For example, Thailand has reduced its reserve requirements to 7 percent, while in the Philippines, reserve requirements were reduced from 25 percent in 1993 to 21 percent in 1994. Another related factor is that several East Asian countries do not require banks to mark−to−market their bond portfolios. As a consequence, banks are reluctantcontinue

to trade bonds, as trading may incur realized losses that need to be booked as opposed to holding bonds on a cost basis. If banks were required to mark−to−market, they would more likely trade those securities which have declined in value, thereby minimizing the realized losses and investing the proceeds in securities with relatively high expected yields. Other factors that impede secondary market trading, such as the lack of liquid benchmarks, ineffective credit rating agencies, and discriminatory taxation on bond trading, are examined in the ensuing sections. Benchmarks Benchmarks play a crucial role in the efficient functioning of both the primary and the secondary bond markets. They serve a variety of purposes. They are used as a bellwether to gauge the prevailing interest rate structure; the market's expectations of future interest rate movements, inflation, and the associated risk premia; and provide hedging vehicles for some underwriting and trading risks, and to identify that portion of issuance yields which pertain to credit or default risk. Investors in fixed income securities are exposed to a variety of potential risks6 depending on the local market climate. The major sources of risk include: (a) business risk (or risk of default); (b) interest rate risk; (c) liquidity (or market stability risk); (d) purchasing power risk; and (e) issue−specific risks (reinvestment risk, call rise, price risk). Given the risks involved in fixed income securities, the availability of market−based benchmarks is essential to price these securities. In industrial country markets such as the United States, fixed income securities are priced off US treasury securities, which are considered risk−free. A margin to Delivered by The World Bank e-library to: cover credit risks and other specific issue risks000000 is added to the prevailing yield on benchmark securities. 0000000000 IP : 000.000.00.00 Availability of a market−based benchmark also facilitates development of other risk management instruments 000, 00 000 0000 00:00:00 such as futures and options. Information Sources

53 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market While benchmarks do not have to be risk−free, their risk should be easily assessable. The defining characteristic of benchmark securities is their liquidity (i.e., narrow bid−ask spreads for large trades), which is often associated with regular and large issues. High liquidity enables market participants to close out their positions without incurring large losses, which make them ideal hedging vehicles. For benchmarks to be useful, the size of issuance should be large and cover the entire maturity spectrum to create a yield curve. In the emerging bond markets of East Asia, however, the development of risk−free yield curves has been somewhat limited in contrast to the situation in industrial countries. The primary reason for the lack of market−based government security benchmarks has been the fact that most East Asian governments, except China and the Philippines, have not been active issuers of bonds, in view of their fiscal surpluses. Since most bonds are held to maturity by the contractual saving sector and financial institutions, secondary markets have been slow to develop. Another impediment to establishing benchmark yield curves has been the short maturities of bond issues. For example, the Philippine bond market is dominated by 91−day treasury bills and corporate bonds are priced off the 91−day T−bill rate. Figure 2.4 illustrates benchmark yield curves in East Asian bond markets. Interest rate controls are also hampering the efforts to establish benchmarks in China and Korea. In Korea, the use of Monetary Stabilization Bonds (MSBs) issued by the Bank of Korea offers alternative benchmarks, although in a limited sense as the maturities of MSBs do not stretch beyond two years. It is expected that Korea will accelerate its financial reforms and by 1997, market−based benchmarks should emerge with complete deregulation of interest rates. In the absence of government securities in Indonesia money market instruments issued by Bank Indonesia, or bank deposit rates are possible alternative benchmarks. The offshore swap rate is another indication of funding cost that could be used as a benchmark. Nevertheless, the governments in East Asia have been taking steps in recent years to develop benchmark securities. For example, in Hong Kong, the Monetary Authority started the Exchange Fund Bills and Notes program in 1990 to foster the establishment of a benchmark yield curve. These securities are issued on a regular basis with up to 3−year maturities and are actively traded. The Monetary Authority is in the process of expanding the maturity structure of exchange fund bills and notes is now planning to issue 5−year securities. The GOM has helped strengthen the Cagamas, which now issues 3−, 5−, and 7−year bonds. These bonds are actively traded and potentially can be used as benchmarks. In Thailand, the state enterprise sector bonds could be used as benchmarks by encouraging a large entity such as EGAT to issue securities on a regular basis across all maturities. Repackaging of IFCT (Industrial Finance Corporation of Thailand)continue

loans and the outstanding government bonds into new securities could also provide another avenue in the development of benchmarks. In the Philippines, the government has been trying to lengthen the maturity structure in an effort to develop benchmarks, which may be aided by the recent introduction of 3−year floating rate notes. Role of Credit Rating Agencies A key ingredient of bond market development is the establishment of a credit rating industry. Several Asian countries have begun to take steps to develop domestic rating agencies to boost their bond markets and ensure investor protection. China, Indonesia, Malaysia, the Philippines, and Thailand all have rating agencies. The effectiveness of these rating agencies thus far has been, however, mixed. With rapid growth in its bond market, Rating Agency Malaysia (RAM) is well established and has been successful. The Thai Rating and Information Service (TRIS) is relatively new, but has done well in stabilizing its presence in the market. In Korea and the Philippines, however, rating agencies Delivered have been relatively effective despite being in operation for more than a by The World Bankless e-library to: 000000 0000000000 decade. The Indonesian rating agency was established only in November 1994 and its role is still evolving. The IP : 000.000.00.00 00 000 00:00:00 below. A more comprehensive review of credit key issues facing the rating industry in East000, Asia are0000 discussed rating agencies is presented in a companion report. Role of Credit Rating Agencies (c) The International Bank for Reconstruction and Development / The World Bank

54

The Emerging Asian Bond Market Issues in Emerging Market Rating Agencies Role of Government

The role of government is crucial in fostering the development of bond markets and, especially, credit rating agencies. In the United States, the government facilitated the development of credit rating agencies, though in an indirect way, by instituting regulations that use ratings as a measurement of risk. The Uniform Net Capital Rule is an example of such a regulation. In emerging markets, the role of government in promoting credit rating agencies is even more crucial. East Asian governments should move decisively to eliminate the remaining impediments, such as guarantees, to ensure uniform accounting and disclosure requirements7 and to establish prudential regulations designed to encourage the use of ratings. These issues are highlighted below. break

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Issues in Emerging Market Rating Agencies (c) The International Bank for Reconstruction and Development / The World Bank

55

The Emerging Asian Bond Market

Figure 2.4 Yield Curves in Selected East Asian Markets

Guarantees Delivered by The World Bank e-library to:

000000 0000000000 Prior to the start of credit rating agencies, governments had required that bond issues be guaranteed. In Korea, IP : 000.000.00.00 bonds were required to be guaranteed until 000, recently. This00:00:00 has had a significant impact on investment culture in 00 000 0000 that Korean investors rely on guarantees rather than measuring and managing credit risks even though three rating

Guarantees

56 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market agencies have been in operation for almost a decade. In Indonesia, the absence of ratings has forced the BAPEPAM to impose strict guarantee and sinking fund requirements. The result was that a limited range of bonds was brought to the market. Regulators can accelerate the development of rating agencies by eliminating guarantee requirements on bond issues. Accounting Procedures and Disclosure Requirements

The absence of a uniform set of accounting principles and proper disclosure requirements poses a serious threat to the integrity and reliability of credit ratings. Governments can facilitate the rating process by mandating these requirements. In East Asia, accounting procedures are, in general, well developed and are broadly in line with internationally accepted standards. Throughout the region, listed companies are required to comply with the local code of accounting procedures and standards of practice. Accounting principles and the extent of their conformity with international standards of practice, however, depend on the stage of development of their financial markets. Hong Kong, Singapore, and Malaysia have the most developed accounting systems, which are consistent with International Accounting Standards; accounting procedures in Korea, the Philippines, and Thailand are based on International Accounting Standards, with some modifications to suit local requirements. The Indonesian accounting practices are based on local requirements, and as such their conformity with international standards is somewhat limited. Reflecting the transition from a centrally planned to a market economy, the Chinese accounting procedures and standards are still evolving. With regard to disclosure requirements, certain minimum standards have to be met to be listed on stock exchanges. For bond issues, the prospectus requirement ensures that adequate information is disclosed to the market. Prudential Regulations

Bond issuers must be convinced that obtaining a rating will provide access to a wider investor base for their securities and help reduce the cost of issuing debt. The United States has prudential regulations governing the quality of investments of such institutions as banks, insurance companies, and savings and loan associations. These regulations have provided incentives for issuers to be rated and contributed to the success of US rating agencies. In emerging markets, however, the lack of sophisticated investment cultures and the fact that most institutional investment tends to be clustered in the contractual savings sector necessitate that prudential regulations be in place, as Indonesia has done by passing the new pension fund law. Profitability

Credit rating, over time, can be a profitable business. The opportunity set for rating and financial information services is constantly expanding due to growth in debt markets. However, since rating agencies are service−oriented enterprises, their commercial success depends on the demand for their services and the price users are willing to pay. In industrial countries, demand for rating agency services is firmly established and almost all rating agencies have been profitable. In an emerging market environment, however, rating agencies face several challenges in establishing their commercial viability. They incur losses in their initial years of operation due to high start−up and operating costs, lack of sufficient demand for rating, and a limited number of debt issues. For example, in Asian emerging markets, only two rating agencies—CRISIL (Credit Rating Information Services of India Limited) and RAM of Malaysia—have been profitable, while the Philippine rating agency (CIBI) posted its first year of profits in 1994 after being in existence for more than a decade. Competition

With the exception of Korea, emerging East Asian markets have only one rating agency in operation. A competitive environment in the ratingDelivered industry helpBank ensure objective ratings and eliminate rent−seeking. by will The World e-library to: 000000 However, this may not be practical given the size of0000000000 these markets. In the absence of an adequate number of IP : 000.000.00.00 issuers and investors, the proliferation of rating will not be cost−effective. There must also be enough 000, 00agencies 000 0000 00:00:00 qualified rating analysts and other professional staff in the local labor market to support more than one rating Accounting Procedures and Disclosure Requirements (c) The International Bank for Reconstruction and Development / The World Bank

57

The Emerging Asian Bond Market agency. Given these limitations and the costs associated with establishing rating agencies, most emerging markets should focus their attention, at this stage, on strengthening existing rating agencies and achieving economies of scale by pooling resources, both human and financial. However, in countries with mature or rapidly growing bond markets, new rating agencies should be encouraged. Mandatory Ratings

From a market development perspective, mandatory ratings can help jump start the rating industry, especially when investor demand for credit ratings is low. However, mandatory ratings may discourage issuers from raising funds in debt markets. Incontinue

Malaysia, the central bank ruled that all public debt securities must be rated, and in Thailand, the SEC has instituted a requirement that all unsecured debt must be rated. Indonesia adopted a similar regulation in 1994. Experience in Malaysia and Thailand suggests that mandatory ratings can help the rating industry and contribute to the growth of bond markets. However, it is essential that rating agencies further develop their rating techniques and train their staff to gain the acceptance of market participants. Rating Standards

It is generally perceived that rating processes and the analyses of emerging market rating agencies are not as rigorous as those of their international counterparts. The lack of highly trained professional analysts, the absence of uniform accounting and disclosure requirements, and the ability of an agency to function as an independent entity free from political influence all contribute to this criticism. A particular issue is that agencies rate some domestic corporations above the country's sovereign risk limit. The inflow of foreign investment can help increase the breadth and liquidity of nascent bond markets, and domestic rating agencies can facilitate this effort by striving to earn credibility in the international arena. Role of Institutional Investors

Investors in bond markets tend to be predominantly institutional. The success of the credit rating industry hinges on their demand for ratings. Indeed, in the United States and Japan, the emergence of pension funds, insurance companies, and mutual funds has had a strong positive impact on the use of ratings. In East Asia, institutional investors such as pension funds, contractual savings institutions, and insurance companies tend to be in the public sector. A natural tendency for these institutions is to invest in government securities. With the expected change in their asset allocation policies, these institutions are likely to provide a major impetus for the rating industry. Cross−Border Rating

As the region's capital markets become more and more integrated with further liberalization of capital flows, issuers will increasingly tap different markets of the region in search of low−cost capital and investors will expand their universe of investment opportunities to maximize the return on their investments, regardless of where the issuers are based. In such a scenario, rating agencies face an additional challenge of rating issuers domiciled in other countries and the impact of sovereign risk on their ratings. Credit rating on a reciprocal basis may provide an alternative. Another approach is to encourage national agencies to establish a regional rating company. Such a company could bridge the gap by rating cross−border issues or offer second opinions on the ratings of a national agency. Also, in countries where the bond markets are thin, establishing a local rating agency may not be economical. Regional agencies can mitigate the issue of lack of breadth and depth in national bond markets and achieve economies of scale in improving the quality Delivered by The World Bank e-libraryand to: efficiency of ratings. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Mandatory Ratings

58 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Derivatives In East Asia, the market for derivative instruments has been mostly limited to commodities. The development of commodity futures markets was a natural progression in East Asia, given the region's abundance in commodities such as copra, palm oil, and rice. Financial futures have only recently begun to evolve and are dominated by foreign exchange future contracts. The open capital accounts in many East Asian countries have fostered active foreign exchange markets and necessitated the development of currency futures in recent years in response to increasing demand for effective risk management products. The rapid growth in FOREX futures can be, in part, attributed to fund managers who use derivative instruments such as futures and options to gain access to these countries without exposure to the underlying financial assets. A recent Lehman Brothers' survey8 of institutional investors indicated that currency−oriented derivatives are used by most institutional investors with exposure to East Asia. Although Hong Kong, Singapore, Malaysia, the Philippines, and China all have futures exchanges, active trading has been confined to Singapore's SIMEX—Singapore International Monetary Exchange (see Box 2.2). China's domestic market in treasury bond futures grew substantially in 1995. The development of interest rate futures and swap markets has been relatively slow due to the fact that the underlying fixed income markets are in developmental stages and as such are not active enough to support derivatives market. However, given the rapid pace of growth experienced by the region's bond markets over the past five years, and the expected acceleration in growth of these markets over the next decade, interest rate−linked derivative instruments will soon follow. The Lehman Brothers' study also showed that investors are increasingly becoming interested in interest rate swaps. For example, investment managers indicated a fivefold surge in their intention to use interest rate swaps. Also,continue

the low correlation between East Asian interest rate contracts and the major interest rate contracts in the United States and the United Kingdom has helped increase foreign interest in these products. Taxation The fiscal regime—taxes and related charges such as stamp duty and registration fees—consistently ranks as a priority issue for emerging bond market participants. A recent survey of foreign institutional investor approaches to these markets places taxation with macroeconomic/currency and interest rate/yield considerations as a decisive element in decisionmaking. A 1992 World Bank working paper identified withholding tax levels as a major barrier to portfolio allocation requiring increases in pretax rates of return to be profitable. Complicating the tax analysis are differences in treatments of residents and non−residents, institutions and individuals, treasury and corporate instruments, and interest and capital gains. Disparities between debt and equity withholding influence the broad range of securities choices, as do international accords which provide for relief against double taxation. Corporate taxation can also weigh heavily on trading activity, and limited deductibility can raise the cost of carrying bond portfolios. Emerging Markets Trends

A comparison by region of withholding rates on interest, dividends, and capital gains over the past five years shows that they have fallen in Asia and elsewhere as authorities move to stimulate securities activities. With the market boom during this period, a supply−side type effect has occurred, with lower rates generating increased revenues. However, budget deficits inDelivered severalbycountries havee-library grownto:commensurately, and with financial The World Bank 000000 0000000000 institutions typically constituting a large part of the tax base, new types of transaction taxes have been introduced IP : 000.000.00.00 to raise revenue and so corporate tax obligations secondary 000, 00 for 000 0000 00:00:00 trading have often remained stiff. They also have been proposed to temporarily curb capital inflows which interfere with monetary and exchange rate policy by Derivatives

59 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market placing upward pressure on currencies and expanding money supply. Steep capital gains taxes designed to discourage speculation have been slashed during the period as they tended to stifle securities activity generally and varied widely from interest and dividend withholding. The divergence was especially pronounced for foreign investors who under double tax treaties can usually only claim domestic credit for the latter tax payments.break Box 2.2: Singapore International Monetary Exchange (SIMEX) Without large domestic demand, the Government of Singapore has made a conscious decision to cater to the needs of international investors and to develop Singapore into a regional financial center. Consistent with this goal, SIMEX was established in 1984 to enhance Singapore's ability to provide sophisticated risk management services to international investors. The exchange was designed along the lines of the Chicago Mercantile Exchange (CME) and incorporates many of the latter's well−tried and tested systems which are aimed at safeguarding the financial integrity of the exchange and protecting customer interests. In 1984, SIMEX co−pioneered with the Chicago Mercantile Exchange the SIMEX−CME Mutual Offset System, which straddles two time zones and allows Eurodollar futures trades initiated in either exchange to be liquidated in or transferred to the other, giving market participants benefits such as extended trading hours, more effective management of overnight risk and price movements in different time zones, greater liquidity, reduced transaction costs, and a single margin structure. From a modest beginning of about one−half million contracts in 1985, the trading level has increased more than fortyfold to reach over 24 million contracts in 1994 (Box Figure 1).

Box Figure 1: Trading Activity on the SIMEX (Millions of Contracts) Source: Monetary Authority of Singapore. Currently, futures and options contracts offered on SIMEX include three−month Eurodollar, three−month Euroyen, Nikkei−225 Stock Index, Nikkei−300 Stock Index, and 10−year Japanese Government Bonds. contracts include DeliveredFutures by The World Bank e-library to: three−month 000000 0000000000 Euromark, British Pound, gold, high−sulfur fuel oil, gas oil, MSCI Hong Kong Stock IP : 000.000.00.00 Index, and deferred spot currency contracts000, on00US$/Japanese 000 0000 00:00:00Yen and US$/Deutschemark. Derivatives

60 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market

Table 2.10: Withholding Tax for US−Based Institutional Investors Interest

Dividends

Capital Gainsa

1988

1993

1988

1993

1988

1993

Indonesia

15.0

15.0

35.0

15.0

35.0

0.0

Korea

12.9

12.0

16.1

15.0

0.0

0.0

Malaysia

20.0

20.0

40.0

0.0

0.0

0.0

Philippines 0.0

20.0

5.0

25.0

0.3

0.0

Thailand

15.0

25.0

10.0

12.5

15.0

15.0

a: Long−term capital gains on listed shares. Source: IFC, Emerging Stock Markets Factbook, 1989 and 1994. The shift toward greater uniformity in treatment of securities reflects an evolving consensus among investors and policymakers alike for parity to the extent possible in all financial assets, including bank deposits and commercial paper, to minimize non−commercial distortions. It has altered patterns cited in the 1992 World Bank survey in which capital gains levels on average were much higher than other levies. Clarification and simplification have also been major objectives as uncertainty, multiple rulings, and frequent changes have acted as disincentives to engagement and payment enforcement. Ad hoc behind−the−scenes determination is gradually being replaced with transparent sustained commitments with finance ministries and central banks publishing and disseminating relevant circulars for the first time. These changes have been accompanied by rationalization of paperwork and filing requirements, and the creation of channels for appeal and complaint. In several cases, supplementary tax frameworks for offshore centers have been simultaneously elaborated as conceptual schemes move into actual operation. Country Reviews

The summaries below address tax concerns first for the open markets of Indonesia, Malaysia, the Philippines, and Thailand, followed by the restricted ones of China and Korea. The non−emerging markets of Hong Kong and Singapore, as well as Japan and other industrial countries, are then covered (Table 2.10). They briefly highlight key aspects with a focus on withholding deducted at source on interest, which typically motivates bond investors more than capital gains. Dividend rates are also cited for purposes of comparison which incorporate both domestic Delivered by The World Bank e-library to: and foreign investor perspectives. Further information can be found in the individual country chapters. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Country Reviews

61 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Indonesia

Withholding tax is 15 percent for local investors, and ranges from 0 to 20 percent for foreigners depending on bilateral treaties. For US−based investors the rate is 15 percent, and for those based in countries with double tax accords—including Austria, Belgium, Canada, Finland, France, Germany, India, Japan, the Netherlands, Singapore, South Korea, and Thailand—the burden can be further reduced, with the rate for UK investors, for example, being 10 percent. Government paper—SBI and state agency bonds—is not subject to stamp duty and commission, but registered corporates trade on the exchange must pay a levy of 0.8 percent of transaction value, with a ceiling of 1 percent on the overall brokerage charge. Bearer debenture and OTC issues are exempt from the assessment. The status of zero coupon instruments has received conflicting rulings. Initially they were thought to escape withholding entirely, but recent clarification has treated gains as taxable interest. Confusion stems from the absence of capital gains tax at the source. Previously local investors had to pay a self−assessed 35 percent capital gains levy on stocks and bonds which was widely avoided through transactions with foreign counterparts not liable for the tax. New regulations abolish capital gains tax domestically, although coupon income may be taxed more heavily than deposit income. Fixed−return cross−currency interest rate swaps are not liable for stamp duty or withholding tax. Malaysia

A 20 percent withholding rate is applied generally to both domestic and foreign investors, with no tax on capital gains or stamp duties on transfer. These figures hold for MGS, Cagamas, and corporate bonds, while treasury bills, zero coupon paper, and individual purchase of exchange listed and unlisted company issues rates by the Ratings Agency of Malaysia are tax exempt. For corporate instruments, no commissions are paid for transfers in the over−the−counter market, but a 1 percent charge enters if traded on the KLSE. Tax positions are often arbitraged through the practice of coupon washing: selling bonds before their payment date to buy them back afterward. Cross−currency interest rate swaps often routed through the Labuan offshore center escape tax and stamp duty, although domestic counterparts are subject to strict exposure limits. Philippines

The interest withholding rate for T−bills has recently been raised from 20 to 25 percent, althoughcontinue

transactions are free of capital gains and the final transfer tax of 0.25 percent of trading value. However, there is a corporate tax of 35 percent on bond dealers. As a result, there is no incentive to carry inventory. Two−year government paper just introduced falls under the same regime, although treatment of the revamped corporate bond market due to start this year is still under review. To date, private bond activity has been stifled by the 0.5 percent stamp duty, which places the instrument at a disadvantage with bank deposit holdings, and by the inability of financial institutions to deduct the interest expenses of carrying securities portfolios. Thailand

Domestic investors pay 15 percent interest withholding, and foreigners 10 to 15 percent depending on relevant tax treaties, which apply to, among other countries, Sweden, Denmark, Norway, Japan, Germany, the Netherlands, France, Singapore, South Korea, Italy, Belgium, Pakistan, UK, Indonesia, the Philippines, Poland, Canada, Malaysia, Austria, India, Ireland, Finland, andbyChina. ABank capital gains Delivered The World e-library to: tax of 15 percent can also be reduced, such 0000000000 as in the case of onshore country funds, when 000000 it drops to 12.5 percent. There is no stamp duty, but a 0.1 percent of IP : 000.000.00.00 transaction value—0.3 percent for unit trusts—is imposed for debenture and state enterprise bond transactions 000, 00 000 0000 00:00:00 through the exchange. Several of the latter are tax exempt, and bill of exchange dealing conducted off−exchange Indonesia

62 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market escapes transaction tax. Previously uncertainty in fiscal provisions led to multiple taxation of individuals as each trade was also subject to a 15 percent levy while corporate and institutional investors were exempt. Recent clarification mandates that individuals pay 15 percent on only the first trade. Offshore Thai bank CDs often traded through the Bangkok International Banking Facility are free of all withholding and commission. Thai baht−US dollar interest rate swaps through this means are also exempt. For the four countries, interest withholding tax also applies generally at the above rates for bank deposits; however, for banks and financial institutions, these holdings are often exempt to the extent they form the basis of daily activity. China

Ten percent interest withholding and 0.3 percent stamp duty apply but often are not applied in practice. A moratorium on capital gains has been declared at least through 1995. International investor treatment with partial opening of the market has yet to be determined, although it could parallel the dividend levy of 20 percent for direct investors, many of whom have been recently targeted for audits by revenue authorities. Korea

Bonds are exempt from a 0.35 percent transaction levy which applies to equities, and non−residents pay interest and capital gains of 25 percent—climbing to 27 percent for institutions with establishments in Korea—which can be reduced through double tax agreements. Residents pay at their respective corporate and interest income tax levels, with a 20 percent rate applicable if separately itemized for bonds and bank deposits. From 1995, approved international organizations will be able to issue locally, for which tax exemption is expected. Hong Kong and Singapore

Hong Kong has no withholding tax but a profits tax of 17.5 percent and stamp duty of HK$1.5 per HK$1,000, from which exchange fund bills/government bonds and offshore/supranational issues are exempt. Singapore does not tax capital gains, although dividends are targeted at the marginal 27 percent corporate income rate. Non−residents are exempt from withholding on deposit interest, and approved Asia−dollar bonds, which also escape normal stamp duty, was just halved to 0.05 percent of transaction value. Foreign securities firms acting for their own accounts and overseas clients in approved domestic securities are taxed at a 10 percent concessional rate, also free of stamp charge. Table 2.11: Indicative East Asian Bond Tax Rates Country

Interest Withholding

Transaction Tax

Capital Gains Tax

Indonesia

020

0.8

0

Korea

020

0.35

25

Malaysiaa

20

1.0

0

Philippines

25

0.25

0

Thailanda

1015

0.1Delivered by The World15Bank e-library to: 000000 0000000000

IP : refer 000.000.00.00 a: Transaction taxes for Malaysia and Thailand to exchange 000, 00 000 0000 00:00:00 trading.

China

63 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Source: World Bank. Withholding and associated taxes are an important dimension in bond market development. Table 2.11 shows indicative taxes on the bonds in East Asian countries. Local investors deciding between bank deposits, equity, and debt will want to ensure that interest, dividends, and capital gains treatment do not unduly favor asset choices. High interest withholding can create a disincentive to bond participation and deepening of the securities sector. Differences between government and corporate instruments can also impede growth of the latter, and preferred status is unnecessary in many Asian markets with low budget deficits. Turnover tax can also cramp securities activity generally, both on−and off−exchange, keeping savers confined to traditional banking products, while corporate tax and limits oncontinue

deductions can impede secondary trading and the participation of intermediaries. For overseas investors, taxes join exchange rate trends and regulations, custody, and other elements as primary features in market judgment. They look to equal treatment with domestic counterparts both in terms of rates and payment conditions, and alignment with emerging markets elsewhere in the global perspective. In broad measure, Asian taxation is competitive with other developing regions. The slow development of Asian bond markets has translated into scant attention to tax definition and interpretation, presenting both domestic and foreign investors with legal and administrative uncertainty and complexity, frustrating engagement and spawning loopholes bringing domestic revenue seepage. Importantly these complications have often driven activity offshore both in the region and globally, where taxes, when they exist at all, are lower and the associated framework is far better defined. Local markets must ensure that rate disparities are not exacerbated by additional research and compliance costs and that efforts are geared to providing offsetting protections and predictability. A ready temptation for onshore development to proceed is the imposition of special fiscal incentives, but such extraordinary measures should be avoided. Rates should remain broadly in line with other financial instruments so as not to skew flows and invite backlash from other asset holders, which may again spur sudden tax code changes. Summary and Conclusions In 1994, the size of the East Asian bond market was US$338 billion or 22 percent of GDP. Although this is small relative to the world bond market, the growth in these markets has been quite impressive. Indeed, this market doubled in size over 199094 though equity market capitalization, and the assets of the banking system still remain quite large at 71 and 92 percent of GDP, respectively. At the country level, the bond markets in China, Korea, Indonesia, and the Philippines have more than doubled (in local currency terms); Thailand and Malaysia have registered growth rates in excess of 35 percent. The East Asian bond market comprises five distinct sectors: national government bonds, state government bonds, state enterprise bonds, central bank securities, and corporate bonds. Among the issuer universe, historically, national governments have dominated the primary markets. In the last five years, however, there has been a clear shift in this trend in many East Asian countries. In the light of fiscal surpluses in all East Asian countries except for China and the Philippines, the prominence of the government bond sector has been steadily declining while the state enterprise and corporate segments have been growing rapidly. This trend is expected to continue over the next decade, with infrastructure investment and corporate expansion being the main driving forces. In contrast, Delivered by The World Bank e-library to: the bond markets in China and the Philippines are dominated 000000 0000000000 by government bonds, and it is expected that this IP : 000.000.00.00 segment of the bond market will grow rapidly in the future. 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market Among investors, the contractual saving sector, financial institutions, and pension funds constitute the major investor classes. In Korea, Thailand, and the Philippines, the bulk of bonds are held by financial institutions, while in Malaysia and Singapore, the contractual saving sector is the main investor in bonds. These institutional investors have accumulated vast amounts of investable funds and are expected to remain the main investors in bonds even though their dominance is expected to decline somewhat with the emergence of new institutional investors such as mutual funds and insurance companies. Bond issuance methods vary across East Asia. Traditionally, most government bonds were administratively allocated among captive investors such as commercial banks. However, many East Asian countries have moved decisively toward issuing bonds through competitive auctions. A well−functioning secondary market requires both sound policy framework and efficient supporting institutional infrastructure. These include: (a) market−based benchmarks; (b) efficient clearing, settlement, and payment systems; (c) liquidity support facilities; (d) well−functioning credit rating agencies; (e) central information systems; and (f) non−discriminatory taxation. Most East Asian countries are taking concrete measures to build such infrastructure. Hong Kong, Malaysia, and Thailand have been making progress in developing the supporting institutional infrastructure to facilitate trading activity. To develop vibrant secondary markets, policymakers and regulators must address a host of issues—institutional and policy−oriented. On the institutional side, the establishment of electronic clearing and settlement systems is a priority. The establishment of CMU in Hong Kong has greatly facilitated secondary market trading. The CMU is operated by thecontinue

Hong Kong Monetary Authority and performs the role of a central custodian and clearing agent for Hong Kong dollar debt instruments. This system also has international linkages. Malaysia established the SPEEDS system to expedite clearing and settlement and to ensure the safety and accuracy in transactions. Other bond markets in the region are also moving in this direction, although progress has been slow. Secondary market liquidity has been thin in East Asia, mainly because of the absence of well−capitalized market makers and the lack of liquidity supports. It is crucial that this issue be addressed quickly. To facilitate market−making activity, dealer financing and liquidity supports are essential. This means the creation of REPO markets and central bank rediscounting windows, which have been absent throughout the region. Such facilities currently exist in Hong Kong. Thailand and Malaysia also operate such facilities, but they are limited to banks and should be expanded to include accredited dealers. The issue of benchmarks should receive greater attention than in the past. The absence of liquid benchmarks has been a serious constraint in pricing bonds and consequently has hampered trading. East Asian bond markets face a unique constraint in this area as many governments in the region do not issue bonds. A promising alternative would be to use state enterprise bonds to establish benchmark yield curves, although at present state enterprise bonds do not have a critical mass of outstanding bonds and their issuance has been sporadic. However, this is expected to change as corporatization of state enterprises gathers momentum and bond financing becomes the instrument of choice. Another viable approach is to develop implicit yield curves from offshore swap rates. While this has immediate potential—Indonesia and Thailand have already been using swap rates to price bonds—the maturities of these swaps have been rather short. The absence of liquid swap markets in Asian currencies also limits their use as benchmarks. Securities issued by mortgage corporations such as Malaysia's Cagamas should also be considered. Another related issue in fostering the development of bond markets is credit rating. Most East Asian countries now have rating agencies. However, their effectiveness in providing timely and accurate information to the marketplace has been mixed. While rating agencies in Malaysia andto:Thailand have been quite successful, Korea's Delivered by The World Bank e-library 0000000000 rating agencies have been ineffective because 000000 of the requirement that bond issues be guaranteed. In the IP : 000.000.00.00 000, 00 000 0000 00:00:00 Philippines, the ownership structure of the rating agency and its perceived ineffectiveness have limited its role. In many countries of the region, credit ratings are now mandatory. This may be justified at this time given that the Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market bond issues are limited in number and the issue sizes are relatively small. However, as these bond markets mature and investors become more sophisticated, mandatory rating should be lifted. Bond markets cannot thrive without active participation from institutional investors. In many countries of the region, there are stringent regulatory requirements on their asset allocation and investment strategies. Commercial banks are subject to high liquidity reserve requirements, and the contractual saving sector has mandatory requirements to hold government bonds. For example, in Singapore, the CPF holds about 80 percent of government bonds. These rigid asset allocation requirements need to be relaxed to stimulate further development of secondary markets. The East Asian governments, especially Singapore and Malaysia, have taken the lead in this area.break

3— Regulation of the Emerging Asian Bond Market Introduction An efficient and well−functioning bond market requires a regulatory system with well−defined objectives, transparent supervision procedures, an adequate and clear legal framework, and a well−structured regulatory body capable of implementing policies. Effective regulation must take into account economic costs as well as benefits. Regulation that permits markets to perform their important economic function of efficient capital mobilization and allocation is more effective than a system that largely relies on government micro−management and market control. This means, in operational terms, a regulatory infrastructure that enables investors, issuers, and intermediaries to make informed decisions in a transparent fashion and thus inspires confidence among market participants. This chapter discusses the existing regulatory framework and regulatory models employed in selected developed countries and East Asian countries and the important role being played by the newly created securities commissions in the region. Securities Market Regulatory Systems There are important differences between the regulatory systems employed to supervise market operations and to protect investors in developed and those in emerging securities markets. Bond market regulation varies across countries depending on the level of market and financial sector development, legal frameworks, the extent and quality of self−regulation, and the mission of the regulatory body. The extent to which the legal framework and government policies have encouraged development of specialized securities firms and investment banks—as opposed to universal banks or financial conglomerates—to provide capital market services is an important institutional factor. This is important from both a market development and a regulatory stand−point because of the significant differences in the risks associated with capital market instruments and more traditional commercial banking. In some countries, government−controlled banks have played dominant roles in the financial sector, making it more difficult to create the required infrastructure for securities market development and its regulations. The impetus given to developing securities markets by governments and the private sector differs in developed and emerging securities markets. Industrial country securities markets usually began as a private response to meet an economic need. Their stock exchanges were organized by private individuals as membership organizations to facilitate transactions in securities. In contrast, securities markets in developing countries have more often been established by governments with specific goals in mind, or governments at least have played a role in the development of securities markets to aid capital mobilization, privatization, and other economic goals. As a result, Delivered by The World Bank e-library to: the authorities in these countries have a larger 000000 stake 0000000000 in ensuring successful development of the market.1 This IP : 000.000.00.00 diversity in approach has naturally led to diversity in regulatory mechanisms. The design of a regulatory system 000, 00 000 0000 00:00:00 involves several policy options. Will there be direct government regulation, self−regulation, or some combination 3— Regulation of the Emerging Asian Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market of the two? Will there be an independent regulatory body, or will the regulatory body be part of a government ministry? Will the government be involved in the management and control of the market? Will functional regulation prevail, or will regulation be conducted by assigning financial institutions to a regulatory body based on the principal type of business they conduct? Or, will hybrids of these approaches be used? One of the most important considerations is the extent to which market forces and private decisions will be relied on to guide the allocation of capital in the short and long runs. These policycontinue

considerations will affect the type of regulatory regime that is chosen and the extent to which markets will be able to perform their basic economic function of capital mobilization and allocative efficiency. Economic Rationale for Regulation

Two basic economic functions of securities markets must be recognized in developing a regulatory regime. First, securities markets mobilize capital. Second, if operated efficiently, securities markets provide market discipline by allocating capital to its most productive uses. Achieving allocative efficiency requires that secondary market prices be determined in a fair and transparent manner based on market forces. It is necessary to recognize that regulation has a cost as well as a benefit. The most difficult task of any regulator is to balance the costs and benefits of regulation by devising a regulatory regime that allows the market to perform its essential economic functions while protecting investors. The costs of regulation are both direct and indirect. Direct costs include the administrative costs of operating government regulatory bodies, the cost of self−regulation, and the cost to market participants and investors of complying with the rules of government and self−regulatory bodies. Indirect costs are the costs of economic misallocation caused by regulation, failures to raise capital due to administrative controls or cumbersome regulatory procedures, and costs imposed on the market by preventing anti−competitive behavior by market participants, or cartel arrangements that increase transaction cost to investors. Contracts and Property Rights

Clearly defined property rights and the ability to enforce contracts are essential to efficient capital markets. Alan Greenspan has observed that ''the cornerstone of any well functioning market system is the law of contracts."2 For investors to be willing to surrender funds in exchange for a promise of future returns in the form of interest or dividend payments, they must have confidence that contract terms will be honored. If contracts cannot be readily enforced, transaction costs will be higher. The ability to execute financial transactions rests on a legal and regulatory structure that fosters public confidence in the integrity of the market. Contract enforcement is also important to the operation of efficient secondary markets. Failure to deliver securities or cash within prescribed time frames, for example, can threaten counterparty performance and result in large losses to investors in volatile markets and damage other market participants, clearing organizations, and other financial markets. Thus, the enforceability of contracts is crucial in reducing systemic risk in the financial markets. The enforceability of contracts is especially important for bond market development. The legal rights and obligations of bond holders and issuers need to be clearly defined and the provisions of the bond contract (normally referred to as a bond indenture) must be enforceable. In the United States, for example, the Trust Indenture Act requires that corporate trustees be used for corporate bonds offered to the public. Corporate trustees are chosen to represent the interests of bond holders and have a fiduciary obligation to them. Bond contracts must have certainty with respect to methods of interest payment and principal repayment, provisions for early retirement, and the integrity of any collateral securing the bond. Definition of a Security Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 of the securities regulatory body is 000, 00 000 0000 00:00:00

The first step in delineating the role to define the meaning of the term "security." The legal definition of a security is important in protecting investors and in defining the jurisdiction of Economic Rationale for Regulation (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market the regulatory bodies supervising the financial sector. This legal definition can be complex.3 The most common forms of securities are stocks, notes, and bonds, but options and other financial instruments can also be included in the definition of a security. A distinction between money and bond market debt instruments is normally drawn on the basis of maturities. Debt instruments with maturities of less than one year are normally defined as money market instruments; these include negotiable certificates of deposit, commercial paper, interbank loans, short term government paper, and other negotiable debt instruments. While these instruments are normally short term, some—such as variable rate commercial paper—may be issued with maturities of up to five years. Marketable debt instruments with maturities longer than one year are usually categorized as notes or bonds—that is, capital market debt instruments—depending on the length of maturity. Notes normally have maturities of one to five years, while bonds have longer maturities. However, in emerging markets, the vast majority of capital market debt instruments have maturities of one to five years and are categorized as bonds. There must be clarity as to the responsibilities and authority of the securities regulatory body and those responsible for regulating commercial banks and other intermediaries comprising the financial sector. This is important to ensure that some issuers of securities, or similar instru−soft

ments, and intermediaries do not escape regulation. This is most likely to occur in instances where an intermediary—such as a broker−dealer—does not fall within the legal definition of a bank or securities firm. The role of each regulatory body must be clear with respect to supervising money and capital market instruments issued by private firms, the government, and government−owned enterprises. The term security may or may not include futures and options contracts, as the legal definition of a security is not uniform throughout the region. As these markets are clearly interrelated, it would appear highly desirable for the securities commission to have responsibility over derivative products as they are introduced to the market. Organization of Markets

Clear rules are essential for efficient financial transactions. Securities markets, either stock exchange or over−the−counter markets, require some form of organization to ensure that market participants can transact with one another in a fair and efficient manner. In the absence of direct government regulation, stock exchanges have historically exercised some form of self−regulation over their members to assure that rules of conduct are obeyed and that members exhibit sufficient financial responsibility to assure that transactions can be effected without disrupting the market. Sometimes these rules take the form of economic regulation, or even cartel arrangements, for the benefit of stock exchange members. To a large extent, the role of government regulation is to assure that these rules operate in the public interest. Type of Regulatory Models

Several regulatory models are used in securities markets. The most common is a variant of the basic US model that allows relatively free markets, competition in the financial sector, and practitioner−based self−regulation accompanied by strong government oversight. This model has recently begun replacing the more traditional practitioner−based self−regulatory model that was often employed in developed markets and in some emerging securities markets. The traditional approach to regulating securities markets is based on the principle that only minimal formal government oversight of the stock exchange and market practitioners is necessary. A third model—often employed in countries with new and emerging securities markets—is a regulatory regime under which government exercises extensive management and control over the securities market. In some countries, government management and control over the market is accomplished with the help of self−regulatory Delivered by The World Bank e-library to: organizations—which are sometimes given monopolistic powers to engage in what otherwise would be 000000 0000000000 IP : 000.000.00.00 considered anti−competitive activities. A fourth regulatory system employed in many countries is one of direct 000, 00 000 0000 00:00:00 government supervision or control over the market with minimal reliance on self−regulation. In emerging Organization of Markets (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market securities markets, it is important to recognize that the securities regulatory bodies are usually responsible for both promoting the development of and regulating the market, whereas in mature markets their role is generally limited to regulation. Most countries employ hybrid models. Many countries are in transition from controlled environments to systems that rely more on market forces to allocate capital, with strong government regulatory oversight to ensure that prudential standards and other safeguards to protect investors are in place. Regulation in East Asia

Regulation on fixed income securities in East Asian countries has gone through a major change in recent years. Until 1991, central banks were largely responsible for regulating fixed income securities since they are considered as deposit substitute instruments. With the creation of the new securities commissions (Securities and Exchange Commission in Thailand in 1992 and the Securities Commission in Malaysia in 1993), the primary responsibility for fixed income securities has shifted to these commissions. However, the practice is still not uniform. The regulatory scope of Indonesia's securities regulator, BAPEPAM, is limited to financial instruments with maturities exceeding one year, and the central bank is responsible for regulating money market instruments. In Singapore, all financial instruments are regulated by the Monetary Authority of Singapore. Hong Kong and the Philippines follow the more common path of placing private sector bond offerings under the jurisdiction of a securities commission. In Malaysia, the issuance of marketable debt instruments, including corporate bonds, still requires approval by Bank Negara Malaysia, the central bank, as subscribing to bonds is deemed to be deposit−taking under the 1989 Banking and Financial Institution Act. Furthermore, approval for issuing private sector bond offerings must be obtained from the Securities Commission and the Registrar of Companies, which has considerable power over the registration of prospectuses under the Companies Act of 1965. In the Philippines, the Securities Commission regulates the issue of commercial paper by banks and nonbank financial institutions. Notwithstanding these divergent practices, the trend in favor of giving the main responsibility for bond market activities to the securities commission is clearly emerging in the East Asia region. In Thailand, SEC has the sole responsibility for regulating the bond market.break

Government Oversight and Self−Regulation The role of regulatory bodies in securities markets is influenced by their stage of economic development and institutional and legal considerations. In the United States, the Securities and Exchange Commission does not have the legal authority to engage in merit regulation or to control the prices or quantity of issues brought to the market. Its mandate is to ensure orderly functioning of the securities market by setting clear rules for issuers and intermediaries, and to provide adequate protection for investors through disclosure requirements and surveillance of market participants. In countries with new and emerging securities markets, regulatory authorities often exercise extensive influence over the market by controlling the number and quality of issues brought to the market and, in some countries, determining the price at which securities can be issued. Role of Securities Commissions Developed Markets

The United States has the oldest and most experienced national regulatory body in the world. Its SEC was established in 1934 with the passage of the Securities and Exchange Act in the aftermath of the stock market crash of 1929 to administer federal securities laws and protect investors by ensuring that markets are fair and honest and that market practitioners comply with applicable laws and regulations. The legislation followed the Banking Act of 1933, which generally required the separation of investment banking and commercial banking, and the SEC Delivered Thesecurities World Bank activities e-library to: of commercial banks. The courts have held does not have direct regulatory authority overby000000 the 0000000000 IP :of 000.000.00.00 that banks are not included within the definition "broker−dealer" under the 1934 Act. 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market The US SEC is an independent regulatory body headed by a chairman and four commissioners appointed by the president for staggered five−year terms with the advice and consent of the Senate. Commissioners cannot be removed except for cause. While the SEC is independent of other government departments, it is subject to substantial oversight by the US Congress, and its rules and decisions are subject to challenges in the courts. Its annual budget is approved by the Office of Management and Budget and the US Congress. One unique aspect of the US regulatory regime is its very open and transparent rule−making process. Commission meetings to discuss and act on proposed rules, or modifications to existing rules, are public. Rule proposals must be published in the Federal Register so that the public is afforded adequate opportunity to comment, and are adopted by majority vote. The SEC supervises only the securities markets—including options, which US law defines as securities. A separate regulatory body, the Commodity Futures Trading Commission (CFTC), supervises commodities markets, including futures contracts on stock indices and other financial futures. The separation of the commodities and securities regulatory bodies is primarily due to historical circumstance in that commodities futures were once regulated by a bureau within the US Agriculture Department that later became the CFTC. US law does not permit futures contracts on individual stocks. Japan

Japan based its 1947 Securities and Exchange Law on the US model.4 A Securities Bureau to administer the law was established within the Ministry of Finance. A Securities Exchange Council was formed in 1952 with members appointed by the ministry to provide policy advice on matters related to the securities markets. The Securities Bureau supervises Japan's securities and futures markets, with self−regulation playing an important role in the supervision of market practitioners. Although disclosure principles are well established, merit regulation has been widely practiced in the new issues market. Moreover, commission rates on the Tokyo Stock Exchange remain fixed, unlike in the United States and United Kingdom, where they are deregulated. Although there are differences in the administration and enforcement of securities laws, Japan and the United States both rely on self−regulation with strong government oversight. In Japan, however, the securities markets have traditionally been subject to government management. United Kingdom

The practitioner−based self−regulatory model, without formal government oversight, was employed by the London Stock Exchange until the passage of the Financial Services Act in 1986. In addition to creating a more competitive marketplace by deregulating commission rates and permitting foreign ownership of stock exchange firms, the 1986 Act established a Securities and Investments Board (SIB) with extensive powers to regulate securities and investment activities through a network of self−regulatory organizations. The SIB, which is self−funded through fees levied on regulated entities, is overseen by the Department of Trade and Industry. Anyone conducting a securities or investment business must be supervised by a self−regulatory organization, or by the SIB directly.break

The Bank of England plays an important role in establishing prudential standards for financial institutions and controlling the issuance of Sterling−denominated domestic and international bonds. Before the Financial Services Act, the international market based in London was subject to only limited self−regulation of secondary market operations. Also, the issuance of Eurobonds denominated in currencies other than the dollar was often controlled by the issuer's home government. International borrowers could issue bonds in the US domestic securities market or the dollar currency sector of the Eurobond market without being subject to such controls. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market Germany

Germany established its securities regulatory body, the Federal Securities Supervisory Office (FSSO), only in January 1995. The FSSO has four main responsibilities: monitoring trading and taking enforcement actions to prevent unlawful insider trading; monitoring disclosure of transactions involving significant shareholders of listed companies; developing rules of good conduct for market professionals; and coordinating and fostering international cooperation on securities regulatory matters. The FSSO president is appointed by the president of Germany in consultation with the land minister. In 1990, the First Market Promotion Law abolished taxes on stock exchange turnover, the bill of exchange tax, and broadened the investment scope of German investment funds. It also abolished approval procedures for issuing domestic bonds, which, along with the elimination of the turnover tax, facilitated development of a market in D−mark commercial paper. Amendments to the Stock Exchange Law created the legal conditions that permitted options and futures trading in Germany. All of these measures were intended to improve the German capital market in anticipation of a more competitive European and global capital market in the 1990s. Prior to the creation of the FSSO, there was no special government agency in charge of securities regulation, and the federal government had very little supervisory authority over the markets for corporate securities. The supervision of the stock exchange was carried out by the state securities commissioners. East Asian Markets

Most East Asian countries have recently established commissions to regulate and develop securities and bond markets. The Philippines Securities and Exchange Commission, established in 1936, is the oldest securities commission in the region. It was not until 40 years later that BAPEPAM (the Indonesia Capital Markets Supervisory Agency) was established in Indonesia, followed in 1977 by the Korean Securities and Exchange Commission. Since 1992, securities regulatory bodies have been established in Thailand, Malaysia, and China. Hong Kong

In 1989, Hong Kong reshaped its regulatory system in the aftermath of the stock market crash and disruptions in the futures market by creating the Securities and Future Commission (SFC) to replace the Securities Commission, the Commodities Trading Commission, and the Office for the Commissioner for Securities and Commodities Trading and to oversee the securities and futures markets. The stock exchange and futures exchange were also reconstituted. The SFC's mission is to promote confidence in the efficiency and fairness of the securities and futures markets, support market development, especially in relation to capital formation in China, and balance regulatory goals against the need to accommodate further market development and innovation.5 The SFC is an independent agency with extensive authority to regulate the securities and futures markets. It has a clear mandate to foster the continued development of the Hong Kong market. It was established as an autonomous statutory body outside the civil service and is largely self−funded,6 but is accountable to the government and reports to the financial secretary. The annual budget must be approved by the governor and presented before the legislative council. The governor appoints its ten directors and may give policy direction to the SFC. The Hong Kong Stock Exchange is a self−regulatory body under the oversight of the SFC; it has been delegated important regulatory responsibilities over its members, corporate issuers, and the market operation. Singapore

The Monetary Authority of Singapore (MAS) is responsible for developing and regulating securities markets. Before passage of the 1986 Securities Act, the regulatory model employed in Singapore was practitioner−based self−regulation exercised by the StockDelivered Exchange Singapore (SES), by TheofWorld Bank e-library to: although certain regulatory responsibilities 000000 0000000000 are delegated to the stock exchange and SIMEX. With respect to futures trading, under the Securities Act, the IP : 000.000.00.00 Monetary Authority has substantial powers000, and00effective control over the securities markets and intermediaries. 000 0000 00:00:00 The SES supervises regulatory requirements for prudential standards, licensing, maintenance of books and Germany

71 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market records, financial reporting, annual audit, market surveillance, and insider trading and manipulation. The SES is governed by a nine−member committee undercontinue

MAS oversight. In addition, the Securities Industry Council, whose members are appointed by the government, serves as an advisory body to the Minister of Finance and administers the Singapore code on takeovers and mergers. The Registrar of Companies and Businesses administers prospectus requirements for public companies, while the MAS regulates Asian dollar bond issues offered in Singapore. Philippines

The Philippine Securities and Exchange Commission was originally based on the US model. However, the regulatory model employed appears to be based more on merit regulation, and self−regulation is not well developed in the Philippines. A revised Philippines Securities Act was enacted in 1982, and other major laws administered by the SEC include the Corporation Code of 1980, the Investment Company Act of 1960, and the Financing Company Act of 1969. Presidential decree 902A established the SEC as a quasi−judicial body with authority to investigate and prosecute fraud and other misconduct, adjudicate corporate disputes, and interpret the laws it administers. No domestic or foreign securities, other than exempt securities (i.e., government securities), may be offered to the public without being registered with the SEC. In addition to acting as a securities regulatory body, the SEC also serves as a registrar of companies. It has jurisdiction over all corporations, partnerships, and associations required to register with the SEC. While the Philippine's SEC is the oldest in Asia, it has played only a marginal role in developing the capital market, which has been hampered by institutional and economic impediments. In recent years, the government has taken steps to improve the economic underpinnings of the capital market and the Asian Development Bank has provided technical assistance to strengthen the SEC. Korea

The Korean Securities and Exchange Commission (KSEC) and its executive body, the Securities Supervisory Board (SSB), were established under the revised Securities and Exchange Law in 1977. In Korea, the regulatory model employed traditionally has been one of government administration and control over the securities markets, with self−regulatory bodies playing an important role in the regulatory process. The KSEC and the SSB are responsible for developing and regulating the Korean markets at the direction of the Ministry of Finance and Economy (MFE). The SEC chairman serves as the governor of the SSB. In addition to regulating the securities markets and related institutions, the MFE and the KSEC have traditionally exercised considerable direct control over the market, securities firms, issuers, cross−border investment flows, foreign participation in the Korean securities industry, and access to the international markets by Korean issuers and securities firms. The Korea Stock Exchange and the Korean Securities Dealers Association serve as self−regulatory bodies with respect to the operation of the exchange and over−the−counter markets and their members.7 The Korean finance ministry exercises considerable control over the SEC and SSB in administering the securities laws. Although the authority to implement regulatory policies is delegated to the KSEC, it must immediately report decisions to the MFE, which can cancel or suspend all, or a part, of these decisions and, in some instances, may order the SEC to take actions. In addition to the Securities and Exchange Law, the Commercial Code, the Securities Investment Trust Business Law, and the Law on Fostering the Market govern the regulation and supervision of Korean securities markets and participants.8 Indonesia Delivered by The Worldwas Bank created e-library to: The Capital Market Supervisory Agency (BAPEPAM) in Indonesia in 1976 by the Ministry of 000000 0000000000 Finance under broad powers granted to the Ministry under Law Number 15 of 1952, as amended in 1990 and IP : 000.000.00.00 000, regulatory 00 000 0000 00:00:00 1991. Fundamental changes in the Indonesian system and capital market occurred with the implementation of the 1990 Capital Market Decree. This decree changed the mission of BAPEPAM by

Philippines

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The Emerging Asian Bond Market transferring ownership and administration of the Jakarta Stock Exchange from the government to the private sector and expanding BAPEPAM's regulatory responsibilities. Indonesia now has two private stock exchanges under the oversight of BAPEPAM. Until 1990, BAPEPAM was responsible for the operation of the Jakarta Stock Exchange (JSE). The Surabaya Stock Exchange was established under private ownership in 1988. Both JSE and the Surabaya Stock Exchange perform self−regulatory functions under the supervision of BAPEPAM. However, the Ministry of Finance, which formulates capital markets policy, remains the ultimate regulator of the capital market. While BAPEPAM is not an independent agency, it has substantial responsibility for carrying out the day−to−day supervision of the market and issuers, and for licensing underwriters, broker−dealers, and investment managers. BAPEPAM has both regulatory and investigative powers and can take legal actions through the Ministry of Finance. Since the 1990 reforms, there has been movement away from government administration and control over the market toward a system based more on disclosure principlescontinue

and prudential standards for intermediaries. Further movement in this direction is expected under a revised securities law expected to be adopted in the near future. Thailand

The Securities and Exchange Act of 1992 established the Thai Securities and Exchange Commission. In addition to regulating the securities business, the SEC has a mandate "to formulate policies to promote and develop, as well as to supervise," securities markets, issuers, and related entities.9 Before 1992, the securities business was supervised by the Ministry of Finance, the Bank of Thailand, and the Stock Exchange of Thailand (SET). The act gave the SET greater independence to serve as a self−regulatory organization. As a result, the SEC does not regulate the day−to−day operations of the stock exchange; its role is to establish overall policy and approve major stock exchange regulations. Before the establishment of the SEC, the securities business was supervised by two government ministries and the SET, resulting in some inconsistency and inefficiency in the enforcement of securities regulations.10 Thailand appears to be in transition to a system that will rely primarily on disclosure and prudential standards administered by the SEC with substantial responsibilities for day−to−day market supervision delegated to self−regulatory organizations. China

The China Securities Regulatory Commission (CSRC) was created in October 1992 by the State Council as an executive agency of the State Council Securities Policy Committee (SCSPC). Under the direction of the SCSPC, the CSRC administers and supervises the securities markets and industry, and formulates regulations. The Peoples' Bank of China (PBC) supervised China's securities markets before 1992. The CSRC is responsible for regulating and monitoring equity and bond markets. The PBC is in charge of licensing securities companies and mutual funds. In China, most securities companies are operated by banks. The State Planning Commission (SPC) also plays an important role in policy coordination, issuing an annual securities plan in conjunction with the SCSPC. Finally, the Securities Association of China—which includes securities firms, trust and investment companies, and the Shanghai and Shenzhen stock exchanges—serves as a self−regulatory body. In addition to the two stock exchanges that were approved by the State Council to operate on an experimental basis, two computerized electronic over−the−counter markets trade bonds. The Securities Trading Automated Quotation System (STAQS) was established in July 1992 by the Stock Exchange Executive Council.11 In April 1993, the National Electronic Trading System was launched by China Securities Trading System Corporation, by The World Bank e-library to: which is owned by the Peoples' Bank Delivered of China, four 0000000000 other large banks, three securities companies, and the Peoples 000000 IP : 000.000.00.00 Insurance Company. While CSRC rule making can affect the operation of STAQS and NETS, it does not directly 000, 00 000 0000 00:00:00 regulate the two electronic trading systems whose trading is largely confined to debt instruments.12 Local Thailand

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The Emerging Asian Bond Market regulatory bodies have also been established by municipal governments in Shanghai and Shenzhen.13 Debt securities and T−bond futures are traded on China's two stock exchanges. Prior to the establishment of the CSRC, Shanghai and Shenzhen had separate legal frameworks governing their securities markets. Equity securities must be listed and traded on the Shanghai Securities Exchange or the Shenzhen Stock Exchange. As is common in the region, over−the−counter trading in listed equities is not permitted. Both stock exchanges perform self−regulatory functions over their members. Because China's securities markets are relatively new, securities laws and related legal frameworks are still being drafted.14 In the absence of a national securities law, administrative measures govern the operation of the securities markets.15 Malaysia

The Malaysia Securities Commission was established in March 1993. In addition to the regulation of the securities business, the securities commission will have responsibility for the administration of the Futures Industry Act of 1993 once futures trading begins in Malaysia. There are two main regulatory agencies in the financial system—Bank Negara (the central bank) and the Securities Commission. Prior to the creation of the Securities Commission, there were six governmental bodies involved in capital market supervision.16 Two private bodies—the Kuala Lumpur Stock Exchange and the Rating Agency of Malaysia (private bonds must receive a rating before being issued)—are also involved in the regulatory process. Malaysian corporate bond issues require approval from Bank Negara and the Securities Commission. Bank Negara supervises and regulates the banking system, including the money markets. The Securities Commission is responsible for regulating and developing the securities industry and markets, derivatives, unit and property trust, and takeovers. It is a self−funded statutory body with regulatory, investigative, and enforcement powers. The commission has established acontinue

Securities Industry Development Center to educate the investing public, directors, and shareholders; promote professionalism in research, fund management, stock−broking, and the underwriting business; and promote training programs for regulators in Malaysia and other Asian countries. Although merit regulation is still practiced in Malaysia, a major goal of the Securities Commission is to move toward disclosure−based securities offerings. Governance of Securities Commissions

Securities commission governance, which influences the quality of regulation, has varied across East Asia. Asian securities regulators have not been as independent as those in more developed countries such as the United States and the United Kingdom. Most East Asian regulatory bodies play important roles in formulating strategy for the development of securities markets and related institutions. Government representation by the ministry of finance, central bank, and other ministries involved in financial sector development, law, and regulation can improve coordination among policymakers and help assure that securities markets get the attention they require in the early stages of market development. Only in the Philippines are government ministries not represented on the governing board of the securities regulatory body. The Korean SEC has nine commissioners—six appointed by the president on the recommendation of the minister of finance and economy and three ex−officio commissioners—the governor of the Bank of Korea, the chairman of the Korea Stock Exchange, and the vice minister of finance. Three of the appointed commissioners, including the chairman, are full−time standing commissioners and three serve on a part−time basis. The governing body of the Thai SEC is composed of five ex−officio members—the minister of finance, who serves as chairman, the Delivered by The World Bank e-library to: governor of the central bank, the permanent secretaries of the Ministries of Finance and Commerce, and the 000000 0000000000 IP four : 000.000.00.00 general secretary of the office of the SEC—and to six members appointed by the cabinet on the 000, 00 000 0000 00:00:00 recommendation of the Minister of Finance. Only the general secretary is a full−time post.17 Malaysia

74 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market The Malaysian Securities Commission has an executive chairman, four public members, and four private sector members, all appointed for three−year terms. The public sector members represent the Ministry of Finance, Bank Negara, Ministry of Primary Industries, and the Economic Planning unit. The private sector members are comprised of two lawyers, one accountant, and one banker. The Philippine SEC has a chairman and four associate commissioners, all full−time, who decide regulatory matters on the basis of majority votes. The chairman serves as the chief executive officer of the commission, and each of the four associate commissioners has certain line responsibilities for management. The Philippine commission's market development role does not appear to be as strong as in Korea, Thailand, or Malaysia.18 As an executive agency created by the State Council, China's CSRC administers and supervises the securities markets under the directorship and supervision of the SCSPC. The CSRC is composed of a chairman, two vice chairmen, a secretary general, and several commissioners.19 The CSRC acts as an executive agency for the SCSPC, which is comprised of the heads of 14 ministries and commissions including the Ministry of Finance, the State Planning Commission, the Ministry of Foreign Trade and Economic Cooperation, and the State Commission for Restructuring the Economic System. The SCSPC is responsible for broad policy formulation with respect to the securities markets, and the CSRC for market supervision. There is an interlocking arrangement between the governing bodies of the SCSPC and the CSRC, with the CSRC chairman serving as first deputy director of the SCSPC. Indonesia's BAPEPAM is not an independent agency but functions more as an adjunct to the Ministry of Finance, and its chairman reports directly to the minister. While BAPEPAM can make policy recommendations, the ministry is the ultimate regulator of the capital market and is responsible for policy formulation for the capital market. BAPEPAM does not have an independent governing body. One of the important factors in establishing the independence of the SECs is the degree of financial independence. The Thai and Malaysian securities commissions are self−funded (i.e., transaction fees on securities). As a result, they have been able to operate more like private institutions and have been able to attract and retain highly qualified staff. Consequently, the staff has provided leadership in introducing necessary reforms to foster development of their financial markets. This is a model which should be of interest to other SECs in the region. Role of Self−Regulation Developed Markets

In most industrial country securities markets, including the United States, United Kingdom, and Japan, much of the day−to−day regulation of the markets is conducted by self−regulatory organiza−soft

tions, such as stock exchanges and clearing organizations, under the oversight of a government regulatory body. US stock exchanges were already regulating their members when the SEC was created. Indeed, it is not possible to operate an organized securities market without agreed rules, and it is in the interest of market practitioners to ensure that rules of conduct are obeyed so that securities transactions are conducted in a fair and honest manner. With the passage of the Securities and Exchange Act of 1934, much of the responsibility for regulating the US securities markets was left to the stock exchanges and other self−regulatory organizations, subject to strong oversight by the SEC. US self−regulating organizations are required to register with the SEC and obtain approval of their rules. In general, stock exchanges are responsible for market surveillance, the day−to−day supervision of their members, and rule enforcement with respect to their members. Every broker−dealer registered with the SEC must join a self−regulatory organization. Self−regulation also plays an important role in the United Kingdom and Delivered by The World Bank e-library to: Japan, and anyone conducting securities or investment business in Britain must belong to a self−regulatory 000000 0000000000 IP : 000.000.00.00 organization, or be regulated directly by the000, SIB. 00 000 0000 00:00:00

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The Emerging Asian Bond Market Self−regulatory organizations in both developed and emerging securities markets can play an important role in arbitrating and resolving disputes among market participants. Arbitration, which is a contractual, non−judicial method of resolving disputes, is used extensively by US organizations, and can be a fair and efficient means of resolving disputes and avoiding the costs of litigation, which is pervasive in countries with complex legal systems such as the United States. US arbitration proceedings are administrated by the self−regulatory organizations themselves, and, while the SEC oversees the process, it cannot intervene on behalf of or directly represent individual investors, or vacate or modify an arbitration decision. The grounds for judicial review of arbitration decisions are quite limited.20 In emerging securities markets, arbitration offers promise as a vehicle for enhancing investor confidence. This would especially appear to be the case in countries where the court system is not well developed, or where judges may not be well trained in securities law. This is not uncommon. In most countries in the region, the securities laws are relatively new, or have been substantially modified in recent years. East Asian Countries

Each of the eight East Asian markets covered in this study has some degree of self−regulation. One of the important basic tasks for countries with new and emerging securities markets is to develop more fully the potential of stock exchanges and other private sector organizations to serve as self−regulators. While this requires the delegation of responsibilities to market practitioners to act as front line regulators, it also calls for strong government oversight. Thailand, Korea, and Malaysia rely largely on delegation of authority for market supervision as a part of self−regulation. Indonesia's BAPEPAM permits the two stock exchanges now in private hands to regulate themselves. The Philippines is an exception, but this apparent weakness in its regulatory mechanism may be corrected with the recent establishment of a new unified stock exchange. China's Securities Industry Association, in which all securities firms and the two stock exchanges are members, functions as a self−regulatory body. China's securities markets and regulatory bodies are relatively new, and effort is still needed to build the infrastructure necessary to support them. Given China's size and its potential for a large and diverse securities market with a wide range of financial instruments, it could benefit greatly from a system of self−regulation to supplement government regulatory oversight. Enforcement of Securities Regulations

Enforcement of securities regulations is essential to protect investors and preserve the integrity, fairness, and efficiency of the securities markets. If, for example, a country does not have the legal and accounting infrastructure for a disclosure−based system at the early stage of market development, this should be recognized at the outset. While the economic benefits of allocative efficiency can best be achieved through a disclosure−based system that relies on market discipline to determine the merits of securities offerings, such a system cannot be relied upon without the trained accountants, lawyers, and analysts essential to the proper functioning of the market. The development of infrastructure necessary to make a disclosure−based system effective should be given high priority. The short term objectives such as listing standards can be relied upon to control the quality of publicly traded issues. Developed Countries

The enforcement mechanism is the most highly developed in the United States, whose legal infrastructure has evolved over many decades. The principal areas in which enforcement actions have been instituted include insider Delivered by The Worldwith Bank e-library to: offerings; violations in connection trading; market manipulation; violations in connection securities 000000 0000000000 withcontinue IP : 000.000.00.00 000, 00 000 0000 00:00:00

East Asian Countries (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market changes in corporate control; and financial disclosure and reporting. Enforcement actions initiated by the SEC generally are preceded by an examination pursuant to the commission's inspection powers, or by an investigation. The SEC is authorized to file injunctive actions in federal court and proceed administratively against regulated entities and certain other persons and entities. It is authorized, among other things, to seek fines and disgorgement of ill−gotten gains. The staff may also provide substantial assistance to criminal authorities for criminal prosecution of securities violations. International cooperation has become important with the increased volume of cross−border securities transactions. East Asian Markets

East Asian markets have grown rapidly without strict enforcement, and there have been some major securities fraud cases in countries such as the Philippines and Thailand. However, East Asian countries have made notable progress in improving enforcement in recent years. Thailand's enforcement mechanism improved dramatically with the establishment of the SEC in 1992. Before the adoption of the SEC Act, investigation into unfair practices in the stock market was conducted by the Stock Exchange of Thailand, but procedures for enforcement could be protracted, involving personnel from the SET, Bank of Thailand, and Ministry of Finance. Enforcement responsibilities are now clearly within the domain of the Thai SEC.21 In Malaysia, the SEC has important investigative and enforcement powers and serves as the focal point for securities market enforcement, while the prosecution of cases is referred to the Justice Ministry. In the Philippines, the SEC has direct enforcement, powers, and in some instances, it may even act as a quasi−judicial agency. In Indonesia, although BAPEPAM has investigative powers, it can take legal action only through the Ministry of Finance. Hong Kong has also improved its enforcement capability. Regulation of Securities Markets, Private Issuers, and Intermediaries Private Issuers of Securities

Disclosure and accounting standards that enable investors to make informed judgments about the purchase and sale of new issues of securities are an important element of securities market regulation. Efficient operation of secondary markets also depends on a continuous flow of information about companies whose securities are being traded. The US securities regulations, the most advanced in this regard, generally focus on the disclosure of information rather than the merits of the issuer or a particular security. The regulations contain detailed disclosure requirements, and a general requirement that the materials used in connection with an offering not contain any material misstatements or omissions. Under this full−disclosure approach, individual investors, rather than regulators, have responsibility for evaluating the merits of an investment. As a practical matter, however, institutions and individual investors often depend on private analysts, rating agencies, brokers, investment advisors, or other securities professionals to evaluate the available information about an issuer or the securities being offered. Without adequate accounting, auditing, and financial reporting, it is not possible for the securities markets to properly value a company. Investors can be misled and funds misallocated in the economy. Securities issuers are required to incorporate financial information in their registration statements, periodic reports, and other documents filed with the SEC and made available to the public. Greater emphasis is now being placed on the adequacy of accounting and disclosure standards in both industrial and emerging securities markets as disclosure−based systems replace government control over the issuance of securities. Merit regulation is more common in East Asia markets than in more developed markets. Even the United States, however, has merit regulation under the securities laws of certain states.22 Several of Asia's emerging markets are now in transition from a system of merit regulation to one based primarily on the principle of full and fair disclosure. The Securities Commission of Malaysia, for example, has set a major goal of evolving from merit Delivered by The World Bank e-library to: regulation to disclosure−based regulation.23 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

East Asian Markets

77 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market With the establishment of new securities commissions in the region, disclosure standards are improving, with greater emphasis now being placed on the quality of information disclosed to investors. Thailand's SEC Act had a major impact by increasing the emphasis on disclosure standards in the public offering of securities. It also liberalized the requirements for public bond offerings. Prior to the passage of the SEC Act, companies not listed on the SET were not permitted to issue bonds in the public market. In a public offering, the issuer must satisfy the SEC that the issuer has experience in the business and that the business is financially viable. The issuer must file with the SEC for permission to issue the bond. The issuing process takes about 60 days. Bonds may also be offered privately if sold to no more than 35 investors (though the number may exceed 35 if one or more of the investors are among 17 institutionscontinue

specified by the SEC). In Thailand, a private placement requires SEC permission, but the issuing process takes only about two weeks. For an unsecured debenture, permission to issue is automatic once the bond is registered with the SEC and regulations for selling and transferring the issue are complied with. For a secured and subordinated debenture, permission is automatic if the SEC does not object within seven business days. In Korea, the issuance of bonds is limited to listed companies or companies registered with the Securities and Exchange Commission, and a company that is not listed on the stock exchange must register with the SEC before it can issue bonds. To issue bonds, a company must meet registration and disclosure requirements administered by the SEC. The issuing company must file a registration statement or a shelf registration, along with other documents such as the guarantee contract for the payment of principal and interest and a copy of the underwriting agreement.24 The lead manager must submit an underwriting plan to the SEC and the Korean Securities Dealers Association, which are authorized to recommend that the lead manager change the volume and time schedule for the public offering if necessary to protect investors. After the registration becomes effective, the issuing corporation must enter into a contract with a transfer agent for the publication and distribution of bond certificates. Also, copies of the registration statement and prospectus must be available to the public before receiving applications for subscriptions from investors. A performance report—available to the public—must be filed with the SEC once subscription payments are completed.25 In the Philippines, disclosure requirements are administrated by the SEC through the registration process. However, there is an element of administration and control over the issuance process, and private issuers must disclose information to investors concerning the business history of the company, the qualifications of directors, along with audited financial statements and independent valuations of assets. Issuers must also file sworn statements with regard to information required to be disclosed under the Securities Act and the rules and regulations of the SEC. Corporate bonds are not listed or traded on the Philippines Stock Exchange (PSE), but bond trading is planned. The PSE is in the process of developing listing standards, which must be approved by the SEC.26 For the future, it would appear appropriate to rely upon a combination of SEC disclosure standards and PSE bond listing requirements as the criteria for determining eligibility for public offerings. As in most countries, government securities are exempt securities and are not required to be registered with the SEC. Issuance requirements for public securities offerings in Indonesia are not covered under Indonesian Law, though the requirements for offering securities are likely to be set forth in a revised securities law. The basic definition of a public offering is contained in a 1990 ministerial decree, and BAPEPAM is responsible for determining the conditions and procedures for public offerings, specification of disclosure standards, and for determining the effectiveness of registration statements. BAPEPAM can require that certain standards be met for debt securities, including guarantees or collateral, or require that the leverage ratio of an issuer not exceed a certain level. It is anticipated that these requirements will change once a rating agency becomes operational. The regulations appear to cover only listed issues and privateDelivered placements notBank clearly defined. This may be a problem for short−term by Theare World e-library to: 000000 0000000000 commercial paper that is considered a money market instrument covered by banking regulations, and there is a IP : 000.000.00.00 000, 00 000 0000includes 00:00:00 the concept of an accredited institutional investor. need to develop a definition of private placements that The new Thai securities law, the Malaysian Companies Act, or the US concept of a private placement or an East Asian Markets

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The Emerging Asian Bond Market offering under Rule 144a27 could serve as a basis for defining private placements. Bond issues in China must be approved by the Securities Administration Department of the State Council. While bonds offered to public investors must be listed, current regulations are unclear on where they should be listed. The Company Law sets forth basic disclosure provisions for information memoranda that accompany bond issues, documents that must be provided to the State Council to obtain approval, and the form and content of bond certificates. Issuers are required to maintain a registrar of bond holders. China's Company Law also contains provisions establishing criteria such as company asset size, earnings history, and use of proceeds from the offering that must be met in issuing bonds.28 Three types of companies are authorized to issue bonds: companies limited by shares; companies with limited liability with at least two shareholders that are state−owned entities; and companies wholly owned by the state. Listed companies must issue financial and accounting reports every six months and prepare financial reports at the end of each fiscal year that are examined and verified.29 Under regulations administered by the CSRC, listed companiescontinue

must provide them the stock exchange interim reports within 60 days of the end of the first six months of each fiscal year and audited annual reports within 120 days of the end of the fiscal year. China offers an interesting example of the diverse institutions that can be involved in regulating and supervising the issuance of bonds. For bonds issued by financial institutions and investment funds, the Peoples' Bank of China is in charge of inspection and approval, while the State Planning Commission has responsibility for bonds offered by state investment companies. Both agencies must inspect and approve central enterprise (i.e., corporate) bonds. Regional enterprise (corporate) bonds and bonds issued by regional investment companies must obtain approval by provincial or municipal government, whereas the Finance Ministry is in charge of the issuance of state treasury bonds. Secondary Market Regulation

Secondary market trading plays a very important role in the capital mobilization process. While bonds are normally listed on the stock exchange, trading generally occurs in the over−the−counter market because of the unique features of bonds. Unlike stocks, bond buyers are interested in several variables (yield, price, rating) which have to be factored in the trade. Standard quotations are just the beginning of the trade. Furthermore, the volume involved in bond trading generally tends to be much larger and institutional in nature. An efficient secondary market enables investors to trade securities after an initial offering to the public. The availability of liquidity is extremely important for development of the bond market. Secondary market trading, if conducted in an efficient and transparent manner, allows securities to be priced by market supply and demand forces. Market surveillance is normally the front−line responsibility of the stock exchange as a self−regulatory organization with the securities commissions acting in an oversight capacity. East Asian Markets

In Malaysia, secondary market supervision is carried out by the Securities Commission and the Kuala Lumpur Stock Exchange as a self−regulatory organization. The stock exchange has on−going responsibility as the front−line regulator with oversight by the securities commission. The Market Supervision Division of the Securities Commission conducts surveillance and compliance. It monitors trading to detect unusual price and volume movements, market manipulation, or insider trading. It also conducts investigations and collects evidence to support prosecutions for securities law violations. Likewise, in Thailand, secondary market surveillance is a responsibility of the stock exchange with oversight by the SEC. In Korea, the Korean Stock Exchange is Delivered by The World Bank e-library to: responsible for the day−to−day supervision of 000000 the market for listed securities, while the Korean Securities Dealer 0000000000 IP : 000.000.00.00 Association functions as the self−regulatory000, authority for the over−the−counter market. In Indonesia, the two 00 000 0000 00:00:00 stock exchanges are responsible for supervising listing and trading requirements; they can take action against a Secondary Market Regulation (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market member or the trading staff. In China, the PBC has a role in the ownership (i.e., the NETS trading system), operation, and regulation of secondary market trading facilities. Regulation of Securities Firms

A number of intermediaries and market professionals are essential to the operation of a securities market. These include brokers, dealers, and underwriters of securities. The functions of a broker, dealer, or underwriter may be performed by specialized securities firms, investment banks, or diversified financial firms—such as universal banks or merchant banks—offering wide arrays of financial products to investors and issuers. Some countries permit securities firms and universal banks to compete in providing capital market services. Competition in the financial sector can contribute to market efficiency and foster the development of a wide array of financial instruments for issuers and investors. Some countries in East Asia restrict the type of entities that can perform investment banking services, such as underwriting, or require different licenses for brokers and dealers in securities even if the same entity is performing each function. Others require the separation of the functions of brokers and dealers, which may impede the development of the dealer function. In regulating securities firms, it is essential to devise registration, entry, and financial responsibility standards, and reporting requirements. It is also important to monitor the financial condition of securities firms and inspect and examine firms to ensure compliance with capital and other regulatory requirements. The type of business conducted has a direct impact on the level of risk assumed by firms delivering services to the money and capital markets and raises important issues with respect to the protection of investors. Customers of securities firms, banks, and other market professionals must be protected from fraud or other misconduct, or in the event of a firm's insolvency. In Korea, securities firms registered with the Finance Ministry are the principal intermediaries in the private bond market, acting as underwriters, brokers, and deal−soft

ers in corporate bonds under the Securities and Exchange Act. Securities firms are supervised by the SEC and the SSB, and by the KSE and Korean Securities Dealers Association (KSDA) as self−regulatory bodies under the oversight of the SEC. The SEC and the SSB are responsible for regulating securities firms, monitoring their financial condition, and conducting on−site inspections. Commercial bank participation in the bond market is limited under the General Banking Act and regulations issued by the Monetary Board and the Bank of Korea. Commercial and development banks may participate in the primary government bond market as members of the Government Bond Underwriting Syndicate, and in the secondary market for corporate bonds for their own and their customers' accounts within prescribed limits. In the Philippines, broker−dealers in securities must be registered with the SEC and meet capital and financial responsibility requirements. Broker−dealers that are also members of the Philippines Stock Exchange are subject to regulatory oversight by the stock exchange. A Securities Investors Protection Fund protects public investors in the event of the insolvency of a broker−dealer.30 In addition to broker−dealers, universal banks and investment houses provide capital market services to private issuers and investors in securities. The underwriting activities of commercial banks may be carried out in−house by setting up a department within the bank, or by establishing a separate subsidiary. In addition to underwriting activities, universal banks may promote and manage mutual funds. Brokers play a role in distributing securities as members of underwriting syndicates. Most dealers in government securities are commercial banks. As such, they are regulated by the central bank. Broker−dealers registered with the SEC may also participate in the government securities market. Delivered by The World Bank e-library to:

Indonesian financial institutions are regulated000000 by the0000000000 Finance Ministry, except for licensed banks, which are IP : 000.000.00.00 regulated by the central bank. The ministry 000, has00delegated BAPEPAM the power to issue licenses for underwriters, 000 0000 00:00:00 broker−dealers, and investment managers in securities. These entities are also subject to supervision by the stock Regulation of Securities Firms (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market exchanges. In Korea, Thailand, Malaysia, and China, securities firms are subject to prudential standards and other regulations imposed by regulatory bodies and self−regulation by the stock exchange or, in the case of Korea, the exchange and the Korean Securities Dealers Association. In Korea, only a company that has obtained a license from the Ministry of Finance can operate as a securities company. Securities companies perform the function of broker, dealer, and underwriter. Foreign securities firm participation in the securities business is restricted by a requirement that more than 50 percent of paid−in capital be owned by a Korean individual or corporation. In China, all financial institutions, including securities companies, are licensed by the PBC. The CSRC has on−going regulatory responsibilities for the activities of securities firms, while the principal self−regulatory body over securities firms is China's Securities Industry Association. Regulation of Government Securities and Intermediaries Government securities are normally exempt from registration and disclosure requirements with the securities regulatory body. The secondary market for government securities and issuing procedures in the primary market are normally the responsibility of the central bank, or similar institution. Intermediaries in government securities may be regulated by the central bank or securities commission depending on the type of institution that acts as broker or dealer in government securities. Commercial banks, deposit−taking companies, and similar institutions are normally regulated by the government authority responsible for the regulation of banks and financial institutions, while securities firms or investment banks acting as intermediaries in government securities are regulated by the securities regulatory body. Government Securities Dealers Developed Countries

Supervision of most major firms involved in the secondary market for government securities in the United States is part of the overall supervision of these entities. One of the federal banking supervisors—usually the Comptroller of the Currency—supervises banks involved in the market, which includes a number of primary dealers. The main focus of this supervision is to ensure these banks' financial soundness. Securities firms involved in the market fall under the jurisdiction of the SEC. This supervision focuses on financial soundness and customer protection, although it does not extend to subsidiaries of registered broker−dealers, which in many cases are unsupervised. Prior to 1986, US banks engaged in government securities transactions were subject to regulation by the appropriate bank regulatory authority. Brokers and dealers registered with the US SEC (that may also have engaged in the government securities business) were subject to its supervision. However, firms that were notcontinue

financial institutions and conducted a business solely in government securities and other exempt securities (other than municipal securities) were largely unregulated at the federal level because they were not required to register with any regulatory agency as a result of their activities. Subsequent to the passage of the Government Securities Act of 1986 (GSA), it became necessary for previously unregistered brokers and dealers in government securities to be registered with an appropriate regulatory body.31 The GSA gave authority to the US Secretary of the Treasury to promulgate rules and regulations concerning financial responsibility, protection of investors, securities and funds, record keeping, reporting, and auditing of government securities brokers and dealers.32 Formerly unregulated government securities dealers were required to comply with capital requirements and other regulatory safeguards for the first time. However, firms involved in the market but not brokering or dealing may Delivered by The World Bank e-library to: be exempt from supervision. Firms operating in government 000000 0000000000securities outside the United States are also not IP : 000.000.00.00 covered by the supervisory regime.33 000, 00 000 0000 00:00:00

Regulation of Government Securities and Intermediaries (c) The International Bank for Reconstruction and Development / The World Bank

81

The Emerging Asian Bond Market Publication of quote, price, and trade information had been incomplete until recently, but the Federal Reserve Bank of New York has developed a better market surveillance system in the last two years that uses economic price data to detect anomalies that may be associated with market manipulation. US authorities recently received authorization to request reports of large position in securities where pricing anomalies exist. The US offers examples of problems that can arise in the supervision of government securities intermediaries. In the US, the failure of several unregulated government securities dealers between 1975 and 1985 caused a number of savings and loan institutions, municipalities, and school boards to incur sizable financial losses.34 It is estimated that between 1982 and 1986, investors lost $900 million due to the failures of unregulated government securities dealers. The losses resulted primarily from repurchase agreement (REPO) transactions with the failed government securities dealers.35 In the US, all of the firms that failed were outside the federal regulatory structure, which led to the passage of the Government Securities Act of 1986.36 There appear to be at least three factors involved in the US experience in the early 1980s. First, there was a lack of regulatory supervision for an important segment of the secondary market in government securities in both instances. Second, safeguards for the protection of customers' government securities held by dealers on behalf of their customers were not adequate. Finally, there were inadequate checks and balances built into the systems to reduce the potential risk exposure to customers. The market for government securities in the United Kingdom centers around Gilt−Edged Market Makers (GEMMs), firms approved by the Bank of England, which also acts as the supervisory agency, and authorizes and supervises two special types of institutions, the inter−dealer−broker and stock exchange money brokers who transact business with the GEMMs. Other participants in the gilts market fall under general investment regulations, and must be authorized by the Securities and Investment Board and join a self−regulatory organization. This does not apply to firms operating offshore, but covers foreign firms operating in the country. It also does not apply to investors in gilts and other securities.37 Firms operating in the market for treasuries fall under the money market supervision system. Firms conducting wholesale transactions in the sterling money market or in the foreign exchange or bullion markets must be listed by the Bank of England under its wholesale market supervision system. This listing extends a system of checks on firm management, reputation, and financial positions. Firms conducting non−wholesale money market transactions fall under the general securities regulation/supervision of the SIB and its self−regulatory organization.38 The UK authorities monitor market participants intensively. GEMMs submit daily electronic reports of their position in each gilt issue to the Bank of England. For money market firms, the Bank requires fortnightly reports on risk exposures and capital positions except for pure brokers, which submit monthly reports. The Bank can also spot−check firms to ensure continuous compliance with its capital requirements. UK securities firms also are subject to detailed investor protection rules. Most securities firms, including GEMMs, are subject to the rates of the Securities and Future Authority, a self−regulatory organization under SIB. Wholesale money market firms are subject to a lighter regulatory system under the Bank of England. Japanese banks and securities firms acting as market makers for government bonds must receive permission to operate from the Finance Ministry, which examines their capital levels and management before granting licenses; it also authorizes brokers in the markets.continue

Trading in government securities can Delivered take place either or on the by The WorldOTC Bank e-library to: Tokyo Stock Exchange, where all domestic 000000 0000000000 bills, are traded.39 bonds, including government securities other than short−term IP : 000.000.00.00 000, 00 000 0000 00:00:00

Regulation of Government Securities and Intermediaries (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Most dealers and brokers in securities markets in Germany are banks. In contrast to the United States and Japan, there is no legal distinction in Germany between securities firms and commercial banks. Banks are licensed and supervised by the Federal Banking Supervisory Office. Some brokers, however, fall outside this supervisory system and are licensed and supervised by one of the eight regional stock exchanges. The implementation of a new regime with a federal securities supervisor is under way.40 East Asian Markets

In Hong Kong, dealers in government securities include banks and independent securities dealers. These entities are regulated by the Monetary Authority (banks and deposit−taking companies) and the SFC (securities dealers). In Korea, both banks (regulated by the central bank) and securities firms (supervised by the KSEC and Ministry of Finance) participate as brokers and dealers in the government securities market. All financial institutions in Singapore are regulated by the Monetary Authority. In the Philippines, the central bank is responsible for regulating commercial banks dealing in government securities and the activities of primary dealers in such securities, while the SEC regulates dealers in government securities to the extent that they are registered broker−dealers in non−exempt securities. Accredited government securities dealers, commercial banks, and investment houses are subject to regulation over their government securities activities; however, it appears that secondary market dealers not falling into one of these categories may not be subject to supervision under the regulatory regime. In the spring of 1994, the failure of a secondary dealer in government securities—apparently involving the sale of non−existent government securities for future delivery—brought into question the adequacy of regulatory supervision. This failure was apparently aided by the Philippine practice of using confirmations of sale under which securities are expected to be delivered up to one or two months in the future. These confirmations are used by secondary market dealers in government securities due to operational constraints involving the delivery of securities at the central bank. Most investors do not receive securities purchased but instead receive a confirmation and a safekeeping receipt, and this exposes investors to substantial risks. This exposure will be dramatically reduced with the planned implementation of fully automated book−entry clearance and settlement of all private and government securities. Regulation of Investment Companies An investment company (referred to as unit trusts in many countries) is essentially an organization that is primarily engaged in investing in securities. It offers investors diversification of risk and professional investment management. There are several types of investment companies; the most common are open−end (mutual) funds and closed−end funds with a variety of investment objectives. Both types of funds are prominent in industrial and emerging securities markets. Also, many closed−end country funds are listed on major stock exchanges around the world that invest in the emerging securities markets of specific countries. Investment company regulation should require that: the purpose, form, and management of investments be clearly specified; disclosure to investors be accurate and complete; pricing accurately reflect market conditions; and high standards for management and financial responsibility be maintained. Investment company regulations should provide for the registration with the regulatory body charged with supervising investment companies, the filing of regulatory reports, monitoring, inspections, and examinations. It is also desirable to have checks on management through independent directors, shareholder elections, and outside auditors. It would also appear useful to have reasonable restrictions on the use of fund assets to promote distributions, and limits on the compensation paid to investment advisors. Finally, competition and innovation in the provision of investment company services to investors should be encouraged. Delivered by The World Bank e-library to:

000000 0000000000 important. Their role in capital markets in general In East Asia, investment companies are becoming increasingly IP : 000.000.00.00 and in bond markets in particular is expected in the coming years. Therefore, it is essential that they 000,to00increase 000 0000 00:00:00 are properly regulated. The investment companies in East Asia are normally regulated by the securities

East Asian Markets

83 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market commission, the Ministry of Finance, or both. In Thailand, under provisions of the 1992 Securities and Exchange Act, a company must be licensed by the SEC as a securities company and receive approval to manage a mutual fund. Before offering securities of the fund, a prospectus must be prepared in accordancecontinue

with SEC rules and the management company must appoint a custodian. All of the fund's assets must be deposited with the custodian, who is required to be a commercial bank or qualified financial institution under the Securities and Exchange Act. The custodian, commonly referred to as the mutual fund supervisor, must meet financial responsibility and other regulatory requirements relating to internal controls and the relationship between the custodian and the sponsoring securities company. The custodian must also file reports with the Thai Securities and Exchange Commission. Until 1992, only the Mutual Fund Company, which was partially owned by the government, was authorized to sponsor mutual funds in Thailand. With the establishment of the Securities and Exchange Commission, the mutual fund industry was deregulated and new licenses were granted to seven management companies. The number of mutual funds floated rose from about 10 in 1992 to 87 in 1995. Malaysia and the Philippines are trying to encourage development of the investment company industry through legal and regulatory reforms that will expand the range of collective investment structures allowed by law. Indonesia is in the process of changing its law to permit private investment companies. In contrast, Korea has an established securities investment trust industry. Korean securities investment trusts and their management companies are regulated by the Ministry of Finance. There are two types of investment trusts: unit and open investment trusts.41 A trust company must obtain a license from the Finance Ministry, and the management company is required to invest fund assets primarily in listed securities. Under the 1993 Malaysian Securities Commission Act, unit trusts must file a registration statement and a prospectus must be filed with the Securities Commission. The management company must meet certain financial responsibility requirements and appoint a trust company as an independent advisor. Prior to the establishment of the securities commission, unit investment trusts were regulated by an informal Committee on Unit Trusts established by the central bank. One goal of the Malaysian Securities Commission is to expand opportunities for investors to invest in unit trusts by diversifying the range of collective investment structures allowed by law. The 1990 Indonesian Capital Markets Decree opened the Indonesian investment company business to the private sector. Before 1990, PT Danareksa, a government−owned investment company, was the only company permitted to establish an investment company. The Ministry of Finance authorizes licenses, while BAPEPAM is responsible for regulations controlling the operations of the fund and its relationship to its shareholders. Up to now, only closed−end funds have been permitted. However, regulations are being amended to permit open−end mutual funds. Summary and Conclusions An effective regulatory system should consider both the costs and benefits of regulation. At the initial stage of market development, regulations should not be complex and burdensome, lest they impede the development of the capital market. This is especially true in new markets without a large number of trained lawyers and accountants or an appropriate institutional framework. Regulatory bodies in new and emerging securities markets normally have two functions: to foster market development and to regulate it. The developmental role should focus on introducing and encouraging a full range of capital market and money market instruments. Once new instruments emerge, the regulatory body should take center stage to see that the rules are observed fairly and transparently so that the public confidence in the bond market is enhanced and sustained. Securities only Delivered commissions by The World Bankhave e-library to: recently been established in Malaysia, 000000 a 0000000000 Thailand, and China, but China has not yet adopted national securities law. In Malaysia and Thailand, the IP : 000.000.00.00 00 000 0000 00:00:00 securities commissions are in the process of000, implementing new regulatory regimes. In Indonesia, the responsibilities of the Indonesian Capital Market Supervisory Agency were significantly modified in 1990, and a Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

84

The Emerging Asian Bond Market revised capital markets law is expected to be adopted in the near future. Thailand, Malaysia, and Indonesia appear to be committed to greater reliance on disclosure and market mechanisms, rather than on merit regulation and government control over the issuance of securities. Although Korea is in the process of liberalizing market access, the general thrust of regulation has been to rely on regulatory controls and merit regulation. Table 3.1 provides a profile of the regulatory system in the East Asian countries. Regulatory systems can be expected to evolve. Clearly, the extent and type of regulations needed will change as the securities market infrastructure and institutional framework are put in place and the market evolves. It is important to decide who will perform the essential regulatory functions. Often this will involve more than one government body and one or more practitioner−based self−regulatory organizations. The United States, for example, has relied on a system of self−regulation sincecontinue

Table 3.1: Asian Bond Markets: A Profile of Regulatory Systems Korea

Philippines

Singapore

Hong Kon

BAPEPAM Securities SEC Commission

SEC

SEC

MAS

SFC

Established 1992

1976

1993

1992

1977

1936

Reports to

State Council

MOF

MOF

MOF

MOF

MOF

Funding

Government Government Self−Funded Self−Funded Government Government Self−Funded Largely & Fees & Fees & Fees Self−Fund

Regulator

China

Indonesia

CSRC

Malaysia

Thailand

1989 MOF

Finance Secretary

Prospectus CSRC Filed with

BAPEPAM SEC ROC BNM

SEC

SEC

SEC

Stock Exchange

SFC SEH

Approvals

Varies

3

5

2

1

1

1

1

Merit Review

Yes

Yes

Yes

No

Yes

Yes

No

No

Mandatory No Yes Yes Yes No No No Rating 1934 with strong government oversight over the securities markets. The US model, with appropriate modifications, could be employed effectively in many emerging securities markets.

No

The legal infrastructure for bond markets is also important. Well−conceived and clearly defined contract and property right laws are essential to the development of bond markets, as are laws that permit corporations to issue bonds without requiring bank guarantees or other non−essential regulatory requirements that add to the cost of issuance. Unless bond market contracts can be enforced, investors cannot be expected to participate in the market. Also, excessive regulation or administrative procedures can impede the development of the market, as will a lack of clarity as to what is expected to obtain approvals for the issuance of bonds or other financial instruments. Also, the line of demarcation between the money and bond markets should be clear, particularly when issuance requirements or procedures are more burdensome for bonds than for money market instruments. Delivered by The World Bank e-libraryplacement to: There is a clear need to define the conditions under which private of debt instruments will be 000000 0000000000 IP : 000.000.00.00 permitted. Private placements—offerings to a limited number of investors or to sophisticated institutional 000, 00 000 0000 00:00:00 investors—can reduce the cost of debt financing. The concept of shelf−registration should be considered for

Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

85

The Emerging Asian Bond Market public offerings of debt securities to allow segments of an issue to be brought to market over a specified period of time as market conditions dictate. Designated regulatory authorities and requirements for money market instruments must be clear. Regulations should also allow non−listed companies to issue debt paper provided they meet the disclosure and bond−listing standards applied to public companies and listed bonds. In several East Asian countries, over−the−counter trading in equities is not permitted, which may have harmful spillover effects into the bond markets in which trading is normally over−the−counter, with dealers playing a prominent role. The absence of an over−the−counter market may have contributed to the lack of development of a dealer function, which is of vital importance for bond market development in many Asian markets. Another factor that has retarded development of dealer functions and secondary market trading in government debt securities is the immobilization of significant amounts of government debt through requirements that financial institutions and provident funds hold significant portions of their assets in the form of those securities. As more sophisticated instruments—such as derivatives—are introduced into the debt markets, or the use of repurchase agreements is permitted to finance positions in securities, it is imperative to develop appropriate regulatory safeguards and programs to educate investors about the risks and rewards of investing in such transactions. Also, with respect to repurchase agreements, or similar financing techniques, there is acontinue

clear need to ensure that customer funds and securities are adequately protected through prudential standards, record−keeping, clearance, settlement, and custody procedures that adequately protect investors. Governments should choose regulatory models appropriate to the stage of development of their bond markets. If the regulatory framework chosen calls for investors to decide on the merits of a particular investment based on the principle of full and fair disclosure, the necessary pre−conditions for such a system must be in place. Market efficiency is diminished by creating one regulatory regime on paper (i.e., disclosure−based standards) but employing merit regulation in actual implementation. Finally, the success of a fledgling bond market is predicated on the existence of well−informed investors, market professionals, and regulators. Each of these key participants has to have a solid understanding of new financial instruments and their characteristics, trading mechanisms, and procedures for the clearance, settlement, and safekeeping of securities. As the market becomes more sophisticated with the emergence of financing techniques such as repurchase agreements, or hedging strategies through the use of derivatives, it is important that both governments and the private sector develop training programs that enable market participants and regulators to understand the intricacies and complexities of these financial products.break

4— Internationalization of the Emerging Asian Bond Market Role of Foreign Portfolio Investment Introduction

This chapter reviews the patterns of private portfolio investment in East Asian countries against trends in international portfolio flows. Analysis of the underlying factors, the returns, and the policy initiatives, in particular in the domestic bond markets, clearly indicates that East Asia is well poised for further increases in its Delivered by The World e-library to: share of global investable capital through portfolio flowsBank both in equity and bonds. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

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86

The Emerging Asian Bond Market Overview

Private capital flows to developing countries have shown a spectacular increase in recent years. These flows increased by four times during the 199093 period. In 1993, total private capital flows to developing countries amounted to US$159.2 billion, a 55 percent increase over 1992. Out of this amount foreign portfolio investments, both equity and debt−creating flows, amounted to US$45.7 billion, or 58.2 percent (Table 4.1). Spurred by strong growth in portfolio investment flows as well as foreign direct investment (FDI), private source financing now accounts for three−quarters of aggregate resource flows to the developing world. The share of private capital was less than one−third of the total until the late 1980s. The striking growth in private capital flows has several key characteristics: (a) the growing dominance of non−debt flows—equity investment flows accounted for two−thirds of private capital flows in 1993; (b) within flows from private sources, the shift from bank to non−bank sources in the form of securitized flows such as bond issues; (c) strong and sustained growth in FDI, which is being facilitated by structural and secular (as opposed to cyclical) developments, including the global integration of production; (d) the shift from predominantly sovereign to mainly private flows—private−to−private flows now represent roughly 70 percent of the 1993 net flows to developing countries, compared to 47 percent in 1990; and (e) the predominance of recipients of middle−income countries, which have either avoided the debt problem or dealt with their debt overhang, and are now experiencing a surge of private investment flows. Table 4.1: Private Capital Flows to All Developing Countries, 198993 198993

%GDP

1992

%GDP

1993

%GDP

412.2

1.9

102.7

2.3

159.2

3.5

202.9

0.9

47.1

1.0

66.6

1.5

76.0

0.3

14.2

0.3

46.9

1.0

76.2

0.3

12.9

0.3

42.1

0.9

Loans and other 57.1

0.3

28.5

0.6

3.6

0.1

Total Private Capital Flows Foreign Direct Investment Portfolio Equity Flows Debt−creating Flows Bonds

Source: The World Bank. In 1993, total private capital flows to the East Asian countries amounted to US$63.1 billion, of which US$28.7 billion, or 45.5 percent, was in portfolio flows. Sixty−three percent of the portfolio flows were in equity flows. Portfolio investment in bonds of the East Asian countries amounted to US$8.2 billion in 1993 (Table 4.2). Unlike Latin America, portfolio flows to the East Asian bond markets have been limited because the major markets in the region have been closed to foreign portfolio investments.break Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Overview

87 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Table 4.2: Capital Flows to East Asia, 198594 (US$ billion) 1985

1990

1991

1992

1993

1994

Public Sources

7.2

9.3

8.4

8.8

11.0

7.9

Official Devel. Assistance

5.2

8.3

5.7

5.6

6.6

6.2

Other Official Finance

2.0

1.0

2.7

3.2

4.4

1.6

Private Flows

10.9

20.5

25.6

42.8

63.1

82.5

Commercial Banks

1.0

4.5

5.1

7.6

2.1

—

Bonds

4.3

0.5

3.6

3.0

8.2

—

Other Private

2.2

2.2

1.9

6.2

2.4

—

Foreign Direct Investment

3.2

11.0

14.0

20.9

36.5

42.7

Portfolio Equity Flows

0.1

2.3

1.0

5.1

18.1

17.6

Total

18.0

29.8

34.0

51.6

74.1

90.4

Source: Managing Capital Flows in East Asia, 1995, The World Bank. Table 4.3: Share of Developing Country Bond and Equity Issues 1992

1993

Q1Q3 1994

Developing country bond issues in international markets (in billions of US$)

24.1

53.1

38.6

% of international bond issues

7.2%

11.0%

12.2%

East Asia (in billions of US$)

5.2

12.1

15.7

% of international bond issues

1.6%

2.5%

5.0%

Developing country equity issues (in billions of US$)

5.9

11.5

15.6

% of international equity issues 25.1%

28.3%

44.3%

East Asia (in billions of US$)

3

5.7

7.4%

16.2%

481

317

1.5

% of international equity issues 6.4% Memorandum Item (in billions of US$) Total International Bond Issues 334 Total International Equity Issues (in billions of US$)

23.5Delivered by The 40.7 35.2 World Bank e-library to:

Source: World Bank, OECD, and

000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00 Euromoney Bondware.

Overview

88 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Bond and Equity Market Opening in East Asia The share of developing country equity and bond issues has grown significantly in the last several years. Of the total international issues, bond issues by developing countries grew from 7.2 percent in 1992 to 12.2 percent in the first three quarters of 1994. Developing countries' share of equity issues has grown from 25.1 percent to 44.3 percent over the same period. The share of East Asia in both cases has grown at a more rapid rate, as Table 4.3 illustrates. The fundamental causes of this change are largely structural. Major contributing factors have been: (a) low real interest rates (particularly in key source countries), leading to improved developing country creditworthiness; (b) the sea change in developing country policies, including financial and trade liberalization, fiscal consolidation, and deregulation; (c) structural changes in global financial markets, including increased financial integration of developing countries, growing international diversification of investment funds, and easier access by developing countries to industrial country capital markets; (d) structural factors such as deregulation of the private sector, the growth of regionalism in trade and investment, disintermediation from the banking system (since the onset of the debt crisis), and lower costs in transportation and communication; and (e) privatization of state−owned enterprises. International Bond Market Access by East Asian Developing Countries While being the recipient of portfolio bond flows,1 the countries in this study have also been accessing international bond markets directly for purposes of financing investments. This provides an alternative mechanism for investment for international investors. The trends in international bond issues, in terms of markets, currencies, maturities, and other factors, can give important insights into the level of access and integration that the individual countries in East Asia have. From an investor's point of view, this has important implications in terms of assessing investment potential in any particular country. Country Trends

The involvement of the East Asian countries in this study in international bond markets has grown, with the exception of Singapore, at a spectacular rate. Table 4.4 illustrates the trends in terms of bond issues for selected countries in the period 1989 to 1994. The modest participation of Singapore in this period (US$530 million in 1994) reflects its limited need for financing through international bond markets for its own purposes. Of the total bond issues in the period 1989 to 1994, the Republic of Korea took the single largest share with 44 percent of the cumulative total. China and Thailand had 18 percent and 10 percent shares of the total,continue

respectively. Each of the other countries had a share less than 10 percent. Given the sharp increase in the growth rate of bond issues in the countries with smaller proportions, it is likely that the country composition will change over time toward a more balanced representation by all countries. Table 4.4: International Bond Issues by Selected East Asian Countries (US$ million) 1989

1990

1991

1992

1993

1994

China

151

0

258

1,355

2,852

3,452

Indonesia

50

50

393Delivered244 683 by The World510 Bank e-library to:

Korea, Republic of

288

1,507

2,510

000000 0000000000 IP : 000.000.00.00 2,878 5,622 6,090 000, 00 000 0000 00:00:00

Bond and Equity Market Opening in East Asia (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Malaysia

429

200

190

0

958

2,345

Philippines

0

0

0

20

1,014

1,134

Singapore

921

115

0

137

0

530

Thailand

200

0

0

522

1,512

2,326

Total

2,039

1,872

3,351

5,156

12,468

16,560

Source: Euromoney Bondware and World Bank staff estimates. As the evidence indicates, China's international bond issues have grown twentyfold in this period in spite of its absence from bond issuance in 1990. While China has been the single largest recipient of foreign direct investment among developing countries, it is increasing its use of international bond issuance in a major way. This reflects the fact that investment opportunities in China are perceived as being extremely favorable. As China has not allowed foreign portfolio investment in its domestic debt market, international issues are the only major channel for debt financing using foreign capital by Chinese enterprises. This, however, makes it more difficult for smaller enterprises to avail of debt financing in China. It is expected that international bond issues by China will continue to play an important role in the future, particularly until its domestic debt market has been reformed and is open to foreign investors. Indonesia has seen a steady increase in bond issues in international markets. In terms of absolute amounts, however, Indonesia's involvement has been relatively modest at US$683 million in 1994. Among developing countries in general, and East Asian countries in particular, Indonesia has the most liberal capital account policy, suggesting that its capital market is well integrated with world markets. Given the size and growth potential of its economy, the relatively stable participation of Indonesia in international bond issues is more reflective of a fundamental concentration in equitylinked financing and less so in debt financing. Korea is the major borrower in international market. During 1994, total bond issues by Korea amounted to US$6.1 billion. Korean companies have had access to foreign bond markets since 1985. There has been a recent trend toward significant liberalization of the domestic capital markets. Traditionally, however, the Korean domestic markets have been restricted to foreign participation. Given the strong growth in the Korean economy and the investment needs of domestic corporations, international bond issues were the single most important channel for investing in Korea. The growth in international bond issues is likely to be sustained, but with alternative channels such as participation in the domestic equity and debt markets, it is conceivable that the enormous growth rates in international bond issues will slow down. Malaysia's bond issuance in international markets declined from US$429 million in 1989 to 0 in 1992 (where there were no issuances), but in 1994 it issued US$2.3 million in bonds. Malaysia is considered to be a highly creditworthy country and therefore has been able to access international markets on very favorable terms. The Malaysian financial markets are very well developed. Malaysia has had a strong foreign presence in its financial markets both in equity and domestic bond markets. The Philippines did not have any issuance until 1992 when it raised US$20 million, but that grew to $1,134 million by the end of 1994. The recent wave of economic reforms and the relaxation of portfolio and direct investment have opened the domestic market to foreign investor participation. Some international investors remain concerned about the macroeconomic performance of the Philippines and the sustainability of the current account. There have also been pressures on the exchange rate of late, which have further added to the general sensitivity of foreign investors. However, thebygovernment is e-library takingto:measures to restore investor confidence in Delivered The World Bank 000000 0000000000 macroeconomic sustainability. IP : 000.000.00.00 000, 00 000 0000 00:00:00

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90

The Emerging Asian Bond Market Thailand did not issue bonds overseas during 199093, but in 1994 it raised US$2,326 million through bond issues. Similar to Malaysia, Thailand is considered a highly creditworthy country, and it has relatively easy access to international bond markets. Furthermore, the Thai bond market has been open to foreign investors since 1986. As discussed above, while some cross−country differences in trends remain, it is still true that bondcontinue

issuance has grown by large amounts in each of the above countries. In particular, the last few years (1993 and 1994) have seen spectacular growth of bond issuance. This should be understood in the context of the international environment. While certainly 1993 was a year when interest rates in industrial countries and particularly in the United States were low relative to the cycle, they had started climbing through 1994. The returns on US Treasury securities are a reasonable proxy for alternative returns for international investors. The fact that all the countries in this study were able to increase their bond issuance in 1994, and usually by large amounts, points to the potential that the international financial markets have to supply investment capital to countries even in the face of rising interest rates in the industrialized countries. It must be kept in mind, however, that external shocks, such as the recent turmoil in Mexico, can have effects in markets which are seemingly unrelated, and some measure of caution has to be exercised in judging stability of flows. Portfolio flows do tend to be somewhat vulnerable to external factors in the short run, while being more highly correlated with recipient country fundamentals in the long run. As the business cycle progresses and interest rates in the United States rise, there may be a slowdown in the rate at which bond issuance from the Asian countries will be successful. The trends so far seem to indicate the resilience of this market, and bond issuance in international markets is likely to continue to see rapid growth in the future. Issuer Types

The evidence suggests significant differences in the cross−country classification of international bond issues by issuer type. The classification of bond issues by issuer type is provided in Table 4.5. In China, for instance, 47 percent of total international bonds were issued by the central government and 32 percent by public banks. The share of other public financial institutions declined in China between 1993 and 1994. In Indonesia 57 percent of the bond issues in 1994 were by public banks and the rest by the private corporate sector. However, the private corporate sector in Indonesia was the major bond issuer in international markets until end−1993. The Republic of Korea has had a wider group of issuers. The largest single class of issuers in 1994 was the public banks with a 44 percent share of the total. Private corporate issuers and private banks accounted for 30 percent and 17 percent, respectively, of total bond issues. Significantly, Korea also witnessed the first local authority bond issue, of US$300 million in 1994. As mentioned before, Malaysian participation in international bond markets grew largely in 1993 and 1994. In 1994, 55 percent of the bonds issued were by the private corporate sector. Private utilities accounted for 26 percent of the bond issues, but they had no presence at all in previous years. The Philippines, too, had a very recent expansion in terms of its participation in the international bond markets. In 1994, bond issues were divided between public banks and utilities, and private corporate and utilities. The largest proportion of bond issues in 1994 by Thailand was by private banks (35 percent of total) but private corporate, the central government, public utilities, other private financial institutions, and utilities were all quite active.

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Issuer Types

91 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Table 4.5: Bond Issues in International Markets by Issuer Type in Selected East Asian Countries (US$ million) 1993

1994

Public Banking/Finance

4,466

5,335

Public Corporate

3,393

1,312

Central Government

907

2,099

Private Banking/Finance 760

5,796

Private Corporate

2,941

2,019

Total

12,467

16,561

Note: Private/Public Finance (other) refers to Private/Public Nonbank financial institutions. Source: Euromoney Bondware and World Bank staff estimates. In summary, the types of borrowers who have issued bonds in each of these countries have varied a great deal. With the exception of China, the central government has not been the primary borrower in any of these countries. But there is significant dispersion of borrower types between public and private entities among all the countries. Major Instruments

In broad terms, bond instruments can be classified as fixed rate instruments, floating rate instruments, and convertible instruments. There is significant variation in the types of instruments that countries have used in the course of their international bond issues. Table 4.6 presents summary information on bond issues by instrument. In China in 1994 the predominant type of issue was the fixed rate bond, accounting for 88 percent of total dollar value. In Indonesia, 57 percent of the total value was floating rate issues, 37 percent of the 1994 issues were fixed rate issues, and the rest convertible. In the Republic of Korea, for 1994, fixed ratecontinue

issues were 46 percent of the total dollar value and floating rate issues were 44 percent of the total. In Malaysia, two−thirds of the value of issues was convertible. In the Philippines, the proportions of fixed rate, floating rate, and convertible issues were 46 percent, 24 percent, and 30 percent, respectively. Singapore's bond issues in 1994 were equally divided between fixed and floating rate issues. For Thailand, the largest subgroup in terms of the value of issues was on floating rate terms (43 percent of the total). Fixed and convertible issues were 30 percent and 27 percent of the total dollar value in 1994.

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Major Instruments

92 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Table 4.6: International Bond Issues by Selected East Asian Countries by Instruments (US$ million) 1990

1991

1992

1993

1994

Fixed

144

985

1,859

3,028

Floating

114

370

970

424

485

250

25

388

China

Convertible

23

Indonesia Fixed Floating

50

Convertible

393

244

45

Korea, Republic of Fixed

827

1,356

2,285

4,501

2,791

Floating

530

557

320

580

2,681

Convertible

150

596

272

541

618

958

600

Malaysia Fixed

200

Floating

200

Convertible

190

1,545

Philippines Fixed

970

Floating

519 265

Convertible

20

44

351

Singapore Fixed

75

75

265

Floating

40

63

265

Convertible Thailand Fixed

300

169

696

Floating

222

110

1,000

1,233

630

Convertible

Source: Euromoney Bondware and World Bank staff Delivered by The World Bank e-library to: estimates. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Major Instruments

93 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market As the above data suggest, there is significant variation among countries in the types of issues that they undertake. As the table illustrates, even across time countries have changed their relative shares of alternative instruments. Such choices may reflect comparative cost advantages and also expectations about the future prospects and environment that countries and the international market may have. Currency of Denomination

In each of the countries, the currency of issue for the bonds gives an indication of the type of market and investor base that it is targeting. A striking feature of the cross−country comparison is that in each of these countries, the US dollar and occasionally also the yen have been the major currency of issue of the bonds. In the case of dollar−denominated issues, the markets would have been the Yankee, Eurodollar, or the Asia dollar market, in general. In the case of the yen, the market of bond placement may have been the Samurai or the Euroyen market. The breakdown of international bond issues by currency is presented in Figure 4.1.

Figure 4.1 International Bond Issues in Selected East Asian Countries (By Currency; 198994) CHN: China; IDN: Indonesia; KOR: Korea; MYS: Malaysia; PHL: Philippines; SGP: Singapore; THA: Thailand Source: The World Bank. In 1994, 57 percent of total bond issues by China were denominated in dollars and 38 percent of issues were in yen. The choice of currency for Korea in 1994 was similar to that of China, with 59 percent of international bond issued in dollars and 36 percent in yen. The rest of the East Asian countries have a strong preference for dollars since their currencies are linked to the dollar. In 1994, the share of the dollar in international bond issues of these countries ranges from 100 percent for Indonesia to 76 percent for Thailand.break

Table 4.7: Average Maturity (Years) 1990

1991

1992

US$

—

—

5.0

Yen

—

5.0

5.2

1993

1994

China Delivered by The World Bank e-library to: 7.0 000000 9.00000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

4.5

6.8

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94

The Emerging Asian Bond Market Others

—

—

—

5.0

5.0

US$

5.0

12.6

5.8

5.9

6.1

Yen

—

—

—

—

—

Others

—

5.0

4.9

—

—

US$

8.8

7.9

8.3

9.3

6.8

Yen

5.0

6.4

5.0

4.9

4.4

Others

5.0

5.0

4.6

4.7

5.1

US$

10.0

10.0

—

10.0

9.8

Yen

—

—

—

—

10.0

Others

—

—

—

—

—

US$

—

—

7.0

5.7

6.3

Yen

—

—

—

—

—

Others

—

—

—

*

3.6

US$

6.0

5.0

—

—

10.8

Yen

—

—

—

—

—

Others

—

—

—

—

3.0

US$

—

—

7.9

9.3

7.6

Yen

—

—

—

7.0

5.0

Others

—

7.0

5.0

7.7

6.6

Indonesia

Korea

Malaysia

Philippines

Singapore

Thailand

* = has one peso denominated perpetual issue in 1993. — = not available. Source: World Bank staff estimates. Terms of New Issues

Table 4.7 presents data on the average maturity of bond issues by currency for each of the countries in this survey. The data in this table give some insight into the type of financing that these countries are availing themselves of. This question is important for several reasons. One of them which stands out is that longer−maturity bonds imply a smaller need for refinancing or ''rolling over" of bonds. Short−term instruments need to be rolled over frequently, especially if they are used to finance long−term investment. This means that the ability of the country Delivered by The affected World Bankby e-library to: to borrow again at favorable terms is significantly short−term fluctuations in the economy and the 000000 0000000000 international environment and by its own liquidity considerations. IP : 000.000.00.00 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market The average maturity of bonds for China has been lengthening across both dollar− and yen−denominated instruments. The trend in China, therefore, has been for the lengthening of maturities of bond instruments. Indonesia's maturity profile has remained more or less stable in the last few years. In Korea, too, the maturities across currencies have been roughly stable. While Malaysia's involvement on a large scale is relatively recent, the maturity of bonds in Malaysia is very long (910 years) and has remained in that range. The relatively stable maturity trend appears to be true of Thailand as well. Information on the spreads on international bond issues based on a limited sample of recent borrowings by the East Asian countries shows that the spread over the benchmarks generally reflect the relative credit ratings of these countries (Table 4.8). The spreads paid by Korea, Malaysia, and Thailand are the lowest (less than one hundred basis points), while those in respect of Indonesia and the Philippines are among the highest (200350 basis points). China is somewhere in between and Chinese issuers also seem to have benefited from relatively favorable terms. Table 4.8: Ratings of Sovereign Foreign Currency Debt, March 1995 a Country

Moody's

Standard & Poor's

China

A3

BBB/A−2

Indonesia

Baa3

BBB−2

Korea, Rep.

A1

A+2

Malaysia**

A1

A+/AA+*1

Thailand

A2

A1

Investment grade

Below investment grade Philippines

Ba3

a: Rating systems for investment−grade bonds are as follows: Moody's: Aaa Aal Aa2 Aa3 Al A2 A3 Baal Baa2 Baa3 Standard & Poor's: AAA AA+AA AA− A+ A A− BBB+BBB BBB−Not rated. * The first rating applies to foreign currency debt; the second rating applies to domestic currency

BB−/BBB*2

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96

The Emerging Asian Bond Market debt. ** The outlook for domestic currency debt is stable. 1. Stable outlook. 2. Positive outlook. Source: Moody's and Standard and Poor's. Summary and Conclusions There has been a surge in the international issuance of bonds by East Asian countries, which suggests that the bond markets in East Asia are likely to play an important role in the capital inflows to East Asia in the future. The success in international bond issuance bycontinue

East Asian countries is reflective of their past economic performance, good track records in servicing external debt, and the growth potential they offer to international portfolio investors. The economies of East Asia are, in general, exhibiting high growth combined with macroeconomic stability and strong fundamentals. The growth in private capital flows is important to further growth in these economies. International bond issuance has been rising rapidly, enabling issuers to access investment capital in established bond markets. The outlook for the East Asian issuers is generally positive, subject to the continuation of sound macroeconomic policies. Access to domestic bond markets in the East Asian countries has been limited in the major markets due to the policies of the authorities in these markets. Thailand, Indonesia, and Malaysia allow relatively easy access to their domestic bond markets (which are also expected to develop rapidly). The bond market in Korea is not open to foreign investors to any significant degree, and China's bond market is currently closed to foreign investors. International participation in domestic bond markets should be allowed and encouraged for several reasons. First, it would broaden the investor base, which would facilitate trading. Second, the domestic market is more diversified in terms of borrowers from a particular country, and therefore presents better portfolio management capabilities for foreign investors who wish to diversify among different sectors within the same country. While improving funding possibilities, this would also present a greater degree of stability to aggregate flows since portfolio reallocation can be done among bonds of the same country. Third, many smaller entities will have difficulty in accessing international bond markets because of the lack of information about them in the global markets. Fourth, foreign participation would impart greater depth and liquidity to the domestic financial market as a whole, and help in establishing linkages between domestic and global markets. Fifth, given that domestic markets are greatly influenced by domestic factors, access to these markets would allow better risk management for investors while benefiting bond issuers. Finally, the opening up of domestic bond markets results in greater sophistication of the markets due to the transfer of intermediation technology. Allowing access to domestic bond markets is an important policy initiative in the East Asian countries. However, this will require additional reforms of the domestic securities markets. To function efficiently, the market mechanisms have to be strengthened. In terms of the bond market, this means that yields have to be determined by Delivered by The World Bank e-library to: market forces of supply and demand and not by administrative 000000 0000000000 fiat. Also, access to domestic markets by a IP : 000.000.00.00 diversified group of international borrowers and investors needs to be encouraged. There is a need to build 000, 00 000 0000 00:00:00 market−based benchmarks to facilitate secondary market trading. The legal, regulatory, and clearing and Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

97

The Emerging Asian Bond Market settlement systems should be transparent and efficient. The linkages to other markets (such as repurchase and interbank markets) need to be strong. This also implies simultaneous reform of other markets in addition to the debt market. Country−specific suggestions are given in Chapter 2. Because of the strong fundamentals and bright economic prospects of the East Asian countries, they will continue to attract foreign portfolio investments. In order to manage volatility of these flows, conservative fiscal and monetary policies should continue to be followed. Given the sensitivity of markets to current account prospects, special care should be given to maintain external viability. In addition, the authorities should publish regularly accurate data on the general health of the economy and on the viability of the balance of payments.break

5— Bond Markets and Monetary Policy Introduction This chapter deals with the indirect monetary policy procedures in the East Asian countries covered in this study. As a prelude, industrial country experiences in operating monetary policy instruments are discussed, as these countries are likely to be the models used by the emerging market economies in designing monetary policies. Emergence of bond markets is essentially a phenomenon of financial liberalization which creates extensive incentives for investors and borrowers in the financial markets. Until the early 1980s financial markets in East Asian countries were dominated by banking systems which suffered from extensive controls on interest rates on bank deposits, loans, and credit allocation. Investors had very limited choices of financial assets for their savings, and borrowers had limited choices in financing their investment requirements. The onset of financial reforms in recent years has dramatically changed the financial environment in these countries, providing a wide range of financial assets and types of instruments available to investors and borrowers and forging the links of their financial system with international financial markets. Deregulating financial asset prices has allowed new instruments, from short−term money market instruments—treasury bills, commercial papers, certificates of deposits—to long−term government and corporate bonds, to flourish in competitive conditions where rewards are consistent with the risks involved. Government bonds, for which prices and subscription amounts had often been mandated before deregulation commenced, now face increasing competition from domestic and external financial instruments. While the financial deregulation becomes a major facilitator of the bond market development, in regard to both its size and diversity, the latter in turn provides different kinds of market−based instruments of monetary policy to substitute for those direct instruments which get out of tune with a liberalized financial system. Indirect monetary policy is exercised through transactions in short−term money market instruments and government bonds of various maturities, and rediscount operations at the central bank. Central bank buying and selling of government bonds and money market instruments affects bank reserves, which changes interest rates and the availability of credit. This can also be achieved by varying the cost and availability of on−demand rediscounting facilities and changing reserve requirements imposed on the banking system. Though the initial impact of these actions is felt by banks through changes in prices of government bonds and money market instruments, it is transmitted, sooner or later, to the prices of private sector bonds, changing the whole spectrum of market interest rates. Indirect Monetary Controls in Selected Industrial Countries

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Monetary policy basically refers to to influence short−term interest rates and bank reserves. Until the mid−1970s central banks in the industrial countries relied on mixes of direct and indirect 5— Bond Markets and Monetary Policy (c) The International Bank for Reconstruction and Development / The World Bank

98

The Emerging Asian Bond Market methods for this purpose. In recent years, however, their emphasis has shifted strongly toward indirect methods that impart greater flexibility to monetary policy. The basic idea underlying indirect monetary control procedures is that a central bank can influence short−term interest rates in the interbank market—given the demand for central bank liabilities in the form of bank notes and reserve deposits held by banks forcontinue

clearing purposes or meeting reserve requirements—by varying the supply of reserves, over which it has almost total control. Transactions by individual banks to secure reserves from other sources net out in the interbank clearing process and merely redistribute reserves provided by the central bank. The central bank's ability to control short−term interest rates depends, under indirect monetary control procedures, on how it can induce banks to seek central bank accommodation at the margin. A precondition for effective central bank control over bank reserves is the pressure exerted on banks by changes in other items in the central bank balance sheets so that banks are left with no alternative but to be dependent on central bank accommodation. Figure 5.1 presents the main instruments used in indirect control procedures in four selected industrial countries—the United States, Germany, Japan, and the United Kingdom. A brief description of how they are used is given below. Central Bank Credit Facilities

In the United States a distinction is drawn between a system in which the central bank makes extensive use of outright purchases of securities on the open market to supply reserves to banks and ones in which the liquidity of individual banks and the banking system as a whole is more dependent on direct central bank lending. In the latter, money market rates have been seen to be more closely influenced by rates on credit provided by the central bank. In the United States credit made available through discounting is rationed by administrative constraints on bank use of the Federal Reserve's discount window that permit the discount rate to be maintained below the day−to−day interbank rate (the federal funds rate) by a variable margin. The influence of the discount rate on money market rates has increased in recent years, unlike during the period prior to 1979, when open market operations were geared to keeping the federal funds rate within a narrow range. The 1979 adoption of operating objectives for bank reserves changed this situation by permitting bank demand for reserves to influence market interest rates. The operating target has been non−borrowed reserves, which is derived by deducting the estimated level of borrowed reserves of banks from the forecast demand for total bank reserves which is arrived at on the basis of the Federal Open−market Committee's judgment about the level of interest rates likely to be consistent with the monetary growth target—usually M1. Since mid−1982, non−borrowed reserve objectives have been adjusted weekly as required reserves deviated from the projected level to achieve the desired degree of monetary restraint or ease, but also with a view to permitting more short−run stability in bank borrowings at the Federal Reserve. After the 1987 stock market crash, the Federal Reserve supplied liquidity generously through open market operations targeted at the norm of the federal funds rate. Against the background of an apparent rise in the demand for required and excess reserves and a strong disincentive on the part of banks to use the discount window, the Federal Reserve made no attempt to avoid an unexpected steep decline in adjustment and seasonal borrowing. By early 1988 non−borrowed reserve operating procedures were again brought into play to encourage a rise in the federal funds rate.1 In the United Kingdom, the Bank of England's practice of announcing minimum lending rates ended with the 1981 money market reforms. This change wasbypart of anBank effort to overcome a propensity to delay making changes Delivered The World e-library to: 000000 0000000000 in official posted rates by permitting market judgments—formed on the basis, among other things, of IP : 000.000.00.00 developments in the money stock—to exert000, more influence on interest rates. At the same time, the authorities did 00 000 0000 00:00:00 away with the practice of deliberately creating reserve shortages by issuing treasury bills in excess of expected Central Bank Credit Facilities (c) The International Bank for Reconstruction and Development / The World Bank

99

The Emerging Asian Bond Market treasury cash needs at the weekly auction and of relieving them subsequently—either by purchasing treasury bills at posted dealing rates or by lending to the discount market to make effective the minimum lending rate chosen by the authorities. The Bank continues to operate an interest rate−based monetary control system. Earlier, it tried to confine these operations to very short−term market transactions in bills at interest rates quoted by the discount houses at the initiative of the Bank of England, but these arrangements were not successful in disengaging longer−term money market rates from direct official influences. It came to be recognized that in certain circumstances, procedures that would permit a clearer official lead in forming interest rates were needed. Since 1985 the Bank of England has invited discount houses to borrow from it at a minimum lending rate posted in the morning for one day and on many occasions later in the day. Such lending is effected at an interest rate and for periods chosen by the authorities.2 In Germany, under arrangements prevailing until 1985, the day−to−day money market rate often tended to remain just above the Bundesbank's Lombard rate atcontinue

Market Operations

Germany

Reserve Requirements

Standing Facilities

Reserve requirements differentiated according to the type of deposits—demand, time, and savings and also the size of deposit. The reserve−requirements ratio on demand deposits is 12.1 percent, on time deposits, 4.95 percent, and on savings deposits 4.15 percent.

The discount rate used for monetary policy is charged for rediscounting eligible assets of financial institutions. This rate is typically lower than short−term market rates. Lombard rate is a rate charged for collaterized short− term loans of financial institutions designed to bridge temporary reserve deficiencies.

Instruments

Markets

Primary and Government securities including secondary markets. those issued by government−owned entities for outright purchase. Government securities and central bank bills for outright sale. Only government bonds for refinancing and foreign exchange swaps for managing liquidity but not for influencing the exchange rate.

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Central Bank Credit Facilities (c) The International Bank for Reconstruction and Development / The World Bank

Operating Procedure Three types of interest rate tender occur when the amount is fixed and the interest rate is determined by auction. A volume tender, when the interest rate is set but the amount is variable and a mixture of both. These are typically conducted every week. Repurchases are supplemented by sale of short−term treasury bills, foreign exchange swaps, and shift of public authorities' deposits from central bank to banks and vice versa. 100

The Emerging Asian Bond Market United Kingdom

0.35 percent of eligible liabilities to be deposited at central bank.

Overnight support given at discretionary interest rate to offset overnight shortage; also lender−of−last resort facility for banks in liquidity difficulties.

Purchases and sales usually outright, but sometimes REPO of eligible instruments, including government securities and private paper, most frequently with less than 15 days' maturity.

Monetary management through secondary markets.

Central bank usually deals twice a day; additional dealing at pre−specified time later in day if necessary. Strong announcement effect of timing of dealing, of maturities, and of rates of dealing.

Japan

Introduced in 1957; unremunerated; rarely changed during last few years.

Discount facility accounts for three−fourths of refinancing to banking system; discount rate below money market rates; quarterly individual bank ceilings, but central bank determines every day the amount each bank can use and reserves the right to call back advances at any time.

Commercial bills, commercial papers, government financing bills, treasury bills, government bonds, and CDs.

No monetary management through primary issuance. Purchases of short−term commercial bills held by banks through money market dealers. Sales of commercial bills drawn on Bank of Japan to money market dealers. Repurchase and reverse repurchase agreements in a variety of papers with financial institutions and security firms. Outright purchases of government bonds.

Modalities differ depending on type of security; REPOs and reverse REPOs generally made through auctions; transactions in commercial bills at bill rate determined in the inter−bank bill market; outright purchase of government bonds offered by Bank of Japan to limited number of financial institutions on a rotational basis at prevailing market rate.

Figure 5.1: Instrument Mix and Operation for Selected Countries (figure continued on next page) Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

(figure continued from previous page)

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101

The Emerging Asian Bond Market Market Operations

United States

Reserve Requirements

Standing Facilities

Reserve requirements are currently assessed only on demand deposits and other checkable deposits, but the law allows imposition also on other deposit categories; reserve ratios are rarely changed and are at present 3 percent for balances up to $51.9 million and 10 percent for balances above that level.

Adjustment borrowing for short−term liquidity needs; access strictly controlled by Fed; discount rate below short−term market rates. Seasonal borrowing. Extended credit borrowing for depository institutions in difficulty; interest rates on the latter two are market related; modest volumes.

Instruments

Markets

Operating Procedure

Outstanding treasury and federal agency securities (bills, bonds, and notes).

No monetary management through primary market. Outright purchases and sales of securities in secondary market at market prices. Repurchase agreements in securities up to 15 days.

When participating in the secondary market, the manager of the Fed's System Open Market Account has leeway as to the choice of security, maturity, timing, counter−party, and use of repurchase agreements.

Figure 5.1: Instrument Mix and Operation for Selected Countries which bank reserve deficiencies are met. These arrangements then underwent a basic change as the Bundesbank raised the Lombard rate to a level above that applied in its temporary operation. These changes provided a strong disincentive to the use of Lombard facilities except in exceptional circumstances. This also freed money market rates from their dependence on the Lombard rates. To prevent excess liquidity in the market from causing too steep a fall in money market rates, the Bundesbank has made available a facility under which it offers banks treasury bills—normally with three−day maturities—to invest their surplus funds.3 Japan's basic official discount rate lies well below the call money and bill rates in the interbank market. Central bank credit is rationed by credit lines established under the bank's credit−control system. Furthermore, decisions about the daily allocation to banks are made entirely at the discretion of the Bank of Japan, which may at any time withdraw credit granted previously to impose "repayment pressure." The effective cost of using Bank of Japan credit rises as the period of utilization falls. Thus, central bank lending has become a flexible and powerful instrument that is still used, in conjunction with new market instruments, to offset daily fluctuations in bank reserve positions or tighten or ease these positions. The discretion exercised by the Bank of Japan creates uncertainty among banks about how future reserve needs will be met. In recent years, the deregulation of the money market has allowed these rates to move somewhat more freely in response to changing pressures on reserve positions. Open Market Operations Delivered by The World Bank e-library to: 000000 0000000000 conducted by outright purchases and sales IP : 000.000.00.00 000, 00 000 0000 00:00:00

Open market operations as are on a modest scale in Germany and Japan, but are well entrenched in the United States and United Kingdom. The main accent is on developing new Open Market Operations (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market techniques and instruments, such as purchase/repurchase agreements or reverse operations, directed at effecting temporary changes in a bank's reserve positions in the direction desired by the central banks. Outright Market Transactions in Securities and Bills

The instruments used in these operations in the United States are either long−term government securities or treasury bills; no private paper is used. Transactions are handled "over−the−counter," with the bulk of orders being placed with so−called primary dealers in treasury securities, some of which are specialized departments of money−center banks. Normally, dealers are required to tender for securities of a particular type and maturity. Allocations take place at the most favorable bid price until the desired amount is purchased or placed. The main characteristic of this operation lies in a sharp distinction drawn between debt−management operations (conducted by the Treasury) and monetary policy operations consisting of net purchases in the secondary market (conducted by the Federal Reserve). The Federal Reserve does not acquire government securities in the primary market, though it may in effect redeem securities directly, and often does so, when a large reduction in bank reserves is warranted. In general, there are three to four outright purchase operations in notes and bonds each year, andcontinue

not more than two open market sales. Transactions are mostly in the treasury bill market and are carried out in such a way that their impact on the structure of yields is minimal.4 The 1981 reforms in the United Kingdom were designed to make transactions in treasury bills by the Bank of England the principal instrument for regulating the money market. Against a background of strong pressures on money market liquidity and a depleted supply of treasury bills in the market that followed persistent overfunding of the government's borrowing requirements, purchases of treasury bills became a main and continuing source of bank reserves. The central bank's effort to lengthen the short average maturity of its bill holdings to reduce the huge volume of purchases necessitated by redemption alone implied that the determination of term−money rates could not be left to the market. Though the market could initiate declines in interest rates, the responsibility for making increases was clearly passed back to the authorities. After the decision to cease overfunding was taken in mid−1985, the stock of treasury bills in the market, by then barely enough to keep the market in existence, rose, and the Bank of England's holdings of commercial bills fell.5 Germany's Bundesbank has engaged since the early 1980s in major open market purchases. Only sporadically and rarely has it held a large portfolio of banks for any length of time. It conducts operations designed to ensure a steady market for fixed interest securities by the federal government and its funds. The Bundesbank has occasionally sold "mobilization" paper—treasury bills and treasury discount notes—to absorb bank reserves.6 For many years the Bank of Japan followed a policy of gradually increasing its holdings of securities, including 10−year government bonds, to meet rising demand for central bank credit. These purchases are made from dealers and banks through a tender procedure that initially took four to five days to complete, but was simplified to permit day−to−day transactions. Tenders have become smaller in amount and more frequent, but the operations are still not normally used for short−term or seasonal reserve adjustments. For smoothing seasonal variations in reserves, the Bank of Japan has followed a novel method since the early 1970s of buying and selling first−class corporate bills and bills of financial institutions with corporate bills as collateral in the market. However, the average stock of commercial bills it sells has grown little over time. Sales in the call−money and bill markets of self−addressed and self−accepted bills drawn by the Bank of Japan with maturities ranging from several days to a few months have also been made from time to time. These instruments are used to supplement changes in lending in day−to−day or hour−to−hour adjustments in bank reserve positions, and to offset seasonal swings. Most of the Delivered by The World Bank e-library to: 000000 0000000000 treasury bill issues are still normally taken up directly by the Bank of Japan, but the Bank since 1981 has sold IP : 000.000.00.00 limited amounts of short−term treasury bills000, to 00 absorb seasonal 000 0000 00:00:00 surpluses of bank reserves. The degree of freedom in determining the timing and amount of the sales has increased gradually, but the market has not expanded Outright Market Transactions in Securities and Bills (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market enough to permit buying on any significant scale. In 1986 the Bank of Japan purchased certificates of deposits for the first time, and it started transactions in commercial paper in 1984. Market operations at different maturities and in different papers allow the Bank of Japan to influence the term structure of money market interest rates and help ensure that interest rate policy impulses are effectively transmitted from the inter−bank market to markets that have been open to participation by nonbanks since 1988, when open market rates moved well above interest rates in the call and bill markets. The Bank of Japan announced that it would from then on directly influence only short−term rates at maturities of up to seven days, leaving long−term rates to be determined by market forces.7 Reversed Transactions in Securities and Bills

Reversed transactions are resorted to increasingly in the industrial countries because they are flexible and can be implemented quickly without significant effect on the prices of the underlying securities. Under this procedure, purchases and sales of securities are effected with a contract to reverse them at specified prices and a future date. Usually the central bank retains the initiative in setting the amount, timing, and duration of contracts, and in deciding whether to renew them or to let them unwind on maturity. This instrument is used to counter movements in the supply of bank reserves from other sources. On some occasions, private markets are also used; in others, special procedures endow the transactions with many of the characteristics of a secured loan. Such reversed security transactions are now used to implement monetary policies in all four industrial countries. In the United States, where the private market for reversed transactions in government securities has long been large and active, the Federal Reserve regularly uses reversed security transactions for adding to and withdrawing from bank reserves in large amounts for acontinue

very short period. While the scale of reverse transactions has been geared mainly to objectives for bank reserves, their timing has been influenced by awareness that the federal funds rate could record large fluctuations in the absence of offsetting Federal Reserve operations. Reverse purchase transactions can contribute directly to stabilizing interest rates in that they often serve to finance dealer positions that might otherwise have to be liquidated. The dealers normally have an option to terminate repurchase agreements in advance of maturity, and tend to do so if market conditions turn out to be easier than expected; they can also at times help to moderate fluctuations in interest rates. Most operations are in government bonds.8 The Bank of England has in recent years periodically carried out purchase and resale transactions with banks in government securities (and paper relating to government−guaranteed, fixed interest rate, shipbuilding and export credits) outside the market on market−related terms proposed by the central bank. These transactions, originally used only for meeting peak seasonal liquidity needs in the market in the main tax collection period, came to be employed more often to reduce the burden of providing cash to the banking system for normal day−to−day operations. The use of the technique remained restricted by the availability of suitable collateral in the banking system. Purchase and resale transactions in commercial bills with the discount houses have been conducted more frequently, also on terms proposed by the central bank, either to mobilize long−term bills not eligible for purchase by it, or when expectations of declining interest rates made the market unwilling to offer long−term bills for sale on terms acceptable to the central bank. Neither type of purchase or sale operation directly contributes to establishing the official view of interest rates against that of the market.9 The German Bundesbank announces the terms on which it is prepared to purchase certain types of domestic bills from banks under repurchase agreements. Reversed purchase from the Bundesbank of securities eligible as collateral for Lombard loans began in 1979. The timing and frequency of these operations, the duration of repurchase periods, the amount of funds to be provided to the banking system, and the rate of interest charged on Delivered by The World Bank e-library to: 000000 0000000000 the funds are decided under liquidity considerations and policy guidelines set by the Central Bank Council. The IP : 000.000.00.00 decision is generally based on the Bundesbank's of bank reserve positions over the next several 000, 00estimation 000 0000 00:00:00 months, given its current policy stance. Repurchase agreements transactions were conducted at approximately Reversed Transactions in Securities and Bills (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market monthly intervals between 1983 and 1985, but have since become more frequent, typically every week. Securities repurchase operations take place under a tender system. There are three types of tender. For volume tenders, the central bank presets the interest rate (repurchase rate) and the amount is open for bid. The total amount of funds provided by the central bank is generally a portion of the total bids made by banks (usually 50 percent). Under interest rate tenders, both the amount and the repurchase rate are open for bids from banks. Funds are allotted at a uniform repurchase rate equal to the rate at which marginal bid is accepted (Dutch auction method). The third tender method is a mix of both. The repurchase rates, especially those set under an interest rate tender, are closely related to prevailing money market rates−typically between the discount rate of the Bundesbank at the bottom and the Lombard rate at the top.10 The Bank of Japan's purchase of long−term government bonds under resale agreements began in December 1987. The purpose of these operations is to increase flexibility in managing the supply of bank reserves and permit better control over interest rates in markets that are open to participation by nonbanks.11 Reverse Foreign Currency Operations

Official spot purchases and sales of foreign exchange are normally linked to exchange rate considerations, though they have incidental effects on bank reserves. However, they have implications for monetary policies similar to the open market operations described above. Central banks in many industrial countries regard spot foreign exchange transactions as an instrument of money market policy designed to affect the foreign exchange rate. Outright forward purchases or sales of foreign exchange that have a delayed impact on bank reserves can also be used as an instrument of money market policy. Swap operations in the foreign exchange market, made under contracts to buy and sell foreign currency in the market at two different value dates, are seen in a number of countries as being more clearly a standard instrument of money market policy. However, among the countries discussed here, only the United Kingdom and Germany arranged foreign exchange swaps between the authorities and banks on a few occasions in the early 1980s.12 Transfers of Nonbank Deposits Between Central Banks and Banks

In countries whose treasuries normally hold cash balances in excess of immediate needs with the centralcontinue

bank, shifting funds to accounts with the banks may be a convenient way of dealing with distribution of bank reserves, especially when their timing and expected short duration make it difficult to counteract them through security transactions. Conceptually, the simplest and quickest procedure for managing bank reserves—transferring government deposits from the central bank to banks and back—can often be inconspicuously effected with little direct impact on shortterm interest rates. If the intention is to affect interest rates, these transfers should be made conspicuously to have an "announcement" effect. However, a framework agreement covering the distribution of funds among banks, conditions of remuneration, and collateral requirements is often necessary. This mode of monetary control procedure is used widely in Germany, but not in the United Kingdom and Japan.13 The US Federal Reserve's management of treasury balances, though not seen as a policy instrument, is subject to close consultation between the two organizations. On occasion, the Federal Reserve asks the treasury to build up, or draw down, its balances to assist in managing reserves. Under a 1978 agreement, the treasury undertook to keep the balances on its accounts at the Federal Reserve (which are used for making payments) reasonably steady around a specified level, leaving its recurring balances with commercial banks in "Treasury Tax and Loan" accounts into which most taxes are paid. Large short−run and tax−season swings in the treasury's balance at the Delivered by The World Bank e-library to: Fed continue, nevertheless, partly because the 000000 collateral requirements made commercial banks unwilling to accept 0000000000 IP : 000.000.00.00 more than a negotiated maximum amount of000, treasury deposits. In recent years increased variability in treasury 00 000 0000 00:00:00 balances at the Federal Reserve due to major changes in the tax laws, the high level of treasury borrowing, and Reverse Foreign Currency Operations (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market congressional delays in increasing the federal debt ceiling have reduced the precision with which the open market desk can forecast factors influencing reserve developments.14 Reserve Requirements

Reserve requirements, though not strictly an indirect monetary instrument, have been a part of monetary policy procedures since the 1980s. The difference between the use of reserve requirements then and now is that their level has been considerably reduced in these countries, more or less to a level that enables banks to meet their needs for reserves for clearing purposes. Reserve requirements are also resorted to, under indirect monetary control procedures, to influence the demand for bank reserves in ways intended to be conducive to achieving money market objectives. The period of holding reserves and other technical details related to it have implications for the management of short−term money market rates. In the United States, Germany, and Japan, reserve holdings are semilagged, while they are lagged in the United Kingdom. In fact, there is no contemporaneous accounting in any of the G−10 countries. These holding arrangements are considered good for facilitating interest rate−oriented money market policies. The length of reserve holding is highest in the United Kingdom (180 days) and the lowest in the United States (14 days); in Japan, the period is 30 days. In Germany and Japan, the penalty rate for reserve deficiencies above the respective discount rates is 3 and 3.75 percent.15 Indirect Monetary Control Procedures−−Divergence and Convergence

Procedures for implementing monetary policies in the four countries are similar in many respects and divergences are of minor importance, dictated by the specificity of institutional structures in each of these countries and their histories. The broad contours of indirect monetary policy are alike, except in details. In view of the prominence given to short−term interest rates in the money markets in these countries, changes in monetary policy stance are represented by changes in the central bank rates charged on their refinancing facilities. In Germany, the discount and the Lombard rate set the tone for call money rates. The Bank of England generally supplies reserve shortages or absorbs reserve surpluses on a day−to−day basis at the prevailing interest rate. When it alters its policy posture, it adjusts the dealing rate below which it refuses to buy bills, and if sufficient bills are not offered at that rate, the discount houses are obliged to borrow from the Bank of England at an interest rate different from that prevailing in the interbank market. Practices in the United States and Japan vary at the margin. Their monetary authorities administer discount rates, but do not change them frequently. Instead, policy direction is indicated through movements in market−determined rates—the call rate in Japan and the federal funds rate in the United States—that are influenced through market operations. The monetary authorities in these four countries implement monetary policies by acting on the supply of bank reserves, which in turn influences short−term interestcontinue

rates. Each of the authorities employs either open market or interbank market operations as its major instrument of reserve management. Repurchases or matched sale−purchase agreements are often used for these purposes in Germany and the United States. In Germany, the same procedure is followed, but the Bundesbank uses reversed transactions in longer−term securities, while the Fed relies on short−term maturity bonds. Reversed security transactions do not play a major role in Japan or the United Kingdom. The Bank of Japan entered into repurchase agreements in the late 1980s, while the Bank of England resorts to repurchase agreements primarily to meet peak seasonal reserve demands; in both countries the emphasis has been on the outright purchase or sale of securities. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 short−term reserve management declined 000, 00 000 0000 00:00:00

The role of discount windows for in all four countries during the 1980s. In Japan, the discount rate is usually below the market rate, and the Bank of Japan rations refinancing or uses it at Reserve Requirements (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market its discretion. In Germany, the effective rate is a Lombard rate—a rate charged on 5− to 10−day repurchase agreements. In the United States, the rediscount rate is typically the short−term market rate and, for that reason, various non−price methods are used to raise the cost of discounts. The United Kingdom has no official discount window, though it lends occasionally to discount houses at rates different from those prevailing in the market. Learning from the Industrial Countries' Experience

Countries thinking of emulating the indirect monetary control procedures used by these industrial countries should first understand the conditions under which each procedure is used. Two kinds of contextual conditions should be kept in mind. The first is the ability of a central bank to control other items on its balance sheet, such as the currency issued, float, net position vis−à−vis the government, and net foreign assets. This is because changes in these items can neutralize or offset the marginal adjustments in bank reserves that its indirect monetary procedures bring about. In this connection, the relationship between government finance and monetary policy is of crucial importance to the effective functioning of monetary procedures: if governments incur liabilities to central banks to monetize fiscal deficits, monetary procedures will be considerably weakened as they will be unable to make the reserve adjustments needed to achieve the intended impact on market interest rates. The second is the institutional and behavioral aspects of the money and foreign exchange markets, both of which impart flexibility to interest rate determination and effectively integrate domestic money markets with foreign financial markets. In the four industrial countries discussed above, central banks do not, in practice, extend loans to their treasuries. However, the central banks in these countries often extend credit indirectly to their governments by acquiring government paper in the secondary market in pursuit of the objective of managing market interest rates—or in their capacity as managers of public debt. Auction procedures are prevalent in all four countries. In general, the holdings of central banks in these countries, through debt management policies and other operations, have been small and stable. Debt management policy was used in the United Kingdom in the early 1980s as an instrument for directly moderating the growth of the banking system's balance sheets to meet targets for a broad monetary aggregate (M3). Debt management in this context took the form of large net sales of government paper (mainly long−term bonds) that were normally unattractive to banks. Overfunding was associated with a net reduction in the banking system's holdings of treasury bills and a net improvement in the government's position vis−à−vis the Bank of England—reflected both in a buildup of government deposits at the Bank and a reduction in its holdings of government securities as the central bank acted to ease bank reserve positions by progressively adding to its stock of private bills. The resulting downward pressure on bill rates in relation to interest rates in the interbank market and on bank deposits at times has made it difficult to implement changes in interest rate policy. Interest rates on short−term treasury bills in Japan have been kept so far below market level that, although bills are in principle marketable, few could actually be sold to the public. Bank of Japan purchases have not given rise to long−term bank reserve control because the government issues this paper only for the purpose of covering seasonal liquidity needs. For instance, issue yields on government bonds sold to the syndicates of financial institutions have in recent years been brought closer to market yields. Establishing an open market for short−term government paper in which the Bank of Japan could intervene would widen the range and effectiveness of its money market intervention instruments. The second contextual condition is represented by domestic money and foreign exchange markets, changes in which have enhanced flexibility in interest rate determination and ensured greater integration of domestic and international money markets. However,continue

the first of these two effects, interest rate flexibility, hasBank beene-library distinctly beneficial in providing scope for complex Delivered by The World to: 000000 0000000000 policy strategies; market integration has tended to place constraints on monetary policy insofar as it strengthens IP : 000.000.00.00 the influence of expectations on interest rate000, determination. Integration of markets has raised the risk that 00 000 0000 00:00:00 exchange rate and domestic money stock or interest rate objectives will more often come into conflict. Such Learning from the Industrial Countries' Experience (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market changes, together with a tendency for other interest rates on bank lending to respond more flexibly to changes in money market rates, are likely to ultimately help establish a monetary policy transmission mechanism that relies more on the interest rate impacts on the demand for money and therefore spending, and less on the direct credit allocation effects that come about with rigid rates on bank loans and deposits. The way foreign exchange market objectives impinge on a country's scope for the pursuit of independent domestic interest rate objectives has also influenced the design of their money market instruments. In some small open economies, where money market policy has given clear priority to exchange rate objectives, the instruments designed to permit short−term interest rates to respond quickly to external disturbances have tended to stabilize exchange rates. In most larger countries, on the other hand, central banks have attempted to keep money market interest rates under close control, and in many cases, their instruments are designed more to protect money market rates against external disturbances by facilitating flexible adjustments in the supply of bank reserves. Even in larger countries, however, the efforts made to introduce more flexibility in money market procedures have been intended to permit exchange rates to be taken more into account in setting short−term interest rates. Bank reserve targeting procedures in the United States, though designed to facilitate control of the monetary aggregates, may give the market some scope for initiating adjustments in short−term interest rates consistent with other assumed Federal Reserve objectives, including ones for the exchange rate. The borrowed reserve procedures since 1982 have often operated to keep fluctuations in the federal funds rate within a narrow range, and to the extent that the objective for the dollar exchange rate has an impact on US interest rates, the influence has mainly come through adaptation of the Federal Reserve norms for fund rates. In recent years, increasing weight has been given to using the exchange rate in formulating interest rate policy in the United Kingdom, partly because of the difficulties experienced in interpreting developments in monetary aggregates. The arrangements in place for official bill transactions have been effective in allowing interest rate declines in response to changes in exchange market conditions, but less so in achieving increases in short−term rates. The authorities have also at times wished to resist declines initiated by the market. Reductions in the stock of bank bills built up by the Bank of England during the earlier period of overfunding have recently proved to be a flexible instrument for limiting the short−run impact of large−scale official purchases of foreign exchange on bank reserves. Although the impact on movements in the Bank of Japan's foreign exchange reserves has at times been very large in dollar terms in recent years, the impact on bank reserves in Japan has remained small relative to domestic influences and was readily managed by using the instruments available to the Bank of Japan. As in other large countries, the influence of exchange market developments on interest rates has come about mainly by the adaptation of money market policy. Yet another lesson that East Asian countries can draw from the industrial countries' use of indirect monetary policy instruments is that the level of reserve requirements, though used as one of them, has to be kept very low as not to impede financial intermediation. Reserve requirement changes should be such as to enable banks to meet their needs of reserves for clearing purposes. This lesson has particular implications for China and the Philippines. Equally important is the choice of the markets used by the industrial countries for conducting open market operations. All four of the countries operate in the secondary markets, though Germany does so both in the primary and secondary markets. This implies that a mere bond market existence is not sufficient for effective use of open market operations. A secondary market development is indispensable for a sustained and efficient use of that instrument. Along with this, it should also be noted that the industrial countries employ a mix of outright purchases and sales of government securities and REPOs as a part of open market operations. In the initial stages when the secondary markets were in infancy and evolving, reliance had been on REPOs, in order not to create volatility in bond prices, but there was a gradual switch to outright purchases and sales as the markets were broadened and the secondary market functioned smoothly. Delivered by The World Bank e-library to: Likewise, a choice of instruments adopted

000000 0000000000 IP : 000.000.00.00 000,open 00 000market 0000 00:00:00 for operations

in the industrial countries can becontinue

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The Emerging Asian Bond Market instructive too for East Asian countries. Japan and the UK, for instance, used commercial bills and commercial papers mainly of short−term maturity along with government bonds in open market operations. At times different instruments are used for achieving different monetary policy objectives. In Germany, foreign exchange swaps are used for managing liquidity and not for influencing the exchange rate. East Asian countries would do well in comprehending how the development of sophisticated bond markets has fundamentally changed the way monetary policies operate in the industrial countries (as sooner or later they would face similar situations). The change has manifested itself in three forms. First, bonds have become an arbiter of monetary policy. Second, it has heightened the sense for need to coordinate fiscal and monetary policies within national boundaries. Third, it has created even greater compulsion to synchronize action among sovereign nations in the sphere of monetary and exchange rate policies in particular, and economic policies in general. Changes in bond yields set the direction for the monetary policy. If for some reason inflationary pressures surge in these economies, they first impact bond prices—government and private—which vary according to the risk premium on them. This is because the holders of medium− and long−term bonds try to obtain real returns on them by adjusting their prices to compensate for a rise in price levels. Bank depositors with low−earning assets move them into high−earning bonds, thereby raising the whole yield curve, even if the central bank fails to raise short−term interest rates. Even more importantly, with the variety of bonds—asset−backed securities in particular—increasing in volume, the importance of banks is likely to wane. Since central banks change monetary stance by operating on bank reserves, their power to influence market liquidity is likely to diminish as a consequence.16 The crucial importance of the coordination between fiscal and monetary policies can hardly be exaggerated. Loose fiscal policy creates pressures on domestic interest rates, which central banks are not always in a position to counter, in view of different domestic economic policy goals. But their bond markets often provide different signals to the monetary authorities, which they find difficult to ignore. The independence of monetary policy, thus, is seriously compromised. The third dimension of change is the imperative of coordination and convergence of industrial country economic and monetary policies. This has become more urgent since the growing internationalization of their bond markets in the 1980s. Capital migrates between countries with open capital accounts in search of greater rewards, but its movements lead to changes in exchange rates as well as interest rates in directions that are often different from those desired in both the capital inflow and capital outflow countries. For instance, in the United States the recent raising of short−term interest rates by the Federal Reserve resulted in larger inflows of capital from countries with lower interest rates. The message in the experiences of these four industrial countries in regard to the operation and effectiveness of monetary policies and the problems they face is clear. Though monetary policy instruments have become more flexible and work better by using markets to influence monetary conditions, while minimizing information and transaction costs, they have serious implementation problems far too complex to handle in real world situations. Sophisticated and well−developed bond and capital markets do not leave a large margin of error for monetary authorities unless countries pursue prudent and well−orchestrated economic, fiscal, and monetary policies. Indirect Monetary Instruments and Monetary Policy in the East Asian Countries Before discussing implementing indirect monetary policies in the Asian countries, it is essential to look at the financial liberalization that has taken place in these countries because of the relationship between financial deregulation and the evolution of market−based instruments of monetary control. Equally relevant, if moral hazard problems are to be avoided, is Delivered the health of World their Bank banking systems, through which monetary instruments by The e-library to: 0000000000 would be used to distribute liquidity. It should000000 also be noted that transition from direct to indirect monetary IP : 000.000.00.00 000, 00 000 0000 00:00:00 control alters the channels for transmitting monetary policy as well as its targets, particularly in the context of freer capital flows. Indirect Monetary Instruments and Monetary Policy in the East Asian Countries (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Progress of Financial Liberalization in the East Asian Countries

Financial liberalization during the 1980s in the countries included in this study was motivated by a variety of factors, a major one being the adoption of sound macroeconomic policy by key decisionmakers. It is well appreciated in the East Asian countries that competitive markets ensure more efficient resource allocation,continue

higher savings mobilization, and rapid economic growth. Furthermore, efficient and deregulated financial markets tend to create a more favorable environment for policy responses to internal and external shocks. Reforms also encourage the objective of improving fiscal and monetary policy effectiveness. Singapore and Hong Kong have been pioneers in financial sector reform and have developed into major regional financial centers. Malaysia and Thailand have been the leaders in deregulating their financial markets. Malaysia's financial reforms were not much of a departure, as its economy was fairly free and largely competitive. In contrast, Thailand had a controlled financial sector, while its real economy was largely deregulated. Its financial deregulation lagged behind that in other East Asian countries, but once started in 1990, gathered momentum to almost reach the level of liberalization in its advanced neighboring countries. Indonesian reform came largely as a response to the oil price shocks, while China's reflected its transition from a command economy toward a market economy. Korea pursued financial liberalization to keep pace with demands made on its financial system by its fast−growing real economy and the pressure exerted by its major trading partners. The Philippines accelerated financial deregulation to get out of serious macroeconomic imbalances, including a payments crisis.17 The East Asian countries have either completely freed interest rates or begun regulating them to reflect market conditions. Rates have been fully deregulated in Indonesia and the Philippines; Korea, Malaysia, and Thailand initially relaxed controls through more frequent adjustments in rates, wider bands for regulated rates, and removal of interest rate ceilings. Korea maintained a general strait jacket of regulated interest rates, with frequent adjustments in response to inflation rates. It took decisive steps toward full interest rate liberalization in 1994, and is expected to completely eliminate regulations by 1997. China's progress toward interest rate deregulation has been relatively slow. Since 1985 interest rates have been changed no less than a dozen times, largely to keep pace with inflation. Money market rates in China are the outcome of negotiations between the authorized financial institutions, and consequently are still far from being exposed to market influences. By and large, financial liberalization in these countries has contributed to attaining positive real interest rates, except in China where they remain negative, particularly during 199394. Singapore's nominal interest rates not only outpaced its inflation rate but moved closely in alignment with international rates, signifying rapid integration of its financial system with foreign financial markets. The prevalence of positive real interest rates deepened financial markets, which is reflected in the growth of broad money as a proportion to the GDP in these countries. Thus, the M2/GDP ratio surged up from 20 percent in Indonesia in 1983 to 48 percent in 1994; the corresponding 1994 ratios for Singapore, China, Korea, Thailand, and Malaysia were 92, 88, 42, 77, and 88 percent, respectively. Sectoral credit allocation requirements involving interest subsidies have been substantially modified in most of the East Asian countries. They were drastically scaled down in Indonesia, the Philippines, and, more recently, in Korea, but still form a substantial part of bank credit in China, Malaysia, and Thailand, though they have been modified to reduce the subsidy element in the last two. Delivered by The World Bank e-library to:

000000the 0000000000 Financial reforms also have focused on enhancing operational and management efficiency of the financial IP : 000.000.00.00 system. Indonesia, Korea, Malaysia, the Philippines, and00:00:00 Thailand undertook extensive measures to reduce market 000, 00 000 0000 segmentation and obstacles to competition by allowing greater freedom of entry, expanding the scope of

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The Emerging Asian Bond Market permissible business activities for different types of financial institutions, and relaxing restrictions on foreign banks. Better management often implied that banks needed to be given greater autonomy and more responsibilities for operational performance, which in turn has led to new lending policies, sophisticated information systems, and new products. The reform of China's financial system has not progressed as much as that of the other countries. In contrast, banks in Singapore and Hong Kong have been more efficient, modern, innovative, and financially sound, and are better positioned to respond to the use of indirect monetary policy instruments. The development of money markets in these countries is closely related to financial liberalization from the point of view of indirect monetary control procedures. The Philippines and Singapore had active organized money markets before the onset of financial sector reforms, and with liberalization, they grew faster and became more competitive as new and diversified money market instruments emerged. By the beginning of the 1980s money markets assumed increasing importance in Indonesia, Korea, Malaysia, Thailand, and Hongcontinue

Kong. China's money market has remained rudimentary, thin, and less competitive. In general, the development of money markets has been fostered by the introduction of new financial instruments, including central bank and government securities, certificates of deposits, various kinds of commercial paper, and repurchase agreements. Interest rates on these instruments are relatively competitively determined. The development of deep and wide money markets has provided flexible means for central bank management of liquidity through open market operations and rediscount mechanisms. The hallmarks of external financial liberalization are the opening of the current and capital accounts and the extent of flexibility in exchange rate determination. By the early 1980s restrictions on capital flows had been virtually eliminated in Indonesia and Singapore. Malaysia imposes almost no restrictions on capital flows that are not financed by local borrowing. In the Philippines, capital account controls remained on the books in the 1980s but were not vigorously enforced. By 1994 the capital account was substantially open, paving the way for linking the domestic money and capital markets to international financial markets. In Korea, on the other hand, though some liberalization measures, particularly for foreign direct investment and overseas investment by residents, were in place by the late 1980s, capital account convertibility has been limited. It is likely that these remaining impediments to capital flows will be eliminated by 1997 when its financial deregulation plan is fully implemented. The exception is China, which has limited the opening of its capital account, though it too is moving gradually toward that goal. During the 1980s the East Asian countries adopted more flexible exchange rate arrangements, replacing fixed exchange rates, usually pegged to the dollar. Malaysia, Thailand, and Hong Kong put in place flexible exchange rate arrangements with currencies pegged to composite baskets. Indonesia, Korea, the Philippines, and Singapore have managed float regimes. China's is more akin to a dual exchange rate, though it unified its rates recently at a fixed parity. In general, these exchange arrangements correspond to the International Monetary Fund classification of pegged exchange rate regimes. The rates are adjusted frequently, albeit in small steps, while the flexible exchange rates are operated as pegged rates. The essence of these arrangements, however, is that the rates, whether pegged to the dollar or a basket of currencies, or operated as a managed float, in fact function like fixed nominal exchange rates, which is what matters from the point of view of operating a monetary policy. Viability of the Financial System

Use of indirect monetary policy instruments, such as open market operations or central bank rediscounts, requires a healthy national banking system. A Delivered central bank indirect by The designing World Bank e-library to: procedures for monetary control tries to pick 000000 0000000000 creditworthy and liquid instruments to place on its balance sheet so as to minimize its risks. To the extent IP : 000.000.00.00 government bonds or central bank bills are 000, used00in market operations, or as collateral for rediscounting with 000open 0000 00:00:00 banks, there is rarely any risk, but when the instruments are spawned by the private sector, the central bank has to Viability of the Financial System (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market assess the creditworthiness of those instruments carefully. The central bank has to use its judgment to assess the risk of paper offered as collateral for rediscount or outright purchase by focusing on the borrowers of banks who create the instruments. Bank creditors—mainly depositors—also have to determine whether they should trust banks with their funds. Seen in this perspective, the most relevant consideration is the financial soundness of the banks to which the central bank lends through rediscounting.18 If the banks are burdened with non−performing assets, the central bank should obviously use extreme caution in using indirect monetary policy instruments. Banks in Singapore, Hong Kong, Malaysia, and the Philippines measure up well as creditworthy institutions, while those in China have yet to clean up their balance sheets. Several Korean banks have problems with nonperforming assets, but these are not serious enough to deter the central bank from undertaking indirect monetary control procedures.19 The likelihood of losses from bad loan policies has been contained in almost all these countries by measures to strengthen the supervisory framework. Singapore, Malaysia, Thailand, and Hong Kong have well−honed monitoring and prudential control mechanisms to maintain the soundness of their banks, while Indonesia, Korea, and the Philippines have introduced measures to strengthen supervisory functions in the last few years. These measures include centralizing supervisory responsibilities, developing and unifying regulatory machinery, and extending supervision to nonbank financial intermediaries. In general, the emphasis of supervision has shifted from monitoring routine operations to monitoring credit analysis procedures and bank portfolios, and enforcing prudential ratios. Their financial systems, thus, have geared themselves to be sound counterparts that will enable central banks to conduct open market opera−soft

tions or open market type transactions without risking adverse selections and moral hazard problems.20 Implementation of Monetary Policy

The setting in which monetary policies operate in the East Asian countries has changed dramatically with the progress of financial liberalization, particularly money and capital market developments. This change in the environment has implications for three main aspects of monetary policies—the linkages between monetary policy and the domestic economy, the significance of monetary aggregates as a target variable, and the relative effectiveness of monetary policy instruments. Channels of Monetary Policy

A major impact of financial liberalization is on the channels through which monetary policy is transmitted. Earlier most of the East Asian economies except Hong Kong's were closed, with rigidly fixed exchange rates and credit availability, and interest rates—to the extent they were allowed to vary—were the only channels available for monetary policies to transmit signals of monetary stringency or relaxation. With changes in the financial environment in these economies, interest rates, exchange rates, and capital flows have come to occupy the center stage. Implementing a restrictive monetary policy through open market operations—or raising rediscount rates or reserve requirements—tends to culminate in rising interest rates, which increases demand for financial assets and dampens aggregate demand. The other two channels—the exchange rate and capital flows—become additional transmission channels when the economy is open and the exchange rate fluctuates depending on market conditions. Monetary expansion, for instance, through purchases of securities by the central bank puts downward pressure on domestic interest rates and leads to an outflow of capital. However, the contractionary impact on money supply is offset by a depreciation of the domestic currency, which shifts resources to tradables. Lower Delivered by The World Bank e-library to: interest rates and consequent decreases in the current account deficit counterbalance the impact of capital 000000 0000000000 IP : 000.000.00.00 outflows. The reverse occurs with monetary000, restraint. The exchange rate, in this case, becomes a transmission 00 000 0000 00:00:00 channel of overriding importance. However, the interest rate channel cannot be ignored if monetary conditions Implementation of Monetary Policy (c) The International Bank for Reconstruction and Development / The World Bank

112

The Emerging Asian Bond Market abroad become a major concern to domestic monetary authorities. A tightening of monetary policy in other countries raises their interest rates, leading to an outflow of capital from the domestic economy and downward pressure on its exchange rate. This puts upward pressure on domestic prices, which may warrant a restrictive domestic monetary policy. The reverse happens with a fixed exchange rate and an open economy, with a loss of control on domestic money supply by the central bank. In this case the main transmission channel to be monitored by the monetary authorities is international capital flows.21 The important point here is that the model that fits the economic and financial profile of the East Asian countries is the one with more or less stable exchange rates in an environment of freer capital mobility described earlier in this chapter. Targets of Monetary Policy

Financial reforms have created a number of problems for the conduct of monetary policy in the East Asian countries. Interest rate flexibility requires monetary authorities to decide whether to target interest rates or quantities such as credit and monetary aggregates—though deciding which aggregates to use will require striking a balance between targeting narrow money, which is easier to control, or using broader but more difficult to track variables that include new financial instruments. The choice among interest rate, exchange rate, and monetary aggregates depends on the type of exchange rate regime—fixed or floating—and the degree of openness of the economy. The experience of the Asian economies in this respect is not uniform. Singapore and Hong Kong rely on the exchange rate as their monetary policy target. In view of a high degree of substitutability between domestic and foreign financial assets in their very open economies, monetary and credit aggregates are demand−determined and any disparity between domestic and foreign interest rates is removed through capital flows. Indonesia, on the other hand, adopted interest rate targets after the financial reform in 1983 because of its concern that setting monetary targets in the midst of financial reform and large portfolio shifts would result in instability in interest rates that could have an adverse impact on output. The authorities shifted, however, to protection of international reserves as a target in the latter half of the 1980s, when the Indonesian rupiah came under heavy speculative attack.22 In Korea, broad money (M2) has been set as a target of monetary policy. The choice of M2 was made initially on the grounds that there is no predictable relationship between narrow money and economic activity. This mechanism has recently come into question, however, as financial products not included in M2, such ascontinue

Market Operations Countries

Reserve Requirements

Rediscounting/Refinancing Instruments

Markets

Operating Procedures

China

Since 1988, reserve requirements are set at 13 percent of time and demand deposit. − not frequently altered. Remunerated at 9.18 percent interest rate per

Refinancing available to the financial institutions, but a major part is demand driven. Only small part of refinancing is used for liquidity management.

Development of open market operations is being actively considered.

Infrequent sale.

Short−term treasury bills and central bank notes issued in the primary markets. Only two issues have taken place Delivered by The World Bank e-library to: so far. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

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113

The Emerging Asian Bond Market annum. Hong Kong Accounting arrangements under which a Management Bank holds a certain balance in the clearing account required by the Hong Kong Monetary Authority. − Purpose is to regulate interbank liquidity. Though not reserve requirements exactly, functions similar to that.

Liquidity adjustment facility to make late adjustment to banks, liquidity set up in 1992 to stabilize HIBOR within the range set by LAF bid−offer rate. Liquidity is adjusted through Sale and Repurchase Agreement of government debt.

Exchange Fund Primary market. Bills and notes of maturities of two, three, and four years. Government's short−term bills issued only once.

Indonesia

Since 1988, uniform rate of 2 percent on all deposit liabilities, kept constant at 15 percent before 1988 due to uneven liquidity distribution among financial institutions.

Two discount facilities created in 1984, one for temporary liquidity shortage, the other one to provide assistance to temporary special discount facility added in 1985 to provide liquidity to banks in distress; repayment of special facility within one year.

Central bank certificates (SBIs) introduced in 1984; standardized bankers' acceptance (SBPUs) added in deposits between the central bank and banks.

Primary market actions in SBIs; secondary market for SBIs. SBPUs used by the central bank for daily auctions.

Weekly auction of SBIs since 1984; in 1987 introduction of daily auction of one−week repurchase agreements in SBI dealers and agents for the issuance of SBIs in the weekly auctions and as market makers in the secondary market.

Korea

Current reserve requirements at 11.5 percent of time and demand deposits except for a few long−term time and saving deposits. Lower ratio on non−resident deposits. Liquidity ratios for nonbank financial intermediaries,

Rediscount in two forms Monetary stabilization for monetary policy bonds at two−year purposes; rediscount of commercial bills and markets issued by lending to banks against the central bank. Use of repurchase collateral to influence agreements to money market liquidity; control liquidity other window of subsidized credit. sale and purchase of foreign Substantially revised exchange rediscount mechanism in rediscounts removed and stabilization Delivered by The World Bank e-library to: bonds. Treasury ceilings on000000 rediscounts 0000000000 IP : 000.000.00.00 overall and individual 000, 00 000 0000 00:00:00 bills. bank imposed in 1994.

MSBs in primary market and to a small extent in secondary market since 1994; intention of the authorities to use MSB and government bills for open market operations.

Issue of MSB in a captive market. The rate is linked to time deposits of comparative maturities. Auctioning of MSBs to general public limited in size and frequency. The operating desk determines the issuing and size of transaction.

Targets of Monetary Policy (c) The International Bank for Reconstruction and Development / The World Bank

Issued at regular interval for liquidity management purposes. Purchased by bank for liquidity management.

114

The Emerging Asian Bond Market Figure 5.2 Indirect Monetary Policy Instruments in the East Asian Countries (figure continued on next page)

(figure continued from previous page) Market Operations Countries

Reserve Requirements

Rediscounting/Refinancing Instruments

Markets

Operating Procedures

Malaysia

Statutory reserve requirements at 11.5 percent of all deposit liabilities. This is frequently used for liquidity control.

Discount window for liquidity management. Several refinancing facilities including subsidized facilities. Use is infrequent.

Outright sale and purchase of government securities, repurchase and reverse repurchase agreements, foreign exchange swaps, and recycling of government deposits. Central bank securities—Bank Nagara certificates.

Primary market mainly and sporadically in the secondary market.

The auction system used for treasury bills. Weekly for 91−day T−bills, every two weeks for 182−day T−bills, and every four weeks for 364−day T−bills. The amounts and maturities are announced in advance. The rate not fully market determined.

Philippines Reserve requirements which include also government securities.

Regular rediscounting. It involved subsidy until recently.

T−bills of all maturities, central bank bills (to be phased over), and repurchase, reverse repurchase, and special repurchase agreement.

Primary essentially and of late also secondary market, which has become more competitive in recent years.

Transactions in central bank bills are outright. In regard to T−bills, three forms—repurchase, reverse repurchase, and outright. Auction method adopted but not fully market determined. Only security dealers can participate.

Singapore

Rediscount with the Treasury bills of Monetary Authority of 182−day, 273−day, Singapore (MAS); usually and 364−day pre−export and export bills maturities are of exchange are issued. Delivered by The World Bank e-library to: discounted. 000000 Also treasury 0000000000 IP : 000.000.00.00 bills. MAS borrows 000,also 00 000 0000 00:00:00 and lends in the interbank

Reserve requirement ratio is currently at 6 percent. Used occasionally as a liquidity control instrument,

Targets of Monetary Policy (c) The International Bank for Reconstruction and Development / The World Bank

Mainly primary but secondary market only moderately.

115

The Emerging Asian Bond Market market through various agent banks. Figure 5.2 Indirect Monetary Policy Instruments in the East Asian Countries bonds, have been growing quickly and the relation of M2 to macroeconomic variables such as GDP and inflation no longer seems valid. The Philippines has changed monetary targets several times. Until 1984 net domestic assets were seen as the determinative variable, but this has been changed to base money to reflect the priority attached to inflation control and the need to contain the effects of possible unanticipated capital inflows. Malaysia and Thailand have shifted monetary policy targets as their circumstances changed, while China sets credit as a target in view of its continued adherence to direct monetary controls.23 Choosing a Mix of Indirect Monetary Policy Instruments

In consonance with their financial liberalization, most East Asian countries have gradually moved toward the use of indirect monetary policy instruments, which broadly comprise open market operations, on−demand rediscounting, and reserve requirements. Figure 5.2 presents a synoptic view of the monetary policy instruments mix used in East Asia. Indonesia, Malaysia, and the Philippines have made the greatest advances toward employing indirect monetary policy instruments, while Thailand, Singapore, Hong Kong, and Korea have taken important stepscontinue

toward this goal. China is still at the planning stage, with steps being taken to establish the infrastructure needed to conduct indirect monetary policy procedures. Open market type operations, if not full−fledged open market operations, are prevalent in Indonesia, Korea, Malaysia, the Philippines, and Thailand. These take the form of sale of government bonds or central bank securities, purchase or reverse purchase of bills, and recycling of bank deposits by the central bank and vice versa. In Singapore and Hong Kong, money market intervention by the monetary authorities is done by buying and selling treasury bills, foreign exchange swaps, lending in interbank markets, and repurchase agreements in government bonds. In Hong Kong exchange fund bills and notes are used. In general, open market type operations are limited by the thinness of the market and a lack of eligible government paper. To get around these problems, central banks in Indonesia, Korea, Malaysia, and the Philippines have issued their own debt instruments. Most transactions occur in the primary market, while open market transactions in the secondary market are extremely limited, though arrangements are being made to broaden the scope of the secondary market in these countries. Using auctions to issue government or central bank paper in the primary market is bringing their yields to the level of market interest rates.24 Indonesia, Korea, Malaysia, Singapore, and the Philippines have phased out the use of subsidized central bank discount facilities to strengthen monetary control. These subsidies had been used to ensure low−cost credit to priority sectors, and central banks often found it difficult to reduce discount financing, even when warranted on macroeconomic grounds because the reductions imposed unsustainable losses on commercial banks. Some of the countries have narrowed the range of special discount facilities in favor of generalized, last resort types of lending by the central bank. The third type of indirect monetary policy instrument used is reserve requirements. Since a change in reserve requirements requires portfolio adjustment among commercial bank assets, it is not considered to be an effective instrument and has been used less frequently, with the increasing resort in recent years to more flexible open Delivered by The has Worldbeen Bank kept e-library market operations. The reserve requirements level toto:the minimum in Indonesia, Korea, and 000000 0000000000 Malaysia, but it remained high in the Philippines 1993 because of the ineffectiveness of open market IP : until 000.000.00.00 00 000 0000 large 00:00:00and it could not undertake open market operations; operations in conditions where central bank000, losses were this constraint has now been removed. Choosing a Mix of Indirect Monetary Policy Instruments (c) The International Bank for Reconstruction and Development / The World Bank

116

The Emerging Asian Bond Market Summary and Conclusions Monetary policy's essential function is to regulate availability of money in order to maintain price stability, conducive to rapid growth of the economy with the highest possible level of employment. It is operated in two ways—direct and indirect. Under the first mode, which was prevalent in most of the East Asian and other developing countries until recently, cost of money, that is, interest rate and its quantity, is controlled through imposing ceilings in a top−down fashion according to the perception and judgment of the monetary authorities about what the economic agents should want. Naturally, cost and availability of money so regulated therefore tend to be arbitrary and cumbersome and do not always converge with the market expectations. Under indirect monetary policy procedures, the whole decisionmaking process is transformed. The monetary policy's main accent is on regulating the quantity of money through changes in the interest rate. It accomplishes this through changing its rediscount rate or through purchase and sale of government paper. The changes in reserves so ensued then affect the rates charged by banks on their assets and liabilities. In either case, for these instruments to be effective, it is necessary that the financial system possesses an adequate amount of marketable securities—commercial paper and government papers of various maturities. This means development of a bond market is a sine qua non of indirect monetary policy control. This is more efficient, effective, and impersonal in execution because it permits variation in quantity of money to be determined by the changes in its price. The industrial countries have switched over to the use of indirect monetary instruments over a period of time as their banking systems became more sophisticated and competitive and as bond and stock markets grew in size and diversity, giving freer play to market forces. Now the stage has been reached in their economies which enables them to fine−tune their monetary policies to control domestic liquidity, exchange rates, and the external capital flows. Procedures adopted for implementing monetary policies are generally similar across countries in many respects, and such divergencies as exist among them are of minor importance, dictated more by the specificity of their institutional structures and historical legacies. For countries in East Asia, moving steadily toward the use of indirect monetary policy instruments, it is essential to have a deeper understanding of the conditions under which each of these procedures is used in the leading industrial countries. The first is the ability ofcontinue

central banks to control other items on the balance sheets, such as currency issued, float, net position vis−à−vis the government, and net foreign assets. This is because changes in these items can neutralize or offset the marginal adjustments in bank reserves that the indirect monetary procedures bring about. In this connection, the relationship between government finance and monetary policy is of crucial importance to the effective functioning of monetary procedures; if governments incur liabilities to central banks, monetary procedures are considerably weakened as they are unable to make the reserve adjustments needed to achieve the intended impact on market interest rates. The second is the institutional and behavioral aspects of the money and foreign exchange markets, both of which impart flexibility to interest rate determination and effectively integrate domestic money markets with foreign financial markets. Almost all the East Asian countries except China have been able to switch to the indirect monetary policies in varying degrees. While a great deal of progress has been made in this regard, much has yet to be accomplished. Currently the accent is mainly on using on−demand rediscounting mechanisms and REPOs or reverse REPOs as part of the open market operations. But full−scale open market operations are still far away in most of the countries because of either absence of secondary markets for government papers or their rudimentary nature, if they exist at all. As argued earlier, in this chapter the existence of the bond market is a necessary condition for effective indirect monetary policy but not a sufficient one. The latter requirement can be satisfied only when the secondary market for bonds is made fully operational with arrayto:of policies suggested in Chapter 2.break Delivered by The World Bankan e-library 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

117

The Emerging Asian Bond Market

6— Looking Ahead East Asia's rapidly growing financial sector has begun an important transformation as its domestic bond markets assume increased importance beside the equity and bank financing that have fueled the region's record economic growth in the last quarter century. This financial deepening is being brought about by a confluence of (a) the need to mobilize massive amounts of long−term resources to finance infrastructure investments and housing; (b) structural changes in the economy from predominantly labor−intensive manufacturing to capital−intensive industries that require long−term debt financing; (c) the advent of risk−based capital adequacy requirements instituted by the Bank for International Settlements, which have strained the banking system's ability to meet long−term financing needs; and (d) increased demand for longterm fixed income investment vehicles from the region's institutional investors. East Asia has grown dramatically in the last 25 years, and that growth is expected to continue through the 19952004 decade. Growth is, however, expected to enter a new phase that focuses more on longer−term investments in capital−intensive industries and infrastructure. This shift will require a parallel change in the financing mix to emphasize longer−term sources of funds. That process has already begun. While East Asia's investment financing has historically been dominated by bank and equity financing, bonds are becoming the fastest growing source of financing in the 1990s. Although banks still provide the bulk of investment funds for East Asian firms, this study concludes that the share of bonds in new financing will increase sharply over the next decade. The East Asian Economy in 2004 East Asia is already a formidable economic power, and is expected to become even more so in the next decade. World Bank projections1 show East Asia's GDP growing at an annual rate of 7.7 percent over the next decade, in contrast to 4.9 percent for the low− and middle−income countries, and 2.7 percent for the world as a whole. To sustain this high growth rate, investment over 19942004 is projected at a total of some US$8 trillion. Gross Domestic Fixed Investment (GDFI) ascontinue Table 6.1: GDP and Gross Domestic Fixed Investment, 19942004 (Indicative Projections; 1994 US$ billion) 1994 GDP

1999 GDFI (% GDP)

GDP

Total Private

2004 GDFI (% GDP)

GDP

Total Private

199504 GDFI (% GDP) GDFI(US$B) Total

Private Total

Private

Korea

377

38

29

522

39

30

715

40

31

2,130

1,655

Malaysia

71

39

24

104

40

25

152

41

26

449

281

Thailand

140

40

30

205

42

32

302

44

32

931

693

China

513

39

19

778

40

20

1,172 40

21

3,339

1,684

Indonesia

157

30

21

217

30

20

297

30

20

681

456

24

17

80

30

22

100

34

25

258

185

1,322 37

23

39

25

7,787

4,953

Philippines 64 Total

Delivered by The World Bank e-library to: 0000000000 1,907 000000 38 24 2,739 IP : 000.000.00.00 000, 00 000 0000 00:00:00

6— Looking Ahead

118 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market GDFI = Gross Domestic Fixed Investment. Source: Global Economic Prospects 1995, World Bank.

percentage of GDP in 1994 ranged from 40 percent in Thailand to 24 percent in the Philippines, with an average rate of 37 percent for the region. The bulk of projected investment will take place in China (US$3.3 trillion), Korea (US$2.1 trillion), Thailand (US$931 billion), Indonesia (US$681 billion), and Malaysia (US$449 billion). Given that manufacturing is the largest sector in most East Asian economies, it will continue to account for the bulk of investment. However, investment in infrastructure and the housing sector will also be substantial. In 1994, the region's (excluding Hong Kong and Singapore) GDFI was about US$489 billion, of which 63 percent was private investment. With enhanced private sector participation in infrastructure projects and the region's efforts toward privatization of SOEs, the private component of GDFI is expected to increase over the next decade. Table 6.1 provides the World Bank's indicative projections of GDFI, both public and private. Corporate Finance Practices in East Asia

Corporate finance practices in East Asia vary across countries and across sectors. Table 6.2 shows debt as a part of financing ranging from 59 percent in Thailand to 72 percent in Korea. Firms in Thailand and the Philippines have operated at a leverage level typical of East Asian countries. Interest rates in most East Asian countries have been deregulated. However, in the case of Korea, leverage has been at the high end because of the access of Korean firms to below market interest rates from the banking system. This is likely to change with full deregulation of the Korean financial markets by 1997. On average, East Asian companies have financed about 40 percent of their investment from internally generated funds (net profit plus depreciation). The banking system has financed, on average, another 40 percent. The remaining 20 percent has been traditionally financed through issuance of new equity (10 percent), domestic bonds (9 percent), borrowing from abroad, and, since 1993, foreign bond issues. Although domestic equity markets have grown dramatically with very large market capitalization, the liquidity in these markets has been quite limited and the amount of funds raised through initial public offerings has been relatively modest. Furthermore, most first−tier East Asian companies have already reached their foreign ownership limits. Therefore, most East Asian companies are resorting to debt capital to finance their investments. The region's rapid growth and high corporate profitability have enabled East Asian companies to finance a significant amount of their investment with internally generated funds, augmented by short−term borrowings from commercial banks. Over the coming decade, however, the industrial structure in these countries will experience a major shift from labor−intensive manufacturing to capital−intensive industries. The long gestation periods of Delivered by The Bank to: these projects will strain cash flows and reduce theWorld ability ofe-library the private sector to finance investment with 000000 0000000000 internally generated funds. Resorting to short−term bank financing will not be a sound financial practice as it will IP : 000.000.00.00 000, 00 000 0000 00:00:00 result in sub−optimal capital structures. Therefore, corporate treasurers will seek fixed rate, long−term resources. Corporate Finance Practices in East Asia (c) The International Bank for Reconstruction and Development / The World Bank

119

The Emerging Asian Bond Market The massive investment requirements of infrastructure projects are another driving force for this transformation. Infrastructure projects, by nature, require long−term debt financing with debt−equity ratios of the order of 3 to 1. A third factor is the availability of long−term, fixed rate debt capital. The emergence of new classes of institutional investors, such as the contractual saving sector and private pension funds, which are natural investors in long−term, fixed income instruments, will further hasten the shift toward fixed income securities. Table 6.2: Capital Structure in Selected East Asian Countries Year

Debt as Percent of Equity

Debt as Percent of Total Capital

1993

260

72

Philippinesb 1994

210

68

Thailandc

1993

147

59

India

1994

113

53

United States

1994 Q3*

174

63

Koreaa

a: For corporations listed on Korea Stock Exchange. b: For the largest 1,000 corporations in the Philippines. c: For 14 largest public utilities in Thailand. *Q3= third quarter. Sources: Korea: Korea Securities Research Institute; Philippines: ''Philippines 5000: Growth Beyond Year 2000, 1994 Edition," Securities and Exchange Commission; Thailand: Increasing Private Sector. Participation and Improving Efficiency in State Enterprises, World Bank, 1994; India: ICICI Securities and Finance Company; United States: Department of Commerce. In the light of the changing patterns in corporate finance as discussed above, the share of internally generated funds, bank borrowing, and bond issuance in corporate investment is expected to change substantially over the next 10 years. An indicative financing plan is shown in Table 6.3. This analysis assumes that the share of internally generated funds and bank borrowings in total financing will decline from about 40 per−soft

cent in 1994 to 35 percent in 1999 and to about 30 percent in 2004. New equity financing, however, is assumed to remain at a modest 10 percent of total financing. Thus, bond financing as a share of total financing is expected to increase from about 9 percent in 1994 to 17 percent in 1999 and to about 26 percent by 2004. Under such a financing pattern, the size of the East Asian bond market is projected at over US$1 trillion, net of redemptions by 2004. Of this amount, about US$341 billion and US$766 billion are projected to be the new issuance amounts over 199599 and 200004, respectively. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Corporate Finance Practices in East Asia (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Table 6.3: East Asia: Indicative Financing Plan of Projected Investment (US$ billion; 1994 Prices) 1994 (Actual)

199599 (Projected)

20002004 (Projected)

US$

Percent

US$

Percent

US$

Percent

309

100

2,007

100

2,946

100

124

40

702

35

884

30

New Equity

31

10

201

10

295

10

Bank Borrowing

124

40

702

35

884

30

Sub−total

279

90

1,605

80

2,063

70

Remaining Gap

31

10

402

20

884

30

Bonds

28

9

341

17

766

26

Foreign Financing

3

1

61

3

118

4

Total Private GDFI Financing Internally Generated Funds

GDFI: Gross Domestic Fixed Investment Source: World Bank staff estimates. Table 6.4 shows the size of the East Asian bond markets by country at the end of 1994 and forecasts for 1999 and 2004. These projections are derived from a country− and sector−specific analysis based on information contained in the companion country studies and the authors' own judgment. The analysis further assumes the maintenance of sound macroeconomic policies and continued implementation of financial sector reform programs. The analysis is carried out for illustrative purposes only and as such represents a likely scenario for the East Asian bond market in 2004. Sectoral breakdown of individual bond markets, similarly, reflects historical patterns of public and corporate finance and the authors' own judgment. To the extent that these assumptions are subjective, the resulting projections reflect rough order−of−magnitude estimates rather than being conclusive. Therefore, care must be taken in interpreting the relative sizes of these bond markets projected over the next decade. The size of the bond markets and their composition will depend on the pace of reforms in these countries, actual investment levels, and the associated financing mix. Under our likely scenario, Korea will be the largest market in the region followed by China, Malaysia, and Thailand by 2004. The fastest growing market is likely to be Thailand, which is projected to have a sevenfold increase in its bond market during the next decade. Up to 1994, bond financing was a very small part of Thailand's investment finance, accounting for 11.5 percent of GDP. Traditionally, commercial banks have played a dominant role in Thailand and until 1993, non−listed companies were not allowed to float bond issues publicly. However, this will change with the corporatization of state enterprises and rapid growth of the private sector. The Thai bond market is likely to be predominantly a corporate market. It is assumed that the RTG will continue to follow sound fiscal policies and therefore the need to resort to bond financing will be very limited. China's bond market is projected to grow fivefold during the same period. However, it will remain dominated by the Delivered by The World Bank e-library to: government securities market. Given China's massive capital requirements for development, the government is 000000 0000000000 likely to run fiscal deficits for many years to come. In China, the bond market's institutional infrastructure needs IP : 000.000.00.00 000,growth 00 000 0000 00:00:00 Malaysia's bond market is also expected to grow to be strengthened substantially to unleash its potential. rapidly during the next decade to meet the capital requirements of privatized entities. The Seventh Malaysian Plan Corporate Finance Practices in East Asia (c) The International Bank for Reconstruction and Development / The World Bank

121

The Emerging Asian Bond Market (19962004) estimates a total private investment requirement of RM350 billion ($136 billion). break Table 6.4: Indicative Size of the East Asian Bond Market a (US$ billion; 1994 Prices) End−1994 (Estimate)

End−1999 (Projected)

End−2004 (Projected)

US$

% GDP US$

% GDP US$

% GDP

Korea

161

43

311

59

646

90

Malaysia

39

56

56

54

103

68

Thailand

14

10

36

18

106

35

China

33

6

71

9

154

13

Indonesia

9

6

19

9

40

14

Philippines

25

39

39

48

59

59

Total

282

21

533

28

1108

41

a: Hong Kong and Singapore have been excluded from the analysis in view of the fact that these are international financial centers. Source: World Bank staff estimates.

Issuers Figure 6.1 shows that in 1994 East Asian governments were the major issuers of bonds and accounted for 45 percent of all outstanding bonds, followed by the corporate sector (23 percent), the state enterprise sector (18 percent), central bank securities (14 percent), and state governments (1 percent). This profile will change dramatically during the next decade. The government bond sector is expected to decline to about 33 percent by 1999 and to about 23 percent by 2004, as the governments of Malaysia, Thailand, Indonesia, and Korea are expected to continue their conservative fiscal policies and may even achieve fiscal surpluses; the governments of Singapore and Hong Kong have already accumulated large Delivered by The World Banksurpluses e-library to: and will continue to do so in the future. Only 000000 0000000000 in the Philippines and China will the government securities retain their dominance. IP : 000.000.00.00 000, 00 000 0000 00:00:00

Issuers

122 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market

Figure 6.1 Composition of the East Asian Bond Market in 2004a (Indicative Projections; 1994 US$ billion) a: Hong Kong and Singapore have been excluded from the analysis in view of the fact the these are international financial centers. Source: World Bank staff estimates. The fastest growing sector of the bond market will be the corporate sector. Corporate bonds are projected to grow from $70 billion in 1994 to about $201 billion in 1999 and about $520 billion by 2004, raising the corporate share from 23 percent in 1994 to about 42 percent in 2004. The major issuers of corporate bonds will be from Korea, Malaysia, and Thailand, as these countries will undertake major industrial projects during the next decade. The second largest group of issuers will be the corporatized state enterprises from Thailand, Malaysia, and Korea. Infrastructure Projects

Infrastructure financing is expected to form a major part of investment in East Asia during the next decade. The current level of infrastructure investment of about 5 percent of GDP is not adequate to satisfy even the current levels of unsatisfied demand, let alone meet future needs. It is estimated that this investment level will have to increase to about 8 percent of GDP to meet the increasing demand. The main forces propelling demand for infrastructure services are: • Unsatisfied demand for infrastructure (telecommunications, urban housing, transportation, water supply, waste disposal, etc.) remains quite high in East Asia. Upgrading of existing infrastructure and addition of new stock and services will require substantial investment. • East Asia's rapid industrialization and a clear shift to manufacturing are raising the demand for power and other physical infrastructure in economies such as Hong Kong, Korea, Singapore, and Thailand. • The increasingly integrated global marketplace also demands a vast array of well−functioning infrastructure services to maintain global competitiveness. The competitiveness issue is particularly important in FDI recipient countries, and this is nowhere more imperative thanWorld in East 198692, FDI inflows to East Asia Delivered by The Bank Asia. e-libraryDuring to: 000000The 0000000000 increased sixfold to reach an estimated $19 billion. region now accounts for about 13 percent of global FDI, IP : 000.000.00.00 000,of 00 the 000 0000 00:00:00 and its share is projected to double by the end century.

Infrastructure Projects (c) The International Bank for Reconstruction and Development / The World Bank

123

The Emerging Asian Bond Market During the 1980s, despite high gross domestic investment, East Asian investment in infrastructure averaged only about 4.7 percent of GDP, with the bulk of it (2.1 percent) in the power sector followed by the transportation (1.6 percent), telecommunications (0.6 percent), and water and sanitation (0.4 percent) sectors. While this compared favorably with other developing regions, East Asian investment in infrastructure represented a mere 12 percent of gross domestic investment, partly because of the emphasis placed on modernizing and expanding the industrial base and partly due to highcontinue

investment in social infrastructure such as education and health care. During the early 1990s, public investment in infrastructure rose slightly to about 5 percent of GDP. However, in the 1990s, infrastructure investment is increasingly being switched to the private sector. An estimate based on an internal World Bank study2 puts the infrastructure investment requirements of the East Asia region over the next decade at about $1.4 trillion, which means investment is likely to increase from about $100 billion in 1995 to about $210 billion by 2004. The largest block of the estimated level of investment is in the transportation sector followed by power, telecommunications, and water supply and sanitation (Table 6.5). A low−case scenario estimate of infrastructure investment requirements will be about $1.2 trillion. Investors Domestic Institutional Investors

The size of institutional investors in East Asia is quite large. At the end of 1994, the total size of institutional investorsmainly central provident funds, social security organizations, and mutual funds−was about $103 billion, or 8 percent of GDP (Table 6.6). This ratio would be higher if assets of insurance companies and private pension funds were included. Contractual Saving Institutions

The contractual saving sector across East Asia has been able to mobilize large amounts of long−term resources. Singapore and Malaysia have been the pioneers in developing the contractual saving sector. At the end of 1994, total assets of the Central Provident Fund in Singapore stood at $38 billion, while the Employee Provident Fund in Malaysia had accumulated RM84 billion ($33 billion). The Royal Thai Government started funding its civil servant pension plan in August 1994, by introducing a new plan that combines defined−benefit and defined−contribution plans. This plan is expected to start with an asset size of $2 billion to $3 billion in 1996. Thus far, the role of the contractual saving sector in capital market development has been fairly modest. In the past, these provident funds were initially used to meet government funding requirements, leaving their managers limited freedom in asset allocation. However, most East Asian countries have recently moved toward making the contractual saving sector more autonomous by lifting controls on their investment policies. The Singapore authorities are opening the Central Provident Fund to professional managers and allowing more freedom in investment strategies, and Malaysia's provident fund managers are now required to invest no more than 50 percent of their assets in government securities. The driving force behind this change is the fiscal surpluses of these countries, especially Singapore, Malaysia, andcontinue Table 6.5: Indicative Investment Requirements in Infrastructure, 19952004 (US$ billion in 1994 Prices) Power US$ B % GDP

Telecom

Transport

Delivered by The World Bank e-library to: 000000 0000000000 US$ B IP% US$ B % : 000.000.00.00 000, 00 000 0000 00:00:00

GDP

Water and Sanitation US$ B

GDP

Investors

Total

% GDP US$ B % GDP 124

(c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Baseline Growth Scenario China

200

2.0

141

1.4

302

3.0

101

1.0

744

7.4

Indonesia

54

2.7

25

1.3

62

3.1

20

1.0

161

8.1

Korea

101

2.1

32

0.7

132

2.7

4

0.1

269

5.6

Malaysiaa

17

1.7

6

0.6

22

2.1

4

0.4

50

4.8

Philippines

19

2.7

7

1.0

18

2.5

4

0.4

48

6.8

Thailanda

49

2.4

29

1.4

57

2.8

10

0.5

145

7.2

Other

25

3.1

18

2.2

14

1.7

4

0.5

61

7.5

East Asia

465

2.2

258

1.2

607

2.8

145

0.7

1,476

6.8

China

150

1.7

113

1.3

265

3.0

88

1.0

616

7.0

Indonesia

53

3.0

20

1.1

61

3.5

19

1.1

153

8.8

Korea

80

1.9

26

0.6

106

2.5

3

0.1

215

5.1

Malaysiaa

16

1.8

6

0.7

22

2.4

4

0.4

48

5.3

Philippines

16

2.6

5.5

0.9

14

2.3

2

0.3

38

6.1

Thailanda

38

2.2

26

1.5

52

2.9

9

0.5

125

7.1

Other

18

2.5

14

1.9

13

1.8

3

0.4

48

6.7

East Asia

371

2.0

219

1.1

525

2.8

128

0.7

1,243

6.6

Low Growth Scenario (GDP growth lower by 2 percentage points)

a: Estimates were available only for the public sector. Source: Kondury, K., Investment in Infrastructure: Past Trends and Future Requirements, World Bank, 1994.

Thailand. With new−found freedom in investment decisionmaking, these institutional investors are now seeking long−term fixed income instruments that minimize their asset−liability mismatches, opening a new field for fixed income securities. Table 6.6: Asset Size of East Asian Institutional Investors (US$ billion) 1994 (Actual)

2004 (Projected)

Contractual Savings Institutions Central Provident Fund 38.0 (Singapore) 33.0

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134.0

Investors

125 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Employee Provident Fund (Malaysia) Pension Funds SSS/GSIS (Philippines) 6.0

16.0

SSO/Civil Servant Pension (Thailand)

1.3

37.0

All Government Plans (Indonesia)

5.0

15.0

Private Pension Funds

5.7

18.0

Mutual Funds

20.0

81.0

Total

109.0

400.0

Sources: World Bank staff estimates. With the increase in income and aging of populations, most East Asian countries have adopted or are in the process of adopting social security programs. Indonesia and Thailand have also developed social security organizations and are strengthening their operations. The Thai social security fund is likely to grow exponentially with coverage increasing from the current 1 million to about 5 million members within the next 10 years.3 Mutual Funds

The mutual fund industry is also developing rapidly in East Asia. At the end of 1994, the size of the mutual fund industry was roughly $20 billion. Hong Kong, Thailand, and Malaysia have been at the forefront of developing their mutual fund industries. With the deregulation and the licensing of new fund managers, the size of the Thai mutual fund industry expanded tenfold to about $10 billion over 199294.4 In Malaysia, unit trusts have experienced dramatic growth, while Korea and Indonesia are in the early stages of developing mutual funds. Given the pace at which East Asian countries have been deregulating their financial sectors, private insurance companies will blossom during the next decade, further increasing the role of institutional investors. A rough estimate shows that the size of the institutional investors (government−sponsored pension plans, social security organizations, and mutual fund industries) will increase to around $400 billion by year 2004. Since most East Asian governments do not borrow from these institutions to finance their deficits, these institutions have been allowed greater freedom in their asset allocation. Singapore and Malaysia have already taken the lead in enabling their contractual saving institutions to diversify their portfolios and, to a limited extent, allowing them to invest overseas, initially within East Asia. These institutions are likely to emerge as major investors in long−term debt instruments and provide a big stimulus to the development of corporate bond markets. International Investors International Bond Issues

As discussed in Chapter 5, East Asian issuers have raised substantial amounts in the international bond markets in recent years. Between 1991 and 1993, Asian issuers other than Japan floated $25.7 billion in fixed income securities in foreign markets, far more than what they raised through share offerings. 5 Adding convertible bonds issued during this period brings the total to some $32.7 billion. This trend is likely to continue, but issuance in Delivered by The World Bank e-library to: domestic markets is likely to expand rapidly and become more cost−effective. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Mutual Funds

126 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market Foreign Portfolio Investment

The rapid growth in East Asia's equity markets has been influenced to a large extent by the increase in foreign portfolio investment, especially by the US institutional investors. Most investments have been limited to first−tier companies and in many countries, they have already reached the limit permitted for foreign ownership. In fact, the availability of first−tier shares has become a constraint in Thailand and Korea. To address this problem, several East Asian countries have permitted the issuance of convertible bonds. With a robust macroeconomic environment in most East Asian countries and partial or full convertibility on their capital accounts, East Asian fixed income securities offer attractive investment opportunities for foreign investors. Total pension fund assets in OECD countries are very large (Table 6.7) and allocations for non−domestic investment have been rising. In the case of the United States, 8 percent was allocated for non−domestic investment. Allocation to emerging markets was very small, but is expected to grow. East Asian bond markets could be the beneficiaries of these flows However, access to most of thesecontinue

markets has been limited. For example, large markets such as Korea are reluctant to permit foreign portfolio investment in bonds because of the potential impact on the exchange rate. There are currently only three markets (Thailand, Hong Kong, and Malaysia) that are completely open for foreign portfolio investment. This is likely to change with the accelerated implementation of remaining financial sector reforms in Korea and the Philippines. Table 6.7: Total Pension Assets in Selected Countries (US$ billion) 1989

1994

1999a

United States 2,426

3,760

5,936

Japan

513

1,118

1,750

United Kingdom

453

775

1,116

Canada

181

238

381

The Netherlands

202

264

361

Switzerland

133

191

343

Germany

84

124

177

Australia

42

82

166

Sweden

60

78

134

Denmark

33

53

96

a: Projected. Source: InterSec Research Corporation, Stamford, CT

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Foreign Portfolio Investment (c) The International Bank for Reconstruction and Development / The World Bank

127

The Emerging Asian Bond Market Summary and Conclusions East Asia has made remarkable progress in developing its economies and financial markets, especially banking systems. If East Asia is to sustain rapid growth over the next decade, investment in capital−intensive manufacturing, infrastructure, and housing will need to expand tremendously. Financing of investment of this huge magnitude will require substantial mobilization of resources on a large scale. Given the region's high saving rate, the investment can be financed mostly within the region. However, this will call for major efforts by governments and regulators, in close collaboration with market participants in the private sector, to accelerate development of domestic capital markets, especially bond markets so that intermediation of long−term savings and long−term investment can be performed efficiently. Most East Asian countries have undertaken major policy reforms during recent years. These reforms will need to be accelerated. In addition to undertaking policy reforms, there is a need to further develop required institutional infrastructure for bond markets (credit rating, clearing and settlement, custody, market makers, and bond insurance agencies) to foster the growth of a robust East Asian bond market.break

Annex A— Bond Market−−Statistical Profile Summary Tables Size of the bond market (local currency)

link

Size of the bond market (US dollars)

link

Outstanding bank assets by country

link

Equity market capitalization by country

link

Size of bond market as a percentage of GDP

link

Outstanding bank assets as a percentage of GDP

link

Equity market capitalization as a percentage of GDP

link

Size of major bond markets

link

Bond Market Profile China

link

Hong Kong

link

Indonesia

link

Korea

link

Malaysia

link

Philippines

link

Singapore

link

Thailand

link

India

Delivered by The World Bank e-library to:link 000000 0000000000 IP : 000.000.00.00 link 000, 00 000 0000 00:00:00

Germany Japan

link

Summary and Conclusions (c) The International Bank for Reconstruction and Development / The World Bank

128

The Emerging Asian Bond Market United Kingdom

link

United States

link

Size of the East Asian Bond Market (Local Currency; billions)

1989

1990

1991

1992

1993

1994

US$ billion 1994

China1

105.8

123.4

163.6

232.2

275.0

281.6

33.3

Hong Kong

1.0

7.5

14.6

23.3

46.7

88.9

11.5

Indonesia2

4,658.5

3,251.5

12,739.5

23,555.5

28,111.5

19,978.0

9.1

Korea

51,128.7

63,160.4

78,084.8

95,777.7

111,604.8 126,966.7 161.0

Malaysia

67.7

73.2

77.6

83.5

94.7

101.0

39.5

Philippines

237.2

243.4

332.0

514.6

655.3

612.5

25.1

Singapore3

42.4

43.2

45.3

61.3

61.8

65.5

44.9

Thailand

213.4

213.4

201.0

215.2

261.9

344.6

13.7

Memorandum Items: India4

1,359.0

1,644.0

1,660.0

1,913.0

2,171.0

2,624.0

83.6

Germany5

1,456.0

1,700.1

1,946.3

2,286.8

2,746.1

2,664.5

1,719.0

United Kingdom6

143.5

133.7

140.4

163.0

211.5

234.2

365.9

Japan7

269,715.0 284,342.0 297,761.0 310,275.0 322,886.0 343,375.0 3,442.7

United States8

4,671.9

1 The outstanding value of state government bonds was not available for 1994. The outstanding balance of state enterprise bonds was incomplete in 1994. 2 The decrease in the

5,167.8

5,773.2

6,388.8

6,993.1

7,429.0

7,429.0

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Size of the East Asian Bond Market (Local Currency; billions) (c) The International Bank for Reconstruction and Development / The World Bank

129

The Emerging Asian Bond Market outstanding bond amount in 1994 was due to a large decrease in the amount of central bank notes outstanding in 1994. 3 The 1994 figure is estimated. 4 The figures for India are as of March 31 of the year indicated. 5 Includes both Euro and international bonds. The 1994 figure is preliminary. 6 Excludes Eurosterling bonds. The 1994 figure is preliminary. 7 Excludes Euroyen bonds. The 1994 figure is preliminary. 8 Excludes Eurodollar bonds. The 1994 figure was provided by the Public Securities Association and is not fully comparable with prior year totals because the 1994 figure

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Size of the East Asian Bond Market (Local Currency; billions) (c) The International Bank for Reconstruction and Development / The World Bank

130

The Emerging Asian Bond Market does not include foreign bonds. Sources: The World Bank, The Emerging Asian Bond Market, June 1995; Hong Kong Monetary Authority; The Korea Securities Research Institute; The Central Bank of the Philippines; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; Public Securities Association. Size of the East Asian Bond Market (US$ billion) 1989

1990

1991

1992

1993

1994

China1

22.4

23.6

30.1

40.4

47.4

33.3

Hong Kong

0.1

1.0

1.9

3.0

6.0

11.5

Indonesia2

2.6

1.7

6.4

11.4

13.3

9.1

Korea

75.2

88.2

102.6

121.5

138.1

161.0

Malaysia

25.1

27.1

28.5

32.0

35.1

39.5

Philippines

10.6

8.7

12.5

20.5

23.7

25.1

Singapore3

22.4

24.8

27.8

37.4

38.4

44.9

Thailand

8.3

8.4

Total

166.7

183.6

Delivered by The World Bank e-library to: 0000000000 7.9 000000 8.4 10.3 IP : 000.000.00.00 000, 00 000 0000 00:00:00

217.7

274.6

312.3

13.7 338.0

Size of the East Asian Bond Market (US$ billion) (c) The International Bank for Reconstruction and Development / The World Bank

131

The Emerging Asian Bond Market Memorandum Items: India4

79.8

91.0

64.3

73.0

69.2

83.6

Germany5

856.5

1,141.0

1,280.5

1,420.4

1,587.3

1,719.0

United Kingdom6

231.5

257.1

264.9

247.0

311.0

365.9

Japan7

1,880.2

2,115.6

2,378.3

2,487.2

2,886.8

3,442.7

United States8

4,671.9

5,167.8

5,773.2

6,388.8

6,993.1

7,429.0

1 The outstanding value of state government bonds was not available for 1994. The outstanding balance of state enterprise bonds was incomplete in 1994. 2 The decrease in the outstanding bond amount in 1994 was due to a large decrease in the amount of central bank notes outstanding in 1994. 3 The 1994 figure is estimated. 4 The figures for India are as of March 31 of the year indicated. 5 Includes both Euro and international bonds. The 1994 figure is preliminary. 6 Excludes Eurosterling bonds. The 1994 figure is preliminary. 7 Excludes Euroyen bonds. The 1994 figure is preliminary. 8 Excludes Eurodollar bonds. The 1994 figure was provided by the Public Securities Association and is not fully comparable with prior year totals because the 1994 figure does not include foreign bonds. Sources: The World Bank, The Emerging Asian Bond Market, June 1995; Hong Kong Monetary Authority; The Korea Securities Research Institute; The Central Bank of the Philippines; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; Public Securities Association. East Asia: Outstanding Bank Assets (US$ billions) 1989

1990

1991

1992

1993

1994

China1

299.3

344.9

403.7

446.1

546.6

387.8

Hong Kong

543.8

671.0

722.4

740.3

784.2

947.3

Indonesia2

46.6

64.1

74.9

80.7

85.0

89.7

Korea

140.3

162.6

185.2

205.0

228.7

282.6

Malaysia

67.2

41.1

48.0

55.1

59.8

70.4

Philippines

17.1

17.3

20.0

24.6

27.9

34.2

Singapore

57.0

64.1

73.2

83.8

92.1

115.1

Thailand

52.5

67.8

81.2

94.8

118.1

153.1

Total

1,223.8

1,433.0

1,608.5

1,730.3

1,942.5

2,080.2

Memorandum Items: India3

117.3

Germany

1,819.9

Delivered The World Bank e-library 98.6 by000000 115.3 111.3to: 0000000000 IP : 000.000.00.00 2,431.7 2,572.7 2,766.2 000, 00 0002,650.4 0000 00:00:00

123.4

124.7 3,255.2

East Asia: Outstanding Bank Assets (US$ billions) (c) The International Bank for Reconstruction and Development / The World Bank

132

The Emerging Asian Bond Market United Kingdom4

1,887.6

2,328.9

2,264.1

2,057.3

2,100.5

2,256.6

Japan6

4,432.1

5,182.6

5,667.9

5,740.3

6,338.1

7,105.6

United States5

2,876.8

3,021.2

3,132.3

3,323.8

3,471.4

3,619.5

1 Only includes the assets of specialized banks. The 1994 figure is as of March, 1994. 2 Only includes the assets of deposit money banks. The 1993 figure is as of March, 1993. The 1994 figure is an estimate. 3 Only includes the assets of deposit money banks. The 1994 figure is as of November, 1994. 4 Only includes the assets of deposit money banks. The 1994 figure is as of March, 1994. 5 Only includes the assets of commercial banks. 6 Only includes the assets of deposit money banks. Source: International Monetary Fund, International Financial Statistics; Hong Kong Monetary Authority. East Asia: Equity Market Capitalization (US$ billion) 1989

1990

1991

1992

1993

1994

China

0.0

0.0

2.0

18.3

40.6

43.5

Hong Kong

77.5

83.4

122.0

172.1

385.2

269.5

Indonesia

2.3

8.1

6.8

12.0

33.0

47.2

Korea

140.9

110.6

96.4

107.4

139.4

191.8

Malaysia

39.8

48.6

58.6

94.0

220.3

199.3

Philippines

12.0

5.9

10.2

13.8

40.3

55.5

Singapore

35.9

34.3

47.6

48.8

132.7

134.5

Thailand

25.6

23.9

35.8

58.3

130.5

131.5

Total

334.0

314.8

379.4

524.7

1,122.0

1,072.8

Memorandum Items: India

27.3

38.6

47.7

65.1

98.0

127.5

Germany

365.2

355.1

393.5

348.1

463.5

470.5

United Kingdom

826.6

848.9

988.0

927.1

1,151.6

1,210.2

Japan

4,392.6

2,917.7

3,130.9

2,399.0

2,999.8

3,719.9

United States

3,505.7

3,089.7

4,099.5

4,497.8

5,223.8

5,081.8

Sources: International Finance Corporation,

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East Asia: Equity Market Capitalization (US$ billion) (c) The International Bank for Reconstruction and Development / The World Bank

133

The Emerging Asian Bond Market Emerging Stock Markets Factbook 1994, June 1994, Monthly Review of Emerging Stock Markets, January 1995, and Emerging Markets Database; Monetary Authority of Singapore; Hong Kong Monetary Authority. Size of the East Asian Bond Market (percentage of GDP) 1989

1990

1991

1992

1993

1994

China1

6.9

6.7

7.9

9.6

11.1

6.5

Hong Kong

0.2

1.3

2.3

3.1

5.5

8.7

Indonesia

2.7

1.6

5.5

8.9

9.2

5.8

Korea

33.9

34.8

34.9

39.5

41.7

42.8

Malaysia

66.1

63.3

60.6

55.2

54.5

56.0

Philippines

24.8

19.6

27.4

38.7

43.5

39.3

Singapore2

77.1

68.1

65.7

77.1

69.6

72.4

Thailand

11.5

9.9

8.1

7.6

8.2

9.8

Memorandum Items: India3

29.1

30.6

25.6

27.3

27.6

31.0

Germany4

65.5

70.0

74.5

72.1

83.1

89.5

United Kingdom5 27.5

26.4

26.2

23.6

33.0

35.1

Japan6

65.5

72.2

71.0

67.9

68.5

73.7

United States7

89.8

94.1

102.1

107.6

111.7

110.2

1 The outstanding value of state government bonds was not available for 1994. The outstanding balance of state enterprise bonds was incomplete in 1994. 2 The outstanding bond amount and GDP figure for 1994 were estimated. 3 The bond outstanding figures for India are as of March 31 of the year indicated. Delivered by The World Bank e-library to: 4 Includes both Euro and international bonds.000000 The 1994 figure is preliminary. 0000000000 IP : 000.000.00.00 5 Excludes Eurosterling bonds. The 1994 figure is preliminary. 000, 00 000 0000 00:00:00 6 Excludes Euroyen bonds. The 1994 figure is preliminary. Size of the East Asian Bond Market (percentage of GDP) (c) The International Bank for Reconstruction and Development / The World Bank

134

The Emerging Asian Bond Market 7 Excludes Eurodollar bonds. The 1994 figure was provided by the Public Securities Association and is not fully comparable with prior year totals because the 1994 figure does not include foreign bonds. Sources: The World Bank, The Emerging Asian Bond Market, June 1995; Hong Kong Monetary Authority; The Korea Securities Research Institute; The Central Bank of the Philippines; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; Public Securities Association; International Monetary Fund, International Financial Statistics; Monetary Authority of Singapore; Arab−Malaysian Merchant Bank Berhad. East Asia: Outstanding Bank Assets (percentage of GDP) 1989

1990

1991

1992

1993

1994

China1

92.5

97.2

106.2

106.6

128.4

75.6

Hong Kong9

849.7

935.8

873.5

768.7

715.5

718.7

Indonesia2

49.3

60.5

64.2

63.0

58.8

57.3

Korea8

63.2

64.1

62.9

66.6

69.1

75.1

Malaysia

92.4

96.0

101.9

95.0

92.9

99.9

Philippines3

40.1

39.1

44.1

46.3

51.2

53.5

Singapore5

196.5

175.6

173.1

172.7

166.8

185.6

Thailand8

72.7

79.2

82.2

85.0

94.6

109.5

India3

42.8

41.5

39.3

43.2

44.4

46.2

Germany8

139.1

149.1

149.6

134.6

144.8

169.4

United Kingdom4

224.3

238.7

223.8

196.9

223.1

216.2

Japan6

154.3

176.8

169.2

156.7

150.4

152.1

United States7

55.3

55.0

55.4

56.0

55.5

53.7

Memorandum Items:

1 Only includes the assets of specialized banks. The 1994 bank asset figure is as of March, 1994. 2 Only includes the assets of deposit money banks. The 1993 bank asset figure is as of March, 1993. The 1994 figure is an estimate.

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East Asia: Outstanding Bank Assets (percentage of GDP) (c) The International Bank for Reconstruction and Development / The World Bank

135

The Emerging Asian Bond Market 3 Only includes the assets of deposit money banks. The 1994 bank asset figure is as of November, 1994. 4 Only includes the assets of deposit money banks. The 1994 bank asset figure is as of March, 1994. 5 Only includes the assets of deposit money banks. The 1994 GDP figure was estimated. 6 Only includes the assets of deposit money banks. The 1994 GDP figure is as of September, 1994. 7 Only includes the assets of commercial banks. 8 Only includes the assets of deposit money banks. 9 Includes assets denominated in HK$ and foreign currencies. Source: International Monetary Fund, International Financial Statistics; Hong Kong Monetary Authority; Monetary Authority of Singapore; Arab−Malaysian Merchant Bank Berhad. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

East Asia: Outstanding Bank Assets (percentage of GDP) (c) The International Bank for Reconstruction and Development / The World Bank

136

The Emerging Asian Bond Market East Asia: Equity Market Capitalization (percentage of GDP) 1989

1990

1991

1992

1993

1994

China

0.0

0.0

0.5

4.4

9.5

8.5

Hong Kong

121.1

116.3

147.5

178.7

351.5

204.5

Indonesia

2.4

7.6

5.8

9.4

22.8

30.2

Korea

63.5

43.5

32.8

34.9

42.1

50.9

Malaysia

105.0

113.6

124.4

162.1

342.1

282.7

Philippines

28.1

13.4

22.5

26.0

74.1

86.9

Singapore1

123.4

94.0

112.5

100.6

240.4

216.9

Thailand

35.5

27.9

36.3

52.0

104.5

94.0

India

10.0

13.0

19.0

24.4

39.0

47.2

Germany

27.9

21.8

22.9

17.7

24.3

24.5

United Kingdom

98.3

87.0

97.8

89.1

122.3

115.9

Japan

153.1

99.6

93.5

65.5

71.2

79.6

United States

67.4

56.3

72.4

75.7

83.4

75.4

Memorandum Items:

1 The 1994 GDP figure was estimated. Sources: International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994, Monthly Review of Emerging Stock Markets, January 1995 and Emerging Market Database; International Monetary Fund, International Financial Statistics; Monetary Authority of Singapore; Hong Kong Monetary Authority; Arab−Malaysian Merchant Bank Berhad. Size of the Major Bond Markets at Year−End 1993 (Nominal Value Outstanding; US$ billion)

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East Asia: Equity Market Capitalization (percentage of GDP) (c) The International Bank for Reconstruction and Development / The World Bank

137

The Emerging Asian Bond Market

Bond Market

Total Publicly Issued

As a Pct. of Public Issues in All Central Markets Govt.

U.S. Dollar

$7,547.2

46.3

$2,274.8 $1,898.9

$988.4

$1,455.3 $249.7

$126.0

Japanese Yen

3,044.0

18.7

1,554.6

176.3

74.1

314.9

700.7

66.3

Deutschemark4

1,590.8

9.8

500.9

61.8

60.3

1.8

762.4

−

Italian Lira

780.7

4.8

620.3

15.1

−

2.2

112.9

1.2

French Franc

748.6

4.6

331.5

215.5

3.9

103.4

−

4.9

U.K. Sterling

436.6

2.7

282.2

−

0.0

25.1

−

5.9

Canadian Dollar

393.0

2.4

149.8

−

113.9

52.3

0.8

0.6

Belgian Franc

301.3

1.8

159.2

12.8

−

7.4

101.9

19.5

Dutch Guilder

227.5

1.4

142.0

−

2.6

49.6

−

6.1

Danish Krone

227.4

1.4

72.9

−

−

−

151.5

−

Swiss Franc4

200.7

1.2

17.3

−

15.4

29.9

54.7

83.4

Swedish Krona

186.4

1.1

61.8

−

0.6

8.7

112.5

−

European Currency 144.6 Unit

0.9

49.3

−

−

−

−

−

Spanish Peseta

144.4

0.9

100.9

5.3

−

19.0

9.7

9.4

Australian Dollar

106.1

0.7

50.2

19.2

−

19.4

−

−

Austrian Schilling

87.8

0.5

32.5

2.1

0.4

2.8

47.5

2.5

Norwegian Krone

40.8

0.2

13.2

2.9

5.8

2.7

15.8

0.3

Finnish Markka

33.7

0.2

12.7

−

1.2

5.7

12.9

−

Portuguese Escudo

28.6

0.2

20.0

−

0.4

2.5

3.9

1.8

Irish Pound

21.4

0.1

20.0

0.6

−

0.4

−

0.1

New Zealand Dollar

15.0

0.1

10.2

1.6

−

1.8

−

0.1

Total3

$16,306.6 100.0

Exchange rates prevailing as of December 31, 1993: Yen 111.85/US$; DM 1.7263/US$; Lira 1,704/US$; French Franc 5.8955/US$; Sterling 0.6751/US$;C$

Central Govt. Agency State & & Govt Local Guaranty Govt.

$6,476.3 $2,412.1

Corp. (Incl Cvts.)

Other Domestic Publicly Foreign Issued Bonds

$1,267.0 $2,104.9 $2,336.9

Int1. Bonds1 /

203.62

$1,709.3

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138

The Emerging Asian Bond Market 1.324/US$; Bfr 36.11/US$; Dfl 1.9409/US$; Dkr 6.773/US$; Sfr 1.4795/US$; Skr 8.3035/US$; Ecu 0.8918/US$; Pta 142.21/US$; A$ 1.4769/US$; ATS 12.143/US$; Nkr 7.518/US$; Fmk 5.7845/US$; Esc 176.81/US$; Irish Pound 0.7088/US$; and NZ$ 1.7895/US$. 1 Includes straight, convertible, and floating−rate debt. 2 The German bond market does not distinguish between Euro and Foreign international issues. 3 The total for international bonds includes both Foreign and Euro bonds. 4 For the privately placed category, an unspecified amount of privately placed issues of the private sectors exists. Source: Salomon Brothers, Inc., International Bond Market Analysis, August 1994. Bond Market Profile: China

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139

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

BBB A3 1989

1990

1991

1992

1993

1994

National Government1

76.9

89.0

106.0

128.3

166.4

205.8

State Government

0.0

0.0

9.5

15.5

0.0

NA

State Enterprises2

28.9

34.4

48.1

88.4

108.6

75.8

Central Bank

0.0

0.0

0.0

0.0

0.0

0.0

Corporate

0.0

0.0

0.0

0.0

0.0

0.0

Total

105.8

123.4

163.6

232.2

275.0

281.6

Total (US$ billion)

22.4

23.6

30.1

40.4

47.4

33.3

Total Bonds as a % of GDP

6.9

6.7

7.9

9.6

11.1

6.5

Bonds as a % of Equity Mkt Cap

—

—

1,485.8

221.2

116.9

76.6

Bonds as a % of Bank Assets

7.5

6.9

7.5

9.1

8.7

8.6

Bonds as a % of East Asian Bond Market

13.4

12.9

13.8

14.7

15.2

9.9

Equity Market Capitalization (US$B)

0.0

0.0

2.0

18.3

40.6

43.5

GDP (US$B)

323.8

355.0

380.1

418.5

425.6

513.0

Stock Market as a % of GDP

0.0

0.0

0.5

4.4

9.5

8.5

Exchange Rate (End of Period)

4.72

5.22

5.43

5.75

5.80

8.45

26.8

10.6

4.0

5.9

0.9

45.7

Total Bank Assets (US$B)3

299.5

344.9

403.7

446.1

546.6

387.8

Bank Assets as a % of GDP

92.5

97.2

106.2

106.6

128.4

75.6

183.6

217.7

274.6

312.3

338.0

(Billions of Yuan):

Memorandum Items:

(Yuan per US$) Apprec./−Deprec. of Exchange Rate (Percent)

Total Asian Bond Market Size 166.7 (US$B) 1 For China, national government bonds are comprised of treasury bonds. The 1993 outstanding balance for treasury bonds does not

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140

The Emerging Asian Bond Market equal last year's balance plus net new issues because of a difference between the redemption amount and settlement amount, owing to a split year adjustment. 2 The 1993 figure for state enterprises is an estimate. Since the total outstanding balance is correct and several categories of the state enterprise balance were missing for 1993, the unreconciled balance between treasury bonds and the total outstanding balance was placed in the state enterprise category in order to reconcile the figures for 1993. The figure for 1994 was the result of bonds issued by the newly established State Development Bank to other financial institutions. This figure would have been higher had additional information been available on the outstanding bond amounts for other state enterprises. 3 Only includes the assets of specialized banks. The 1994 figure is as of March, 1994. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The World Bank, The Emerging Asian Bond Market, June 1995; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994, and Monthly Review of Emerging Stock Markets, January 1995; International Monetary Fund, International Financial Statistics. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: China (c) The International Bank for Reconstruction and Development / The World Bank

141

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Hong Kong Sovereign Rating Standard & Poor's: Moody's:

A1 A3 1989

1990

1991

1992

1993

1994

National Government

1.0

0.0

0.6

3.0

3.6

0.6

State Government

0.0

0.0

0.0

0.0

0.0

0.0

State Enterprises

0.0

0.0

0.0

0.0

0.0

0.0

Central Bank2

0.0

7.5

14.0

20.3

28.1

52.3

Corporate

NA

NA

NA

NA

15.0

36.0

Total

1.0

7.5

14.6

23.3

46.7

88.9

Total (US$B)

0.1

1.0

1.9

3.0

6.0

11.5

Total Bonds as a % of GDP

0.2

1.3

2.3

3.1

5.5

8.7

Bonds as a % of Equity Mkt Cap

0.2

1.2

1.5

1.7

1.6

4.3

Bonds as a % of Bank Assets

0.0

0.1

0.3

0.4

0.8

1.2

Bonds as a % of Asian Bond Mkts 0.1

0.5

0.9

1.1

1.9

3.4

(Billions of Hong Kong Dollars):

Memorandum Items: Equity Market Capitalization (US$B)

77.5

83.4

122.0

172.1

385.2

269.5

GDP (US$B)

64.0

71.7

82.7

96.3

109.6

131.8

Stock Market as a % of GDP

121.1

116.3

147.5

178.7

351.5

204.5

Exchange Rate (End of Period) (HK$ per US$)

7.81 7.80 7.78 7.74 Delivered by The World Bank e-library to:

7.73

7.74

Apprec./−Deprec. of Exchange

0.0

0.1

0.1

000000 0000000000 IP : 000.000.00.00 000, 00 0.1000 0000 00:00:00 0.3

0.5

Bond Market Profile: Hong Kong (c) The International Bank for Reconstruction and Development / The World Bank

142

The Emerging Asian Bond Market Rate (Percent) Total Bank Assets (US$B)3

543.8

671.0

722.4

740.3

784.2

947.3

Bank Assets as a % of GDP3

849.7

935.8

873.5

768.7

715.5

718.7

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

1 Implied rating. 2 Central bank bonds are comprised of Exchange Fund Bills and Notes, which are issued by the Hong Kong Monetary Authority. 3 Includes assets denominated in HK$ and foreign currencies. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; Hong Kong Monetary Authority; International Monetary Fund, International Financial Statistics.

Source: International Monetary Fund.

Bond Market Profile: Indonesia

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Bond Market Profile: Indonesia (c) The International Bank for Reconstruction and Development / The World Bank

143

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

BBB−1 Baa3 1989

1990

1991

1992

1993

1994

National Government

0.0

0.0

0.0

0.0

0.0

0.0

State Government

0.0

0.0

0.0

0.0

0.0

0.0

State Enterprises

1,195.0

1,560.0

1,645.0

2,764.0

3,659.0

3,375.0

Central Bank2

3,301.0

1,529.0

10,942.0 20,599.0 23,435.0 15,053.0

Corporate

162.5

162.5

152.5

Total

4,658.5

3,251.5

12,739.5 23,555.5 28,111.5 19,978.0

Total (US$ billion)

2.6

1.7

6.4

11.4

13.3

9.1

Total Bonds as a % of GDP

2.7

1.6

5.5

8.9

9.2

5.8

Bonds as a % of Equity Mkt Cap

112.7

21.1

94.0

95.2

40.4

19.2

Bonds as a % of Bank Assets

5.6

2.7

8.5

14.2

15.7

10.1

Bonds as a % of Asian Bond Mkts

1.6

0.9

2.9

4.2

4.3

2.7

Equity Market Capitalization (US$B)

2.3

8.1

6.8

12.0

33.0

47.2

GDP (US$B)

94.5

106.0

116.6

128.0

144.7

156.7

Stock Market as a % of GDP

2.4

7.6

5.8

9.4

22.8

30.2

Exchange Rate (End of Period)

1,797.00 1,901.00 1,992.00 2,062.00 2,110.00 2,200.00

(Billions of Rupiah):

192.5

1,017.5

1,550.0

Memorandum Items:

(Rupiah per US$) Apprec./−Deprec. of Exchange Rate (Percent)

3.8

5.8

4.8

3.5

2.3

4.3

Total Bank Assets (US$B)3

46.6

64.1

74.9

80.7

85.0

89.7

Bank Assets as a % of GDP

49.3

60.5

64.2

63.0

58.8

57.3

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

1 Implied rating. 2 Although central bank notes are not technically defined as bonds according to Indonesia's capital markets law, we have decided to include them here in order to maintain consistency with other annex tables.

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144

The Emerging Asian Bond Market 3 Only includes the assets of deposit money banks. The 1993 figure is as of March, 1993. The 1994 figure is an estimate. The number was derived by multiplying the 1993 figure by 15 percent. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The World Bank, The Emerging Asian Bond Market, June 1995; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Monthly Review of Emerging Stock Markets, January 1995. Investors in Bonds (as of Third Quarter 1994) (billions of Rupiah) Holder

Amount

Percent

Taspen

1,350.0

27.0

Astek

321.0

6.4

Other state pension funds

300.0

6.0

Private pension funds

435.0

8.7

Life and non−life insurance cos

463.0

9.3

Banks

1,000.0

20.0

Other

1,131.0

22.6

Source: The World Bank.

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145

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Korea

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146

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

A+ Al 1989

1990

1991

1992

1993

1994

National Government

10,688.7

13,742.1

17,083.0

19,948.1

20,825.2

21,979.8

State Government

618.2

825.3

1,102.3

1,384.3

1,735.3

2,127.2

State Enterprises

6,195.8

9,284.7

15,020.7

18,797.3

24,953.1

29,535.2

Central Bank

17,305.4

15,240.5

13,496.5

20,264.0

24,201.8

25,340.4

Corporate

16,320.6

24,067.8

31,382.3

35,384.0

39,889.4

47,984.1

Total

51,128.7

63,160.4

78,084.8

95,777.7

111,604.8 126,966.7

Total (US$ billion)

75.2

88.2

102.6

121.5

138.1

161.0

Total Bonds as a % of GDP

33.9

34.8

34.9

39.5

41.7

42.8

Bonds as a % of Equity Mkt Cap

53.4

79.7

106.5

113.1

99.1

83.9

Bonds as a % of Bank Assets

53.6

54.2

55.4

59.3

60.4

57.0

Bonds as a % of East Asian Bond 45.1 Market

48.0

47.1

44.2

44.2

47.6

(Billions of Won):

Memorandum Items: Equity Market Capitalization (US$B)

140.9

110.6

96.4

107.4

139.4

191.8

GDP (US$B)

222.2

253.7

294.2

307.9

330.8

376.5

Stock Market as a % of GDP

63.5

43.5

32.8

34.9

42.1

50.9

Exchange Rate (End of Period)

679.60

716.40

760.80

788.40

808.10

788.70

Apprec./−Deprec. of Exchange Rate (Percent)

0.7

5.4

6.2

3.6

2.5

2.4

Total Bank Assets (US$B)1

140.3

162.6

185.2

205.0

228.7

282.6

Bank Assets as a % of GDP

63.2

64.1

62.9

66.6

69.1

75.1

Total East Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

(Won per US$)

1 Only includes the assets of deposit money banks. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The Korea Securities Research Institute; International Finance Corporation, Emerging Stock Markets Factbook 1994, June

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147

The Emerging Asian Bond Market 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Monthly Review of Emerging Stock Markets, January 1995. Holders of Bonds (as of Third Quarter 1994) (Billion of Rupiah) 1989

1990

1991

1992

1993

Financial Sector1

—

34,397

40,663

52,398

69,907

Banks

—

17,496

20,713

24,280

29,504

Insurance Companies

1,812

3,096

5,417

6,238

6,878

Non−life Insurance Companies

622

974

1,170

1,356

1,275

Securities Companies

264

193

173

167

279

Major Funds

—

—

—

—

3,305

Investment Trust Companies

11,413

12,638

13,190

20,357

28,666

Government

—

521

789

952

2,100

Corporation

—

1,802

5,418

5,075

2,644

Individual

—

3,324

5,681

5,011

3,110

1 Financial sector, government, corporation, and individual figures are estimates. Source: The World Bank.

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148

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Malaysia

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Bond Market Profile: Malaysia (c) The International Bank for Reconstruction and Development / The World Bank

149

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

A A2 1989

1990

1991

1992

1993

1994

National Government

63.5

67.3

70.5

72.0

72.3

74.1

State Government

0.0

0.0

0.0

0.0

0.0

0.0

State Enterprises

2.5

2.9

2.6

5.1

5.9

9.5

Central Bank

0.0

0.0

0.0

0.0

7.2

5.0

Corporate2

1.6

3.0

4.5

6.4

9.3

12.5

Total

67.7

73.2

77.6

83.5

94.7

101.0

Total (US$ billion)

25.1

27.1

28.5

32.0

35.1

39.5

Total Bonds as a % of GDP

66.1

63.3

60.6

55.2

54.5

56.0

Bonds as a % of Equity Mkt Cap

63.0

55.8

48.7

34.0

15.9

19.8

Bonds as a % of Bank Assets

71.6

66.0

59.4

58.1

58.7

56.1

Bonds as a % of East Asian Bond Market

15.0

14.8

13.1

11.7

11.2

11.7

Equity Market Capitalization (US$B)

39.8

48.6

58.6

94.0

220.3

199.3

GDP (US$B)

37.9

42.8

47.1

58.0

64.4

70.5

Stock Market as a % of GDP

105.0

113.6

124.4

162.1

342.1

282.7

Exchange Rate (End of Period)

2.70

2.70

2.72

2.61

2.70

2.56

Apprec./−Deprec. of Exchange Rate (Percent)

0.6

0.0

0.7

4.0

3.4

5.2

Total Bank Assets (US$B)

35.0

41.1

48.0

55.1

59.8

70.4

Bank Assets as a % of GDP

92.4

96.0

101.9

95.0

92.9

99.9

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

(Billions of Ringgit):1

Memorandum Items:

(Ringgit per US$)

1 The 1994 figures are preliminary. 2 The corporate bond category is comprised of private debt securities, which do not include short−term commercial paper. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Malaysia (c) The International Bank for Reconstruction and Development / The World Bank

150

The Emerging Asian Bond Market World Bank, The Emerging Asian Bond Market, June 1995; International Monetary Fund, International Financial Statistics; Arab−Malaysian Merchant Bank Berhad. Distribution of Malaysian Government Securities by Holder (RM'mil) 1980

1990

1991

1992

Jun.93

Federal government

443

353

353

302

302

State government

12

0

0

0

0

NEFPEs

274

5,337

5,437

4,935

4,935

Employees provident fund

8,582

36,118

38,266

39,628

39,589

Insurance companies

501

1,437

1,928

2,888

3,278

Social security organization

260

1,354

1,355

1,565

1,533

Central bank

1,627

2,199

1,260

336

330

Commercial banks

2,446

7,846

8,496

8,680

8,206

National savings bank

924

1,595

1,601

1,867

1,919

Other financial institutions

1,478

5,385

6,085

5,960

5,246

Other

41

129

129

129

129

Total

16,587

61,752

64,910

66,289

65,466

Public sector

Social security institutions

Financial institutions

Source: The World Bank.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Malaysia (c) The International Bank for Reconstruction and Development / The World Bank

151

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Philippines Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Philippines (c) The International Bank for Reconstruction and Development / The World Bank

152

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's

BB− Ba3 1989

1990

1991

1992

1993

1994

National Government1

225.2

237.5

282.3

435.5

624.0

605.7

State Government

0.1

0.0

0.0

0.0

0.0

0.0

State Enterprises

5.9

1.9

2.2

2.4

2.3

2.2

Central Bank

6.0

4.0

47.5

76.7

29.0

4.6

Corporate

0.0

0.0

0.0

0.0

0.0

0.0

Total

237.2

243.4

332.0

514.6

655.3

612.5

Total (US$ billion)

10.6

8.7

12.5

20.5

23.7

25.1

Total Bonds as a % of GDP

24.8

19.6

27.4

38.7

43.5

39.3

Bonds as a % of Equity Mkt Cap

88.1

147.3

122.1

148.6

58.7

45.2

Bonds as a % of Bank Assets

61.9

50.2

62.2

83.5

84.9

73.3

4.7

5.7

7.5

7.6

7.4

(Billions of Pesos):

Bonds as a % of East Asian Bond 6.3 Market Memorandum Items: Equity Market Capitalization (US$B)

12.0

5.9

10.2

13.8

40.3

55.5

GDP (US$B)

42.6

44.3

45.4

53.0

54.4

63.9

Stock Market as a % of GDP

28.1

13.4

22.5

26.0

74.1

86.9

Exchange Rate (End of Period)

22.44

28.00

26.65

25.10

27.70

24.42

Apprec./−Deprec. of Exchange Rate (Percent)

5.2

24.8

4.8

5.8

10.4

11.8

Total Bank Assets (US$B)2

17.1

17.3

20.0

24.6

27.9

34.2

Bank Assets as a % of GDP

40.1

39.1

44.1

46.3

51.2

53.5

Total East Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

(Pesos per US$)

1 Treasury bills make up a large percentage of national government bonds outstanding. For example, in 1994 treasury bills made up over 60 percent of national government bonds outstanding. 2 Only includes the assets of deposit money banks. The 1994 figure is as of November, 1994. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The Central Bank of the Philippines; International Finance Corporation, Emerging Stock Markets Delivered by The World Bank e-library to: Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; 000000 0000000000 IP : 000.000.00.00 International Finance Corporation, Monthly000, Review of Emerging Stock Markets, January 1995. 00 000 0000 00:00:00

Bond Market Profile: Philippines (c) The International Bank for Reconstruction and Development / The World Bank

153

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Singapore Sovereign Rating Standard & Poor's: Moody's:

AA+ Aa2 1989

1990

1991

1992

1993

1994

National Government1

42.4

43.2

45.3

61.3

61.8

61.8

State Government

0.0

0.0

0.0

0.0

0.0

0.0

State Enterprises

0.0

0.0

0.0

0.0

0.0

0.0

Central Bank

0.0

0.0

0.0

0.0

0.0

0.0

Corporate

NA

NA

NA

NA

NA

3.7

Total

42.4 45.3 61.3 Delivered by 43.2 The World Bank e-library to:

61.8

65.5

38.4

44.9

(Billions of Singapore Dollars):

Total (US$ billion)

22.4

000000 0000000000 IP24.8 : 000.000.00.00 27.8 000, 00 000 0000 00:00:00

37.4

Bond Market Profile: Singapore (c) The International Bank for Reconstruction and Development / The World Bank

154

The Emerging Asian Bond Market Total Bonds as a % of GDP

77.1

68.1

65.7

77.1

69.6

72.4

Bonds as a % of Equity Mkt Cap

62.5

72.4

58.4

76.6

28.9

33.4

Bonds as a % of Bank Assets

39.2

38.8

37.9

44.6

41.7

39.0

Bonds as a % of East Asian Bond Market

13.5

13.5

12.8

13.6

12.3

13.3

Equity Market Capitalization (US$B)

35.9

34.3

47.6

48.8

132.7

134.5

GDP (US$B)1

29.1

36.5

42.3

48.5

55.2

62.0

Stock Market as a % of GDP

123.4

94.0

112.5

100.6

240.4

216.9

Exchange Rate (End of Period) (S$ per US$)

1.89

1.74

1.63

1.64

1.61

1.46

Apprec./−Deprec. of Exchange Rate (Percent)

2.9

7.9

6.3

0.6

1.8

9.3

Total Bank Assets (US$B)2

57.2

64.1

73.2

83.8

92.1

115.1

Bank Assets as a % of GDP

196.5

175.6

173.1

172.7

166.8

185.6

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

1990

1991

1992

Memorandum Items:

1 The 1994 figure is estimated. 2 Only includes the assets of deposit money banks. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The World Bank, The Emerging Asian Bond Market, June 1995; International Monetary Fund, International Financial Statistics; Monetary Authority of Singapore. Singapore Government Debt by Holders 1 (Millions of Singapore Dollars) 1988

1989

Domestic medium− and long−term debt Government bonds2 Central provident fund

30,120

32,120

32,120

32,120

45,620

Commercial banks3

3,251

5,053

5,934

6,403

6,946

Post office savings bank

1,107

1,135

1,215

1,429

1,604

Insurance companies

848

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 1,014 000, 00 1,137 1,386 1,812 000 0000 00:00:00

Bond Market Profile: Singapore (c) The International Bank for Reconstruction and Development / The World Bank

155

The Emerging Asian Bond Market Other

1,647

1,177

744

472

129

Advance deposits4

2,257

3,672

8,138

13,720

5,928

Treasury bills and deposits Commercial banks3

2,161

1,773

1,989

3,362

4,660

Other

199

127

81

108

280

Total domestic debt

41,590

46,071

51,358

59,000

66,979

1 Net outstanding at nominal value. 2 Tax−free and taxable issues for varying periods of maturity ranging from 220 years and bearing rates of interest between 4 3/4 percent and 7 1/4 percent. 3 Including holdings of Development Bank of Singapore. 4 Deposits placed by the CPF and POSB in the government's account with the MAS for future subscriptions to government securities. Source: The World Bank.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Singapore (c) The International Bank for Reconstruction and Development / The World Bank

156

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Thailand Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Thailand (c) The International Bank for Reconstruction and Development / The World Bank

157

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

A− A2 1989

1990

1991

1992

1993

1994

National Government1

201.4

195.2

150.8

133.9

100.7

66.2

State Government

0.0

0.0

0.0

0.0

0.0

0.0

State Enterprises

12.0

18.2

50.2

76.2

134.9

190.4

Central Bank

0.0

0.0

0.0

0.0

0.0

0.0

Corporate

0.0

0.0

0.0

5.1

26.3

88.0

Total

213.4

213.4

201.0

215.2

261.9

344.6

Total (US$ billion)

8.3

8.4

7.9

8.4

10.3

13.7

Total Bonds as a % of GDP

11.5

9.9

8.1

7.6

8.2

9.8

Bonds as a % of Equity Mkt Cap

32.4

35.3

22.2

14.5

7.9

10.4

Bonds as a % of Bank Assets

15.8

12.4

9.8

8.9

8.7

9.0

Bonds as a % of East Asian Bond Market

5.0

4.6

3.7

3.1

3.3

4.1

Equity Market Capitalization (US$B)

25.6

23.9

35.8

58.3

130.5

131.5

GDP (US$B)

72.3

85.6

98.7

111.5

124.9

139.8

Stock Market as a % of GDP

35.5

27.9

36.3

52.0

104.5

94.0

Exchange Rate (End of Period) (Baht per US$)

25.69

25.29

25.28

25.52

25.54

25.09

Apprec./−Deprec. of Exchange Rate (Percent)

1.8

1.6

0.0

0.9

0.1

1.8

Total Bank Assets (US$B)2

52.5

67.8

81.2

94.8

118.1

153.1

Bank Assets as a % of GDP

72.7

79.2

82.2

85.0

94.6

109.5

Total Asian Bond Market Size (US$B)

116.7

183.6

217.7

274.6

312.3

338.0

(Billions of Baht):

Memorandum Items:

1 National government securities may include state government securities as well. 2 Only includes the assets of deposit money banks. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The World Bank, The Emerging Asian

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Thailand (c) The International Bank for Reconstruction and Development / The World Bank

158

The Emerging Asian Bond Market Bond Market, June 1995; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Monthly Review of Emerging Stock Markets, January 1995.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Thailand (c) The International Bank for Reconstruction and Development / The World Bank

159

The Emerging Asian Bond Market Source: International Monetary Fund.

Bond Market Profile: India Sovereign Rating Standard & Poor's: Moody's:

BB−1 Ba22 1989

1990

1991

1992

1993

1994

National Government4

695.0

877.0

767.0

865.0

1,045.0

1,399.0

State Government

107.0

129.0

155.0

190.0

225.0

261.0

State Enterprises

277.0

348.0

438.0

528.0

571.0

634.0

Central Bank

0.0

0.0

0.0

0.0

0.0

0.0

Corporate

280.0

290.0

300.0

330.0

330.0

330.0

Total

1,359.0

1,644.0

1,660.0

1,913.0

2,171.0

2,624.0

Total (US$ billion)

79.8

91.0

64.3

73.0

69.2

83.6

Total Bonds as a % of GDP

29.1

30.6

25.6

27.3

27.6

31.0

Bonds as a % of Equity Mkt Cap 292.2

235.7

134.7

112.2

70.6

65.6

Bonds as a % of Bank Assets

68.0

73.7

65.2

63.3

62.1

67.1

Bonds as a % of East Asian Bond 47.8 Market

49.6

29.5

26.6

22.2

24.7

(Billions of Rupees):3

Memorandum Items: Equity Market Capitalization (US$B)

27.3

38.6

47.7

65.1

98.0

127.5

GDP (US$B)

274.0

297.1

251.1

267.1

251.0

270.0

Stock Market as a % of GDP

10.0

13.0

19.0

24.4

39.0

47.2

Exchange Rate (End of Period)

17.04

18.07

25.83

26.20

31.38

31.38

Apprec./−Deprec. of Exchange Rate (Percent)

14.0

6.1

42.9

1.4

19.8

0.0

Total Bank Assets (US$B)5

117.3

123.4

98.6

115.3

111.3

124.7

Bank Assets as a % of GDP

42.8

41.5

39.3

43.2

44.4

46.2

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

(Rupees per US$)

1 Implied rating. 2 On review for possible upgrade.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: India (c) The International Bank for Reconstruction and Development / The World Bank

160

The Emerging Asian Bond Market 3 All fixed income figures are as of March 31 of the year indicated. 4 National government bonds outstanding include treasury bills outstanding. 5 Only includes the assets of deposit money banks. The 1994 figure is as of November, 1994. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; The World Bank, The Emerging Asian Bond Market, June 1995; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Monthly Review of Emerging Stock Markets, January 1995.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: India (c) The International Bank for Reconstruction and Development / The World Bank

161

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Germany Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Germany (c) The International Bank for Reconstruction and Development / The World Bank

162

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

AAA1 Aaa 1989

1990

1991

1992

1993

1994

National Government

374.6

450.2

520.4

662.2

864.7

NA

State Government

37.0

40.4

47.7

76.8

104.1

NA

State Enterprises

57.3

64.7

75.1

93.4

106.6

NA

Central Bank

0.0

0.0

0.0

0.0

0.0

NA

Corporate

763.4

903.6

1,043.6

1,159.2

1,319.3

NA

Total2

1,456.0

1,700.1

1,946.3

2,286.8

2,746.1

2,664.5

Total (US$ billion)

856.5

1,141.0

1,280.5

1,420.4

1,587.3

1,719.0

Total Bonds as a % of GDP

65.5

70.0

74.5

72.1

83.1

89.5

Bonds as a % of Equity Mkt Cap 234.5

321.3

325.4

408.0

342.5

365.4

Bonds as a % of Bank Assets

46.9

49.8

53.6

57.4

52.8

621.6

588.0

517.2

508.3

508.6

(Billions of DM):

47.1

Bonds as a % of East Asian Bond 513.6 Market Memorandum Items: Equity Market Capitalization (US$B)

365.2

355.1

393.5

348.1

463.5

470.5

GDP (US$B)

1,308.0

1,630.5

1,719.5

1,969.5

1,910.8

1,921.1

Stock Market as a % of GDP

27.9

21.8

22.9

17.7

24.3

24.5

Exchange Rate (End of Period) (DM per US$)

1.70

1.49

1.52

1.61

1.73

1.55

Apprec./−Deprec. of Exchange Rate (Percent)

4.5

12.4

2.0

5.9

7.5

10.4

Total Bank Assets (US$B)3

1,819.9

2,431.7

2,572.7

2,650.4

2,766.2

3,255.2

Bank Assets as a % of GDP

139.1

149.1

149.6

134.6

144.8

169.4

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

1 Implied rating. 2 Although the total bond figures include international DM bonds, the international bonds were not included in the previous five categories. These bonds include both Euro and Foreign international bonds. Since the West German market does not

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Germany (c) The International Bank for Reconstruction and Development / The World Bank

163

The Emerging Asian Bond Market distinguish between Euro and Foreign international bonds, Euro bonds could not be broken out in order to maintain consistency with other tables in this report. The 1994 figure is preliminary. 3 Only includes the assets of deposit money banks. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Emerging Market Database.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Germany (c) The International Bank for Reconstruction and Development / The World Bank

164

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: Japan Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: Japan (c) The International Bank for Reconstruction and Development / The World Bank

165

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

AAA Aaa 1989

1990

1991

1992

1993

1994

(Billions of Yen): National Government

153,957.0 156,427.0 161,117.0 166,108.0 173,878.0 NA

State Government

6,958.0

7,210.0

7,379.0

7,666.0

8,286.0

NA

State Enterprises

19,973.0

19,992.0

19,847.0

19,965.0

19,717.0

NA

Central Bank

0.0

0.0

0.0

0.0

0.0

NA

Corporate

83,827.0

94,957.0

103,231.0 110,036.0 113,588.0 NA

Total1

269,715.0 284,342.0 297,761.0 310,275.0 322,886.0 343,375.0

Total (US$ billion)

1,880.2

2,115.6

2,378.3

2,487.2

2,886.8

3,442.7

Total Bonds as a % of GDP

65.5

72.2

71.0

67.9

68.5

73.7

Bonds as a % of Equity Mkt Cap

42.8

72.5

76.0

103.7

96.2

92.5

Bonds as a % of Bank Assets

42.4

40.8

42.0

43.3

45.5

48.5

Bonds as a % of East Asian Bond Market

1,127.6

1,152.5

1,092.2

905.7

924.4

1,018.5

Equity Market Capitalization (US$B)

4,392.6

2,917.7

3,130.9

2,399.0

2,999.8

3,719.9

GDP (US$B)2

2,871.7

2,932.1

3,350.2

3,662.4

4,214.2

4,672.6

Stock Market as a % of GDP

153.1

99.6

93.5

65.5

71.2

79.6

Exchange Rate (End of Period) (Yen per US$)

143.45

134.40

125.20

124.75

111.85

99.74

Apprec./−Deprec. of Exchange Rate (Percent)

14.0

6.3

6.8

0.4

10.3

10.8

Total Bank Assets (US$B)3

4,432.1

5,182.6

5,667.9

5,740.3

6,338.1

7,105.6

Bank Assets as a % of GDP

154.3

176.8

169.2

156.7

150.4

152.1

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

Memorandum Items:

1 Although the total bond figures include foreign bonds, these bonds were not included in the previous five categories. For the purposes of this report, Euroyen bonds are not considered to be part of the domestic bond market and are therefore not included in this table. The 1994 figure is preliminary. 2 The 1994 figure is as of September, 1994. 3 Only includes the assets of deposit money banks. by The World Bank e-library to: October 31, 1994; Salomon Sources: Salomon Brothers, SummaryDelivered of Selected Sovereign Ratings, 000000 0000000000 Brothers, Inc., International Bond Market Analysis, August 1994; International Finance Corporation, IP : 000.000.00.00 000, 00 000 0000 00:00:00 Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Bond Market Profile: Japan (c) The International Bank for Reconstruction and Development / The World Bank

166

The Emerging Asian Bond Market Financial Statistics; International Finance Corporation, Emerging Market Database.

Source: International Monetary Fund.

Bond Market Profile: United Kingdom Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Market Profile: United Kingdom (c) The International Bank for Reconstruction and Development / The World Bank

167

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

AAA Aaa 1989

1990

1991

1992

1993

1994

National Government

123.7

115.0

122.4

144.1

190.5

NA

State Government

0.0

0.0

0.0

0.0

0.0

NA

State Enterprises

0.0

0.0

0.0

0.0

0.0

NA

Central Bank

0.0

0.0

0.0

0.0

0.0

NA

Corporate

15.6

14.5

13.8

14.9

17.0

NA

Total1

143.5

133.7

140.4

163.0

211.5

234.2

Total (US$ billion)

231.5

257.1

264.9

247.0

311.0

365.9

Total Bonds as a % of GDP

27.5

26.4

26.2

23.6

33.0

35.1

Bonds as a % of Equity Mkt Cap 28.0

30.3

26.8

26.6

27.0

30.2

Bonds as a % of Bank Assets

11.0

11.7

12.0

14.8

16.2

140.1

121.7

89.9

99.6

108.3

(Billions of Pounds):

12.3

Bonds as a % of East Asian Bond 138.8 Market Memorandum Items: Equity Market Capitalization (US$B)

826.6

848.9

988.0

927.1

1,151.6

1,210.2

GDP (US$B)

841.4

975.5

1,011.5

1,044.7

941.4

1,043.9

Stock Market as a % of GDP

98.3

87.0

97.8

89.1

122.3

115.9

Exchange Rate (End of Period)

0.62

0.52

0.53

0.66

0.68

0.64

Apprec./−Deprec. of Exchange Rate (Percent)

12.2

16.1

1.9

24.5

3.0

5.9

Total Bank Assets (US$B)2

1,887.6

2,328.9

2,264.1

2,057.3

2,100.5

2,256.6

Bank Assets as a % of GDP

224.3

238.7

223.8

196.9

223.1

216.2

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

(Pounds per US$)

1 Although the total bond figures include foreign bonds, these bonds were not included in the previous five categories. For the purposes of this report, Eurosterling bonds are not considered to be part of the domestic bond market and are therefore not included in this

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The Emerging Asian Bond Market table. The 1994 figure is preliminary. 2 Only includes the assets of deposit money banks. The 1994 figure is as of March, 1994. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; International Finance Corporation, Emerging Market Database.

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169

The Emerging Asian Bond Market

Source: International Monetary Fund.

Bond Market Profile: United States

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170

The Emerging Asian Bond Market Sovereign Rating Standard & Poor's: Moody's:

AAA1 Aaa 1989

1990

1991

1992

1993

1994

National Government

1,514.8

1,668.4

1,881.3

2,096.5

2,274.8

NA

State Government

768.5

815.3

870.4

926.1

988.4

NA

State Enterprises

1,267.1

1,445.9

1,577.9

1,734.0

1,898.9

NA

Central Bank

0.0

0.0

0.0

0.0

0.0

NA

Corporate

1,055.2

1,162.6

1,357.6

1,528.7

1,705.0

NA

Total2

4,671.9

5,167.8

5,773.2

6,388.8

6,993.1

7,429.0

Total (US$ billion)

4,671.9

5,167.8

5,773.2

6,388.8

6,993.1

7,429.0

Bonds as a % of GDP

89.8

94.1

102.1

107.6

111.7

110.2

Bonds as a % of Equity Mkt Cap

133.3

167.3

140.8

142.0

133.9

146.2

Bonds as a % of Bank Assets

162.4

171.1

184.3

192.2

201.4

205.2

2815.2

2,651.3

2326.5

2239.3

2197.8

(Billions of Dollars):

Bonds as a % of East Asian Bond 2801.8 Market Memorandum Items: Equity Market Capitalization (US$B)

3,505.7

3,089.7

4,099.5

4,497.8

5,223.8

5,081.8

GDP (US$B)

5,204.5

5,489.6

5,656.4

5,937.3

6,259.9

6,738.4

Stock Market as a % of GDP

67.4

56.3

72.4

75.7

83.4

75.4

Exchange Rate (End of Period)

1.00

1.00

1.00

1.00

1.00

1.00

Apprec./−Deprec. of Exchange Rate (Percent)

0.0

0.0

0.0

0.0

0.0

0.0

Total Bank Assets (US$B)3

2,876.8

3,021.2

3,132.3

3,323.8

3,471.4

3,619.5

Bank Assets as a % of GDP

55.3

55.0

55.4

56.0

55.5

53.7

Total Asian Bond Market Size (US$B)

166.7

183.6

217.7

274.6

312.3

338.0

1 Implied rating. 2 Although the total bond figures include foreign bonds, these bonds were not included in the previous five categories. For the purposes of this report, Eurodollar bonds are not considered to be part of the domestic bond market and are therefore not included in this

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171

The Emerging Asian Bond Market table. The 1994 figure was provided by the Public Securities Association. This number is not fully comparable with prior year totals because the 1994 figure does not include foreign bonds. 3 Only includes the assets of commercial banks. Sources: Salomon Brothers, Summary of Selected Sovereign Ratings, October 31, 1994; Salomon Brothers, Inc., International Bond Market Analysis, August 1994; International Finance Corporation, Emerging Stock Markets Factbook 1994, June 1994; International Monetary Fund, International Financial Statistics; Public Securities Association; International Finance Corporation, Emerging Market Database. Distribution of Holdings of Mortgage−Backed Securities by U.S. Institutions (in Percent) Institution

Percentage Holdings

Thrifts

23.4

Banks

21.0

Pension Funds

9.7

Life Insurance Companies

14.4

Dealers, Mutual Funds, Asset Managers, Property & Casualty Insurance Cos.

31.5

Source: The World Bank.

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172

The Emerging Asian Bond Market

Source: International Monetary Fund.

Annex B— The Industrial Country Experience Introduction Governments and government agencies provided the main impetus for bond market development in the major industrial countries by acting as the leading issuers of bonds. In the aftermath of World War II most of these governments ran large and continuing budget deficits, first to finance the restructuring of their economies and then to sustain social welfare activities. As a result, the ratio of government debt to GDP rose sharply to about 43 percent in 1980. Some industrial countries, including Japan and the United Kingdom, have scaled down their fiscal deficits, but countries with bigger deficits—such as the United States and Germany in the wake of the heavy fiscal burden of unification—have not been able to, and the debt/GDP ratio across the major industrial countries rose to 68 percent in 1994. This rapidly growing debt raised the stakes for the governments trying to minimize its cost, which tended to increase when sales were confined to domestic markets and propelled governments to seek a wider investor base in the international markets. Among the industrial countries with sizable bond markets, four—the United States, Japan, Germany, and the Delivered by The e-library United Kingdom—are the most prominent. The USWorld bondBank market isto:the largest and has the most developed and 000000 0000000000 IP : 000.000.00.00 sophisticated issuing techniques, secondary markets, transaction transparency, bond diversity, regulatory 000, 00 000 0000 00:00:00 instruments and apparatus, and innovations. Though there are broad similarities in the patterns of bond market Annex B— The Industrial Country Experience (c) The International Bank for Reconstruction and Development / The World Bank

173

The Emerging Asian Bond Market development across the four countries, there are significant differences in the organization and path of bond market development. A pace−setter in these markets has always been government securities, which generally lay the groundwork for the evolution of bond markets, though the role of the government in inducing their development varied according to the institutional imperatives and stages of financial sector development in each country. At one end is the United States, where bond market development has been autonomous, responding to profit incentives and a desire to minimize the transaction costs of financing investment. Japan represents the other extreme, with the government assuming an active role in shaping the profile of bond market development to make it conform to its overall strategy of economic development. As bond markets evolve, however, techniques of issuing bonds, market orientation, and international linkages seem to converge. This Annex focuses on how the bond markets in these four countries progressed to their present stage of development, the sources of their strength, their characteristics, and the policy frameworks in which the markets developed. The analysis is designed to provide insights that can be used by the East Asian economies in determining a mix of best practices they can adopt to make their bond markets grow faster by maximizing liquidity and transparency, creating a broad investor base, and establishing effective information channels to assess risk/return prospects. Bond Markets in the United States, Japan, Germany, and the United Kingdom Bonds constitute a significant segment of the market for financial assets in the four industrial countries. In the United States bonds and stocks were 110 and 75 percent of GDP in 1994, and they were almost at the same level in Japan. The German market for bonds was a little less than four times the market for stocks, while the UK stock market was almost three times the market for bonds. Total bank assets as a proportion of GDP were highest at 216 percent in the UK, followed by Japan (152 percent), Germany (169 percent), and the United States (54 percent) (Figure 1). The high ratios of bonds tocontinue

GDP in Japan and Germany reflect the fact that banks in those countries raise a large proportion of their resources in the bond markets, as discussed later in this section.

Figure 1: Bonds, Equity, and Banking Assets as Delivered by The World Bank e-library to: a Percentage of GDP (1994) 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Bond Markets in the United States, Japan, Germany, and the United Kingdom (c) The International Bank for Reconstruction and Development / The World Bank

174

The Emerging Asian Bond Market The size and growth of bond markets in these countries since 1970 in relative and absolute terms are presented in Table 1 and Figure 2. US bonds have grown in size and diversity since the 1970s. The value of bonds in the US market increased from US$485 billion in 1970 to US$7,429 billion in 1994, rising from 48 percent to 110 percent of GDP. The Japanese bond market recorded an increase from US$47 billion in 1970 to US$3,442.7 billion in 1994, rising from 23 to 74 percent of GDP. The German and UK bond markets have been of more modest dimensions. German bonds stood at 90 percent of GDP in 1994, but in absolute terms were less than half the value of the Japanese bond market. The UK's bond/GDP ratio, on the other hand, remained more or less constant at about 35 percent, despite a sixfold rise in the amount of bonds outstanding between 1970 and 1993. Government securities have been the mainstay of the bond markets in all four countries (Table 3). In 1993 they were the highest as a proportion of GDP in the United States (45 percent) and lowest in Germany (29 percent). Municipalities and local governments have been prominent issuers of bonds only in the United States. Corporations have been the largest issuers of bonds after governments in the United States, and, to a lesser extent, Japan. Within the corporate bond class, bank bonds—alternatively called debentures—are important in Germany and Japan, while the main issuers of bonds in the United States are non−financial corporations. This difference in issuer profiles reflects the role Japanese and German banks have taken as the main institutions financing private sector investment; large investment lending led them to issue bonds to raise resources additional to deposit mobilization.

Figure 2: Bond Market as a Percentage of GDP (US$ billion) The corporate sector in the United States has in the past resorted to debt financing more than the other three countries because interest expenses are tax−deductible while dividends are not; this makes it more attractive for corporate treasurers to take on increased leverage. Some 17 percent of private fixed capital formation is financed through bond issues in the United States, in contrast to only 2 percent in the UK and 4 percent in Japan.1 All four bond markets have been increasingly exposed to international bond issues, both foreign bonds—those issued only in the host country−and Euro−currency bonds issued in host—country currency in more than one country. In terms of outstanding amounts, thebylargest international of bonds is in the United States, followed Delivered The World Bank e-library issue to: 000000 0000000000 in descending order by Japan, Germany, and the UK. Of the total international bonds, Euro−currency bonds IP : 000.000.00.00 dominate in the United States, Japan, and the their in German international issues is also substantial, 000,UK; 00 000 0000share 00:00:00 though it is difficult to be precise about the amount, as Germany does not separate data for international and Bond Markets in the United States, Japan, Germany, and the United Kingdom (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Euro−currency bonds.break

Table 1: Bonds Outstanding (US$ billion)* United States 1970

1980

1990

1991

1992

1993

1994

236.8

574.5

2,094.3

2,303.2

2,556.2

2,824.0

—

Municipal Bonds 131.1

288.0

815.3

870.4

926.1

988.4

—

Corporate Bonds

117.1

339.8

1,085.3

1,241.6

1,351.4

1,455.3

—

Mortgage Bonds

0.4

112.2

1,097.3

1,272.0

1,451.6

1,599.4

—

International Bonds

—

63.8

598.7

626.7

655.1

680.1

—

Foreign Bonds

—

—

75.6

86.1

103.7

126.0

—

Eurodollar Bonds —

63.8

523.1

540.6

551.4

554.1

—

Total Bonds

485.4

1,378.3

5,690.9

6,313.9

6,940.4

7,547.2

7,429.0

1970

1980

1990

1991

1992

1993

1994

20.4

364.9

1,312.6

1,445.4

1,491.6

1,730.8

—

Municipal Bonds 1.3

17.7

53.6

58.9

61.5

74.1

—

Corporate Bonds

25.6

176.7

706.5

824.5

882.1

1,015.5

—

Mortgage Bonds

0.0

0.0

0.0

0.0

0.0

0.0

—

International Bonds

0.0

9.4

142.3

173.8

176.8

223.5

—

Foreign Bonds

0.0

8.8

42.8

49.4

52.1

66.3

—

Euroyen Bonds

—

0.6

99.4

124.4

124.7

157.2

—

Total Bonds

47.4

568.6

2,215.1

2,502.6

2,611.9

3,044.0

3,442.7

1970

1980

1990

1991

1992

1993

1994

6.7

60.4

344.6

392.8

468.2

562.6

—

Municipal Bonds 1.9

6.4

27.0

31.5

47.6

60.3

—

Corporate Bonds

34.4

213.3

604.8

688.4

718.2

764.2

—

Mortgage Bonds

0.0

0.0

0.0

—

5.3

40.4

203.6

—

Government Bonds

Japan

Government Bonds

Germany

Government Bonds

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161.4

171.2

183.0

Bond Markets in the United States, Japan, Germany, and the United Kingdom (c) The International Bank for Reconstruction and Development / The World Bank

176

The Emerging Asian Bond Market International Bonds Total Bonds

48.4

320.5

1,137.9

1,283.8

1,416.9

1,590.7

1,719.0

1970

1980

1990

1991

1992

1993

1994

47.2

195.1

221.7

229.0

217.9

282.2

—

Municipal Bonds 1.0

2.4

0.0

0.0

0.0

0.0

—

Corporate Bonds

13.2

12.6

28.0

25.8

22.5

25.2

—

Mortgage Bonds

0.0

0.0

0.0

0.0

0.0

0.0

—

International Bonds

—

1.9

115.9

131.1

110.8

129.3

—

Foreign Bonds

—

0.2

7.9

7.7

6.0

5.9

—

Eurosterling Bonds

—

1.7

108.0

123.5

104.8

123.4

—

Total Bonds

61.3

212.0

365.5

385.9

351.2

436.7

365.9

United Kingdom

Government Bonds

* 1994 totals for US, UK, and Japan do not include Euro Bonds. Source: Salomon Brothers, Inc., International Monetary Fund. Table 2: Government Bonds (US$ billion) Country

1970

% of GDP

1980

% of GDP

1993

% of GDP

United States

236.8

23.4

574.5

21.2

2,824.0

45.1

Japan

20.4

10.0

364.9

34.4

1,730.8

41.1

Germany

6.7

3.7

60.4

7.5

562.6

29.4

U.K.

47.2

38.0

195.1

36.2

282.2

30.0

Table 3: Municipal Bonds (US$ billion) Country

1970

% of GDP

1980

% of GDP

1993

% of GDP

United States

131.1

13.0

288.0

10.6

988.4

15.8

Japan

1.3

0.6

17.7

1.7

74.1

1.8

Germany

1.9

1.0

6.4

0.8

60.3

3.2

U.K.

1.0

0.8

2.4

0.4

0.0

0.0

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177

The Emerging Asian Bond Market Table 4: Corporate Bonds (US$ billion) Country

1970

% of GDP

1980

% of GDP

1993

% of GDP

United States

117.1

11.6

339.8

12.5

1,455.3

23.2

Japan

25.6

12.6

176.7

16.7

1,015.5

24.1

−bank deb.(a)

17.3

8.5

128.3

12.1

700.7

16.6

Germany

34.4

18.6

213.3

26.3

764.2

40.0

−bank deb.(a)

32.3

17.5

211.0

26.1

762.4

39.9

U.K.

13.2

10.6

12.6

2.3

25.2

2.7

Table 5: Mortgage Bonds (US$ billion) Country

1970

% of GDP

1980

% of GDP

1993

% of GDP

United States

0.4

0.0

112.2

4.1

1,599.4

25.5

Japan

0.0

0.0

0.0

0.0

0.0

0.0

Germany

0.0

0.0

0.0

0.0

0.0

0.0

U.K.

0.0

0.0

0.0

0.0

0.0

0.0

Table 6: International Bonds (US$ billion) Country

1970

% of GDP

1980

% of GDP

1993

% of GDP

United States

NA

NA

63.8

2.4

680.1

10.9

Japan

0.0

0.0

9.4

0.9

223.5

5.3

Germany

5.3

2.9

40.4

5.0

203.6

10.7

U.K.

NA

NA

1.9

0.4

129.3

13.7

Source: Salomon Brothers, Inc., International Monetary Fund. Government Securities Primary Markets

Markets for government bonds are often organized by setting up networks—groups of financial firms acting as primary dealers in government securities. In these four countries networks usually operate on a quid pro quo basis: in exchange for certain privileges, which vary across countries, they agree to make secondary markets in government debt, subject to the rules and regulations governing their operations. Delivered by The World Bank e-library to: 000000 0000000000 The United States has a long tradition of primary dealers in government bonds, of which there are now 39. The IP : 000.000.00.00 Federal Reserve Bank of New York designates them, and00:00:00 they are required to be active in both primary and 000, 00 000 0000 secondary markets. The New York Fed requires that primary dealers make markets in all maturity sectors of

Government Securities (c) The International Bank for Reconstruction and Development / The World Bank

178

The Emerging Asian Bond Market treasury securities, and stipulates each primary dealer's share in total secondary markets. Dealers are also expected to demonstrate their continued commitment to the market for securities by bidding meaningfully in all bond auctions. If a dealer fails to do so, the Fed typically contacts him with a reminder of his ''underwriting obligation." Primary dealers account for a majority of the trading volume in the secondary market, though there are approximately 1,700 brokers and dealers trading in that market. The primary dealers and some other market participants rely on inter−dealer brokerage houses (currently seven) to trade in the market for government securities. Inter−dealer brokers compile the best bid and ask prices provided by dealers and make this information available via computer. Unlike the dealers, the brokers do not take positions themselves, but rather match the bids placed with them by the dealers. The identities of the dealers who submit price quotes are kept confidential. In 1991 an irregular episode occurred when a primary dealer purchased government bonds beyond the limit set as one of the privileges. Since then the US authorities have scaled back several dealer privileges and obligations, mainly with a view to increasing competitiveness in the government bond market. The major remaining privilege is exclusive access to some of the inter−dealer broker screens, though this exclusivity is slowly fading away. They also form the conduit through which the Fed conducts its monetary policy. The obligation that each primary dealer should maintain at least 1 percent of the total transactions of all primary dealers with their customers has been removed. Primary dealers must maintain sufficient presence in the secondary market to enable them to make reasonably good markets in their relationships with the Fed's trading desk and provide the trading desk with market information and analysis that may be useful to the Fed in formulating and implementing monetary policy.2 Japan's system has analogous arrangements under which a large group of firms constitutes an issuing syndicate for Japanese bonds. Over 900 firms are members of the syndicate, including banks, securities firms, and insurance companies; a separate group of about 35 firms negotiates the terms of syndicated government bond issues with the Ministry of Finance. The primary obligation of syndicate members is to accept their allocations of bonds. Unlike in the United States, the syndicate in Japan has no role in the secondary market or central bank monetary policy implementation. Forty percent of 10−year bonds are syndicated and the rest auctioned together with other government bonds. Syndicated bonds are sold at the weighted average price of the auction. In exchange for accepting their shares of syndicated bonds, syndicate members are offered two privileges: they have exclusive access to auctions for bonds and they receive commissions from both the syndicated and auctioned portions of the 10−year bonds.3 Germany's primary market system is a variant on the Japanese system. Germany has set up a consortium of 109 members—similar to the Japanese syndicate—through which bonds are sold. Most long−term bonds are sold through the consortium with an auction and sale by the Bundesbank on tap—any investors can buy them at close to auction price. Unlike in the Japanese system, the consortium members accept their share of syndicated bonds at the price determined by the authorities, which may not have any relation to the auction price. A commission is paid on the sale of these bonds, but not on those allocated through the auction or tap; these sales have more the character of a privilege than an obligation. In addition, consortium members enjoy other privileges: exclusive access to government bond auctions, information through regular meeting with the Bundesbank, repurchase agreements (REPOs), and operation of the Bundesbank for financing their government securities purchases.4 The primary dealer equivalents in the United Kingdom are the gilt−edged market makers (GEMMs), which began operating after the Big Bang in 1986. GEMMs are a cross between the US system and those in Japan and Germany. They are required to make markets for gilts—essentially all marketable medium− and long−term UK government securities but not short−term trea−soft

sury bills. GEMMs have no role in monetary policy operation. Theto:principal obligation of GEMMs is to make Delivered by The World Bank e-library 000000 0000000000 gilts, and participate in gilt auctions. continuous markets in gilts of all types, including index−linked IP : 000.000.00.00 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market GEMMs receive a package of privileges in exchange for their market−making activities. They have the exclusive right to deal in gilts with the Bank of England, and they may borrow from it. They also have the exclusive right to borrow gilts, which they do through special stock exchange money brokers. In addition, GEMMs have exclusive use of special inter−dealer brokers but do not have any special privileges relating to gilts auctions, except that only they may submit bids by telephone in reaction to late−breaking market developments. The foregoing discussion about the working of primary markets in the four countries shows the role dealers play in each country. The systems restrict entry of firms into the government securities market and make their participation in one part of the market contingent on participating in others. In essence, the primary market arrangements are motivated mainly by the objective of maintaining liquidity in secondary markets and supervising and monitoring their operations continuously and closely to maintain stability in the bond markets. The four countries differ, at the margin, in frequency of bond issues and the methods used for them. Basically there are three timing patterns—irregular interval, moderately regular, and completely regular. The methods of issue range from auction to syndication and noncompetitive bidding. By and large, all four countries have gradually moved away from direct syndication to market−oriented auctions—which are adopted as bond markets mature and acquire width and depth. Within the auctions, there are further distinctions, such as uniform pricing or discriminatory pricing. Under the first, all securities are sold at one price, while under discriminatory systems each winning bidder pays the price he bid.5 Frequency of bond issue is determined by government funding requirements and market conditions, including market depth. The interest of investors and traders can often be cultivated and maintained through regularity in the calendar, structure, and quantity of securities offered. Those governments with relatively smaller borrowing programs can approach the markets more flexibly, responding to opportunities to minimize the cost of individual issues. Of the four countries, the United States holds bond auctions most regularly, with some maturities issued quarterly and others issued monthly. Predictable issue calendars are maintained, linked closely to the maturity schedule of outstanding bonds. Auction details, including the quantity on offer and whether or not bonds will represent a new issue or a "reopening" (i.e., an incremental offer of previously issued coupon bonds at a reoffered price), are published only a few days in advance. The United Kingdom and Japan are moderately irregular; UK auctions are held monthly or every two months, while Japan holds one every month or quarter. German auctions are irregular. However, there is no sanctity to the frequency of bond issues, and timing is ultimately governed by the exigencies of national situations. There are four basic techniques for issuing bonds in domestic markets: auction, direct syndication, tap, and underwritten syndication. Underwritten syndication is used for Euromarket and global issues, while the other three are used for domestic issues. The countries use all three in varying combinations (Table 7). The US authorities have used both uniform price and discriminatory auctions. They are moving more toward the former because of several incidents of manipulation in discriminatory auctions in 1992. Germany and Japan have resorted to syndication as well as auctions, and their auctions have relied on both uniform and discriminatory pricing, though they were applied to different types of maturities. Germany and the United Kingdom allow tap sale of bonds of different maturities through their central banks. The price of bonds on tap sale, as mentioned earlier, is the weighted average obtained in the auction market. The United States and the United Kingdom use "when−issued" markets as a sort of futures market for discovering the likely prices for bonds. When−issued trading is "the conditional trading that takes place during the interval between the announcement date and the auction date."6 Trading begins in these markets when the details about the auction are announced, including the amount to be issued and the maturity. In both countries—this market mechanism does not exist in GermanyDelivered and Japan—this is about by The World period Bank e-library to: 10 days before the bonds are issued. The 000000 0000000000 deepest and most relevant when−issued government bond market is in the United States, where it operates like IP : 000.000.00.00 000 0000 00:00:00 trading in a futures market, as positions may000, be00taken and covered many times before the actual settlement dates. When−issued securities also displace the most recently issued government bond as a benchmark. In many Government Securities (c) The International Bank for Reconstruction and Development / The World Bank

180

The Emerging Asian Bond Market auctions, the aggregate size of outstanding positions in the when−issued market substan−soft

tially exceeds the quantity of securities to be sold in that auction at some point between the date of announcement of auction and the date on which the securities are delivered. In the United Kingdom anyone can participate in the when−issued market and the Bank of England does not regulate it except for normal supervision of market makers and brokers. Table 7: Techniques for Issuing Domestic Government Securities in Four Industrial Countries (Methods of issuance) United States

Discriminatory auction. Uniform−price auction (two− and five−year notes, on an experimental basis)

Japan

Combination of discriminatory auction and syndicate (ten−year Japanese Government bond) Syndicate (five−year Japanese Government bond) Discriminatory auction (various securities) Uniform−price auction (financing bills)

Germany

Combination of syndicate,

Central Bank

discriminatory auction, and tap sales by central bank (Bundesanleihen) Discriminatory auction (various securities) Tap sales by central bank (various securities)

United Kingdom

Discriminatory auction (Treasury bills and some gilts) Uniform−price auction with minimum price (some gilts, infrequently) Tap sales by central bank (some gilts)

Source: Bank of England; Italy, Ministry of Treasury; and Broker (1993). Working of the Secondary Markets

An efficient secondary market is essential to a robust bond market. It helps increase issue of bonds and their diversity, as it provides liquidity that makes it possible for securities holders to realize cash value when the prospects for risks and returns change. One major measure of liquidity in the secondary market is the volume of transactions. The higher the volume, the greater are the opportunities to buy or sell securities at competitive prices. Increased volume also reduces the carrying cost of market makers and raises their profit margins, drawing more firms into the market. Table 8 shows that the volume of transactions in the markets of the four countries has Delivered by The World Bank e-library to: been rising rapidly since the 1980s. The sharpest increase in transaction volume in government securities has been 000000 0000000000 IP :the 000.000.00.00 in Japan. The US market, as to be expected, had largest volume and it has been steadily rising. Except in the 000, 00 000 0000 00:00:00 United Kingdom, most of the transactions in securities are over the counter (OTC). The UK stock exchange relies Working of the Secondary Markets (c) The International Bank for Reconstruction and Development / The World Bank

181

The Emerging Asian Bond Market on dealers posting quotes, rather than the order−matching processes commonly found in the exchanges.7 Therefore, the exchange functions in the same way as the OTC market. In the countries where OTC prevails, government bonds are not required to be listed on the exchanges, and the bulk of transactions takes place outside the exchanges. In secondary markets, inter−dealer brokers are largely instrumental in augmenting the transactions, as they specialize in gathering price quotes from government securities dealers and conveying them without attribution through the services to which all dealers have access. The ability to engage in repurchase—or REPO agreements facilitates8 inventory management by securities dealers, and thus reduces the cost of market−making and increases liquidity in cash markets. The US REPO market for government bonds is very large; there are also REPOs in government agency securities and mortgage−backed securities. REPO markets in other industrial countries are substantially smaller; in many countries REPO markets and securities lending markets are hampered by regulatory restrictions or taxes. In Japan, REPO transactions are known as gensaki. The market for gensaki on short−term government securities is active. The main borrowers of funds in this market are securities firms. Gensaki in longer−term securities are less common, as these REPOs are considered bond transactions that attract tax. In Germany banks borrowing funds through REPO transactions face reserve requirements on those funds, and domestic REPOs are virtually non−existent. In the UK there is no market for REPOs in gilts between private parties, and there iscontinue

only a limited market in gilt borrowing. Only gilt−edged market makers may borrow gilts, and they must do so through the stock exchange money brokers. The Bank of England started to use gilts REPOs as a regular open market device in 1994. Table 8: Transaction Volume in Government Markets a (Daily Average in US$ billion) 1980

1990

1993

13.78

76.72

119.56

Over−the−counter market 1.38 in Tokyo

44.11

57.62

Transactions inc stock exchanges

0.92

0.19

3.93

9.67

6.75

9.48

United Statesb Japan

0.03

Germanyd United Kingdome

1.39

(a) Data adjusted for double counting. Daily transactions volumes for Japan, Germany, and France are estimated by the IMF staff from the annual volume data. (b) Primary dealers transactions of treasury securities. (c) Data through 1989 from eight domestic stock

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The Emerging Asian Bond Market exchanges; since 1990, from Tokyo Stock Exchange. (d) Stock exchange turnover for bonds of the Federal Government, Federal Railways, and Federal Post Office. (e) Stock exchange transactions of UK government securities. Source: International Monetary Fund, International Capital Markets, 1994. A striking feature of the volume of transactions in the secondary market with important implications for private bond issues is that the most frequent transactions are centered on benchmark securities, which are the most recently issued securities of a particular maturity. Benchmarks in the four countries are most commonly represented by 10−year bonds, the yields on which are used for inter−country comparisons. Non−benchmark securities are traded less frequently. There are variations in the practices adopted in designation of benchmark bonds. In Japan, for instance, Japanese government bonds with an original maturity of 10 years are considered the benchmark, even though they may not be those most recently issued. There is no uniform system for clearing and settling government securities across the four countries. Only the United States and the United Kingdom settle transactions in long−term government bonds by the next day. Other countries take longer, except for clearing transactions in short−term securities. In all four countries computerized book−entry systems are used to avoid cumbersome physical transfer of securities. In the United States securities transaction clearing is done through the Government Securities Clearing Corporation (GSCC), a self−regulating organization registered with the Securities and Exchange Commission. The GSCC nets trades and payments, and securities transfers are made through the wholesale bank payments system known as Fedwire, which is connected to the book−entry system organized by the Federal Reserve.9 The Fedwire and the book−entry system help remove the risk of non−payment and reduce the volume of transactions to be recorded. Having a book−entry system for securities reduces risk by facilitating delivery−versus−payment settlements. The Fedwire payment system, through making netting possible, reduces the number of payments brokers and dealers need to make. The Euroclear and Cedel clearing systems facilitate international settlements by linking domestic and international clearing systems. In the United Kingdom gilt−edged securities are normally settled on the next business day after the date of trade. By special arrangements it is also possible to trade in securities for future settlements, but this period cannot be greater than three weeks.10 Euro−sterling bonds are settled in a seven−day period during which the bonds are held in the clearing system as Euroclear and Cedel. Japanese settlement procedures for both government and private bonds are quite different from those in the United States. Normal settlement in Japan occurs on a predetermined cycle rather than at the discretion of the trading parties. There are six official settlement dates every month, each with an associated Delivered by The World Bank e-library to: trading period, and the average time between trade settlement dates is much longer in Japan than under the 000000and 0000000000 IP : 000.000.00.00 "next day settle" convention of US markets. The parties can also arrange forward settlement and skip one or more 000, 00 000 0000 00:00:00 delivery dates. Settlement can be effected in several ways. Designated financial institutions can settle trades Working of the Secondary Markets (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market through the Bank of Japan's net system, which is a wire transfer system similar to the US Fedwire, or they can be settled in the same manner as the US delivery−versus−payments system. Registered bond transactions can also be settled through a Letter of Transfer (LT) System, which is a delivery−free/pay−system. Under this system the seller delivers an LT to the buyer two days before the settlement date through his agent bank and the buyer endors−soft

Table 9: Holders of Central Government Debt in Selected Industrial Countries (a) (In Percent of Total Debt Outstanding) United States (b) Investors

1980

1992

1993

1994(j)

Domestic banks (f)

18.19

10.35

10.57

10.39

Domestic insurance companies

3.89

6.95

7.69

7.99

Domestic individuals (g) 19.00

10.18

10.17

10.46

Other domestic holders (h) (i)

37.31

50.34

48.50

48.34

Domestic money market funds, unit trusts, etc.

0.57

2.81

2.64

1.92

19.36

20.43

20.90

Foreign and international 21.04

Germany (c) (d) Investors

1980

1992

1993

1994(j)

Domestic banks (f)

69.66

54.31

54.10

56.18

Domestic insurance companies

—

—

—

Domestic individuals (g) —

—

—

Other domestic holders (h) (i)

19.41

21.20

Domestic money market funds, unit trusts, etc. Foreign and international 9.14

26.28

12.29

12.41

—

—

33.61

31.41

United Kingdom (e) Investors

1980

1992

1993

1994(j)

Domestic banks (f)

17.18

6.17

8.39

10.13

Domestic insurance companies

30.36

36.62

38.84

34.36

Domestic individuals (g) 16.34 26.70

Delivered by The World Bank e-library to: 0000000000 5.89 8.94 0000007.43 IP : 000.000.00.00 000, 00 000 0000 00:00:00

30.18

26.59

29.64

Working of the Secondary Markets (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market Other domestic holders (h) (i) Domestic money market funds, unit trusts, etc.

0.53

Foreign and international 8.89 (a) Data as of March 31 for the United Kingdom; end−year data for all other countries. Investor information was not available for Japan. (b) Securities valued at par; some savings bonds are included at current redemption value. (c) Of Federal Government, Equalization of Burdens Fund, ERP Special Fund, Lander governments, and local authorities (for 1980 and 1986); of Federal Government, German Unity Fund, Debt−Processing Fund, ERP Special Fund, West German Lander governments, East German lander governments, West German local authorities, and East German local authorities (for 1992). (d) Excluding public authorities' mutual indebtedness; and holdings of Bundesbank. (e) Total market holdings of gilts. (f) For U.K., includes building societies and other U.K. institutional investors. (g) For U.S., includes savings bonds and other securities. (h) For Germany, includes social security

0.64

1.16

0.98

17.43

17.58

19.00

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185

The Emerging Asian Bond Market funds plus other. (i) For U.K., includes U.K. public sector, industrial and commercial companies, public trustees and various noncorporate bodies, and other (including residual). (j) As of September 31, 1994. Source: International Monetary Fund, International Capital Markets, 1994. Deutsche Bundesbank, Monthly Report, January, 1995. Department of the Treasury, Treasury Bulletin, December 1994. Bank of England, Statistical Abstract, Part 1, 1994. es it and submits it to the Bank of Japan. On the settlement date, the central bank registers the bond in the buyer's name. The Bank of Japan is considering changing to the system of continuous settlement that prevails in other developed bond markets.11 The German system requires payment and delivery of securities on the second trading day following the trade. The selling party either releases trades directly into the stock exchange computer, or alternatively conveys to the stock exchange those items it cannot deliver and approves all others for release, and on the value−date the stock exchange computer starts the settlement securities account, crediting the cash account at the central securities depository and vice versa for the buyer. The daily balances of the cash accounts of banks are auto−soft

matically settled by order of the central securities depository at the local office of the German central bank. The same procedure is adopted for transactions between two banks that are members of different German stock exchanges (settlement of cross−city traders). The value−date for the settlement of off−stock exchange trades is negotiable. 12 Investor Base of Government Bonds

The speed of development of a market for government debt, its maturity, profitability, and liquidity depend, among other things, on a strong and endurable investor base. The more solid and diversified the investing class, the greater the scope of a sustainable bond market. Likewise, the more varied the time preference of investors, the wider the maturity spectrum of the securities that can be sold. The investor base also carries important implications for the degree of liquidity in the secondary market for bonds. If bonds are held by institutional holders, such as banks, insurance companies, and pension funds, rather than retail investors—individuals and Delivered by The World Bank e-library to: to them and widening the maturity households—there is likely to be greater turnover, imparting liquidity 000000 0000000000 structure, as institutional holders are very active trading and their investment horizons span a long period. From IP :in 000.000.00.00 000, 00on 000the 0000composition 00:00:00 this point of view, attention needs to be focused of the government bond holdings. Table 9 reports data on holdings of government bonds over 198094 in three countries (Japan is excluded for lack of data). Investor Base of Government Bonds (c) The International Bank for Reconstruction and Development / The World Bank

186

The Emerging Asian Bond Market The six categories listed are not clearly defined, but are broadly comparable across countries and provide a fairly accurate picture of the investor base in each of them. The pattern of government debt holdings shows marked variations among the three countries. The largest holders of government debt in the United States are other domestic holders, which include pension and social security funds. In the UK the largest holder is insurance companies, in Germany, domestic banks. Foreign holders are second in importance in the United States and Germany, and "other domestic holders" in the UK. The contribution of mutual funds and most trusts is minuscule in all three countries. This order has not changed over 14 years. One trend that emerges strikingly is that the proportion of bank holdings is on the decline in all three countries, while that of the insurance companies has increased in the two for which these data are available. Banks hold generally for liquidity purposes. With rising government deficits, other institutions have come to hold more investment in government securities. The second trend is that the share of individuals in government debt has fallen over the years in both the United States—from 19 percent in 1980 to 10 percent in 1994—and the UK—from 16 to 6 percent. A third trend, with even wider implications, is the movement in foreign holdings of government debt, which increased sharply in the UK and Germany from about 9 percent each in 1980 to 19 and 31 percent, respectively, in 1994; foreign holdings fluctuated in the United States over 198093, but begancontinue Table 10: Remaining Maturity of Domestic Currency Debt (a) (Cumulative Total Value of Outstanding Issues) U.S. (b)

01 Years

End 1980

End 1992

48.69

34.65

Japan (c)

Germany (d)

U.K. (e)

FY 1980

End 1980

End 1992

End End 3−1981 3−1993

17.73

6.75

43.68

25.53

FY 1992

03 Years 05 Years

81.11

71.24

28.85

47.78

66.38

54.71

010 Years

89.47

83.62

100.00 92.40

98.15

97.99

100.00 96.41

100.00 99.68

100.00 99.98

100.00 99.68

015 Years

27.65

57.69

72.20

020 Years

95.01

All

100.00 100.00 100.00 100.00 100.00 100.00 100.00

(a) All debt valued at nominal values, not current market values. (b) Marketable central government debt held by private investors. (c) Domestic central government bonds excluding financing bills and grant−in−aid bonds. (d) Public bonds including bonds issued by the Federal Government, and

87.38

27.74

100.00

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Investor Base of Government Bonds (c) The International Bank for Reconstruction and Development / The World Bank

187

The Emerging Asian Bond Market German Unity Fund, Currency Conversion Equalization Fund, ERP Special Fund, Treuhand privatization agency, Lander governments, local authorities, Federal and East German Railways, and Federal Post Office. (e) Market holdings of central government and government−guaranteed marketable securities. Source: International Monetary Fund, International Capital Markets, 1994.

rising again in 1994, signifying the increasing integration of bond markets in the industrial countries. Patterns of bond holdings—and changes in those patterns—are significant in terms of liquidity, transaction costs, and the interdependence of bond markets, which new entrants into these markets have to take into account. A decline in individual holdings suggests a rise in institutional holdings. To the extent that this occurs, bond liquidity tends to increase, as institutional holders turn over their debt more frequently than individual households. This helps sustain the bond markets, in addition to creating alertness among investors to monitor small differentials in bond yields. Bond market volatility also increases because of the tendency of institutional holders to trade between different markets. The growing exposure of industrial country bond markets can also lower the cost of debt for a country as the market broadens. While this can improve a country's fiscal situation, it increases interdependence and can make it difficult to implement domestic goals while accommodating impulses emanating from the consequences of monetary and fiscal developments in other countries. Maturity Structure of Government Bonds

Table 10 presents data, somewhat limited in detail, on the maturity structure of government debt in the four countries for 1980 and 1992. It should be noted that these maturity profiles reflect only central government debt, except for Germany, which includes all government debts. Maturities lengthened significantly in the United States during this period: the proportion of debt of less than one year declined from 49 percent to 35 percent, while debt of greater than 10 years maturity increased from 11 to 16 percent and debt of maturity of over 20 years increased sharply from 5 to 13 percent. There is evidence that this pattern has reversed since 1993, with securities moving toward the shorter end of the maturity matrix as the US government pared down long−term issues in favor of short−term paper to benefit from prevailing low short−term interest rates. At the other extreme, the maturity structure of Japanese debt shortened between 1980 and 1992 as Delivered The World e-library to: debt of five years and less increased from 29 by percent to Bank 48 percent of the total. In the same period, Germany's 000000 0000000000 maturity profile was extended. The proportion IPof: 000.000.00.00 debt of less than three years maturity declined sharply to 26 000, 00the 000proportion 0000 00:00:00of debt longer than five years rose from 34 percent percent in 1992 from 44 percent in 1980, while to 45 percent in the same period. Maturity Structure of Government Bonds (c) The International Bank for Reconstruction and Development / The World Bank

188

The Emerging Asian Bond Market The UK displays a different pattern. The proportion of debt below 5 years maturity has remained more or less unchanged, but the proportion in the 515 year range has risen at the expense of longer−term debt. In 1993, 72 percent of UK debt had maturity below 15 years, in contrast to 58 percent in 1980. What comes out prominently from the government bond markets in Japan and Germany is that they have a maturity structure concentrated in 510 year bonds. Very often the list of benchmarks includes a 10−year bond. Since it is traded frequently, the market yield information is used for international comparison, and is more reliable and up−to−date than other securities. Yield Curve

Yield curves for 1993 and 1994 in all four countries are represented in Figures 3 and 4. They relate to bonds of 3 months, 2, 3, 5, 10, and 30 years. In 1993 the United States and the UK display more or less normal yield curves, rising with lengthening bond maturities. Japan had a yield curve that remained flat for bond maturities up to 3 years and rose in bonds of longer maturities. Germany's yield curve was inverted, with short−term rates remaining higher than the yield on bonds of 2−, 3−, and 5−year maturities but tilted upwards thereafter, mainly because of a monetary restraint to curb inflation that followed unification.break

Figure 3: Yield Curves for U.S., U.K., Japan, and Germany for 1993

In 1994, however, the pattern of yield curves across the four countries was more or less similar—yields rose with maturities but leveled off on bonds of 30 years. The UK was something of an exception, as its yield curve was normal on bonds in maturities up to 2 years, but flat thereafter.

Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Yield Curve

189 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market

Figure 4: Yield Curves for U.S., U.K., Japan, and Germany for 1994 Other Segments of the Domestic Bond Market As observed earlier, other non−governmental segments of the bond market are most prominent in the United States and Germany, less so in Japan and the United Kingdom. This segment is generally subdivided into a market for municipal bonds, and private bonds issued by corporations and banks. Though these markets across the four countries have many similarities, there are important differences in institutional features, maturity structures, methods of issuance, trading in the secondary market, and regulatory controls. Municipal Bond Market

Municipal bonds are the third most important category in the United States (16 percent of GDP) (Table 3), after government and corporate bonds, but hardly exist in the United Kingdom. In Japan and Germany, they are equal to 2 to 3 percent of GDP. In the United States municipal bonds are issued by state and local governments and their agencies. Interest income from municipal bonds is tax−exempt both at the federal level and the issuing state level. There are two basic types of municipal bonds: general obligation bonds and revenue bonds. The former are secured by the issuer's general taxing power; the latter are issued to finance projects and enterprises and backed by the revenues expected to be generated by those projects. Both are rated by the credit agencies. General obligation bonds acquired more popularity during the 1980s, and now the markets for general obligation bonds and revenue bonds are evenly balanced. Until 1983, municipal bonds were mainly bearer bonds, but since then they have been issued only in registered form, which makes them suitable for book−entry clearance and settlements. Municipal bonds are typically issued in denominations of $5,000, and interest on them—often exempted from taxes—is paid semi−annually. In general municipal bonds are medium and long term; only 13 to 14 percent of them carry maturities of 13 months or less.13 In Japan the governments of the largest metropolitan areas and prefectures are allowed to issue bonds publicly or through private placements. Their importance from the investor's point of view is not comparable to that in the United States because of different tax incentives. Usual maturities are between 7 and 15 years.14 Delivered by The World Bank e-library to: 000000 0000000000 floated by local authorities in a somewhat IP : 000.000.00.00 000, 00 000 0000 00:00:00

In Germany municipal bonds are roundabout way: public sector credit institutions lend to local authorities and in turn refinance these loans through issuing bonds of their own. These Other Segments of the Domestic Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

190

The Emerging Asian Bond Market are generally called bank bonds but in effect are bonds issued to finance the needs of the local authorities. These bonds are in both bearer and registered forms—the latter has been steadily increasing over the years. Normally these bonds are in a maturity range of 10 to 15 years, though occasionally municipals in maturity of 1 year or 10—15 years are floated. Though not listed on the stock exchange, they are sold on the over−the−counter market. In the UK the market for municipal bonds has been shrinking in recent years; this hardly matters from the investor's point of view as they are perceived to be of low credit−quality in view of the political influence of local governments. Also there is no incentive for local authorities to issue bonds, as they have been able to raise resources at very attractive rate and for very long periods, directly from the central government via the Public Works Loan Board. Much of this borrowing has been used by the local authorities to redeem the outstanding municipal bonds.15 break

Procedures for Issuing Municipal Bonds in the Primary Market

Procedures for issuing municipal bonds are governed by the objective of ensuring high bond quality and investor confidence. In the United States the first requirement—after obtaining a legal opinion from bond attorneys specializing in municipal law—is for the issuing authorities to file a prospectus with the Municipal Securities Rule Making Board and circulate it to potential investors. Issuers also have to procure ratings from a reputable credit rating agency. The issuers may insure the bonds, but this is not obligatory. Local governments can issue bonds either publicly or to a small group of investors. In the former case, the issue is underwritten by an investment bank or the municipal bond department of a commercial bank. The underwriting agency undertakes the risk of retaining unsold bonds. The issue price is determined either by competitive bidding or through negotiations with the underwriters. In the case of competitive bidding, the lowest bid has to be accepted. Some US state governments mandate competitive bidding for general obligation bonds. In Japan, the issuing procedure for municipal bonds is more or less the same as that for issues of government bonds in the primary market discussed earlier in this Annex. By and large, the underwriting syndicate is the favored method of issue. Of late, some changes in this procedure, such as emphasis on the overall performance of a firm in bond underwriting and dealing, are introduced to give syndicate participants greater incentive to improve issuance terms and placements. Local governments in Germany offer municipal bonds both to banks—which either take them as assets or offer them to other investors—and to nonbank investors. The bonds are sold on request. There is no fixed date for these issues, which remain on offer until the desired amount is reached, or the coupon has to be changed because market rate variations can no longer be adjusted for by changing the issue price. The only risk lies in the failure to place the required amount of bonds in the designated time period, and it is fully borne by the issuing local authority. Local authorities in the UK municipal bond market had employed the "offer for sale" method, but as noted earlier, there has been no issuance lately. In the event of a resumption of activities in this market, the issues may follow the techniques used by issuers of corporate bonds (see below). Secondary Market Trading

The secondary market for municipal bonds in the United States is large, with some issues traded very actively, although the majority of issues are not. Although it is difficult to be precise about the size of this market, as trading is carried out off the exchange, it is believed to be two to three times larger than the primary market. Buying and selling decisions are taken over the telephone. The most significant characteristic of municipal bond trading is the vast number of issues dealers are required to track, which naturally results in a thin market for many municipal issues. Municipal bond dealers are often associated with large securities firms or commercial banks, but there are also specialized firms. Bond brokers play a key role in the secondary market, acting as agents for dealers. Brokers are respected as much for the anonymity they maintain as for the information they possess. Delivered by The World Bank e-library to: Unlike dealers, they do not carry inventories of000000 bonds or earn income from brokerage commissions.16 Japan's 0000000000 IP : 000.000.00.00 municipal bond secondary market practices are generally similar to those used for bank debentures and corporate 000, 00 000 0000 00:00:00 bonds. The trading volume in these bonds is very low, as they are privately placed. In Germany the trading Procedures for Issuing Municipal Bonds in the Primary Market (c) The International Bank for Reconstruction and Development / The World Bank

191

The Emerging Asian Bond Market networks used for municipal bonds are on a par with those employed for other fixed income securities, although with one difference: local authorities are exempted from prospectus requirements if less than three years have elapsed since the publication of a similar prospectus. Corporate Bond Market

The private bond market generally consists of two submarkets: corporate and bank bond markets. Though bonds issued in these markets differ from each other in certain characteristics, they are broadly alike. The US corporate bond market is the most advanced, and Japan's has been gathering speed since the 1980s. Japan, like Germany, has a sizable amount of bank bonds. The UK's private bond market is dominated by corporate issues, though it is modest compared to that in the United States. In the United States corporate bonds are the main instrument for raising debt financing. It is not unusual to find corporate bonds with maturities of 25 to 30 years. They have the same general characteristics as government bonds. There are different types of corporate bonds−straight debt, convertible bonds with or without warrants attached, subordinated debentures, and asset−backed securities, which gained prominence during the 1980s. Japan's corporate bond market has been slow to develop, as the financial environment until recently was not congenial to corporate issues. Eligibility standards have been greatly relaxed in recent years, and corporatecontinue

bond issues have grown in volume and diversity. This is evident from a sharp increase in bond issuing companies from only 2 in 1979 to over 800 in 1993. Japanese corporate bonds, like those in the United States, are both straight and convertible bonds with warrants. The eligibility standards for convertible bonds are generally less rigorous than those for the straight bonds. Corporate bonds are more diversified in their maturities than government bonds. Convertible bonds, in particular, are offered in maturities of 4, 5, 6, 7, 8, 9, 10, 12, and 15 years. In addition to corporate bonds, a large number of bank debentures are issued by three long−term credit banks (the Industrial Bank of Japan, the Long Term Credit Bank of Japan, and the Nippon Credit Bank), and three smaller specialized financial institutions; the funds they raise through bond issues are redirected to make long−term fixed interest loans.17 The private debt market in Germany is also dominated by the bank bonds, bearer and registered—the latter have been gradually increasing in recent years. Compared to bank bonds, German corporations as an issuing group play a minor role in domestic debt markets. The reasons for this are many and varied. First, the sway of the universal banking tradition is very powerful in determining corporate practices, and is maintained by a powerful bank lobby. Second, cumbersome regulations make issuance time−consuming and costly. Third, merit regulations deter corporations from issuing bonds. Consequently, there has been a growing tendency to resort to foreign subsidiaries in the Eurobond market to issue corporate bonds, as Japanese corporations did until recently and for the same reasons. Corporate bonds in the UK, though limited in volume compared to the United States and Japan, are available in two forms: debenture and unsecured loans. The debenture market consists of bonds secured, in most cases, on the assets of the company (often property). However, a few securities have been issued that have prior call on the general revenue of the issuer. Investment trusts are amongst the most active and innovative issuers in this market, having issued preferred stock, debentures with stepped coupons, index−linked issuers, and zero coupon bonds, showing the continuous innovations in the UK's corporate debt market. Primary Market Delivered by The World Bank e-library to:

Corporate bonds in the US market are normally distributed to the public or placed with institutional investors 000000 0000000000 IP : 000.000.00.00 through underwriting syndicates arranged by investment banks; competitive bidding is rarely resorted to. For a 000, 00 000 0000 00:00:00 public offering of corporate debt, an agreement among underwriters is normally reached before filing a Corporate Bond Market (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market registration statement with the SEC. The underwriters then negotiate with the issuer the terms of the offerings, which are on a firm commitment basis under which the underwriters assume the market risk. There are also alternative best efforts arrangements, which enable issuers to assume that risk. Seasoned issuers often undertake self−registration, under which they can begin offering a portion of the bonds when market conditions are more favorable. Large issuers commonly make public preliminary prospectuses containing all relevant information except offer prices and coupons, which enables underwriters to engage in pre−issue selling. All corporate issues have to be registered with the SEC; this, however, does not apply to private placements. Japan's procedure for issuing bonds differed from that in the United States until 1979, but has since been aligned with the US method. Until 1979 corporate issuers were required to issue bonds on a secured basis, which entailed designating a bank, normally the main bank, to act as a manager of issuer collateral on behalf of bond holders. That requirement was dispensed with. Furthermore, the issue of bonds can be underwritten, in addition to the securities firms, by banks and trust banks, by setting up subsidiaries, widening the scope for competition. Bank debentures are sold through direct subscription. The issuing bank announces the terms and amount of issues to the public. Investors purchase them at banks or securities firms by submitting application forms. Almost all discount bonds are sold to individuals. Issue methods for corporate bonds in Germany are similar to those used for international bonds. There is a slight difference in bank bond issues. Upon application, issuers of bank bonds are assigned special status as "frequent issuers" under German banking law. This status enables them to issue a number of bonds based on a general prospectus usually published every three years, and a very short information prospectus for individual bonds. There are two ways of issuing bonds in the UK: offer for sale and private placement. Under the first, securities are offered for sale, in a manner similar to that for government bonds. However, the exact terms of the issue are usually determined on Wednesday evening before first trading and are derived by calculating a spread over a designated gilt−edged security. The most common form of issuance for private placement is for the lead managers to approach investors with a potential issue on Monday through Wednesday to find firm underwriting. There is a requirement thatcontinue

some portion—around 10 percent of the underwritten issue−be placed with market makers to allow them to meet the demand of investors other than the institutions with which most of the debt is placed. Secondary Market Trading

In the United States, though corporate bonds are listed on the stock exchange, most trading occurs in the OTC market. Trading in corporate bonds can start immediately after they are issued in the primary market. The OTC market consists of several dozen dealer firms that make wholesale markets in corporate bonds. The National Association of Securities Dealers maintains a computerized system in which dealers enter their bids and offers for issues in which they make a market. In Japan the secondary market for corporate and bank bonds is of little consequences, as these bonds are mostly held by individual investors who keep them until maturity, making them largely illiquid. In Germany, all bonds are traded on the secondary market, which is three−tiered—official bank trading, the regulated market, and the unofficial market. While official and regulated markets are confined to the stock exchange, unofficial transactions are carried out by telephone throughout the country and across borders. All private bond issuers have to submit prospectuses detailing full and relevant information as a precondition for admission to the exchange. Trading is conducted by the official brokers. For most bonds, a so−called single quotation is established at which all transactions are settled. For some convertible bonds and bonds with warrants attached, continuous quotations are maintained. In continuous price trading, transactions may be effected at any time during the bourse trading hours. Delivered The significance of official trading for private bonds is marginal, as a large by The World Bank e-library to: 0000000000 proportion of transactions is off−exchange. In 000000 the regulated market, trade in bonds that are not officially quoted IP : 000.000.00.00 takes place on the stock exchange floor. As000, a rule, these are low−turnover securities issued in small volumes or 00 000 0000 00:00:00 bonds that are not issued in official market for cost reasons. Admission to the market is contingent on fulfilling Secondary Market Trading (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market certain requirements, such as full disclosure, guarantee of orderly trading, etc. Trading in the regulated market is handled by the free brokers and the banks. The third tier—the unofficial market—is trading in bonds among banks and free brokers. It is regulated not by the stock exchanges but by the German civil and commercial codes. Bonds traded in this market include those traded in the official and regulated markets and those not eligible for listing in those markets. Clearance and settlement of private bonds in the secondary market varies across the four countries, not so much in basic structure and format as in procedural details. All corporate bonds in the United States are cleared through the National Securities Clearing Corporation, which was established in 1977; before then each stock exchange and the OTC market had a separate clearing house. Most corporate bonds are immobilized at the Depository Trust Company, which works closely with the NSCC and others at different agencies. The clearing house performs multilateral netting of transactions for its members, while the depositories dematerialize securities and provide book−entry securities transfer systems to achieve delivery against payment for securities. Government and corporate settlement procedures are the same in the Japanese bond market. The German system requires payment and delivery of securities on the second trading day following the trading day. The selling party either releases trades directly into the stock exchange computer or conveys to the stock exchange those items it cannot deliver and approves all others for release; on the value−date, the stock exchange computer starts the settlement−securities account and crediting the cash account at the central securities depository and vice versa for the buyer. The daily balances of the cash accounts of banks are automatically settled by order of the central securities depository at the local office of the German central bank. The same procedure is adopted for transactions between two banks that are members of different German stock exchanges (settlement of cross−city traders). The value−date for the settlement of off−stock exchange trades is negotiable. The UK uses seven−day settlement for traders in corporate bonds and municipal bonds. Forward settlement can be done with the agreement of the market makers provided it is restricted to no more than three weeks. Mortgage and Asset−Backed Securities

The US bond market has been the most innovative among the industrial countries. Two of the most prominent innovations in recent years have been mortgaged−backed and asset−backed securities, which dominate the US bond market. There have not been comparable developments on the same scale in the other three countries, though there are indications that they will soon follow the trends in the US bond market.break

Mortgage−backed securities (MBS) emerged in the United States during the 1980s as conduits to channel funds from investors to mortgage borrowers. These are securities backed by a pool of mortgages—which are in turn loans secured by specified real property. The US mortgage market is the largest in the world and also one of the largest components of the US debt market, and has benefited the most from government policies. It offers an instructive case of public policy fostering the development of capital markets. Thrifts, commercial banks, and mortgage banks are the largest originators of mortgages. The process of creating securities, collateralized by mortgages, can happen in two ways: the mortgage originator can issue securities backed by a pool of mortgages, or the mortgage originator can sell the mortgages to a conduit. The two major conduits are the federally sponsored Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae); private conduits (not sponsored by the federal government) include Citimae and the Collateralized Mortgage Securities Corporation. The MBS market is dominated by the federally sponsored agencies. Mortgage−backed securities are attractive to a wide range of investor classes. Investors include banks, thrifts, life insurance companies, pension funds, mutual Delivered by The World Bank e-library to: funds, asset managers, and dealers.18 000000 0000000000 IP : 000.000.00.00 secondary market for 00:00:00 mortgages, 000, 00 000 0000

To establish and maintain a liquid the US Congress created the Federal National Mortgage Association (FNMA or Fannie Mae) in 1938 as an agency of the federal government. By maintaining a Mortgage and Asset−Backed Securities (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market bid for government−guaranteed (FHA/VA) mortgage loans, Fannie Mae encouraged other secondary market traders to buy and sell mortgages. Its standards were applied to most loans (even those not sold), although Fannie Mae's principal purchase activity in mortgages took place during rising interest rate cycles when depositories experienced difficulty in retaining deposits. In 1968, Congress divided Fannie Mae into two separate organizations: the federally owned Government National Mortgage Association (GNMA or Ginnie Mae), which among other businesses would pool FHA/VA loans into Ginnie Mae pass−through securities, and a new, privately owned but government−sponsored Fannie Mae, which was to focus as well on providing secondary market support for conventional (i.e., non−FHA/VA guaranteed) loans. In 1970, the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) was created to provide additional support to the conventional loan market, particularly among the savings institutions which were its original owners. Fannie Mae and Freddie Mac—now with identical government charters—currently purchase a substantial majority of the mortgages originated in the US. Some are financed on the corporations' balance sheets, but most are pooled and financed by the sale of securities backed by the cash flow of the mortgage pools (such securities representing contingent liabilities of the corporations). The creation of these federally sponsored enterprises contributed to the establishment of a vibrant secondary market for mortgage−backed securities by setting product standards for lenders and investors and by providing critical mass to the markets. Mortgage−backed securities can be divided into two broad classes: mortgage pass−throughs and mortgage−derivative securities. The ''plain vanilla" mortgage pass−through security is the more common. Mortgage pass−through securities represent an undivided interest in the cash flows of a pool or pools of mortgages. Derivative mortgage−backed instruments are created by issuing securities structured so that their cash−flow characteristics are appealing to a broad class of investors depending on the nature of their liability structure. A host of derivative mortgage−backed securities are created from mortgage pass−throughs. These include Collaterized Mortgage Obligations (CMOs), Real Estate Mortgage Investment Conduits (REMICs), and stripped mortgage−backed securities such as Interest Only (IOs) and Principal Only (POs). Another class of securities, called mortgage−backed bonds, was popular in the mid−1980s, but is currently not issued in quantity. Asset−backed securities are collateralized by pools of non−mortgage receivables and structured to pass−through payments, often protected through non−collateralization and the establishment of subordinated credit classes. They are created with underlying collateral as varied as automobile vehicle loans, credit card receivables, house equity loans, account receivable, boat loans, recreational vehicle loans, and other types of loans. Asset−backed securities are small compared to mortgage−backed securities, but a fast growing segment of the US bond market. As they have developed using technology once limited to the mortgage securities market—but without the dominant government−sponsored enterprises—asset−backed securities, market growth may be particularly instructive to developing markets.break

International Bond Market Linkages As domestic bond market development gathers speed, the degree of internationalization tends to grow. The United States was the first to forge international linkages, with its dominant private sector and long history of a permissive and receptive attitude toward the free flow of capital across its borders. The other three countries have followed suit as their domestic bond markets developed skill and capital market infrastructure. This internationalization is reflected in foreign bonds, Eurocurrency, and Euro−dollar bonds. The degree of internationalization of the US bond market has risen since 1974, when the interest equalization tax, which prevented foreign issues from coming to the US bond market, was eliminated. However, this tax spawned the Eurobond market—mainly in the UK—which offshore means of raising capital through Delivered by Theprovided World Bank an e-library to: 0000000000 dollar−denominated bonds. During the 1980s, 000000 the US bond market became more hospitable to foreign bonds (also IP : 000.000.00.00 000, strides 00 000 0000 00:00:00 called Yankee bonds), which have made rapid since then. A major factor militating in favor of Yankee bonds has been the adaptation by the SEC of Rule 144A, under which qualified institutional buyers—such as International Bond Market Linkages (c) The International Bank for Reconstruction and Development / The World Bank

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The Emerging Asian Bond Market large pension funds, insurance companies, and mutual funds that manage at least $100 million in securities of non−affiliated companies on a discretionary basis—are able to sell securities to each other without having to go through formal registration with the SEC. Furthermore, in 1994, the SEC streamlined registration and reporting requirements for foreign companies. In recent years, Eurobond offerings in the US market by US corporations have increased substantially as a result of favorable economic circumstances, such as lower interest rates and a congenial regulatory regime. The methods of issuing Yankee bonds and Eurobonds in the primary market, and the workings of the secondary market for them, are the same as those for the private bond market. Since the 1970s Japan has removed most of the impediments that held up the entry of foreign corporations in its domestic bond market, and both foreign issuance on the Japanese bond market and Japanese issuance on the international market rose substantially over 19801993. Foreign issuers can float yen−denominated bonds in Japan through either public offerings (Samurai bonds) or private placements (Tibias bonds). Tibias bonds were originally not allowed to be less than one−third of Samurai bonds, but this practice was discontinued in 1986. Tibias bonds are exempt from the disclosure requirement of the Securities and Exchange Commission. The issuing procedure for Samurai and Tibias bonds varies. Samurais are issued under the bought−deal system of the European model under which the lead manager has complete discretion in the allocation of the issue among syndicate members and the issuer alone determines the terms and conditions of the issue. The procedure for Tibias is simple but is subject to restrictions: only 49 investors can buy them and certain investors, such as private corporations and individuals, are excluded. Issue of these bonds is regulated by the Ministry of Finance. A major criterion used by the ministry is that these bonds should not pose serious competition to government bonds. The first Euro−yen bond was issued by a foreign corporation in 1974. With a view to protecting Samurai bonds, the Ministry of Finance limits issues of Euro−yen bonds to six or seven a year, though these rules have been relaxed considerably since 1984. The list of eligible foreign issue is extended to foreign municipal governments, government agencies, and private corporations. Private agencies with double "A" ratings are automatically qualified to issue such bonds, while those with single "A" ratings must meet standards before issue. Publicly issued Euro−yen bonds are called Shogun bonds. Though Samurai bonds are listed on the Tokyo Stock Exchange, they are traded mostly in the OTC markets, as they are in bearer form. Trading in the secondary market is limited because bonds are held by the investors almost till maturity. However, a variant of Samurai bond call Daimyo bond has been introduced recently, the settlement of which is carried out through the Euroclear or Cedel system to attract more foreigners and increase liquidity. The market for foreign bonds in Germany has expanded tremendously since 1983, largely as a result of the abolition of the coupon tax, announcement of a 10 percent withholding tax on domestic bond issues, reduction of the minimum maturity for public bonds, and private placements to two years, and the abolition of the compulsory period of notice to the Bundesbank for new issues. Germany's complete freedom in capital movement means there is no legal distinction between domestic and foreign buyers of bonds, as foreign bonds are synonymous with Eurobonds. Industrial firms and banks were the most dominant in issuing foreign bonds. The preferred maturity for new issue has been ten years, though issues in a range up to seven years have increased in response to investor preferences. The heterogeneity of the issues—with their different refinanc−soft

ing requirements—results in a comparatively even distribution of redemption dates over the entire remaining life spectrum. The lead manager of a Deutsch mark−denominated bond issue must be a bank incorporated in Germany and it must be floated in Germany. Every lead manager has to inform the Bundesbank of the issue, amount, terms, and placing method. Public bonds have to be listed on a German exchange, and private placements have to be introduced in the regulated market. Bidding procedures are most common in the primary market. Syndication and placing procedures are the same for bonds issued bidding Delivered by Thethrough World Bank e-libraryand to: those issued through an established 000000 0000000000 relationship between borrowers and issuing houses. The secondary market for these bonds functions in the same IP : 000.000.00.00 way as that for other bonds in Germany. 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market In the UK internationalization of the bond market has proceeded faster since the sweeping "Big Bang" financial deregulation of the 1980s. There are various types of foreign and Euro−sterling bonds, ranging from fixed rate five−year bonds to different kinds of floating rate notes (FRNs), convertible bonds, and mortgage−backed securities. Maturities have ranged from 5 to 30 years; there are even some perpetual FRNs. The MSBs were started by the Mortgage Corporation, set up by Salomon Brothers in 1987 to provide mortgage financing to the public. The FRNs are issued by building societies to fund their floating rate mortgage portfolios. The Euro−sterling bonds are issued by UK corporations, which resort to the Eurocurrency market to make their issues attractive to international investors, thereby expanding their investment base. The usual maturity of MSBs is 25 years. The method of issue of all types of foreign and Euro−sterling bonds is a bought deal method similar to that in Germany, with lead managers as prominent actors. In recent years, however, there has been a significant change, and a fixed price re−offer system has replaced the earlier one to some extent. Under this system the manager of the deal agrees not to offer bonds below an agreed price until the syndicate is broken. This system was introduced to eliminate the practice adopted by some managers with no placing capacity of dumping the bonds. The period of syndication can be as short as a day, or up to three weeks, depending on the success achieved in placing the deal. Euro−sterling fixed rate bonds are quoted with between 8/32 and 16/32 spreads, which narrow during periods of high turnover and rise when turnover is low. Most FRNs are quoted at spreads of 5 to 10 basis points. Settlement in the Euro−sterling market uses a seven−day period, and the securities are held in a clearing system such as Euroclear or Cedel.break

Endnotes Executive Summary

1. Defined to include: China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand.

2. The distinction between money and bond market instruments is normally determined by the length of maturity of instruments. Debt instruments with maturities of less than one year are normally defined as money market instruments, while those with longer maturities are referred to as notes or bonds (i.e., capital market debt instruments). Capital market debt instruments are normally classified as either bonds or notes depending on the length of maturity. Notes are debt instruments with maturities of one to five years, while bonds have longer maturities. In emerging bond markets, the vast majority of capital market debt instruments have maturities of less than seven years and are usually referred to as bonds. Therefore, unless specifically indicated, this report does not make a distinction between notes and bonds.

3. Kondury, Kali. East Asia and the Pacific: Investment in Infrastructure—Past Trends and Future Requirements. World Bank, 1994.

4. Thailand, Social Security System−Issues and Options, December 22, 1994.

5. In April 1995, the RTG announced guidelines for licensing new insurance companies.

6. Thailand: Increasing Private

Delivered by The World Bank e-library to: 000000 0000000000 Sector Participation and Improving Efficiency IP : 000.000.00.00 000, 00 000 0000 00:00:00

in State Enterprises. World Bank.

Endnotes

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The Emerging Asian Bond Market 7. The Economist: Survey of Asian Finance, November 12, 1994.

8. Carling, R.G. "Reforms of Monetary Instruments in South East Asia," included in Frameworks for Monetary Stability Policy Issues and Country Experiences. (Ed) Balino, T. and Cottarelli, C. International Monetary Fund, Washington, DC, 1994; Wang, C.H. Market−Based Systems of Monetary Control in Developing Countries: Operating Procedures and Related Issues, Working Paper No. 40, International Monetary Fund, Washington, DC, 1991; Johnston, R.B. and Brekk, O.P. Monetary Control Procedures and Financial Reforms: Approaches, Issues and Recent Experiences in Developing Countries. 1990, op. cit.

9. Korea Financial Sector Study, World Bank, January 1993. Chapter 1

1. Defined to include: China: CHN; Hong Kong: HKG; Indonesia: IDN; Korea: KOR; Malaysia: MYS; The Philippines: PHL; Singapore: SGP; and Thailand: THA.

2. The Economist: Survey of Asian Finance, November 12, 1994.

3. Sustaining Rapid Development in East Asia and the Pacific. World Bank, 1993.

4. Kondury, Kali. East Asia and the Pacific: Investment in Infrastructure—Past Trends and Future Requirements. World Bank, 1994.

5. Shilling, John and Wang, Yan. Managing Capital Flows in East Asia. World Bank, 1995

6. Thailand: Increasing Private Sector Participation and Improving Efficiency in State Enterprises. World Bank. Chapter 2

1. A comprehensive discussion of bond markets in each of the eight East Asian countries is contained in the companion country reports.

2. Stiglitz, J. The Role of the State in Financial Markets, Proceedings of the World Bank Annual Conference on Development Economics. World Bank, 1993.

3. United States, Japan, Germany, Italy, France, United Kingdom, Canada, Belgium, Netherlands, Denmark, Switzerland, Sweden, Spain, Australia, Austria, Norway, Finland, Ireland, and New Zealand. Delivered by The World Bank e-library Portugal, to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

Chapter 1

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The Emerging Asian Bond Market 4. Contractual saving sector is defined to include central provident funds, insurance companies, and social security organizations.

5. Benavides, Rosario. How Big is the World Bond Market?—1994 Update. International Bond Market Analysis, Salomon Brothers, New York.

6. Fabozzi, Frank J., and Pollack, Irving M. The Handbook of Fixed Income Securities.

7. In the United States, two types of disclosures are required: (i) initial disclosure at the time of registration of securities and (ii) continuous disclosure. In general, initial disclosure requires that the registration statements contain material financial information (income statement and balance sheet) and non−financial information concerning the business of the registrant management and certain security holders. Under the Securities and Exchange Act, four types of continuous disclosure are required: (i) periodic reports; (ii) proxy solicitation; (iii) tender offers; and (iv) insider trading practices.

8. Institutional Investor Report (Asia/Pacific), 1995, Lehman Brothers.break

Chapter 3

1. Chuppe, Terry M., and Atkin, Michael. "Regulation of Securities Markets: Some Recent Trends and Their Implications for Emerging Markets," WPS 869. World Bank, January 1992.

2. Greenspan, Alan, Chairman of Board of Governors of the US Federal Reserve System. Remarks before 16th Annual Conference of the International Organization of Securities Commissions, Washington DC September 24, 1991.

3. In the United States,for example, under Section 2(1) of the Securities Act of 1933 a security is defined as "any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit−sharing agreement, collateral trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting−trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, any put, call, straddle, option or privilege on any security, certificate of deposit, or group or index of security (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange related to foreign currency, or, in general, any interest or instrument commonly known as a security, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to purchase, any of the foregoing."

4. Securities Markets in Japan, Chapter XIV, Securities Administration, Japan Securities Research Institute, 1992, pp. 248257. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000Hong 00:00:00 Futures Commission, Kong, 1994;

5. Annual Report, Securities and Annual Report, Hong Kong Stock Exchange, Hong Kong, 1994; Chance, Clifford, Regulation of Securities Markets in Hong Kong, Hong Kong, Chapter 3

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The Emerging Asian Bond Market 1994; and Securities and Futures Commission of Hong Kong, Briefing by Deborah Gates of the SFC at the Regional Regulators Workshop, Penang, Malaysia, January 9, 1995.

6. The SFC is funded by the members of the securities and futures markets and an annual grant from the government. From the market practitioner, there is a statutory levy on stock market and futures transactions (currently at 0.006 percent and HK$1.00 per futures contract) and fees and charges for services performed by the futures contract) and fees and charges for services performed by the regulatory body under the ordinances administered by the SFC.

7. Korea Stock Exchange, Seoul, Korea, September 1992, pp. 512 and Atkin and Chuppe, op. cit., pp. 2022.

8. The 1968 Law on Fostering the Capital Market was enacted to promote development of the capital market by encouraging companies to go public and to stimulate participation of individual investors in the market. It provides tax and other incentives for listed companies. Also, the SEC is empowered to designate companies eligible to go public and, if necessary, recommend that they go public. See: Korea Stock Exchange, op. cit., p. 7.

9. Thailand Securities Markets and Regulation. Briefing presented by Soontorn Pojthanamas, Securities and Exchange Commission of Thailand at the regional Regulators Workshop, Penang, Malaysia, January 9, 1994.

10. The Securities Exchange of Thailand, Bangkok, Thailand, 1994, pp. 15.

11. STAQS has not been able to function as a fully automated market due to the lack of an adequate telecommunications network for such a market. As a result, STAQS now operates on four trading floors.

12. Quality securities not listed on the Shanghai and Shenzhen stock exchanges (i.e., certain C shares) are eligible to trade on the electronic over−the−counter market. Stocks listed on the two stock exchanges are not eligible to trade over the counter because each exchange has a monopoly on exchange−listed issues. Consequently, while there is competition to obtain new listings, dual listings are not permitted in the current regulatory environment.

13. Local securities commissions in Shanghai and Shenzhen administer municipal government regulations relating to the securities markets. The Shanghai Securities Commission and the Shenzhen Securities Commission do not have authority in areas covered by national securities regulations on bonds and equity securities. The role of the local regulatory body in Shanghai can be gleaned by looking at the structure of the governing board of the Shanghai Securities Commission, which is composed of the vice mayor of Shanghai, the Shanghai Branch of the Peoples' Bank of China, the Shanghai Planning Committee, the deputy director of the Shanghai Commission on Restructuring, the Shanghai Bureau of the Ministry of Finance, the Municipal Auditing Bureau, the Shanghai Foreign Investment Commission, Municipal Office of Justice, the Director of the Office of the Commission, Deputy Secretary General of the Municipal Government responsible for assets, and the Shanghai Branch of the State Asset Management Bureau. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, China's 00 000 0000 00:00:00 securities law, July 1994 Company

14. In the absence of a national Law contains provisions that normally would be covered in a securities statute. For instance, the Company Law states that all shares issued to the public Chapter 3

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The Emerging Asian Bond Market must be fully underwritten and offered with a prospectus. The law also provides that additional shares may be offered only if a company has been profitable for the three previous years and at least one year has elapsed since the last share offering.

15. See: Yi−Chen, Zhang and Da, Yu, "China's Emerging Securities Market," Columbia Journal of World Business, Vol. XXIX, No. 2, Summer 1994, pp. 113121, and Duoguang Bei, "The CSRC and China's Stock Market, " China's Securities Regulatory Commission, Beijing, China, April 25, 1994.

16. The six governmental bodies involved in capital market regulation before the Malaysia Securities Commission was established in 1993 were: the Capital Issues Committee (Ministry of Finance); the Takeover Panel and the Foreign Investment Committee (Prime Minister's Department); the Registrar of Companies; the Ministry of International Trade and Industry; and Bank Negara Malaysia.

17. At the Thai SEC, there is a separate Office of the SEC that was set up as an independent organization with the general−secretary in charge of the administrative affairs of the office.

18. The Philippines has a Capital Market Development Coordinating Committee chaired by the SEC and including the Department of Finance, Bangko Sentral, Bureau of Internal Revenue, and the Office of the Insurance Commission as representatives from the public and the Philippines Stock Exchange and FINEX representing the private sector. See: Securities and Exchange Commission, Fifty−Seventh Annual Report, Manila, Philippines, 1993, p. 21.

19. Duoguang, Bei. The CSRS and China's Stock Market, China Securities Regulatory Commission, Beijing, China, April 25, 1994.break

20. See, for example: What Every Investor Should Know: A Handbook from the US Securities and Exchange Commission, Washington, DC, October 1990, p. 5.

21. Securities and Exchange Commission of Thailand, op. cit, pp. 23.

22. Each state in the United States has a securities law, and some contain merit regulation provisions. Much of the coordination work between the US SEC and the states is carried out under the auspices of the North American Securities Administrators Association, an organization of state, territorial, and provincial securities regulators in the United States, Canada, Mexico, and Puerto Rico. See: The Role of the 50 States in Regulation of the Global Securities Markets, Report to the 16th Annual Conference of the International Organization of Securities Commissions, Washington, DC, September 1991.

23. Malaysian Securities Market, op. cit., p. 11. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000and 0000 an 00:00:00 are guaranteed, issuing corporation

24. In Korea, most corporate bonds normally contracts with a financial institution such as a commercial bank, merchant bank, or securities firm as guarantor, and with a bank to act as Chapter 3

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The Emerging Asian Bond Market paying agent for principal and interest.

25. Korean Stock Exchange, op. cit., pp. 2024.

26. Although no corporate bond has been registered with the SEC since 1991, private corporations issue both short− and long−term commercial paper that is required to be registered with the SEC, and private placements of debt are issued to institutional investors. There are several impediments to issuing corporate bonds. The Philippine company law makes it easier to get approval from shareholders for the issuance of commercial paper. Corporate bonds require the approval of two−thirds of all shareholders, while commercial paper can be approved by the board of directors. Also, there may be more stringent merit reviews for corporate bond issues. Nevertheless, it does not appear that the SEC has impeded the development of the corporate bond market. The lack of demand for corporate bonds in the past has primarily been due to unfavorable macroeconomic conditions and ambiguities in the tax code regarding the tax treatment of capital gains on corporate bonds.

27. US SEC Rule 144A, adopted in 1990, had the effect of making the US private placement market more accessible to foreign and domestic issuers by expanding opportunities for issuers to raise capital without going through formal registration with the SEC. Rule 144A provides a "safe harbor" whereby qualified institutional buyers (i.e., large institutional investors such as insurance companies and investment companies that own and invest at least $100 million in securities of non−affiliated companies) of securities are able to sell securities once offered to other qualified institutional buyers. Rule 144A has made the US private−placement market more competitive with the Eurobond market.

28. Under the Company Law, the following provisions must be met in order to issue bonds: (1) For limited liability companies the net asset value of the issuer must not be less than RMB30 million ($3.5 million) whereas a company limited by shares must have a net asset value of at least RMB60 million ($6.9 million); (2) the total value of bonds issued may not exceed 40 percent of total net assets; (3) during the three years prior to the offering, the average distributed profits must be sufficient to cover one year's interest on the bonds; (4) funds raised must be invested in industries which comply with policies of the state; (5) funds raised may not be used to cover losses orfor non−productive expenditures; (6) the interest rate on the bonds may not exceed the limit set by the State Council; and (7) the offering must also be able to meet any other conditions prescribed by the State Council for the issuance of bonds.

29. Article 175 of the Company Law requires the preparation of a balance sheet, profit and loss statement, statement of financial changes, explanation of financial conditions, and a profit distribution statement.

30. Philippines Capital Market Study.

31. Under US GSA of 1986, a government securities broker or dealer is defined to be any entity, including a financial institution, which acts as a broker or dealer in government securities. The passage of the GSA in 1986 required, for the first time, previously unregistered brokers and dealers that limit their business to government and other exempt securities (except municipal securities) to Bank register with Delivered by The World e-library to: the US SEC and join a self−regulatory 000000 0000000000 organization ("SRO"). Under the US regulatory scheme, all brokers and dealers registered with the Securities and IP : 000.000.00.00 0000one 00:00:00 Exchange Commission are also required to 000, join00at000 least self−regulatory organization (i.e., a stock exchange or the National Association of Securities Dealers ["NASD"]). The GSA also specified that firms registered as Chapter 3

202 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market general securities brokers or dealers or as municipal securities brokers or dealers must notify the US SEC if they conduct government securities transactions. Also, financial institutions, functioning in the capacity of a broker or dealer in government securities, were likewise required to give notice of their status (as a government securities dealer) to their appropriate regulatory agency.

32. With respect to financial responsibility, broker−dealers registered with the US SEC must comply with its net capital rule for the purpose of complying with the financial responsibility rules pursuant to the GSA requirements. Financial institution government securities dealers must comply with the respective capital requirements of the appropriate financial institution's regulatory agency in order to comply with the GSA regulations.

33. For a comprehensive discussion of the regulation of government securities markets and dealers in government securities, see: Government Securities Act of 1985, House of Representatives Report, 99258. 99th Congress, 1st Session, Washington, DC, September 9, 1985; Joint Report on the Government Securities Market, Department of the Treasury, Securities and Exchange Commission, and the Board of Governors of the Federal Reserve System, US Government Printing Office, Washington, DC, January 1992; Study of the Effectiveness of the Implementation of the Government Securities Act of 1986, Prepared by the Department of the Treasury, Securities and Exchange Commission, Board of Governors of the Federal Reserve System, Washington, DC, October 1990; The Government Securities Act of 1986; A Historical Perspective, Thomas J. Lykos, Jr., Practicing Law Institute (J. Eugene Marans and Robert C. Pozen, Co−Chairmen), New York, 1987, pp. 223298; The Government Securities Act of 1986, Report of the Committee on Banking, Housing, and Urban Affairs.

34. Between July 1975 and April 1985 the following unregulated government securities dealers failed: Financial Corporation of Kansas City, Mo. (1975), Winters government Securities (1977), Drysdale government Securities (1982), Lombard−Wall (1982), Lion Capital Group, Inc. (1984), E.S.M. government Securities (1985), and Bevel, Bresler & Schulman Asset Management Corporation (1985).break

35. A repurchase agreement ("REPO") is a transaction in which the owner of securities sells them to another party and agrees to repurchase the same or equivalent securities on a specified date, at a specified price. As agreed to by the parties to the transaction, most REPOs are entered into on an overnight, or short−term basis, but long−term REPOs are not uncommon. In the US, repurchase agreements are the principal means by which government securities dealers obtain funding for their inventories in securities. REPOs are by far the cheapest source of funding for inventories in securities. Consequently, the use of the financing technique contributes to the efficiency of the government securities market. Dealers in government securities also engage in reverse REPO transactions (in which the dealer is the initial purchaser of securities) to obtain securities that are needed to deliver securities, or to engage in other REPO transactions.

36. Prior to the passage of the US GSA of 1986, the lack of regulation and supervision resulted from the classification of "government securities" as exempted securities as defined in section 3(a)(12) of the Securities and Exchange Act of 1934. Although the vast majority of government securities brokers and dealers were subject to some form of federal government regulation, brokers or dealers that executed transactions exclusively in US government securities were not subject to supervision by any federal regulatory agency. Delivered by The World Bank e-library to: 000000 0000000000 37. IMF. International Capital Markets: Developments, Prospects and Policy Issues, Washington, DC, 1994. IP : 000.000.00.00 000, 00 000 0000 00:00:00

Chapter 3

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The Emerging Asian Bond Market 38. IMF, Ibid.

39. Isaac, Jonathan, and Ejiri, Takashi. Japanese Securities Market, Economy Books, 1990; Japan Securities Research Institute, Securities Market in Japan 1992.

40. "Financial Center Germany: Underlying Conditions and Recent Development. " Monthly Report of the Deutsche Bundesbank, March 1992.

41. The principal distinction between the two types of trusts is that no addition may be made to a unit investment trust after it has been established while additions to principal are allowed over time with respect to open investment trusts. For unit trusts, beneficial certificates must be listed on the Korean Stock Exchange. An investor in an open investment trust is entitled to request repurchase of its certificates at any time based on the trust's net asset value. Chapter 4

1. For details and comprehensive discussion, see Shilling, John and Wang, Yan, Managing Capital Flows. World Bank, 1995. Chapter 5

1. For elaborate discussions of the industrial countries' experiences in the use of indirect monetary policy instruments, see the following: Kneeshaw, J.T., and Vanden Bergh, P. Changes in Central Bank Money Market Operating Procedures in the 1980s, Bank for International Settlement, Economic Paper No. 23, Basle, 1989; Khatkhate, Deena. Indirect Monetary Control in Selected Countries (Mimeograph). The World Bank, Washington, DC, 1992; Johnston, R.B. and Breck, O.P. "Monetary Control Procedures and Financial Reforms." Approaches, Issues and Recent Expenses in Developing Countries, in P. Callier (ed.) Financial Systems and Developments in Africa. The World Bank, Washington, DC, 1990.

2. Kneeshaw, J.T., and Vanden Bergh, P. Changes in Central Bank Money Market Operating Procedures in the 1980s, op. cit.

3. Dudler, H.J. "Changes in Money Market Instruments and Procedures in Germany, " included in Changes in Money Market Instruments and Procedures: Objectives and Implications. Bank for International Settlements, Basle, 1986.

4. Gilbert, R.A. "Operating Procedures for Conducting Monetary Policy. " Review of Federal Reserve Bank of St. Louis, February 1985; Batten, D. et al. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments and Operating Procedures. International Monetary Fund, Washington, DC 1990. Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 000in0000 00:00:00 Bergh, P. Changes Central Bank Money

5. Kneeshaw, J.T., and Vanden Market Operating Procedures in the 1980s, op. cit. Batten, D. et al. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments Chapter 4

204 (c) The International Bank for Reconstruction and Development / The World Bank

The Emerging Asian Bond Market and Operating Procedures, op. cit.

6. Deutsche Bundesbank. "The Bundesbank's Transactions, in Securities Under Repurchase Agreements. " Monthly Report, May 1983.

7. Suzuki, Y. "Monetary Control Mechanism in Japan," in P. Hooper et al.,(ed) Board of Governors of the Federal Reserve System, Financial Sectors in Open Economies: Empirical Analysis and Policy Issues. Washington, DC, 1990.

8. Batten, D. et al. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments and Operating Procedures, op. cit.

9. Batten, D. et al. Ibid.

10. Batten, D. et al. Ibid.

11. Batten, D. et al. Ibid, and Suzuki. "Monetary Control Mechanism in Japan, " op. cit.

12. Kneeshaw and Vanden Bergh. Changes in Central Bank Money Market Operating Procedures in the 1980s, op. cit.

13. Quintyn, M. Government Securities Versus Central Bank Securities in Developing Open−market Operations−Evaluation and Need for Coordinating Arrangements, Working Paper No. 108, International Monetary Fund, 1993.

14. Kneeshaw and Vanden Bergh. Changes in Central Bank Money Market Operating Procedures in the 1980s, op. cit.

15. Kneeshaw and Vanden Bergh. Ibid.

16. Brittain, Samuel. "Post−Money World on our Doorstep," Financial Times (London), November 17, 1994.

17. Most of this discussion in this section is sourced from Cho, Y.J., and Khatkhate, D. Lessons of Financial Liberalization in Asia: A Comparative Study, World Bank Discussion Paper No. 50, World Bank, Washington, DC; Dalla, I., and Khatkhate, D. Regulated Deregulation of the Financial System: The Case of Korea, World Bank Discussion Paper, Washington, Delivered DC 1995; Tseng, Corker, R. Financial Liberalization, Money by The World W., Bank and e-library to: 000000 0000000000 Paper 84, International Monetary Fund, Demand and Monetary Policy in Asian Countries, Occasional IP : 000.000.00.00 000, 00 000 0000Sector 00:00:00Study, Report No. 11373−KO;, The Philippines: Washington, DC, 1991; World Bank. Korea: Financial Capital Market Study, Volume I, Report No. 10053−PH, Washington, DC, 1992; and Indonesia: Financial Sector Chapter 4

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The Emerging Asian Bond Market Report, Report No. 8159−IND, Washington, DC, 1990.

18. Mathieson, D., and Haas, R.D. Establishing Monetary Control in Financial System with Insolvent Institutions. PPAA 10, International Monetary Fund, Washington, DC, 1994.

19. Dalla, I., and Khatkhate, D. Regulated Deregulation of the Financial System: The Case of Korea, op. cit.break

20. Tseng., W, and Corker, R. Financial Liberalization, Money Demand and Monetary Policy in Asian Countries, op. cit.

21. Tseng, W, and Corker, R. Ibid.

22. Sundararajan, V., and Molho, L. Financial Reform and Monetary Control in Indonesia. IMF Working Paper No. 88. International Monetary Fund, Washington, DC, 1988, and relevant country chapters in the study.

23. Dalla., I, and Khatkhate, D. Regulated Deregulation of the Financial System: The Case of Korea, op.cit. World Bank; Korea: Financial Sector Study, Report No. 11373−KO, 1993; and The Philippines: Capital Market Study, Volume I, Report No. 10053−PH, 1992.

24. Carling, R.G. "Reforms of Monetary Instruments in South East Asia" included in Balino, T., and Cottarelli, C., (eds) Frameworks for Monetary Stability Policy Issues and Country Experiences. International Monetary Fund, Washington, DC, 1994; Wang, C.H. Market−Based Systems of Monetary Control in Developing Countries: Operating Procedures and Related Issues, Working Paper No. 40, International Monetary Fund, Washington, DC, 1991; Johnston, R.B., and Brekk, O.P. Monetary Control Procedures and Financial Reforms: Approaches, Issues and Recent Experiences in Developing Countries. " 1990, op. cit. Chapter 6

1. World Bank. Global Economic Prospects, January 1995.

2. Kondury, Kali. Investment in Infrastructure: Past Trends and Future Requirements. World Bank, 1994.

3. Thailand, Social Security System—Issues and Options, December 22, 1994.

4. Thailand: Increasing Private Sector Participation and Improving Efficiency in State Enterprises. World Bank. Delivered by The World Bank e-library to: 000000 0000000000 5. The Economist: Survey of Asian Finance, November 12, 1994. IP : 000.000.00.00 000, 00 000 0000 00:00:00

Chapter 6

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The Emerging Asian Bond Market Annex B

1. Stiglitz, J., The Role of the State in Financial Market Proceedings of the World Bank Annual Conference on Development Economics. World Bank, 1993.

2. Mullins, David W., Jr. Statement Before the Sub−Committee on Securities of the Committee on Banking, Housing and Urban Affairs, US Senate, reproduced in Federal Reserve Bulletin, Vol. 78, No. 3 (March 1992); IMF. International Capital Markets: Developments, Prospects and Policy Issues, World Economic and Financial Surveys, Washington, DC, 1994; Federal Reserve Bank of New York. Administration of Relationships With Primary Dealers, Appendix E in Joint Report on the Government Securities Market (Washington, DC, 1992).

3. IMF. International Capital Markets: Developments, Prospects and Policy Issues, 1994, op. cit. Isaacs, J., and Takashi, E., Japanese Securities Market, Euromoney Books, 1990, Japan Securities Research Institute, Securities Market in Japan, 1992.

4. IMF. International Capital Markets, 1994, op. cit; Kroszner, R.S. "An International Comparison of Primary Government Securities Markets" in US Securities Market: The Scholars' Assessment, Vol. 1, Chicago, 1993.

5. OECD. "Systems of Government Bond Auction in OECD Countries," Financial Market Trends, Nov.1994; IMF. International Capital Markets: Developments, Prospect and Policy Issue, World Economic and Financial Surveys, Washington, DC, September 1994.

6. OECD. op. cit.

7. IMF. International Capital Markets, 1994, op. cit.

8. Repurchase agreements refer to transactions which involve the sale of government bonds with a view to buying them back at mutually agreed future dates and prices. Reverse repurchase agreements are buying government bonds with a view to selling them at agreed future date and prices.

9. Joint Report on the Government Securities Market, Department of Treasury, Securities and Exchange Commission, and Board of Governors of the Federal Reserve System, Washington DC, 1992. Marcia Stigum. After the Trade: Dealer and Clearing Bank Operations in Money Market and Government Securities, Dow−Jones−Irwin, Homewood, Illinois 60430; IMF. International Capital Markets, 1994, op. cit.

10. McClean, S.K. The European Bond Markets, op cit. Delivered by The World Bank e-library to: 000000 0000000000 11. Mason. "The Yen Bond Markets", CSFB Research, Credit Suisse, First Boston, 1987; Securities Market in IP : 000.000.00.00 000, 00 000 0000 00:00:00 Japan, Japan Securities Research Institute, 1992.

Annex B

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The Emerging Asian Bond Market 12. McLean, S.K. The European Bond Markets, op. cit.

13. Public Securities Association, Fundamentals of Municipal Bonds, Washington, DC, 1990.

14. Mason, Richard. "The Yen Bond Markets," CSFB Research, Credit Suisse, First Boston, November 1987.

15. McLean, S.K.; The European Bond Market, 1993, op. cit.

16. Fundamentals of Municipal Bonds, Public Securities Association, Washington, DC, 1990.

17. Karp, E.W., and Koike, A. "The Japanese Corporate Bond Market" included in Fabozzi, F.J., ed. The Japanese Bond Markets, Probus Publishing Company, Chicago, 1990.

18. Fabozzi, F., and Modigliani, F. Mortgage and Mortgage−Backed Securities, Harvard Business School Press, Boston, 1992.break

Selected Bibliography Atkin, Michael, and Terry M. Chuppe. January 1992. Regulation of Securities Markets: Some Recent Trends and Their Implications for Emerging Markets. WPS 869, World Bank. Bangko Sentral Ng Pilipinas. 1993. Forty−fifth Annual Report. Manila. Bank for International Settlements. 1989. Changes in Central Bank Money−Market Operating Procedures in the 1980s. BIS Economic Paper No. 23. Bank of Indonesia. 1994. Report for the Financial Year, 1993/94. Jakarta. Bank of Thailand. 1993. Annual Economic Report. Bangkok. Batten, D., et al. 1990. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments and Operating Procedures. Occasional Paper 70, International Monetary Fund, Washington, DC. Bellchamber, C. 1992. The U.K. Government Bond Market. CSFB Research. Benavides, Rosario. How Big Is the World Bond Market?—1994 Update, International Bond Market Analysis, New York: Salomon Brothers. Carling, R.G. 1994. "Reforms of Monetary Instruments in South East Asia." In T. Balino and C. Cottarelli, eds., Frameworks for Monetary Stability: Policy Issues and Country Experiences. Washington, DC: International Delivered by The World Bank e-library to: Monetary Fund,. 000000 0000000000 IP : 000.000.00.00 000, 00 000 0000 00:00:00

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The Emerging Asian Bond Market Cheng, H., ed. 1988. Monetary Policy in Pacific Basin Countries. Boston: Kluwer Academic Publishers. Cho, Y.J., and D. Khatkhate. 1988. Lessons of Financial Liberalization in Asia: A Comparative Study. World Bank Discussion Paper No. 50, Washington, DC. Chuppe, Terry M., Hugh R. Haworth, and Marvin Watkins. Fall 1989. "Global Finance: Causes, Consequences and Prospects for the Future.", Global Finance Journal 1(1). Chuppe, Terry M., Hugh R. Haworth, and Marvin G. Watkins. 1990. "Public Policy Toward the International Bond Markets in the 1980s." In Advances in Financial Planning and Forecasting. Vol. 4, Part B. Greenwich, Connecticut: JAI Press, Inc. Corbo, Vittorio, and Leonardo Hernandez. 1994. Macroeconomic Adjustment to Capital Inflows: Latin American Style versus East Asian Style. World Bank Policy Research Working Paper, No. 1377. Washington, DC. Dalla, I., and D. Khatkhate. 1994. Regulated Deregulation of the Financial System: The Case of Korea. Mimeograph, World Bank, Washington, DC. Deutsche Bank Research Group. The U.K. Government Bond Market. Updated at irregular intervals.break

Deutsche Bundesbank. May 1983. "The Bundesbank's Transactions in Securities Under Repurchase Agreements." Monthly Report. Dudler, H. J. 1986. "Changes in Money Market Instruments and Procedures in Germany." In Changes in Money Market Instruments and Procedures: Objectives and Implications. Basle: Bank for International Settlements. Duoguang, Bei. April 25, 1994. The CSRC and China's Stock Market. Beijing: China's Securities Regulatory Commission. Emery, Robert F. 1991. "The Hong Kong Money Market." In The Money Markets of Developing East Asia. New York: Praeger Press. Gates, Debra. January 9, 1995. Securities and Futures Commission of Hong Kong, Briefing at the Regional Regulators Workshop, Penang, Malaysia. Gilbert, R.A. February 1985. "Operating Procedures for Conducting Monetary Policy." Review of The Federal Reserve Bank of St. Louis. Goldstein, Morris, David Folkerts−Landau, et al. 1992. International Capital Markets: Development, Prospects and Policy Issues. World Economic and Financial Surveys. International Monetary Fund, Washington, DC. Government Securities Act of 1985. September 9, 1985. House of Representatives Report 99258, 99th Congress, 1st Session, Washington, DC. Government Securities Act of 1986. September 3, 1986. Report of the Committee on Banking, Housing, and Urban Affairs, United States Senate, to accompany S. 1416, 99th Congress, 2nd Session, Senate Report 99426, Washington, DC, Delivered by The World Bank e-library to: 000000 0000000000 IP : 000.000.00.00 000, 00 before 000 0000the 00:00:00 Remarks 16th

Greenspan, Alan. September 24, 1991. Organization of Securities Commissions, Washington, DC.

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Majid, Mohd Munir Abdul. June 20, 1994. ''Challenges for the Malaysian Capital Market." Luncheon address at the International Conference−Asian Capital Markets: Growth Frontiers, Kuala Lumpur Hilton. Majid, Mohd Munir Abdul. January 9, 1995. "Role and Functions of the Securities Commission Malaysia." Regional Regulators Workshop, Rasa Sayang Hotel, Penang, Malaysia. "Malaysian Securities Market." April 14, 1994. Paper prepared by the Securities Commission, Malaysia, Kuala Lumpur. Mass Transit Railway Corporation Financial Profile 1994. 1994. Hong Kong. Mathieson, D., and R.D. Haas 1994. Establishing Monetary Control in Financial System with Insolvent Institutions. PPAA 10, International Monetary Fund, Washington, DC. Delivered by The World Bank e-library to: 000000 0000000000 McLean S.K., ed. 1993. The European Bond Markets. Chicago: Probus Publishing Company. IP : 000.000.00.00 000, 00 000 0000 00:00:00

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Study of the Effectiveness of the Implementation of the Government Securities Act of 1986. October 1990. Prepared by the Department of the Treasury, Securities and Exchange Commission, and the Board of Governors of the Federal Reserve System, Washington, DC. Sundararajan, V., and L. Molho. 1988. "Financial Reform and Monetary Control in Indonesia." Working Paper No. 88. International Monetary Fund,Delivered Washington, DC. Bank e-library to: by The World "Survey of Asian Finance." November 12,

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