Bod Market

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SBP Research Bulletin Volume 3, Number 1, 2007

Bond Market Developments in Emerging Markets: Propsects and Challenges for Pakistan Ahmed M. Khalid•
This paper investigates the development of bond market in emerging economies with a focus on Pakistan. The main objective of this paper is to explore the reasons for a slow development of bond market in emerging economies. To achieve this objective, we first provide a comprehensive survey of the bond market developments in a sample of Asian countries. For comparison purposes, we split the sample into two: (i) the early reformers, and (ii) the hesitant or late reformers. We present a case where bond market developments become an integral part of the financial market development. We also discuss the stages of market developments in a sample of emerging market economies. We compare both sets of countries and then draw lessons for Pakistan. We observe that Pakistan needs to satisfy a set of pre-requisites before some meaningful progress in domestic bond market development is made.

1. Introduction
During the period of early 1980s to mid-1990s, many East-Asian and Southeast Asian countries embarked on policies of financial sector reforms, liberalization, deregulation and financial market developments. By mid-1990s, most of these countries were enjoying the benefits of a liberalized financial market and an open economy. However, until recently, these countries lacked a well-established and well-functioning domestic bond market, especially a secondary market for government bonds. The main question is why the development of bond market so important for emerging economies? Bond market has significant importance in any economy but more so in emerging economy where saving and investment opportunities are limited. As such the question is not ‘why to have a bond market?’ but ‘when to have a bond market?’ The benefits of the development of a market for domestic bonds include both the macroeconomic and microeconomic perspectives. Within macroeconomic perspective, the primary benefit of government bond market is to provide a channel for the financing of fiscal deficits. This is, probably the most Associate Professor of Economics and Finance, School of Business, Bond University, Gold Coast, QLD 4229, Australia, Fax: (617) 5595-1160. [akhalid@bond.edu.au] •

© 2007 State Bank of Pakistan. All rights reserved. Reproduction is permitted with the consent of the Editor.

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SBP Research Bulletin, Vol. 3, No.1, 2007

important benefit for emerging economies such as Pakistan with a history of high fiscal deficits and the failure of other possible sources of financing the fiscal deficits. Another benefit of developing a market for government bonds is to strengthen the transmission mechanism of monetary policy with the use of government securities market. The market for domestic bonds also helps in the use of monetary policy instrument and to keep inflation within desired target. The literature also suggests that domestic bond markets help to sterilize large capital inflows.1 Bond market also helps to make efficient investment and financing decisions, improve efficiency in the design and implementation of monetary policy, risk management, liquidity management and foreign exchange risk management. In view of some recent financial sector developments in emerging economies, it is imperative to assess why the development of bond market could not keep the same pace as other sectors of the financial market in the emerging economies. While doing so, one should also look at the state of sample economies and the challenges ahead. These are the main objectives of this paper. We plan to present a case where bond market development becomes an integral part of the financial market development. We also provide a complete sate of a sample of emerging market economies. For comparison purposes, we split the sample into two: (i) the early reformers, and (ii) the hesitant or late reformers. We compare both...
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