Debt capital markets: unexplored territory as yet

With low interest rates and increased liquidity in banks, now is a good time to tap DCMs.

DUBAI:

In the summer of 2011, the Government of Pakistan planned on issuing Oil and Gas Development Corporation (OGDC)-backed exchangeable bonds worth $500 million. Roadshows were held in cities like Abu Dhabi, Singapore, Kuala Lumpur, Zurich and London. The transaction, if it had gone through, would have been Pakistan’s first foray into the debt capital markets since 2005.

In January 2005, Pakistan raised $500 million at a 6.75% fixed return in the form of a Sukuk issue, which at that time was priced at the London Interbank Offering Rate (LIBOR) + 3.75%. This Sukuk bore the brunt of the financial crisis in 2008 and 2009, when it traded as low as $45 per unit, or at a 55% discount. This was during the time when Pakistan was facing a severe capital crisis in the form of low forex reserves, flight of capital.

Approaching the International Monetary Fund (IMF) then was the right thing, because by becoming part of the programme, some element of discipline was instilled in economic management. Despite all the troubles, the Government of Pakistan successfully repaid the Sukuk on time, and in full. Those who had taken the risk when our Sukuk was trading at its lowest must have been amply rewarded.

Since then, Pakistan has exited the IMF programme for want of reforms that have not been implemented, while substantial repayments are due in the next three fiscal years. On top of that, the much needed increase in taxation to cover fiscal requirements has not been very successful. In essence, our state’s fiscal deficit management has largely depended on externalities like Coalition Support Funds, receivables from privatisation proceeds like Etisalat, remittances, and borrowing internally through the National Saving Schemes and the banking system. One area that has been completely ignored is external debt capital markets (DCMs).

Out of our $58 billion public external debt, only $1.55 billion is raised from DCMs, with two bonds due in 2016 and 2017, and one due in 2036 with an average coupon of 7.15%. As an investment banker, I felt positive when Pakistan was approaching DCMs last year using the exchangeable bonds route of OGDC. Having a rating of B- from Standard & Poor’s and a Ba3 from Moody’s, it would have been an interesting test to see how we are treated in international markets. Even if we had raised money between the range of 9-10% per annum, it may not have been a bad idea. Regular repayment over a course of time, and approaching the capital markets through the establishment of a programme, keeps you in the eyes and minds of investors: as they say “out of sight is out of mind” – Pakistan is a perfect example of the same in credit markets.

As Pakistan currently doesn’t have a proper plan to tap credit markets in the form of bond/Sukuk issues, or approaching multilateral institutions including IMF, we are prone to possible downgrades. Moody’s downgraded Pakistan in July from Ba3 to Caa, Pakistan’s lowest credit rating since 1998, citing upcoming payments to the IMF in fiscal 2013 to 2015 as a major reason for the downgrade.

Looking at the recent downgrade, one can be quite certain that the bottom in our credit ratings has been reached.

What better time to establish a DCM programme and plan accordingly? The reason why it is the ideal avenue right now is that with regular rounds of quantitative easing, banks have the ability to go after cheap money chasing assets. Also, with interest rates having come down and likely to remain low till 2015, there is a greater incentive for borrowers to issue liquid instruments; while for investors, the absolute returns offered by emerging markets allows money to follow.

As a case in point, the Republic of Turkey sought to raise as much as $5.23 billion from external borrowings in 2012. They have exceeded their target and raised more than $6.1 billion by tapping into the highly liquid bonds and Sukuk market. On September 18, 2012, the Republic of Turkey issued their first ever sukuk worth $1.5 billion, for which they attracted orders of a multiple of six times at a pricing of 2.80% and a 5.5 years tenure.

One can see the impact of reducing rates and higher liquidity in that, earlier in January and February, Turkey raised $2.5 billion in the form of 10.5 year bonds at a pricing of 6.25%. By raising more money than they budgeted, they have smartly reduced their average cost of borrowing. Mind you, Turkey is also not investment grade, and has a rating of BB from S&P and Ba1 from Moody’s. Just look at the difference in the perceptions of Turkey and Pakistan. I am sure many would have assumed that Turkey is investment grade. A simple problem that we can be sure of is that we are bad marketers of Pakistan.

Pakistan has to plan its forays into debt capital markets and become a regular issuer. That is the only way the business world will again become receptive to Pakistan. The usual problems of terrorism, honour killings and problems with the Taliban all give us a bad name which we can certainly do without.

A UAE based investment banker who can be contacted at [e-mail]

Published in The Express Tribune, November 19^th, 2012.