State Bank of Pakistan sees foreign inflows in longer-tenor securities

KARACHI: The central bank on Monday expected further inflows in longer-dated maturities on attractive taxation structure and as investors pose trust on economic stability measures taken by the government.

The State Bank of Pakistan (SBP) said the simplification of taxation for investment in government securities – that was recently approved by the ECC (Economic Coordination Committee of the cabinet) –“will promote greater interest in investments in longer-dated maturities”.

The SBP said foreign investment of $1.2 billion in Pakistan’s debt markets currently accounts for less than two percent of the total outstanding marketable government securities and less than 0.5 percent of GDP.

“This investment accounts for less than one-fifth of the increase in SBP’s net reserve buffers at current levels; the bulk of the increase in the net reserve buffers is accounted for by the continued current account improvement,” it said in a statement. “The tenor of such investments has been increasing with more investments in longer dated instruments as investors’ confidence grows.”

SBP Governor Reza Baqir said the strategy is to create “deeper pockets along the yield curve”. “Having deeper segments means that these instruments become more attractive to non-residents as well because they want turnover in the secondary market,” Baqir told Bloomberg in an interview.

Money mainly has so far flown into treasury bills – which have a maximum holding period of 1 year. Baqir wants this spilling over to longer tenors. The yield on 10-year bonds has dropped to 10.95 percent, the lowest in more than a year, according to the Financial Markets Association of Pakistan.

SBP governor said the central bank is working with the finance ministry on a strategy that includes considering bond buybacks, among other measures. “There are many scattered issues from market liquidity and transparency and price discovery,” he added.

Moiz Hussain Ali, country treasurer and head of markets at Citigroup Inc.’s local unit agreed that most of inquiries he had been receiving from overseas clients were about 3-month bills, with some about 1-year paper.

“Investors are coming in the short-term but this was the experience in Egypt, Nigeria, Ukraine and other markets as well,” Ali said in a briefing earlier this month. “So first they will try and experience that” and then think about longer investment periods, he added.

The State Bank said there are several misconceptions about the implications of international investors’ investments in the debt markets of Pakistan. “There are several emerging market economies that have attracted investments from international investors in much greater amounts on a sustainable basis in their local currency debt markets and have used them as a major stimulus in their macroeconomic development,” it said. “The SBP continues to monitor developments in the financial sector carefully and stands ready to take action against any risks.”

The SBP said international investors have been investing in the country’s equity markets for a long time. “Such investments are considered portfolio investments, just like investments in debt instruments, and use the same framework of special convertible rupee account,” it said. “Such investors have been able to move capital in and out of our financial markets without problems for the Pakistan’s economy.”

The SBP said recently international investors have started investing in debt instruments issued by the government. “This is largely a manifestation of their growing confidence in the positive outlook for the economy,” it added. “As endorsed by international financial institutions, including the IMF (International Monetary Fund), the ADB (Asian Development Bank) and the World Bank, and rating agencies, our reform program is beginning to show results.”

The SBP said shift to a market-based exchange rate system since May 2019 has addressed previous concerns regarding thesustainability of the exchange rate regime.

“Together with the continued improvement in our balance of payments and reserve buffers, this has raised the comfort level of international investors to invest in local currency denominated financial assets,” it said.

“It should be noted that interest rates have been higher in the past — for example interest rates were around 13.75 percent on average in FY11 — but our debt markets did not attract interest from international investors.”

The State Bank said investment in government securities by international investors provides several benefits to the economy. “Such investment helps to deepen capital markets by increasing the pool of funds available in the local market and diversifies the investor-base,” it said. “Such investment helps to allow banks to deploy available funds for lending to the private sector since there is growing competition from international investors for placements in government securities.”

The SBP further said growing interest of foreign investors raises the demand for government securities and accordingly lowers yields and reduces the cost of borrowing for the government. “The growing role of international investors in the local debt market may serve as a positive feedback mechanism for further improving domestic practices, policies, systems and institutions in line with international best practices,” it added. “At the same time risks posed by such investments are limited at current levels on account of the following reasons.”