Developing the Asian Bond Market 9789812306340

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DEVELOPING THE ASIAN BOND MARKET

HRH Raja Nazrin Shah

The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publications, an established academic press, has issued more than 1,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publications works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world.

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Olarn Chaipravat DEVELOPING THE ASIAN BOND MARKET

HRH Raja Nazrin Shah

Published in Singapore in 2005 by Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 E-mail: [email protected] World Wide Web: http://bookshop.iseas.edu.sg All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2005 Institute of Southeast Asian Studies, Singapore. The responsibility for facts and opinions in this publication rests exclusively with the author, and his interpretations do not necessarily reflect the views or the policy of the Institute or its supporters. ISEAS Library Cataloguing-in-Publication Data Olarn Chaipravat. Developing the Asian bond market. 1. Bond market—Asia. 2. Capital market—Asia. 3. Government securities—Asia. I. Title HG5703 O42 2005 ISBN 981-230-314-6 Typeset by International Typesetters Pte Ltd Printed and bound in Singapore by Seng Lee Press Pte Ltd

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The Monarchy in Contemporary Malaysia

CONTENTS

Developing the Asian Bond Market 1 About the Author 32

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The Monarchy in Contemporary Malaysia

The lecture was delivered by Dr Olarn Chaipravat at a seminar jointly organized by the Institute of Southeast Asian Studies and the Saw Centre for Financial Studies, NUS Business School in Singapore on 30 September 2004.

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Developing the Asian Bond Market

Developing the Asian Bond Market

I will take this opportunity to share with you my experiences in the Asian bond market development, a topic that received widespread attention in Asia as well as the rest of the world in the last two years. It all started in October of the year 2002, when Dr Thaksin Shinawatra, the current Prime Minister of Thailand, gave a speech at the World Economic Forum Meeting in Kuala Lumpur. For the first time he proposed the establishment and development of an Asian bond as an instrument to help recycle surplus funds that originate in Asia, particularly from surplus countries such as Japan, Taiwan, Singapore, Hong Kong, and others, to deficit countries in Asia. As we all are aware, the savings from Asia were basically recycled 1

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before the 1997 crisis through major financial centres outside of Asia back to Asia in various forms. The most prominent form of recycling at that time was for deficit countries to use the commercial banking system to borrow short-term funds from major international financial centres, such as London, New York, or to a lesser extent the regional financial centres of Singapore and Hong Kong. The funds were recycled in such a way that they ended up being lent to business enterprises and government entities in deficit Asian countries. Unfortunately, this created what we now call the “double mismatch” problem, “double” in the sense that there was a disparity between both the maturities and the currencies in which the funds were denominated. The funds were also borrowed by financial institutions, basically on a short-term basis, and then on-lent to finance investment projects which were basically long term in nature. The funds were borrowed in major currencies, basically the US dollar. And then some of the funds were on-lent by banks in local currency to the commercial borrowers. This was the second mismatch — that is, the currency mismatch. As a result, the borrowers of these funds had to take the foreign exchange risk. 2

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It is believed that the root cause of the financial crisis in 1997 was this double mismatch problem. Let me remind you that this is not a universally accepted proposition. There are various arguments as to what could have caused the Asian financial crisis in 1997. Basically we can divide the arguments into two schools of thought. The first school of thought deals with what is now called the current account problem, meaning that Asian countries spent too much money, saved too little, and borrowed too much from outside the region to finance their current account deficits. That arose because the government or the private sector spent too much money on various investment projects and, with the benefit of hindsight, invested too much in “unproductive” projects. That was the majority view of the root cause of the financial crisis of Asia. I would say that immediately after 1997, 95 per cent of economists believed in this first school of thought. But during the last six or seven years, people who have been engaged in economic and financial activities in Asia, people who understand the workings of the economic and financial system of Asia, people who have lived in Asia for a long time, a minority group to which I belong, have been arguing together 3

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with a number of economists and financial practitioners from Japan, Korea, Singapore, and Malaysia that the root cause of the 1997 financial crisis in Asia was not what was called the current account problem, but rather a capital account problem. This problem surfaced when capital market and banking sector participants lost confidence in certain economies. Take, for example, the sudden reversal of short-term capital flow that used to be drawn in before the loss of confidence in Thailand, Indonesia, and Korea occurred. All of a sudden, for whatever reason, there was a triggering of this loss of confidence, and the capital flow reversed itself. The phenomenon was believed to be a major cause of the collapse in the currency value and other damaging consequences in 1997. The so-called “Tom Yam Kung” disease that was supposed to have started in Thailand triggered this chain of events. This chain of events was financial, as opposed to being real, in nature. The wrong policy responses by some countries in Asia, together with advice and instruction from international organizations like the International Monetary Fund (IMF), could either improve or worsen the situation, depending on the types of policy prescribed and accepted. Yet we still have the polar cases 4

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of Malaysia and Thailand, which have been studied by a number of academics. There is a book written by a French economist who spent two or three years in Kuala Lumpur entitled “The Crisis That Did Not Happen — The Case of Malaysia”. If there was to be a sequel to the book, it could well be named “The Crisis That Should Not Have Happened — The Case of Thailand”. Somebody should work on that. But that was in the past. Now let us come back to the present. There have been proposals to eliminate the double mismatch problem by the Thai Prime Minister. In his keynote address in Kuala Lumpur in 2002, Dr Thaksin Shinawatra described the reasons for developing an Asian bond market. He gave a third reason, which is to support the channelling of long-term funds within Asia to allow fund users to borrow in their own currency. This can be considered as a consequence of the first two points which I raised earlier — that is, to develop local currency–denominated Asian bonds, to be issued by deficit units in Asia and bought by surplus units also in Asia. The fourth reason, relating to the previous reason, is to rectify the imbalance in the financial system, an over-dominance of either the banking sector or the capital market. 5

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The dichotomy between bank-based and the market-based financial systems continues to be debated in academic circles all around the world. In Asia, before the financial crisis, the financial system depended predominantly on the banking sector. Dramatic changes have taken place, however, during the last seven years since the 1997 financial crisis. In all the countries that have been affected by the crisis, Thailand included, the capital market system has gained increasing importance compared with the banking system, which has been plagued by problems of non-performing loans (NPLs). Banks in Asia, including the ones in Thailand, are still working out a set of NPL problems even today, and it may well take a few more years for commercial banks in the crisis-hit countries to work out or resolve their NPL problems so that banks will not be so bogged down by immediate problems and can resume their normal lending operations again in a more forward-looking manner. And this time around, as we all know, the emphasis will no longer be on corporate lending. The focus will instead be shifted more to consumer banking and the financing of small and medium entreprise (SME) operations, as the large corporations with good credit ratings 6

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will be able to tap funds from the capital market through such instruments as equities, convertibles, and bonds. The Asian bond market development is also an attempt to rectify and to restore some balance between the bank-based and the market-based systems. The proportion of the financing that comes from the commercial banking system will decline in percentage terms, not in absolute terms perhaps. There is already a movement towards a better balance in practically all countries in Asia after the Asian financial crisis. I have especially brought up this last point, assuming that you have probably not been hearing all that much discussion on it. While you surely must have heard a lot more about the first three points, the last point in comparison has surfaced only recently due to a realization that there is also a frightening financial imbalance of a global magnitude hanging over us. Specifically, there is one country — namely, the United States of America — which is running a huge current account deficit, accounting for 6 per cent of its gross domestic product (GDP), with no prospect of such a ratio shrinking anytime soon. This 6 per cent ratio of current account deficit to GDP was exactly what Thailand experienced in 1996, one year before the 7

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financial crisis erupted on 2 July 1997. The remaining countries of the world, particularly the Asian countries, all have current account surpluses on their hands. In terms of GDP, Singapore has a huge current account surplus. Even Thailand, which used to have a 6 per cent ratio of current account deficit in 1996, achieved a 4.5 per cent ratio of current account surplus to GDP last year. For 2004, Thailand’s projections moreover indicate an approximately 3.5 per cent ratio of current account surplus to GDP. Similarly, Japan, Taiwan, Malaysia, and other Asian countries have all achieved current account surpluses. In Europe the ratio of the current account surplus to GDP is much smaller, approximating zero. Therefore, when considering all these Asian countries, European countries, and the rest of the world together, we can see that practically everybody has a current account surplus as opposed to the one and only current account deficit that was referred to before. This stark imbalance of course cannot last forever. It can last only as long as the surplus countries are prepared to recycle their financial surpluses and buy up not only the US Treasury securities but also quasi-government entity bonds as well as corporate bonds in the United States. 8

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Should ever there be a lack of confidence, economists will say, “One of these days, a financial crisis similar to the 1997 Asian financial crisis is bound to happen.” However, economists are not capable enough to say when it is going to happen. There are thus economists who will say that “eventually it will happen, but we do not know when”. If you are a surplus unit and you have funds to invest, and you know that one of these days there will be a major currency value change, your currency will, in theory, have to appreciate because you are piling up very large surpluses. Eventually, the law of economics and finance will work themselves out in such a way that the currency value will be one of many variables that will serve to help restore the balance in the global financial system. The currency value is just one determining factor, not the only factor, even though we may have been taught in international finance courses that this is the most important factor. In actual life, it is one of the many factors, and so far it might not have proven to be even the most important factor. Recent history notwithstanding, the possibility that the currency value may become the most important determining factor sometime in the future cannot be ruled 9

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out. When that day comes, what would be the value of your investment? Anybody can calculate a 10 per cent appreciation of the Singapore dollar or the Thai baht vis-à-vis the US dollar. But what would be the impact of such a loss in value of the foreign exchange reserves that is invested mostly in US dollar– denominated assets? Now some countries have already done such calculations or, rather, some reserve managers in Asia have already done such calculations. The first country believed to have done such calculations and to have already developed a mitigation plan is Singapore. Singapore has been rather discreet in carrying out such operations; such a development on the part of Singapore has never been publicly announced or officially published by the Singaporean authorities themselves. The financial figures reflecting this development have, however, come out through the reporting systems of the investee countries. Through the investee country’s practice of publishing the names of the countries that buy its government bonds, the US dollar– denominated assets’ proportion in total foreign assets held by Singaporean fund managers is revealed to have been on the decline. In addition, there are two other 10

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countries in Asia that have taken the same approach to managing the currency composition of reserves. They are Malaysia and Thailand. How have the three countries been diversifying their currency reserve holdings during the last two years? Until six or seven months ago, they had been diversifying out of US dollar assets and into euro assets for obvious reasons. Recently, however, more fund managers are taking more of the non-yen Asian currencies into their foreign exchange portfolios, as neither the euro nor the yen have appeared to be going anywhere for quite some time. The last point that calls for added attention is the much needed effort to create an opportunity for developing Asian central banks and other fund managers to have access to a wider choice of investment-grade Asian currency– denominated bonds. Such an investment opportunity would mean a greater possibility for wealth preservation as well as for better risk-return performance in light of the declining US dollar value and not too excessively strong yen and euro. There is thus reason for there to be interest in the investment in non–major currency– denominated Asian bonds and, of course, equities. Many fund managers in Asia have 11

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already invested in equities, which are local currency–denominated assets by definition. The Asian bond is providing an additional item on the menu for surplus fund managers to consider in managing their portfolios in a more prudent manner, in case a prolonged and substantial currency adjustment takes place sometime in not too distant a future. Now as a corollary to this type of explanation, we might be interested in asking the real question of when such an adjustment would occur. When can the value of Asian currencies be allowed to strengthen vis-à-vis that of the US dollar to help rectify some of the imbalance in the global financial system that we described earlier ? There are two conditions that would provide for such an event to take place. When these conditions materialize, the adjustment will occur. The first condition is China’s readiness, which can only come after it has restructured its banking system, including recapitalizing the big four Chinese banks in a big way in order to get the NPL problem under control. This will include going public for some of these major Chinese commercial banks. One of them has already done so, and a second one is in the planning. This might take six to 12 months, which is probably the time-frame 12

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required for the Chinese authorities to restructure their banking system. The second condition is for the Chinese to have developed an adequate monitoring and intervention system to smooth out the normally volatile foreign exchange market. Then and only then will the Chinese authorities be willing to adopt a flexible exchange rate system, which will see the transition away from a hard peg — “hard” meaning a 100 per cent peg to the US dollar, towards a more managed floating system. Most countries in Asia are now on a managed floating system, except for China, Hong Kong, and Malaysia. When China goes flexible, Hong Kong will automatically follow suit. In fact, the Hong Kong Monetary Authority is already urging the Chinese central bank and authorities to do so as quickly as possible. Malaysia, which used to float the ringgit at one time before 1997 together with Thailand and Singapore, will then have no choice but to follow suit, once China and Hong Kong have gone on the float. When these conditions have been fulfilled, say, in 12 months, 24 months, three years, or whatever, the currency realignment and currency value change will take place. When that happens, it will be very abrupt and very violent. The more the 13

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weather is kept artificially calm, the more violent the typhoon will be. That is my attempt at venturing into guessing when the currency realignment will take place in the Asian financial markets. Let us now return to the topic of Asian bond market development. In a way, it is fortunate that the day we have been waiting for is not arriving too quickly. As a result of having undergone the risk assessment and risk management process, certain risk factors have been anticipated to present themselves some time in the future. It is essential, therefore, to have mitigation plans to soften the negative effects of such adverse currency movements that might occur in the future. The more time there is to develop mitigation plans, the more effective the counter measures will be in the future. Therefore, now is the time to develop the necessary financial markets, instruments, and infrastructure in Asia to cope with such adverse conditions, the fulfilment of which will just be a matter of time. In preparation for this situation and as a result of the financial crisis, many countries in Asia starting with the ASEAN+3 (that is, ASEAN plus Korea, China, and Japan) got together in the year 2000 in Chiang Mai, 14

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Thailand, and jointly developed what is now known as the “Chiang Mai Initiative” to provide short-term, self-help and self-support mechanisms to cope with a crisis like the one in 1997, should it ever occur again in the future. At least there will be no need the next time around for individual countries in distress to have to go around asking neighbours for short-term relief support, were there to be another such crisis. Without such regional rescue mechanisms in place beforehand, Thailand had to go through the ordeal before eventually being forced by situation to go the IMF way in August 1997 in any case. Actually Thailand did go to China, which is now recorded history — officially confirmed by those involved today but not three years ago. In former Prime Minister General Chavalit Yongchaiyudh’s recent autobiography, he spelt out exactly how he dispatched a delegation to ask for a US$20 billion, shortterm liquidity support from China. That request was politely turned down. The request was endorsed by the political circle but was turned down politely by the Chinese central bank. The delegation’s second stop was Japan. Japan agreed but on the condition that Thailand enters the IMF programme. Japan subsequently had second thoughts on 15

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its own position, and proposed in April 1998 in Manila the establishment of an Asian Monetary Fund. This proposal was naturally rejected by the major powers outside of the region. The Chiang Mai Initiative was thus a result of the ASEAN+3 countries’ realization that there was a need for an organized effort within the region to help one another if a crisis were to erupt again. It is the short-term liquidity support which is the fundamental rationale behind the Chiang Mai Initiative. The Asian bond market development is also a parallel effort to facilitate longer-term financial cooperation among the Asian countries. The usage here of the term “Asian” is deliberately intended to infer a meaning beyond the ASEAN+3 group of countries. Some non-ASEAN+3 countries have also made enquiries and are now actively involved in the whole Asian bond market development effort. Participation has expanded beyond ASEAN+3 to include at least India, Pakistan, and some Middle-Eastern countries. Such is the current state of development of the Asian bond market initiative among countries in Asia. Whereas participation in the Asian bond market development had previously been restricted to the central banks and ministries of finance of the Asian countries, it has now 16

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been expanded beyond the public sector to include also private sector participants in the capital markets. These participants now join in the deliberation and discussion of proposals on the Asian bond market development. What is the plan for Thailand to issue Thai baht Asian bonds? Let me digress for a moment in order for us to share information and define what is now being accepted as Asian bond. Two years ago, when Prime Minister Thaksin made a speech in Kuala Lumpur, it was still unclear as to what he meant by Asian bond. I was in Beijing in the year 2002, two months after the Prime Minister made the speech in Kuala Lumpur. I was asked by my Chinese colleagues, “Your Prime Minister proposed an Asian bond market development initiative in Kuala Lumpur recently. Can you tell us what an Asian bond is?” I have to tell you that I was caught completely off guard, because I had not had the opportunity to talk to the Prime Minister about what he had meant by Asian bond between October and November. I was thus forced by the situation to come up with a definition for Asian bond on the spot right there and then. My answer was something like this: “An Asian bond is a long-term obligation issued by an Asian entity, meaning 17

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government, state-owned enterprises, private companies, or even multinational organizations like the Asian Development Bank (ADB), which is located in Asia. It is a longterm obligation which is denominated in an Asian currency and traded actively among Asian countries and with the rest of the world.” In this sense, there are three major characteristics contained in the definition of Asian bond that is now widely accepted. First, a long-term obligation issued by an Asian entity; second, denomination in a local Asian currency, including the yen, Singapore dollar, Thai baht, Malaysian ringgit, and so on; and third, active trade across countries in Asia and with the rest of the world. These are the three characteristics of an Asian bond. Turning now to what does not constitute an Asian bond, Yankee bonds obviously are not Asian bonds by the above definition. Even though they are issued by Asian entities, they are denominated in the US dollar, a condition that disqualifies them from being Asian bonds. Euro-denominated bonds issued by Asian entities are not Asian bonds by this definition either. But Samurai bonds, which are yendenominated and issued by non-Japanese Asian governments or Asian corporations, are by definition Asian bonds, because the yen is 18

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an Asian currency. Therefore, through a process of elimination, a working definition of the Asian bond is arrived at. Asian bonds are normally thought of in terms of these three characteristics. Although some may have all the three characteristics, others may have only up to 95 per cent or 98 per cent. A Samurai bond is not a 100 per cent Asian bond as it fails the last test, which requires an Asian bond to be traded actively across countries in Asia and in the rest of the world. Samurai bonds barely fail the test by only a narrow margin, as they are normally traded heavily only in Japan. If investors from other countries outside of Singapore trade in the Singapore dollar–denominated quasigovernment bonds in Singapore, then the bonds are Asian bonds. Asian bonds already exist in some countries of Asia, particularly in the financial centres. Asian bonds already exist in Singapore and, to a large extent, Japan as well. Some of the markets where investors from other countries venture into and buy bonds, say, the Bangkok market, where bahtdenominated government bonds are issued and traded, would qualify the bonds traded there as Asian bonds, even though the bonds in question are not actively or widely traded across countries. In Asia, investors in one 19

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country have already gone and bought local currency–denominated bonds in another country. Those who have been active investors besides the Singaporeans include the Taiwanese and Korean institutional investors. These three national-ities are the most active investors in Asian bonds, although for different reasons. To be sure, some elements of an Asian bond market already exist in the Asian capital markets. In order to encourage more of such developments that, to a certain extent, are already in process, a financial working group of APEC, which met in Chiang Mai and then in Hua Hin at the APEC meetings hosted by Thailand, asked the ADB to make a comparative study of the local currency bond markets in the developing countries of Asia. The working group asked the ADB to make a list of impediments that were preventing local currency–denominated bonds from being actively traded across countries in Asia. The ADB picked nine countries for a case study. They included all the major ASEAN countries and China, Korea, Taiwan, except Japan. Japan was not included, because it already has a developed capital market. A volume entitled “The Harmonization of Bond Rules and Regulations — Case Study of Nine Asian 20

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Countries” was published based on this study. The study basically concluded that there were seven major impediments that were preventing local currency–denominated bonds in Asia from being traded actively across countries, although they may be traded actively within a country. At the top of the list in the order of priority in removing such impediments is the withholding tax on interests and capital gains. Most countries in Asia still impose withholding taxes on income arising from interests and capital gains of investments in local currency–denominated bonds by nonresident investors. The other impediments include the lack of liquidity of such bonds. Based on this study, the authorities from Asian countries, particular the ASEAN+3, decided to try to remove the first impediment four months ago during the ADB meeting in Korea. On that matter, Thailand has approved that a study project be carried out under its Asian Bond Secretariat on each of the regional countries. Three or four countries have already passed the test, in the sense of having no problem. These countries are Japan, Singapore, Hong Kong, and Taiwan. A country close to resolving the problem is Korea, and not much effort will be required to eliminate 21

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the withholding tax rule or to harmonize the withholding tax rule there. Other countries including Thailand still have this problem. As a result of having identified this problem, the Thai government has decided two months ago to pass a new decree to eliminate the withholding tax rule on interest and capital gain income on Thai baht-denominated government bonds purchased by nonresidents. In so doing, Thailand is demonstrating to its Asian friends that it is willing to achieve this regional objective on a voluntary basis. Thailand will still not waive the tax for resident investors but will do so for nonresidents. This is based on the following simple argument. If Thailand issues, say, dollar-denominated bonds and sell the bonds globally and an investor from anywhere in the world buys the dollar-denominated bonds, he is not subject to withholding tax. But if Thailand instead issues baht-denominated bonds and sell the bonds to an international investor, why then should Thailand impose withholding tax on the investor? Of course Thailand imposes the tax because the original intention was to sell such bonds domestically, so in lieu of the income tax, Thailand imposes the withholding tax. But when the investor is 22

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a non-resident, there is no clear reason why withholding tax should be imposed on him. In fact, in 1970 when the United States of America considered all these problems, the first thing that the US government decided to do was to eliminate the withholding tax rule. The Euro-dollar market was created as a result of the realization that the United States needed to mobilize funds from the outside. Therefore, Thailand actually did not invent anything new. It simply examined history and imitated what had been done 30 years ago by encouraging cross-border trading in local currency–denominated bonds. Thailand has already announced that an elimination of withholding tax for non-resident investors regarding Thai baht Asian bonds will be introduced within this year. It will take four or five weeks to go through the legal steps to formalize the decree before the end of the year. At the same time when that is done, it is planned that approximately 30 billion baht worth of Thai baht–denominated government bonds with different maturities will be issued. This is still at the planning stage, and a formal decision has yet to be made. The plan will depend on inputs from capital market practitioners and underwriters, who will propose the structures for such a baht Asian 23

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bond. This will include, of course, the exemption of the withholding tax on interests and capital gains with no foreign exchange restrictions. We shall now discuss the area of equities. When investors sell equities and remit the funds back to their country, they are subject to a withholding tax rule. That means that while investments in bonds will enjoy no withholding tax, investments in equities will continue to be subject to withholding tax. That is clearly an advantageous feature of the Thai baht Asian bond. It is important, however, to ensure that this is not a one-time proposition, because Asian bond market development means that once an improvement has been initiated, it should be maintained forever and remain a major financial infrastructure of the capital market. Hence, in order to make sure that more and more investors will be coming in and invest in Asian bonds, it is planned for new issues to be launched every six to twelve months for the next five years in order to create and develop benchmark yield curves. At a later stage, or immediately after the initial government bond issue, the ADB and IFC will be allowed to issue baht-denominated bonds, and they will also be, in the case of 24

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ADB bonds, baht-denominated Asian bonds. They would be priced against this benchmark of the Thai government baht Asian bonds. Corporate bonds will subsequently be developed in a similar manner. In order to assure liquidity and active trading of such bonds, there is a need to develop an infrastructure to increase secondary market liquidity of cross-border transactions. The bonds will be listed and traded on the newly created bond market exchange with an electronic matching and trading system. The Bond Electronic Exchange (BEX) was set up by the Stock Exchange of Thailand in November of last year, and is only nine months old. Currently, it trades corporate bonds. However, the first batch of Thai baht government Asian bonds will be listed and traded on this electronic exchange so that there will be continuous quotations of bids and offers of enough volumes. This would benefit potential buyers and sellers of such bonds, especially non-resident investors. That represents an institutional development for secondary market trading of Thai baht– denominated Asian bonds. The registration, clearing, and settlement process across countries will be done by the fully owned subsidiary of the stock 25

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exchange, which already processes the equity part of the capital market. When buying Thai shares, a buyer goes through such a process. To buy Thai baht–denominated Asian bonds, one also would go through the same registration, clearing, and settlement process supported by the Stock Exchange of Thailand. In order to ensure the continuity of the process, the primary dealers and security brokers who are eligible to auction for or to underwrite the bonds will be required to contribute to the market by providing continuous two-way price quotations — that is, both bid and offer prices — with reasonable spreads in the secondary market. Failing to perform the function will bar them from underwriting the next batch of bonds. This is the process that will be implemented within this year after the first batch of Thai baht– denominated Asian bonds is launched. In order to ensure that the bonds will be actively traded with liquidity in the subsequent period, the authorities and the underwriters will have to make sure that the bonds are bought in the primary market by a broadly based and balanced group of investors, covering both domestic and international investors. The composition of a desirable investor base will have to be worked out from a survey of the 26

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potential demands from investors in a bookbuilding process. The exercise will be necessary if the bonds’ primary market offerings are not to be met with a lop-sided investor base, say, with everything being bought solely by Thai individuals. In such an instance, liquidity would be missing from the secondary market as individual investors, not being interested in portfolio rebalancing, will not be trading much. As their main reason for investing in bonds is to earn interest income, they tend to hold the bonds until maturity. In addition, it would not be advisable for the market to limit itself to catering to only domestic investors. It is preferable to ensure that not only domestic investors are brought into the market. The authorities and the private market practitioners will together have to work out how not to preclude the nonresident, international investor base from the market. We already have a number of securities houses that are working together with us to make sure that the bonds are initially distributed in a manner that would assure secondary market liquidity in the future. It is hoped in particular that the initiative on withholding tax elimination, together with the rest of the Asian bond market initiatives, 27

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will go a long way in resolving the many problems of the potential government bond issuers of the various countries in Asia. As regards the initiative on eliminating withholding tax, the immediate target is certainly not Singapore, Hong Kong, Japan, or Taiwan, where appropriate withholding tax structure as well as market infrastructure are already in place, but rather Malaysia and Korea, where only minimal difficulties are expected as they seem to have almost everything already in place. The country facing the most difficulty is surely going to be China, where much needs to be done. Then there are the remaining major ASEAN countries, where the initiative will finally have to reach out to as well. In order to create an Asian bond, and not just an East Asian bond, India has to be brought into the picture first. The new Thai ambassador-designate to Singapore, His Excellency Ambassador Chalermpol Thanchitt, has been travelling with me to Bombay and New Delhi many times during the last twelve months to work on the Asian bond. The new ambassador is an Asian bond expert from the Foreign Affairs Ministry of Thailand. He will be arriving in Singapore next week, so should anyone wish to find 28

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out more about Asian bond development after this lecture is over, the ambassador would be very happy to enlighten you on the matter. He calls himself “my student” in Asian bond. Don’t believe him, though! We have merely been working together. Incidentally, India has expressed very strong interest towards this initiative. In fact, India is already considering changing its withholding tax rule, and the issuance of the first Indian Asian bond is currently on the final drawing board. We had deliberately held back a little bit because of the change of government in India. However, the new government has already confirmed that India’s intentions regarding the matter have not changed. India is after all an undeniably big factor. It is delightful therefore to witness the country’s willingness to go ahead with the Asian bond market development effort even to the point of having already discussed the potential size of India’s first issue. They asked me, “How much do you think the Indian government should be issuing for the first batch of Asian bonds in order to allow nonresident investors to invest in the rupeedenominated bonds?” My preliminary suggestion was something to the equivalent of three to five billion dollars. The size of the 29

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first Thai baht Asian bond issue is going to be one billion dollar equivalent, to which the Indian government officials replied, “Oh, why not US$10 billion equivalent?” It remains to be seen how it is all going to work out, but keen interest has nevertheless been expressed from both the Reserve Bank of India, which is going to invest in such bonds of other countries, as well as the Indian Ministry of Finance, which will be issuing the Indian government rupee-denominated bonds. In the case of India, interests come from both sides — from the central bank as well as the Ministry of Finance — which is only right. If, for instance, Thailand was to provide bahtdenominated bonds for our friends to invest in, on the one hand, while the Thai provident fund managers or the Thai civil servant pension fund managers are prohibited by restrictions from buying other Asian currency bonds, on the other hand, it would not make much sense. The reason why it has to be an international effort is because this works on a quid pro quo basis. It is a case of “I-scratchyour-back-and-you-scratch-my-back”. It is not a one-way thing. Of course, this involves two different agencies: the Ministry of Finance needs to borrow money and the central bank has the 30

Developing the Asian Bond Market

money to invest. Diversification requires that the Asian bond market operation, to be really beneficial, has to be carried out with the participation of as many countries as possible. Otherwise, it would end up being a one-way thing. Many people think that in the Asian bond market development asking for money has now changed to asking for the right type of bonds to invest your money in, because Asian countries have become surplus countries. This is a new problem for Asia — the problem of having too much reserve holdings on hand. Two-thirds of the world’s reserves are in the hands of Asian central banks. Two out of three trillion US dollars are managed by reserve managers of Asian countries, particularly East Asian countries.

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Olarn Chaipravat

ABOUT THE AUTHOR Dr Olarn Chaipravat is adviser to the Minister for Finance, honorary adviser to the Fiscal Policy Research Institute, Ministry of Finance, Thailand, and Council Chairman of Shinawatra University, Thailand. Dr Olarn was with the Bank of Thailand from 1970 to 1981 and the last position he held before he left was Director of the Financial Institution Supervision and Examination Department. After that he was with the Siam Commercial Bank and appointed President and CEO in 1992. Dr Olarn was also a former Chairman of the Thai Bankers Association and Chairman of the ASEAN Bankers Association. He left the Siam Commercial Bank in 2001 and has since been associated with the Thai Ministry of Finance and Shinawatra University. 32