Bond Market
Reviving Bangladesh's Bond Market: Challenges, Impacts, and Strategies for Growth
Al Mamun
Economist
Bangladesh, one of the fastest-growing economies in the world, has a huge financing need for its infrastructure development and industrialization. However, the country’s bond market, which could provide a long-term and stable source of funds, remains underdeveloped and stagnant. What are the reasons behind this situation, what are the impacts, and what can be done to improve it?
The bond market is a segment of the financial market where debt securities, such as treasury bills, government bonds, corporate bonds, and sukuk, are issued and traded. Bonds are attractive for both issuers and investors, as they offer fixed and regular income, diversification, and lower risk than equities. A well-functioning bond market can also enhance financial stability, promote economic growth, and facilitate monetary policy.
However, the bond market of Bangladesh is very small and inactive compared to its potential and its peers. The Capital Markets Fact Book July 2021 reports that the global market for bonds is worth USD124 trillion, while the global market for equities is worth USD106 trillion. Bangladesh’s bond market, which includes both treasury and corporate bonds, has a value of only USD 18 billion. This is much lower than the bond markets of other countries in the region, such as Malaysia (USD345 billion), Indonesia (USD233 billion), and Pakistan (USD66 billion). Bangladesh’s bond market is also dominated by government securities, such as treasury bills, treasury bonds, and sukuk, which make up 8% of the GDP (CFA Institute, 2021). This is less than many of its neighboring countries, such as India (16%), Thailand (59%), China (60%), Malaysia (60%), and Vietnam (26%) (Financial Express, 2022). The main buyers of these securities are banks, non-bank financial institutions, insurance companies, and individuals. The corporate bond market, which is the market for bonds issued by private companies to raise funds for their projects or capital needs, is very negligible, accounting for only 0.01% of the GDP (CFA Institute, 2021). The corporate bond market consists of capital bonds issued by banks and non-bank financial institutions to meet the regulatory requirements and strengthen their capital base, and zero-coupon or coupon-bearing bonds issued by corporates. However, the issuance and trading of corporate bonds are very low and infrequent, as most corporations rely on bank financing or equity financing for their funding needs.
Several factors contribute to the stagnation of the bond market in Bangladesh, such as the interest rate environment, the regulatory framework, the market infrastructure, the investor base, and the awareness and education level. Some of the major challenges and constraints faced by the bond market are:
First, high-interest rate and crowding-out effect: The government borrows heavily from domestic sources to finance its budget deficit, which pushes up the interest rate and crowds out the private sector from the bond market. The high-interest rate also reduces the demand for corporate bonds, as investors prefer other alternative investments, such as bank deposits, treasury bills, treasury bonds, stocks, or real estate. Moreover, the interest rate volatility and uncertainty make it difficult for the issuers and investors to price the bonds and manage the risks.
Second, regulatory barriers and tax disincentives: The bond market in Bangladesh is subject to various regulations and approvals from different authorities, such as the Bangladesh Bank, the Bangladesh Securities and Exchange Commission, the National Board of Revenue, and the Registrar of Joint Stock Companies. The issuance and trading of bonds involve a lengthy and complex process, which increases the time and cost for the market participants. The tax regime also discourages the bond market development, as the interest income from bonds is subject to higher withholding tax and income tax than the interest income from bank deposits or government securities.
Third, inadequate market infrastructure and liquidity: The bond market in Bangladesh lacks a proper market infrastructure and mechanism to facilitate the issuance and trading of bonds. The primary market is mostly based on auctions, which are not transparent and competitive. The secondary market is very thin and illiquid, as there is no active market maker, no electronic trading platform, no efficient clearing and settlement system, and no reliable benchmark yield curve. The lack of liquidity and price discovery hampers the market development and confidence.
Fourth, limited investor base and product diversity: The bond market in Bangladesh has a limited and homogeneous investor base, which mainly consists of institutional investors, such as banks, non-bank financial institutions, and insurance companies. The individual and retail investors are largely absent from the bond market, due to their low awareness, preference, and access. The bond market also has a limited and standardized product diversity, which does not cater to the varying needs and preferences of the issuers and investors. There is a lack of innovative and customized bond products, such as floating-rate bonds, convertible bonds, green bonds, or infrastructure bonds.
Fifth, low awareness and education level: The bond market in Bangladesh suffers from a low level of awareness and education among the market participants and the general public. There is a lack of information and knowledge about the benefits, features, and risks of bonds, as well as the market rules and procedures. There is also a lack of training and capacity building for the market intermediaries, such as the issuers, investors, underwriters, brokers, dealers, and rating agencies.
The stagnant bond market has negative impacts on the economy and the financial system of Bangladesh. Some of the main impacts are:
First, limited access to long-term financing for businesses: The stagnant bond market limits the access of businesses to long-term financing. This can hinder the growth of businesses and the economy as a whole. Long-term financing is essential for businesses to invest in capital-intensive projects, such as infrastructure, power, and manufacturing. Without long-term financing, businesses may have to rely on short-term financing, which can be more expensive and riskier. Alternatively, businesses may have to postpone or cancel their investment plans, which can reduce their productivity and competitiveness.
Second, over-reliance on bank financing: Businesses in Bangladesh are over-reliant on bank financing, which can make them more vulnerable to shocks in the financial system. According to the World Bank, the ratio of domestic credit to the private sector to GDP in Bangladesh was 49% in 2022, which was higher than the ratio of bond financing to GDP. Bank financing can be beneficial for businesses, as it can provide them with flexible and customized loans. However, bank financing can also expose businesses to the risk of credit crunches, interest rate fluctuations, and asset-liability mismatches. Moreover, bank financing can also create systemic risks, as a failure of one bank can affect the entire banking sector and the economy.
Third, high interest rates: The lack of competition in the bond market can lead to higher interest rates for businesses and borrowers. Interest rates are determined by the supply and demand of funds in the market. When the supply of funds is low and the demand for funds is high, interest rates tend to rise. The stagnant bond market reduces the supply of funds in the market, as there are fewer alternative sources of financing available for businesses and borrowers. This can increase the demand for funds, and thus the interest rates, in the market. High interest rates can increase the cost of borrowing and the debt burden for businesses and borrowers, and can also discourage investment and consumption.
To overcome these challenges and constraints, the bond market in Bangladesh needs a comprehensive and coordinated policy and action plan, which involves the collaboration and cooperation of all the stakeholders, such as the government, the regulators, the market participants, and the civil society. Some of the possible measures and initiatives that can be taken to develop the bond market are:
First, reducing the fiscal deficit and the reliance on domestic borrowing: The government should adopt a prudent and sustainable fiscal policy, which reduces the fiscal deficit and the domestic borrowing requirement. The government should also diversify its sources of funding, by tapping into external and non-bank sources, such as foreign investors, the diaspora, and pension and provident funds. This would ease the pressure on the interest rate and create more fiscal space for the private sector to access the bond market.
Second, streamlining the regulatory framework and tax incentives: The regulators should streamline and harmonize the regulatory framework and procedures for the bond market, by simplifying and standardizing the issuance and trading process, reducing the approval time and cost, and enhancing transparency and accountability. The regulators should also provide tax incentives and exemptions for the bond market, by lowering or waiving the withholding tax and income tax on the interest income from bonds, especially for the long-term and infrastructure bonds.
Third, improving the market infrastructure and liquidity: The market participants should improve the market infrastructure and mechanism for the bond market, by establishing a dedicated and independent bond exchange, introducing an electronic trading platform, developing an efficient clearing and settlement system, and constructing a reliable benchmark yield curve. The market participants should also enhance the market liquidity and depth, by creating a market maker system, encouraging the buy-and-hold investors to trade more, and promoting the repo and securities lending and borrowing transactions.
Fourth, expanding the investor base and product diversity: The market participants should expand the investor base and product diversity for the bond market, by attracting and facilitating the participation of the individual and retail investors, as well as the foreign and non-resident investors. The market participants should also introduce and offer more innovative and customized bond products, such as floating-rate bonds, convertible bonds, green bonds, or infrastructure bonds, which can meet the varying needs and preferences of the issuers and investors.
Finally, increasing the awareness and education level: The market participants and the civil society should increase the awareness and education level of the bond market, by disseminating and sharing more information and knowledge about the benefits, features, and risks of bonds, as well as the market rules and procedures. The market participants and civil society should also provide more training and capacity building for the market intermediaries, such as the issuers, investors, underwriters, brokers, dealers, and rating agencies.
The bond market in Bangladesh has a huge potential and opportunity to grow and contribute to the country’s economic development and financial stability. However, the bond market also faces many challenges and constraints that hinder its development and performance. Therefore, it is imperative that the bond market in Bangladesh is given more attention and priority, and that the bond market stakeholders work together to overcome the obstacles and create a vibrant and dynamic bond market.
