Overview and Country Reports

Part 2
Overview and Country

Reports
Overview
4
Overview
Yun-Hwan Kim and Mercedes Suleik
I. Introduction
For most of the Asian developing countries (ADCs) included in

this study, the single and most dening event in the last decade of the
20th century was undoubtedly the Asian nancial crisis, which broke
out in July 1997 in Thailand. The crisis subjected the Thai baht to
intense exchange market pressure that led to losses in reserves, and forced
the authorities to abandon the currencys peg to the US dollar. Conta-
gion e¬ects were soon felt in other countries in the region, especially
Indonesia, Malaysia, and Republic of Korea, exposing underlying weak-
nesses in many of these economies. The prolonged turmoil was even
more traumatic coming as it did on the heels of the much-vaunted Asian
miracle. Quite clearly, before the crunch, analysts considered that inter-
national capital movements, with the removal of barriers impeding
globalization, were helping to fuel the regions remarkable progress.
However, the haste of capital ight in the wake of the crisis clearly
underscores the need to review an otherwise neglected component of
these countries domestic capital markets: the bond market.
II. Rationale for the Development of Bond Markets
The rationale for the development of a bond market rests on the

fundamental thesis that long-term productive investment in any economy
must be nanced by long-term capital, whether in the form of equity or
xed-rate debt instruments. Investment-driven growth, which is typically
what is aimed for, cannot be nanced by bank deposits and short-term
money alone.
The traditional sources of nancing in most of the ADCs in this
study have been the banking system and, to a lesser extent the equities
market, which in some ADCs experienced moments of rapid expansion.
However, the reliance on ckle portfolio inows to nance projects of
long gestation (which arrived in droves during the heyday of the Asian
100 Government Bond Market Development in Asia
miracle and quickly dried up when the bubble burst) is decidedly risky.
Indeed, it has been shown that, while extensive external private capital
has played an important role in supporting the development process,
particularly in some of the middle-income countries (the so-called Asian
tigers), over-dependence on such capital has played havoc on their econo-
mies, as illustrated during the Asian nancial turmoil from 1997 to 1998,
a period marked by a severe drop in private foreign capital inows.
The International Monetary Fund reported in its 1998 Annual Re-
port that net private capital ows to emerging market economies reached
a record of US$240 billion in 1996, with Asia attracting more than 40
percent of the total. However, this dropped steeply to US$174 billion in
1997 as the Asian crisis deepened, with net ows to the developing
countries of Asia falling by more than US$60 billion to less than US$40
billion, the lowest inow since 1992.
The Asian crisis also exposed certain weaknesses in the private
sector, particularly with respect to governance, and also in governments,
which had failed to carry out some important roles, particularly regula-
tion and supervision. Poor regulation of banking was seen to have
contributed to the problem, as domestic banks expanded credit and were
deeply exposed to foreign borrowing. Bank lending to the private sector
rose between 14 percent and 48 percent a year depending on the coun-
try, amounting to 116 percent of GDP in Thailand in 1997, according to
a National Bureau of Economic Research working paper.1 The same pa-
per also noted that, at their peaks during the crisis, non-performing loans
(NPLs) as a percentage of total loans were 50 percent in the Republic of
Korea, 35 percent in Malaysia, 55 percent in Thailand, and 75 percent
in Indonesia. Even in 1996, before the crisis hit, NPLs as a proportion
of total lending reached 13 percent in both Thailand and Indonesia, 14
percent in Malaysia, and 8 percent in the Republic of Korea.
Moreover, the liberalization of the Asian nancial markets allowed
banks easier access to international credit. Banks throughout the region
accumulated large amounts of short-term debt denominated in foreign
exchange. (For that matter, total external debt of some of the a¬ected
countries relative to GDP rose from less than 50 percent to as high as
162.7 percent in the case of Indonesia in 1998.)2 Not unexpectedly, this
resulted in the vulnerability of the banking systems, as banks were exposed
1. Corsetti, Pesenti, and Roubini, What Caused the Asian Currency and
Financial Crisis?, cited in Improving Global Financial Stability, Draft of Policy
Statement of the Research and Policy Committee of the Committee on Economic
Development, by Kathleen Cooper et al.
2. Batten, Jonathan and Yun-Hwan Kim (2000).
Overview 101
to short-term foreign exchange debt while funds were being used to

nance long-term projects.
The crisis was also seen to have been partly caused/exacerbated by
some business practices popularly known as relationship-based banking,
which led to borrowings being made on the basis of personal relation-
ships rather than appropriate business evaluations based on cash ow
analysis, risk assessment, etc. Another analysis is that the crisis was an
example of classic nancial panic: a run on banks and mass capital
ight, accompanied by speculative attacks on currencies.3
Discussions on the causes and repercussions of the Asian nancial
crisis will probably continue to intrigue analysts worldwide for some
time still. Su¹ce it to say, the turmoil has served as a wake-up call to
ADCs to strengthen their domestic capacity by tapping their capital markets,
thus balancing out their hitherto heavy reliance on the banking system.
Well-developed, e¹cient capital markets, and particularly bond markets,
are important in mobilizing savings, e¹ciently allocating investible re-
sources, and accelerating economic recovery and growth.
A. The Importance of Developing Bond Markets in Asia
Bond market development is important to ADCs for several reasons.
First, it helps to diversify the sources of industrial and infrastructure

nancing. Such nancing has been overly dependent on banking insti-
tutions, involving a serious term mismatch between their short-term
bank borrowing and long-term investments,4 inexibility in nancing
methods, and high risks at the time when banks are reluctant to lend.
Second, bond nancing will alleviate the uncertainties caused by the
global bank disintermediation in the postcrisis period. The bank
disintermediation takes place largely due to two factors: (i) domestic
and foreign banks are extremely cautious about providing new credit
to the private sector both in the crisis economies and other ADCs;
and (ii) portfolio diversication and aggressive yield-seeking behav-
ior of domestic and globalized investors have increased the opportunity
cost of bank deposits.
Third, the worlds highest domestic savings are east and southeast
3. These two contrasting theories are ascribed to Professor Paul Krugman

of Massachusetts Institute of Technology and Professor Jeffrey Sachs of Harvard.
4. The best international practices as well as banking laws prescribe that a
commercial bank, which is generally entitled to receive only short-term deposits,
should not provide any long-term loans.
Asian countries. Development of the bond market will contribute to

transforming these savings, which are available mostly in short-term
bank deposits, into long-term development resources.
Fourth, developing the bond market will help ADCs nance huge
infrastructure development projects, many of which were canceled,
delayed, or reduced in the wake of the crisis.
Last, it will contribute to enhancing corporate governance standards
in ADCs, because bond issuers prefer a higher credit rating to reduce
interest rate and issue costs.
B. Role of Government Bond Market in Developing Overall Bond Markets
A treasury securities5 market can play a critical role in stabilizing

government nances, conducting monetary policy, and developing a
countrys nancial and capital markets.
First, a government may use a treasury securities program to nance a

portion of scal needs to cover budget decit or fund-specic na-
tional development projects. This is the most common objective of
issuing treasury securities both in developing and developed coun-
tries. Most ADCs are actively using these securities to this end. However,
in some cases, governments use captive investor arrangements to force
nancial institutions to purchase government bonds, and such nan-
cial repression distorts nancial institutions portfolios and interest
rate determination.
Second, the central bank may use short-term treasury bills to conduct
open market operations to control money supply and interest rate.
The Federal Reserve of the United States is renowned for this operation,
but most ADCs have only limited activity in this regard for various
reasons, including the lack of properly designed treasury securities,
absence of money markets that deal with short-term securities transactions,
and the nancial authorities tendency to rely on credit control.
Third, the most signicant role of a treasury securities market is to
increase investor condence in overall bond and nancial markets,
and provide a risk-free benchmark yield curve.6 If the domestic treasury
securities market functions well under the auspices of the central bank
5. In this paper, treasury securities refer to treasury bills of short-term

maturity for less than a year and treasury bonds for a year or longer.
6. In the extreme case, treasury paper is not risk-free. If a government
accumulates short- and medium-term debt and the risk of default rises, investors
may tend to demand risk premium.
Overview 103
and nance ministry, investors will have condence in the interest

rate level available in the market, which signicantly contributes to
building their own term structure of rate of returns. Any economy that
wants to develop corporate bond and derivative markets must have a
satisfactory treasury securities market in place. A benchmark yield curve
is usually constructed by market participants from the suite of out-
standing treasury securities across a range of maturities. A critical pre-
requisite is that interest rates are liberalized and determined by market
forces. Mathematical interpolation enables construction of a continuous
curve that serves as a benchmark for revaluating portfolios and pric-
ing corporate bond issues. Market convention is to add a time-varying
spread to the risk-free treasury securities rate to establish the yield rate
of a corporate security. This form of construction requires accurate
securities prices to be available in a liquid secondary treasury market.
C. Role of Government Policy in the Development of Bond Markets
A sound macroeconomic environment, characterized by prudent s-

cal policy, a liberalized and e¹cient monetary and nancial regime, and
exible, market-determined exchange rate policies, is a necessary condi-
tion for capital market development. At the Fourth Asia-Pacic Economic
Cooperation Finance Ministers meeting held in Manila in April 1997, it
was recognized that the state of the macroeconomy is of prime consider-
ation to nancial and capital market participants, because it has a bearing
on the return to capital. A stable macroeconomic environment is particu-
larly important for the development of markets for long-term debt because
buyers of such issues, whose capital is obviously exposed over a long
period, need to be assured of adequate returns, expressed in real terms
and adjusted for risks. Macroeconomic policies are also important be-
cause, with greater nancial liberalization and the continuing integration
of capital markets, governments have to balance their objectives of growth
and stability. They will have to make choices between pursuing inde-
pendent domestic policy and allowing the foreign exchange rate to seek
its own level or xing the exchange rate and adopting a monetary policy
consistent with a xed exchange rate. Moreover, governments will have
to decide on how much monetary policy should accommodate scal
decits. Clearly, the choices have not been, and will not be, easy, and
the ADCs covered in the study have taken di¬erent approaches. These
approaches partly explain the state of their bond markets today, while
the methods they adopt from hereon will spell the di¬erence between a
bond market that grows rapidly or lags behind.
III. Fiscal Policy
Fiscal policy in the ADCs has usually been approached in the

context of the size of the governments budget. The planning and the
preparation of the budget is generally an exercise shared by the Na-
tional Planning Agency and the Ministry of Finance. Development budgets
normally coincide with a decit, rather than a surplus, and the manner
by which such decits are funded, particularly where tax revenues are
insu¹cient, determines how the bond market has grown or been held
back.
In some countries, the Finance Ministry is the overriding agency,
with powers that encompass development planning, ensuring the nanc-
ing of development expenditures and stabilization of the economy. In
other countries, strict demarcation is observed between scal and mon-
etary policy, with the Central Bank as an independent (sometimes
constitutionally mandated) body. Each of the 10 countries covered by
the study has explicitly or implicitly accepted the important role that
bond market development plays in the overall development of the capi-
tal market, and in the achievement of macroeconomic goals of growth
and stability.
Countries whose bond markets have developed the fastest have
not necessarily followed the same path. Hong Kong, China, with its
policy of positive noninterventionism, for example, fosters a exible
and competitive environment, which allows the private sector much room
to grow. It is also an outstanding example of a free market economy
with a small public sector. In contrast, the Singapore Government, while
following policies of liberalization in the nancial sector and observing
a free market policy, actively uses scal incentives to promote the island
city-state as a debt hub in Asia.
The eight other ADCs, while in various stages of deregulation and
liberalization, generally have very powerful Finance Ministries, most of
them critically responsible for the long-term direction of their econo-
mies, in coordination with their planning bodies and/or Central Banks.
Some of the Finance Ministries have authority over their Central Banks,
while in some the Chairman of the Monetary Board is the Finance Min-
ister (as in Indonesia, until 1999, when a new law gave Bank Indonesia
more independence). Alternatively, the Central Bank may be merely one
of several statutory bodies under the Finance Ministry (as in Malaysia).
The Philippines, in contrast, has for a long time had a Finance
Ministry and Central Bank whose powers and authority are clearly de-
lineated, the Central Bank being a constitutionally mandated independent
body. Coordination between scal and monetary policy and overall eco-
Overview 105
nomic policy is achieved through various interagency committees. Sri

Lanka also appears to draw a line between scal authority and the Cen-
tral Bank. In Taipei,China the Ministry of Finance, which enforces national
scal policies and budget, appears to act independently of the Central
Bank of China, which is the highest monetary body and has complete
independence over monetary policy.
Thailand, on the other hand, has a Central Bank mandated to con-
duct monetary policy to stabilize the scal balance, manage government
debt, and develop a bond market.
Indonesia and the Republic of Korea have very powerful Finance
Ministries that, together with their planning agencies, are responsible
for setting the long-term direction of nancing for their economies. In
Indonesia, the planning and preparation of the budget is conducted by
the Ministry of Finance (MOF) with the assistance of the National Plan-
ning Agency (BAPPENAS). It also issues guidelines to nancial institutions
and supervises the capital markets. The MOF is the most powerful insti-
tution in the Government. The Minister is the Chairman of the Monetary
Board of the Central Bank, and as such is in charge of macroeconomic
management. The Board coordinates scal, monetary and balance-of-
payments policies, and their implementation. In the Republic of Korea,
scal policy is formulated by the Ministry of Finance and the Economy
whose major functions include making decisions on: (i) setting medium-
and long-term economic policies; (ii) implementing taxation and related
scal policies and managing the national Treasury and resources; and
(iii) establishing a foreign debt management system.
In the case of Malaysia, economic policy has been guided by its
New Economic Policy (19701990), and the New Development Policy
(19912000). Fiscal policy is used as the main tool to allocate resources,
the Government providing public goods and services, while allowing
market competition. The Finance Ministry has ve statutory bodies under
it, one of them Bank Negara Malaysia (BNM). BNM is the main regulator
of the government securities market, issues guidelines and policies, and
sets out standards for trading and settlement procedures.
The Peoples Republic of China (PRC) remains very centralized,
with scal policy or the Finance Ministry aimed at channeling resources
to the state-owned economy, ensuring equitable income distribution through
subsidies, and stabilizing economic uctuations.
While Hong Kong, China and Singapore, which boast the most
developed bond markets among the 10 ADCs, have enjoyed positive
scal balances, the PRC and the Republic of Korea have long eschewed
budgetary decits (until the Asian crisis made such a policy di¹cult to
maintain). Their bond markets are still at a young stage, however.
On the other hand, middle-level ADCs have been plagued with

budgetary decits, and have resorted to borrowingfrom both external
and domestic sourcesto nance their shortfalls. A quick glance at three
of these countries (Malaysia, Sri Lanka, and Philippines), shows that
Malaysias total revenue to GNP ratio averaged close to 26 percent from
1986 to 1990. This dropped to 10.6 percent between 1991 and 1995,
and is estimated at 22 percent for 1996 to 2000. In contrast, its total
expenditure to GNP ratio for these periods were 33.3 percent, 26.7 per-
cent, and 24.4 percent, respectively. The shortfalls funded by total debt
in those periods were, proportionately to GNP, 98.9 percent, 59.5 per-
cent, and 37.3 percent.
For Sri Lanka, for the two years for which data is provided in the
study, the gures show that revenue to GDP in 1986 stood at 20.7 percent,
falling to 17.3 percent in 1998. Expenditures for these two years showed
ratios of 33 percent and 26.4 percent, resulting in a widening decit.
Financing of decits was done through both foreign and domestic
borrowings. Of total nancing in 1986, 59 percent came from foreign
borrowings, falling to 18.7 percent in 1998, indicating a clear shift to
domestic sourcing. Domestic sources rose from 41.6 percent in 1986 to
76.6 percent in 1998. Borrowings came from market, bank, and nonbank
sources.
The Philippines reected overall budget decits (standing at a ratio
of 3.7 percent of GNP at its worst in 1990) until 1994, when a surplus
equivalent to close to 1 percent of GNP was attained and maintained till
1996. However, the Asian crisis brought the decits back to 1.8 percent
of GNP in 1998. Net decit nancing was done through domestic and
foreign borrowings, in 1990 at a ratio of 1.4 percent of GNP for domes-
tic and 0.4 percent for foreign. There is no particular trend, however.
Borrowing sources could simply reect the political preferences of ad-
ministrations in power. For example, net domestic borrowings ratios to
GNP were negative for 1993, 1994, and 1997, but positive for 1995 and
1996. For net foreign borrowings the ratios are positive for 1990, 1993,
1996, and 1998, but negative for 1994, 1995, and 1997.
In contrast, Singapore has reected consistent ratios throughout
the years, with operating revenues relative to GDP at a range of 20
percent to 21.9 percent, until 1998 and 1999, when the ratios dropped
to 18.9 percent and 16.9 percent, respectively. Similarly, operating revenues
have generally been at a range of 9.2 percent to 11.7 percent, the gures
for 1998 and 1999, being 10.4 percent and 10.7 percent, respectively.
Singapore maintained a consistently positive (surplus) ratio to GDP, ranging
from 4 percent to 8.9 percent, until 1998 and 1999, when the ratio
turned negative to 0.3 percent in 1998 and 3.6 percent for 1999.
Overview 107
For Hong Kong, China, the surpluses have ranged from 1 percent
to 6.5 percent of GDP, reecting outstanding budgetary performances
from 1991 to 1998. There was a budget decit only in 1995/96, when
nancing for the new airport was undertaken.
IV. Monetary Policy
The choice of monetary policy stance, and monetary policy instru-

ments, is closely linked to nancial and capital market/bond market
development. When accompanied by e¹cient regulatory and legal processes,
nancial liberalization (generally characterized by a market-determined
interest rate policy) exerts a positive inuence on this development. The
role of monetary policy therefore is to mobilize savings, and channel
these savings into productive investment by providing a conducive en-
vironment, that is, where prices are stable and the ination rate low, so
that real interest rates remain positive over time.
Most of the ADCs in the study have introduced policies to liberal-
ize their interest rates since the mid-1980s. For many of them, the result
was more nancial deepening, with their nancial sectors growing rela-
tive to the rest of their economies. Of the mid-developed countries,
Republic of Korea, Taipei,China and Thailand have generally experi-
enced the greatest nancial expansion, while Indonesia and the Philippines
were slightly behind. The PRC, on the other hand, is still very much in
an emergent stage. Wherever positive real interest rates were achieved,
savings grew substantially relative to the domestic product, and these
were channeled into productive investments. On the other hand, the high
levels of saving in the PRC were not necessarily due to a move towards
market-determined interest rates.
While nancial liberalization clearly plays an important role in
nancial and capital market development, the extent to which monetary
policy (i.e. the use of particular indirect monetary policy instruments)
can be used e¬ectively, also depends on the level of development of
capital and bond markets. Monetary policy a¬ects the quantity of money,
and thus a¬ects interest rates. This sequence is generally e¬ected through
changes in the rediscount rate, or through open market operations (pur-
chase and sale of government paper), which results in changes in bank
reserves, and a¬ects the rates charged or paid by banks. For these instru-
ments to be e¬ective, however, the nancial system must have an adequate
amount of marketable securitiesboth from the government and corpo-
rate sector, at various maturities (so as to produce a yield curve). In
other words, e¬ective monetary policy and bond market developments
are closely related.
As nancial regimes have become more open and deregulated in

the ADCs over recent years, capital inows have increased tremendously,
resulting in challenges to their economies, particularly in the areas of
monetary and exchange rate management. Some ADCs opted to keep
their exchange rates stable to boost their export sectors, but this led to
inated money supply, which had to be sterilized. Open-market opera-
tion (OMO) would have been the best indirect instrument to accomplish
any mopping up operations, but the shallowness of the bond markets
made this a less-than-e¹cient tool (and Central Banks often resorted to
a more direct method, i.e. changes in reserve requirements).
The role and importance of the Central Banks in the development
of the bond market of the 10 ADCs may be viewed in context of their
independence from governments. Some have greater independence and
have made use of monetary policy instruments with varying levels of inu-
ence over their respective nancial and capital markets. Greater indepen-
dence has not always provided assurance of faster development, however.
It is interesting to compare the Central Bank operations of Hong
Kong, China and Singapore, the two most developed in terms of bond
market development. The Hong Kong Monetary Authority (HKMA), was
established only on 1 April 1993, in marked contrast to other economies
in the region, some of which have had Central Banks for at least half a
century (the Philippines, for example, celebrated 50 years of central banking
in 1998). HKMA supervises the banking sector and manages the mon-
etary system, functioning as Hong Kong, Chinas de facto Central Bank.
Its main objective is to maintain the stability of the Hong Kong dollar,
which is linked to the US dollar at a xed exchange rate. In other ADCs,
Central Banks are able to respond to economic conditions through the
management of money supply, without being subject to the size of their
dollar reserve. Hong Kong, China, however, operates a Currency Board
system, which means that the Hong Kong notes issued or in circulation
are fully backed by the US dollar at a xed exchange rate. This means
Hong Kong, China interest rates are kept in line with those of the US,
and HKMA has less freedom to use interest rates as an instrument. This
disadvantage was underscored during the Asian crisis, as well as the
need for a mature debt market to diversify funding sources and reduce
maturity mismatch. HKMA set up a Discount Window whereby banks
can borrow overnight funds by entering into repurchase (repo) agree-
ments, using eligible securities for collateral, a facility that ensures
e¹ciency in the payments and settlements system.
The Monetary Authority of Singapore (MAS) formulates and imple-
ments monetary policy, which as in Hong Kong, China, is basically
focused on the exchange rate rather than on interest rates. It therefore
Overview 109
does not undertake OMO to inuence interest rates. The policy on the
exchange rate is that it must remain competitive. Singapore eschews the
internationalization of its currency, however. Notwithstanding, a repo
market has developed, thus allowing the emergence of a more respon-
sive yield curve, providing opportunities for investors and banks. However,
the policy of noninternationalization restricts repo transactions with non-
bank and nonresident rms. The MAS has exerted concerted e¬orts to
steer Singapore Government Securities as the benchmark for a viable
yield curve, in a bid to eventually position the Singapore market as a
debt hub in the region.
The other ADCs, excepting the PRC, have Central Banks which
have attempted to use indirect monetary policy instruments to develop
and strengthen their nancial systems and inuence the development of
their burgeoning capital markets, all with varying degrees of success.
The Philippines Central Bank was established in 1948. As in other
countries, the Department of Finance exercised a major role in the early
years, with the Secretary of Finance chairing the Monetary Board of the
Central Bank. The objective of economic growth was dened for the
Central Bank of the Philippines, until this was revised to merely provid-
ing a conducive climate for the pursuit of economic growth in 1972.
Then in 1993, as mandated by a new constitution, a new Central Bank
Act dened the Bangko Sentral ng Pilipinas (BSP), as the monetary
authority of the Philippines, with responsibility for providing policy
directions in the areas of money, banking, and credit, with supervisory
powers over banks and regulatory authority over nonbanks. Its primary
objective was the maintenance of price stability conducive to balanced
and sustainable economic growth. The BSP is a key player in a coordi-
nating body for investment and scal planning, that includes the
Department of Finance, Department of Budget and Management, Na-
tional Economic Development Authority (NEDA), and the Bureau of
Treasury. O¹cials from these agencies (except NEDA) constitute the Auction
Committee for government securities. Up until 1995, when the new law
took e¬ect, BSP had a scal agency function, which meant that it handled
the issuance, servicing, and payment of public sector debt on behalf of
the Government. BSP has extensively used OMO and rediscounts as
important tools to inuence monetary aggregates, and thus interest rates
and economic growth or recovery. It has also used the more direct in-
strument of changes in reserve requirements when more immediate action
has been needed. BSP a¬ects the development of the capital market by
enhancing the e¹ciency of nancial intermediation, and is one of the
four government agencies that, together with four private sector institutions,
constitute the Capital Market Development Council.
Monetary policy in Indonesia is implemented by Bank Indonesia

(BI), its main thrust being monetary control through managing monetary
aggregates and credit. The instruments of choice have been the reserve
requirement and OMO, for which BI has utilized its certicates, the SBI
and SBPU, which were introduced in 1984 and 1985, respectively. During
the crisis, the Central Bank utilized interest rate policy to arrest the
slide of the domestic currency, but this met only partial success. This
was seen to be due to the lack of independence of the Central Bank,
and so, in 1999, BI was given independent status under a new law,
which lays down its main mandate as stabilization of the exchange rate
and domestic purchasing power, and maintenance of the national pay-
ments system. BI thereupon transferred its program loans to several state
banks, and will divest its equity holdings in several banks and invest-
ment rms. This is similar to the series of reforms that the BSP went
through to make it a more independent monetary authority.
The Republic of Korea and Malaysia, which like Indonesia, have
powerful nance and planning bodies, profess to have Central Banks
mandated to support sound economic development in line with domes-
tic price and exchange rate stability. The Bank of Korea (BOK) targets
ination, using M3 as the intermediate target, and bank reserves as the
operating target. At the beginning of the year, BOK announces the direc-
tion of monetary policy for the year. This includes monthly announcements
of the size of OMO, target value of call rates for the month, and the
liquidity situation. Malaysias monetary policy has moved in accordance
with its National Economic Plan, and later, National Development Plan,
with selectively restrictive policies implemented in the early 1980s, later
moving to a more expansionary stance. However, the objectives of bal-
ancing a stable exchange rate and reducing interest rates, particularly in
its period of rapid economic growth, was made particularly di¹cult as
interest rates abroad were falling, and the interest rate di¬erentials were
attracting substantial (but volatile) foreign funds into Malaysia. This
underlying problem became a reality with the onset of the Asian crisis,
and the economy was faced with the depreciation of the ringgit, aggra-
vated inationary pressures, and prolonged regional uncertainties. The
policy that was adopted considered the need to address the increasing
volatility in the nancial market, irrational market behavior, the deterio-
ration of the nancial position of the banking and corporate sectors, and
the contraction in the economy. Regulations were issued to deect these,
but ensured full convertibility for current account transactions. While
Malaysia was roundly criticized for its capital control measures, the country
considered these actions necessary for its recovery. Bank Negara Malaysia
(BNM) recognizes the importance of developing a viable capital mar-
Overview 111
ket and deepening the market for government securities to ensure the
e¹cacy of OMO as a monetary instrument. BNM is responsible for the
issuance of government bonds, being one of the ve statutory bodies
under the Ministry of Finance. In this aspect, Malaysia di¬ers from other
ADCs, notably the Philippines and Indonesia, whose Central Banks are
independent.
The Central Bank of Sri Lanka (CBSL) is responsible for monetary
policy, and its main objectives are stabilization of the domestic and
external value of the rupee and promotion of economic growth. It uti-
lizes both direct and indirect instruments, in recent years having preferred
indirect ones such as OMO. It acts as the issue manager of government
securities in the domestic market through weekly auctions of Treasury
bills. OMO use rates based on yields of T-bills in the primary market,
but the underdeveloped state of the secondary market for government
securities renders such operations less than e¬ective. The introduction
of repo agreements, and reverse repos in 1993 and 1995, however, pro-
vided the CBSL with additional instruments to inuence interest rates.
As in the Philippines and Indonesia, the Central Bank of China
(CBC) is the highest monetary authority in Taipei,China, with complete
independence over monetary policies. Its main functions include the
regulation of nancial conditions, implementation of foreign exchange
regulations, examination of nancial institutions, issuance of currency,
and provision of check clearing services. It also performs scal agency
functions for the Government, conducting the issuance of government
bonds, although this source of funding has not been developed until
recently, and is still not very actively utilized. The banks main policy
instruments are OMO, rediscounts, reserve requirements, and selective
credit controls. OMO is the most important and exible monetary tool,
and CBC has adopted an intermediate targeting strategy with M2 as its
target variable. Since 1979, the New Taiwan (NT) dollar has been al-
lowed to oat, but balance of payments constraints inhibit the inuence
of monetary policy.
The Bank of Thailand (BOT) was established in 1942, and is man-
dated to conduct monetary policy in accordance with the following policy
objectives: (i) to stabilize the countrys scal balance to consolidate the
budget decit and control debt repayment over the medium-term; (ii) to
build a management mechanism to minimize nancing cost and avoid
bunching of government debt, and (iii) to develop a bond market to
promote public and private saving and support debt management. BOT
is thus responsible for the maintenance of monetary stability, as well as
being a major advisor to government on economic policy. BOT is thus
apparently a key player in both scal and monetary policy.
Meanwhile, in the Peoples Republic of China, monetary policy is

theoretically conducted by the Peoples Bank of China (PBC), which
supposedly uses instruments such as the interest rate, reserve require-
ments, and discounting facility. In practice, however, the use of these
instruments is inhibited by various restrictions, such as xed interest
rates, credit allocation, and caps on drawings on the Central Bank by
the Finance Ministry. Still very much at an embryonic stage, the PBC
will still have to learn how to deal with the high volume of savings
available in the economy and how to allocate these to e¹cient uses,
hobbled as the Government is with nonperforming state enterprises. The
development of the bond market will have to be actively supported and
promoted, but the immediate task should be a rationalization of the
currently available instruments.
V. Regulatory, Supervisory, and Institutional

Framework
Apart from sound macroeconomic, scal, and monetary policies

and liberalization of the nancial sector, transparent and e¬ective regu-
latory and supervisory systems are crucial for the development of a viable
debt market, as well as e¹cient market institutions to support its growth.
At the APEC Finance Ministers Meeting in 1997,7 the importance
of creating stable and transparent legal and regulatory systems was stressed
as a prerequisite for enhancing nancial and capital market participation
among buyers, sellers, and intermediaries. It was noted that the existing
legal framework in many of the APEC countries does not provide satis-
factory mechanisms for conict resolution and dispute settlement among
capital market players, or between governments and the major capital
market players. This observation was also made at a recent ADB Symposium
on Insolvency Law Reforms, held in Manila on 2528 October 1999.
Likewise, at the recent Philippine Local Debt Conference held on
17 February 2000, 8 among the important building blocks mentioned
were those which had to do with custody, accounting, information, legal
aspects, and taxes. Existing tax frameworks in a number of the ADCs are
such that bonds are subject to discriminatory taxation, vis-à-vis stocks,
7. ADB, Promoting Financial and Capital Market Development, Voluntary

Principles and Collaborative Initiatives, A Background Paper on the Recommen-
dations of the APEC Finance and Central Bank Deputies for the Fourth APEC
Finance Ministers Meeting, 46 April 1997.
8. First Philippine Local Debt Conference Sponsored by Finance Asia and
Thomson Ratings Philippines, Manila Peninsula Hotel, 17 February 2000.
Overview 113
and therefore provide little attraction. Disparities in the tax treatment of

stocks and bonds, as well as di¬erential tax treatment as between for-
eign and domestic investors, inuence investment choices to the detriment
of bond market development. ADCs should thus endeavor to make their
legal and tax systems more conducive to capital market development.
Similarly, regulatory systems must be attuned to the economic func-
tion of nancial and capital markets, i.e. they must recognize the importance
of savings mobilization and the allocation of these resources to their
most productive uses. Therefore, regulatory regimes should have well-
dened objectives and transparent supervisory procedures, capable of
dealing e¬ectively with problems related to moral hazard and systemic
risk. The Asian crisis exposed only too well the weaknesses of many
regulatory systems in the region. It clearly illustrated that sound nan-
cial supervision plays a central role in contributing to nancial stability
and capital market development. Of course, there should be balance in
regulation. Too little enforcement of regulations exposes institutions to
moral hazard (as was seen in the recent crisis), but overly strict and
circuitous regulations results in the inhibition of the emergence of inno-
vative instruments and practices, and reduces the incentive of managers
to be responsible for their own institutions, relying instead merely on
the Central Bank. In this regard, ADCs should encourage the emergence
of a cadre of regulators and supervisors who are highly competent, pro-
viding opportunities for professional training and skills development.
The next set of building blocks refers to market infrastructure. Crucial
to the enhancement of e¹cient infrastructure for bond market develop-
ment are institutions and practices including credible credit rating agencies,
well-functioning clearing and settlement systems, bond insurance, provi-
sion of liquidity, creation of benchmarks, and the emergence of hedging
instruments such as derivatives, as well as the development of a second-
ary market for bonds, both government and corporate. There are disparities
in the prevalence these practices in the 10 ADCs, which is only to be
expected, because many of these economies have a very shallow market
for government securities, and even less for corporate securities.
High-quality, transparent, timely and internationally accepted re-
porting and disclosure practices on the nancial positions of debt issuers
provide investors with condence. Some developed countries have rigor-
ous disclosure requirements that result in self-regulating nancial
institutions (which theoretically should lead to less central regulation).
Moreover, access to information helps to reduce market imperfections
and encourage greater competition and innovation. ADCs should thus
try to promote well-organized, up-to-date, and easily accessible data-
bases to help investors make sound and well-informed decisions.
As regards credit rating, it is important to have credible and inde-

pendent credit rating agencies to further provide assurance to investors,
and help them make proper assessment. ADCs should consider ways of
encouraging the use of credit ratings, although in recent years some of
these countries have already established credit rating agencies.
Well-developed and e¹cient clearing and settlement systems are
also clearly indispensable to the development of capital markets. There
is a lot to be desired in the clearing and settlement systems of many
ADCs, and it might be appropriate for these member countries to take
denitive steps towards facilitating the development of modern clearing
and settlement systems to minimize costs and settlement risks.
The development of a credible and market-based yield curve is
crucial too. A benchmark yield curve exists when a spectrum of securi-
ties of di¬erent tenors meets the market yield and liquidity requirements.
Generally, the benchmark yield curve is provided by a government secu-
rity of certain tenor that is so liquid that it carries a market-determined
yield at all times. The ADCs, except perhaps Hong Kong, China, have
not yet developed market-based benchmark rates for medium- to long-
term instruments to facilitate price discovery and encourage the deepening
of the bond market, including local or municipal bonds. In practically
all of these ADCs, the municipal bond market is very much in the rudi-
mentary stages, as all issuances have generally been made by the central
government, or state-owned enterprises which have the backing of the
central government.
VI. Overview of Bond Markets in the ADCs
Since the onset of the Asian nancial crisis, a major sea-change

has started to take place in many of the ADCs in terms of their tradi-
tional reliance on overseas borrowings and bank-intermediated nancing.
The 10 country papers show an increasing trend to view the direct issu-
ance of securities, particularly bond issues by the government and the
private sector, as a viable way of nancing their projects, and of har-
nessing the budget decit as an important and viable means of bringing
about the emergence of a local debt market.
In particular, the development of government securities markets is
gaining ground as a principal method of encouraging the capital market
development of their economies. Budget decits, per se, are no longer
viewed as anathema, even by those countries that long maintained bal-
anced scal positions, especially since some have found themselves in
the previously unwelcome situation of having to post substantial budget
decits. For some of the countries, it was a rude awakening, but one that
Overview 115
BOX 1
Asian Developing Countries Efforts in the Use of Credit Rating
In recent years, several Asian Developing Countries have established

credit rating agencies to boost their bond markets and promote investor
protection. Some have one or more rating agencies in operation, and all are
at different stages of sophistication.
The earliest to establish a local agency was the Philippines, which
established the Credit Information Bureau, Inc. (CIBI) in 1982 through the
efforts of the Central Bank, the Securities and Exchange Commission, and
the Financial Executives Institute of the Philippines. Recently, the CIBI
was reorganized as the Philippine Ratings Services Corporation (PhilRatings),
with technical assistance from Standard and Poors. In 1999, a second
rating agency, Thomson Ratings Philippines, was established, with the help
of Thomson Watch and the IFC. Malaysia established the Rating Agency of
Malaysia (RAM) in 1990, and in 1996 the Malaysia Rating Corporation.
In Indonesia, PEFINDO (Credit Rating Indonesia, Ltd.), which is
the sole credit rating agency, was established in July 1994. Technical sup-
port is extended by the RAM and the International Bank Credit Rating
Agency.
The Thai Ratings and Information Service (TRIS) is the only credit
rating agency in Thailand. It receives technical assistance from Standard
and Poors and is also supported by the Bank of Thailand. TRIS is owned
by public, private, and international institutions.
The Korea Investors Service, which is funded by the nonbank finan-
cial industry, was established in 1985 to support the rapidly growing securities
industry. The commercial banking industry also established the National
Information and Credit Evaluation, Inc. Likewise, the Korea Development
Bank established the Credit Rating Corporation.
In the Peoples Republic of China, only the Chenxing Securities
Rating Company, Ltd. and Dagong International Company, Ltd. were ap-
proved by the Peoples Bank of China. However, there are around 50
rating institutions composed of accounting and consultant firms which also
offer rating services. The ratings process in the Peoples Republic of China
is not well-established, however, and investors do not give much impor-
tance to the assessment given by the agencies.
In Sri Lanka, Duff and Phelps Credit Rating Lanka, Ltd., was estab-
lished in July 1999.
Meanwhile, Moodys, Standard and Poors and Thomson Bank Watch
have recently opened o¹ces in Hong Kong, China.
Singapore and Taipei,China have no local credit rating agencies.
led to a di¬erent view of budgetary decits as a means by which gov-

ernments can play a more active role in the development of their bond
markets. For those countries, which had long been plagued by annual
budgetary shortfalls, developing government bond markets provides a
means for better debt management and rationalization of security issu-
ances. For others, such as the PRC, which is only recently emerging
from a closed and insular nonmarket oriented economy, it provides a
fresh insight on hitherto unused tools to help it enter the globalizing
world.
Meanwhile, some observers have also noted that there has not been
a signicant increase in the size of the domestic bond markets of the
crisis economies (Malaysia, Indonesia, Republic of Korea, and Thailand)
from 1996 to 1999. The study observes that there was no compensating
increase in domestic market issues to o¬set the reduction in interna-
tional bank lending. The proportion of total debt issued by the public
sector was relatively low, suggesting that the use of government securi-
ties as a benchmark for constructing accurate yield curves is still unlikely.9
Overall however, the 10 economies proled in the recent ADB
Conference on Government Bond Markets and Financial Sector Devel-
opment in Developing Asian Economies held in Manila, 2830 March
2000, agree on the importance of developing their bond markets, and of
the role that government securities can play in providing the catalytic
push towards that goal.
A. Government Bond Market in ADCs
The infrastructure of the market for government securities includes:

(i) the supply of government securities in varying maturities; (ii) issuing
schedule and lot sizes; (iii) the yield curve; (iv) the demand for bonds
by institutions and other investors; and (v) the depth of the market.
Market infrastructure includes mechanisms for primary issues, sec-
ondary market trading, clearing and settlement, and support activities
such as credit ratings and trading of hedging instruments. An e¹cient
primary market system is one whose competitive procedures and dealer
participation ensure that interest rates generated by the market process
reect true market conditions. There are various alternatives for distrib-
uting bonds in the primary market, such as straight allocation, public
9. Batten, Jonathan and Yun-Hwan Kim, Expanding Long-Term Financing

Through Bond Market Development: A Post-Crisis Policy Task. Paper presented
at the ADB Conference on Government Bond Markets and Financial Sector De-
velopment in Developing Asian Economies, ADB Manila, 2830 March 2000.
Overview 117
subscription, private placements, underwriting and organized auctions.

Government scal agents may use more than one distribution technique.
More advanced systems use underwriting and organized auctions, using
other methods only for special circumstances. In contrast, less developed
countries tend to use forced subscriptions and allocation systems involv-
ing large government-run nancial institutions, such as state pension
funds and government savings or development institutions. The more
centralized the economy, the greater the tendency to make use of its
captive markets. Such mandatory systems inevitably distort interest rates.
The most competitive procedures are auctions, and especially those uti-
lizing electronic access to the bidding process, which provides anonymity
and rewards most competitive participants. The 10 ADCs make varying
use of auction methods and mandatory allocation.
Most of the ADCs that profess to use development-oriented scal
policies nance their budget decits through the issuance of domestic
government securities. While a number of them have either had sur-
pluses due to well-managed balance in revenues and expenditures, or
because of a political avoidance of decits, the supply of securities in
the market has necessarily come from the government rather than the
corporate sector. Governments have moved towards issuing debt with
longer-term maturities, not only because they wish to avoid bunching of
maturities or renancing problems, but because in recent years they have
taken responsibility for the development of their capital and bond mar-
kets. In recent years too, the problems of external debt burdens have
prompted governments to look to their domestic markets for the nanc-
ing of their economic development objectives. This policy change is a
turnaround from the past funding of economic development through
external debt, which in the last decade had imposed severe foreign ex-
change burdens on some of the ADCs.
The maturity structure of public debt depends considerably on whether
the country is in a state of relative macroeconomic stability or adjust-
ment. Issuing bonds becomes a viable option when the government has
a credible macroeconomic stabilization policy and program, and the will
and the capability to implement it. Where an economy has a history of
large and chronic decits, it may be expected that the government will
tend to issue more short-term instruments such as Treasury bills rather
than bonds. This means the cost of renancing over the long term will
be higher, particularly when ination rates are high. It is therefore in a
governments interest to encourage the development of a smoothly func-
tioning debt market that covers a spectrum of maturities, running from
short-term debt that gets consolidated into bonds in the primary market,
and to provide the supporting measures to deepen the secondary market.
Governments should schedule issuances in appropriate amounts so

that the yield curve reects interest costs that are indicative of market
conditions, reasonable price expectations, and macroeconomic develop-
ments. The size of scheduled issuances can help in bringing this about.
In countries that tend to be in decit, timing is often linked with rev-
enue expectations, but surplus economies aiming to develop their bond
markets would also nd it opportune to schedule o¬erings so that inves-
tors may consider them in their business plans.
Another important issue is investor demand for securities. In the
country paper on the Philippines, the structural feature of the demand
for bonds is described as comprising the institutional composition of
investors, size and depth, and the economic incentives of bonds relative
to alternative investments. When considering investors, it is important to
identify them. Are they institutional investors, such as government pen-
sion funds and other state-owned enterprises, or nancial institutions?
While they constitute a large pool of long-term funds available for in-
vestment in bonds, their preferences may relate to their need to ensure
liquidity in future, as in the case of insurance and pension funds, which
may tend to hold to maturity, or for reserve assets purposes, in the case
of banks and nancial institutions. This has implications for secondary
bond market development.
Of course, investors, whether institutional or retail always look at
the nancial returns o¬ered by bonds vis-à-vis alternative investments.
Risk and return are important, but the market looks at these variables in
relation to other considerations such as tax policies and regulatory re-
strictions. Sometimes, tax policies and cumbersome regulatory procedures
(imposed by Central Banks and securities regulatory agencies) have a
disincentive e¬ect on the development of the bond market.
The government bond markets in the 10 ADCs are at contrasting
stages of development, and are adopting di¬erent approaches in their
e¬orts to develop their markets. The two most developed economies,
Singapore and Hong Kong, China, provide the paradigms for market-led
development. Hong Kong, China in fact was a late starter, and is now at
a stage where the private sector debt market is three times as large as
the government bond market. It is also well ahead of the other ADCs in
its e¬orts to develop market infrastructure. Singapore, meanwhile, aims
to promote itself as an international nancial center in Asia, and ulti-
mately as the debt hub in the region for arranging, underwriting, and
trading of bonds. Its market comprises both government and private bonds,
with a fast-growing primary market of government securities coursed
through a network of primary dealers (PDs), and a secondary market
supported by a second line of secondary dealers. At the other end of the
Overview 119
spectrum is the PRC, where the only debt is government debt, since
only state-owned enterprises other than central government may issue
debt. Domestic bonds dominate the market, and debt issuance is an im-
portant source of nance, next to bank loans. Initially, bond issuance
was introduced very cautiously, mainly to meet the scal decit. The
Asian nancial crisis brought about a change, however, which led to the
use of debt as a tool for stimulating the economy, as well as an impor-
tant macroeconomic adjustment mechanism. The PRC has a long way to
go, however, as it slowly moves away from its very closed and insular
system. Any development of its bond market will have to go along with
scal reforms, as well as reforms in the nancial sector and resolution of
the issue on market liberalization.
Between these two extremes lie the seven other ADCsIndonesia,
Malaysia, Thailand, Philippines, Republic of Korea, Sri Lanka, and
Taipei,China. Hardest hit by the Asian nancial crisis were Indonesia,
Malaysia, Thailand, and Republic of Korea. Indonesias bond market is
quite simply shallow and illiquid. This underdevelopment is the result
of past scal policy, which relied heavily on foreign loans to nance
budget decits, and undue reliance on government subsidies by state-
owned enterprises. Battered by the nancial crisis and the e¬ects of
continued political di¹culties, Indonesia has to address many issues,
including harmonization of scal and monetary policies, its debilitating
debt burden, governance issues, and developing the appropriate infra-
structure for the emergence of a bond market. Malaysia too su¬ers from
an underdeveloped bond market, which could be partly ascribed to a
confused regulatory structure. It has, however, taken an initial step with
the mandate given to Khazanah, a wholly owned government subsidiary,
to issue Benchmark Bonds. It is hoped these will be useful as a guide to
pricing corporate bonds. While Malaysia still has to improve its market
infrastructure, it has begun to set up a modern and e¹cient settlement
system, has made some progress with a scriptless system, and opened
two credit rating agencies. Its secondary market, however, has so far
failed to take o¬. Thailand, the other crisis-hit ADC, issued government
bonds to fund successive budgetary decits. These were absorbed by a
captive market that held these to maturity, and the secondary market
thus failed to develop. A number of impediments to the development of
the bond market have to be addressed, chief among which is probably
the need for e¬ective issuance planning. For secondary market develop-
ment, market infrastructure issues have to be tackled. The Republic of
Koreas bond market, meanwhile, developed di¬erently, in that it emerged
without the benet of a benchmark government bond, and has been led
by corporate bonds. The countrys precrisis aversion to decit accounts
for the underdeveloped state of the government bond market. The Asian
crisis, however, served as a catalyst for the development and deepening
of the government bond market, with the move to using three-year Trea-
sury bonds as the benchmark, the introduction of a PD system, and the
opening up of noncompetitive participation in the bond market to indi-
viduals of up to 20 percent of the volume of the auction, thus latter
providing a venue for long-term public savings. The Republic of Korea
still has to address various issues, however, important among which are
the absence of liquidity, and coordination of scal and monetary issues,
including tax and interest policy issues, as well as governance issues,
which were highlighted during the Asian crisis.
The Philippines, Taipei,China, and Sri Lanka were less a¬ected by
the Asian nancial crisis. Their government bond markets, while rela-
tively undeveloped, have nonetheless made some important strides, with
the governments seemingly committed to making them play leading roles
in their economies capital market development. The Philippines and Sri
Lanka have both introduced market-oriented long-term bonds to provide
a rudimentary yield curve, although the latter still has to do away with
its nonmarketable rupee loans to be able to concentrate on government
bonds. For the Philippines, the market for short-term government securi-
ties (T-bills) constitutes the largest market for debt instruments, even as
attempts to deepen the securities market and broaden investment alter-
natives are being made to help develop a long-term yield curve. For
both, continuing structural reforms and improvements in market infra-
structure are necessary, as well as greater coordination between monetary
and scal policies. Taipei,China, on the other hand, provides a good
example of how a government bond market can be made to develop in
a short time. It was only in the early 1990s that the Government began
to use scal policy for infrastructure development, using government
bonds as the funding source. Short- and medium-term government bonds
were issued, with longer-term bonds gradually included, 20-year tenors
being introduced in 1998. There is a well-spaced maturity range that
provides a good basis for establishing a risk-free benchmark yield curve.
B. Corporate Bond Markets in ADCs
Except perhaps for the Republic of Korea, corporate issuances in

the ADCs have tended to be smaller than issuances of government secu-
rities. Historically, the capital market has dealt mainly in government
debt. Corporations nancing their long-term requirements for expansion
have tended to opt for equity infusions, reinvestment of retained earn-
ings, or bank borrowing, rather than bond issuance, despite the wide
Overview 121
variety of instruments that corporations could use, such as secured bonds,

mortgage bonds, debentures, convertible bonds, and oating rate bonds.
Apparently, there is an incentive problem. Where the company is owned
mostly by outsiders, and managers are mere employees or have little
equity stake, they tend to follow what is in their interest rather than in
the interests of the stockholders (they are overly cautious, for example
steering clear of risky projects that require large nancing). On the other
hand, gung-ho attitudes for risky investments may result in problems
related to corporate governance, as seen during the Asian crisis.
As already mentioned, there is a wide disparity in the level of
development of bond markets among the 10 ADCs, ranging from the
highly developed markets of Hong Kong, China and Singapore to the
PRC. Of the seven countries in between, some are at similar stages of
development, but each with unique features, often resulting from the
scal and monetary stance of their authorities.
C. Types of Securities
ADC bond markets are composed of both government and private

bonds, with government bonds usually in the majority. Government se-
curities are issued either by the central government, state-owned enterprises,
municipal or local governments, or the Central Bank. Private bonds are
usually corporate issues.
Government securities are composed of short-term Treasury bills
and longer-term Treasury bonds. Across the ADCs these may be called
by di¬erent names. The PRC for example, has T-bonds, E-bonds (Enter-
prise bonds) and F-bonds (Financial Institution bonds); Indonesia has
SBIs and SBPUs; Hong Kong, China issues Exchange Fund Notes, and
Singapore has Singapore Government Securities (SGS). Distinctions are
by issuer or length of maturities, with bills generally referring to those
with short-term maturities, and bonds those with long-term tenors.
D. Size of Domestic Bond Markets
The size of domestic bond markets varies across the ADCs, ranging
from 5 percent of gross national product (GNP) in Indonesia to 97 per-
cent in Singapore. The Republic of Korea, Malaysia, and Singapore are
the largest relative to GNP, as well as, surprisingly, the Philippines, de-
spite its lack of a corporate bond market.
The size of the bond markets may be taken in the context of the
nancial depth of the ADCs. The Philippines and Indonesia have the
shallowest markets compared with similar economies such as Thailand
TABLE 1
Comparison of Domestic Bond Markets
Total Bond Market Composition (percent)

Size Percent
Countries (US$ billion) of GDP Government Corporate
China, Peoples Rep. of 776 30 72 28
Hong Kong, China 50 30 25 75
Indonesia 4 5 42 58
Korea, Rep. of 269 84 68 32
Malaysia 42 63 54 46
Philippines 21 32 100 0
Singapore 84 97 80 20
Taipei,China 46 18 66 34
Thailand 14 12 78 22
Sri Lanka n.a. 5 n.a. n.a.
Note: n.a. not available

Source: Table 7 of Philippine Country Paper
and Malaysia, using the ratio of nancial assets to GDP. The Asian crisis
reduced the value of the equities markets, and induced a marked shift to
bank assets, except in the Republic of Korea, where the corporate sector
accessed the bond market during the crisis. As of 1998, the nancial
assets and depth of the ADCs are shown below.
TABLE 2
Financial Assets and Depth of Financial System in Selected ADCs, 1998
(US$ billions)
Total Percentage of Total Financial Assets

Financial Percentage
Countries Assets of GDP Equities Bonds Bank Assets
China, Peoples Rep. of 151 15 1 9 75

Hong Kong, China 79 47 4 6 50
Indonesia 8 9 2 5 74
Korea, Rep. of 71 22 1 37 49
Malaysia 23 35 4 18 41
Philippines 10 15 3 21 44
Singapore 36 41 4 23 32
Taipei,China 81 31 3 6 64
Thailand 28 24 1 5 84
Sri Lanka n.a. n.a. n.a. n.a. n.a.
Note: n.a. not available

Source: Philippine Country Paper
Overview 123
E. Investors
Institutional investors are the major investors in Hong Kong, China;

Singapore; Indonesia; Malaysia; Thailand; and Philippines. The PRC, in
contrast, has an investor base dominated by individuals, while Republic
of Korea, Taipei,China, and Sri Lanka have a larger market in the nan-
cial sector. Institutional investors comprise pension funds, provident funds,
insurance companies, investment funds, post o¹ce banks, etc.
F. Issuing Process
Di¬erent countries have various means of issuing their securities

in the primary market, such as the xed-price public subscription, other-
wise known as the classical bond, private placements, tap issues, and
auctions.
In xed-price public subscription, the Treasury announces most
parameters some days before the issue, such as the price of the bonds,
coupon, subscription period, issuing volume, maturity, and any special
features. These subscriptions are normally done through a consortium,
and a high proportion of the debts usually end up held by nancial
institutions.
In private placements, nontradable bonds are sold only to a few
investors, usually banks or institutional investors, but when the second-
ary market becomes active, the bonds will become tradable. For tap
issues, debt is sold directly through the branch network of the banking
or postal system.
The auction procedure is now the most common method of gov-
ernment securities issuance among the ADCs, and is used in competitive
capital markets whose key factors include internationalization, institu-
tionalization, and dematerialization. Auctions are open to diverse
investorsnancial institutions and other nonnancial institutional in-
vestors. There are a number of auction formats, among which are: (i)
multiple price auctions (or discriminatory auctions, or rst price auc-
tions), a sealed bid type of auction where no one has any information
on the bids of other participants, bids are ranked, and bidders with the
lowest yield (i.e. highest price) are awarded rst, followed by the next
lowest, until the entire allocation is awarded; (ii) uniform price auctions
(or single price auctions, or second price auction, often called Dutch
auction). These are similar to the multiple-price auction except that all
winning bidders pay only one and the same price, i.e. the highest losing
bid; (iii) ascending price auction (or English or American auction), where
participants are allowed to react to the bids of others, and the auctioneer
starts at a low price and gradually increases it until demand and supply
meet, after which the entire issue is sold at that single market clearing
price; (iv) descending price auctions, where the auctioneer starts at a
high price which is gradually decreased until someone buys a certain
amount, and further decreased until the entire quantity is sold; (v) non-
competitive auctions, which are organized for specic investor groups,
with debt securities sold at a price resulting from the auction, usually
open to smaller, retail investors and not intended for PDs; and (vi) when-
issued trading, where governments dispose of another instrument to reduce
the winners curse for competitive bidders, with bidders starting to trade
the securities as soon as the Treasury announces the amount it will issue
with a certain maturity, and until the moment they are actually issued.
Each method has its advantages and disadvantages.10
The 10 ADCs presently utilize the auction method to issue govern-
ment securities. Some have evolved from methods of direct allocation
through various underwriting techniques, and currently use either the
Dutch or English/American auction methods according to their specic
needs. They have also evolved to a system whereby securities have been
dematerialized, and electronic book entry means are increasingly uti-
lized, especially for T-bills and T-bonds. Other types of government
securities (such as those issued by state-owned institutions, or special
types of issues) are issued in bearer form, but the general rule is now for
a scriptless environment. The Central Bank, except in the case of the
Philippines, where the Central Bank has turned over this function to the
Bureau of Treasury, is usually the issue manager. There is some sort of
dealer network in every ADC, with each country calling it by an o¹cial
name, except in Indonesia, where it appears a PD network is still being
proposed.
G. Benchmark
Benchmarks play a crucial role in developing securities markets.

They are used to gauge the prevailing interest rate structure, market
expectations on future interest rate movements, and ination and associ-
ated risk premia. This is because investors in xed-income securities are
exposed to many potential risks, including business risk, interest rate
risk, unstable market conditions, purchasing power risk, foreign exchange
10. Types and Rationale of Primary Market Arrangements in 21 OECD

Countries, cited in Thailand country paper as coming from De Broeck et al.,
Theoretical and Empirical Analysis of the Structure and Functioning of Primary
and Secondary Markets for Government Debt in the OECD Countries.
Overview 125
risk, and risks specic to the issues themselves. Thus it is essential to

have market-based benchmarks, so that securities can be appropriately
priced, and investors can make sound decisions. In the US, xed-income
securities are priced against US Treasury securities, which are consider-
ably risk free. A margin to cover the credit risks and any other risks is
added on to the prevailing yield of such benchmark securities. Having a
credible benchmark yield curve also facilitates the development of hedging
and other portfolio management instruments, such as derivatives, futures,
and options. Government securities are usually the best securities to
form the benchmark yield curve, since they are virtually risk-free, but
governments should develop a whole spectrum of maturities. Many of
the ADCs in the study realize the importance of benchmarking, and
have in fact attempted to lengthen the maturities of their bonds, some to
as long as 20 years.
H. Interest Rate Structure
For the government bond market to ourish and set the standards
for the bond market as a whole, interest rates should be at or near the
market value. Hong Kong, China and Singapore, clearly the most devel-
oped of the ADCs, have embraced market direction. Singapore SGS T-bonds
o¬er coupon rates which vary according to market interest rate and tenor,
with maturities now moving out to 10 years. Positive yield curves pre-
vail most of the time. Hong Kong, China likewise provides a reliable
dollar benchmark yield curve, the credibility of which is based on the
exchange rate system under which the Hong Kong dollar is pegged to
the US dollar. The benchmark yield curve tracks closely that of US
Treasuries. In contrast, interest rates in the PRC continue to be regulated
by the authorities, although institutions had been given the exibility
of 20 percent over oating, according to risk, since 1998, which was
raised to 30 percent in 1999. Moreover rural bank cooperatives were
given a higher range of 10 percent to 40 percent. This authority was
only given to short-term loans, with mid- and long-term loans having to
adopt the regulatory xed interest rate.
The seven other ADCs recognize the importance of the develop-
ment of a benchmark yield curve. Indonesia uses the average time deposit
rate (for six-month tenor) as a basis for oating-rate bonds of state-
owned banks, with average spread between 100 basis points to 400 basis
points over the benchmark rate. The disadvantage, however, is that these
time deposit rates do not reect market interest rates. Likewise, the prac-
tice of rate di¬erentiation between small depositors and large institutional
depositors is discriminatory. Malaysia shows a transition in interest rate
levels, which, having experienced sudden hikes in 1997, gradually came

down. The prevailing Malaysian Government Securities yield curve is
positive, with a attening end at 13 years and above. In Thailand, a
proper benchmark did not evolve until 1999, because only synthetic
yield curves could be created from published forward and swap market
rates, the only information available. After 1998, however, information
on government bond auctions became available, facilitating the devel-
opment of a more e¹cient benchmark. The rst Government Bond Yield
Curve, based on weighted average of executed yields of government
bond transactions reported by the Thai Bond Dealers Club dealer mem-
bers, was developed in September 1998, aimed at facilitating pricing of
bonds in both the primary and secondary markets. The Republic of Korea
has used three-year corporate bonds guaranteed by nancial institutions
as the representative market yield. The market yield was directly a¬ected
by the currency crisis, and was at an average of 15.8 percent in 1998.
The Philippines recognizes that the government bond market has
to develop ahead of its corporate counterpart. A key milestone in govern-
ment bond market development has been the shift toward long-term tenor
and xed rates. The extension of maturity of Treasury securities is de-
signed to support benchmark securities that will form the long-term yield
curve. The benchmark security, the 91-day T-bill, is the most liquid, and
reects the market-determined yield at any point in time. The apparently
high premium as the tenor lengthens may, however, be attributed to the
tax-free status of ve-year T-bonds and their limited liquidity. Sri Lanka
reports that the average yields of Treasury bills in the primary market
have signicantly declined since 1997. The average yield of T-bills of
12-month tenor is 16.24 percent, reecting a real return of 4.64 percent
over ination. As for Taipei,China, government bond tenors have been
spread evenly across the maturity spectrum. With active trading of the
outstanding volume of government securities, a benchmark yield curve
could easily be established. The problem, however is that the quality of
the government bond yield curve is less than desirable, as commercial
banks tend to hold to maturity, and the small volume of remaining bonds
is likely to allow price manipulation. Market yields will thus lose their
benchmarking role.
I. Taxation
Among the particular incentives that ADCs provide for the devel-
opment of their bond markets are tax concessions, exemptions, holidays
and similar perks, especially to nonresident investors. Many ADCs have
observed that taxation policies have not been conducive to the devel-
Overview 127
opment of their bond markets, and would like to revise legislation in

the scal regime, such as taxes and related charges like stamp duty and
registration fees. Existing frameworks in a number of ADCs mean bonds
are subject to discriminatory taxation, resulting in disincentives to in-
vest in them vis-à-vis, for example, stocks. In economies where the tax
treatment of bond instruments (as to income or capital gains) is di¬erent
from stocks and other instrument, the after-tax risk adjusted return on
bond investment turns out to be uncompetitive with other investment
vehicles. In some ADCs, while there is no capital gains tax on equity
investments, and dividend income is taxed at low rates, capital gains
from bond trading are taxed at both the corporate and individual levels.
Also, some countries discriminate between foreign and domestic inves-
tors. Disparities between the treatment of bonds and other instruments
adversely a¬ect bond market development. ADCs should therefore take
measures to make their tax systems consistent with capital market devel-
opment. Singapore and Hong Kong, China have addressed this problem
in their own ways, with a view to actively encourage the development
of their bond markets.
J. Clearing and Settlement
ADCs have di¬erent levels of sophistication in terms of settlement

and clearing practices. Some countries have established securities de-
pository, settlement, and clearing mechanisms. A number of these were
established only in the 1990s, for example Hong Kong, China, 1994;
Indonesia, 1993; Philippines, 1995, and Thailand, 1994. The Ministry
of Finance of the PRC plans to establish a central depository, as does
the Central Bank of Sri Lanka.
K. Rating Agencies
The establishment of credit rating agencies in the ADCs has been

very recent in some, while others still do not have their own. Having a
local credit agency is not a sign of the level of advancement of their
bond markets, however. Hong Kong, China and Singapore, for instance,
do not have home-grown credit rating agencies, but utilize international
rating agenciesin Hong Kong, China Moodys, Standard and Poors
and Thomson Bank Watch have recently opened o¹ces. Taipei,China
does not have a local credit agency, but the PRC has, apart from two
approved agencies, around 50 rating institutions (rating provided by
accountants and consulting rms). The Peoples Republic of China,
Indonesia, Malaysia, Philippines, and Sri Lanka have all established their
own credit rating agencies between 1982 (Philippines) and 1999 (Sri
Lanka). Some have recently established second institutions.
L. Primary Market
The Government usually issues its securities to the investing pub-

lic through the Central Bank or the Treasury (in the Philippines). The
instruments are usually called Treasury bills, bonds, or notes, and repre-
sent sovereign obligations of the Government. Treasury bills are usually
short-dated instruments, coming in various tenors of less than one year,
some being expressed in number of days, (following the universal prac-
tice of ensuring that bills fall due on a business day), others in months.
Quotes for T-bills are either by yield rate (discounted) or by price based
on 100 basis points per unit. Treasury bonds are securities of longer
than one-year tenor, with yields equal to the sum of any discount or
premium, and coupon rate expressed as a percentage of face value on a
per annum basis. Many of the ADCs have started to lengthen the matu-
rities of their T-bonds to encourage the development of a yield curve.
The common issuance procedure is by auction, usually by elec-
tronic auction, with a network of government-authorized or -appointed
dealers or market makers, who try to outdo each others bids. An auction
process begins with the Central Bank or Treasury sending out a notice
of public o¬er to sell Treasury securities from the Secretary/Minister of
Finance, which sets out terms and conditions and rules and regulations.
Where electronic trading facilities exist, these notices are sent in elec-
tronically, and tenders are sent in by the authorized dealers from their
own terminals. Once an auction is successfully completed, notices are
also sent electronically, awards downloaded to the winning dealers prin-
cipals securities account, and a summary of auction results normally
prepared.
Private issues, or capital market issues, may be sold in the primary
market in one of two methods: underwriting or private placement. If
sold through the underwriting process, such primary issues are sold by
underwriters to their investor-clients. Private placements, on the other
hand, may take longer to complete, since the issuer negotiates with in-
vestors individually.
The 10 ADCs have varying levels of concentration insofar as the
corporate bond market is concerned. Hong Kong, China has the highest
proportion at 75 percent of total, with only 25 percent for government
bonds. Other countries with signicant corporate bond markets are Indo-
nesia, at 58 percent; Malaysia, 46 percent; Taipei,China, 34 percent; and
the Republic of Korea, 32 percent. Singapore has a larger government
Overview 129
bond market at 80 percent and 20 percent corporate, similar to that of

Thailand whose ratios are 78 percent for government, and 22 percent for
corporate bonds. The PRC and the Philippines have the smallest corpo-
rate bond markets, with the PRC at a ratio of 9 percent for corporate and
91 percent for government, and the Philippines with no domestic corpo-
rate bond market to speak of, since all of its market is in government
bonds.
M. Secondary Market
The secondary market for debt securities in the ADCs is an over-

the-counter system, with trades conducted through PDs and other licensed
securities dealers. For most of these economies, there is no real second-
ary market to speak of, because most investors, especially institutional
investors, tend to purchase securities and hold them to maturity. Some of
the ADCs still rely on a captive market. In the case of the PRC, inves-
tors are mostly private individuals who look on government securities
in the same way as savings deposits. The main reason for the snails
pace development of the secondary market in most of the ADCs, how-
ever, has been the absence of some important parameters found in the
thriving markets of the West, such as benchmark yields, accounting practices
such as marking-to-market, and e¹cient clearing and settlement systems.
Fiscal agents in a number of ADCs, notably Malaysia and Singapore,
limit dealers to a few large merchant banks, but require them to bid for
a high-minimum volume in every auction. Such a process enables deal-
ers to hold inventory and be positioned to make markets. Likewise, some
Central Banks have successfully used repo transactions as a monetary
tool to help develop secondary markets, although there are still prob-
lems that impede their active use (such as tax and regulatory di¹culties).
Some countries have tried to develop the secondary market through
the setting up of secondary market institutions (SMIs). An example of
this initiative is the Hong Kong Mortgage Market Corporation, estab-
lished in March 1997, on the premise that fertile ground exists for the
development of a secondary mortgage market. It was illustrated by the
increase in outstanding residential mortgage loans from 8 percent of
GDP in 1980 to 40 percent in 1998. A properly developed secondary
mortgage market can play a useful role in channeling long-term funds,
such as insurance and pension funds, to meet the rising demand for
long-term home nancing. The Philippines, which considers the provi-
sion of housing to its citizens as a major commitment, last year undertook
a series of round table discussions on how to encourage the development
of asset-backed securities, in particular mortgage-backed securities, and
held a Conference on Securitization in October 1999. Among the resolutions

of the conference was to endorse for legislative sponsorship a bill on
securitization that would provide for the creation of secondary mortgage
institutions and special purpose vehicles, with the private sector taking the
lead for the promotion of the organization of a proposed SMI.
Another challenge to secondary market development is the absence
of a formal organized venue for trading xed-income securities. Some
ADCs, notably Indonesia and Thailand, have initiated the establishment
of formal bond exchanges. This spurs bond market development by cre-
ating a unied venue for primary bond issuance and secondary trading.
BOX 2
The Hong Kong Mortgage Corporation
The Hong Kong Mortgage Corporation (HKMC), incorporated in

March 1997, is wholly owned by the Government through the Exchange
Fund. Its initial phase of development involved the purchase of mortgage
of loans for its own portfolio, and funded the purchase through the issu-
ance of unsecured debt securities. The second phase, which is now in
progress, involves the securitization of mortgages into mortgaged-backed
securities, and o¬ering them for sale to investors.
The HKMC has a mortgage portfolio totaling HK$11.4 billion (US$1.5
billion) as of 31 December 1998, 90 percent of which consists of oating-
rate mortgages and 10 percent of xed-rate mortgages. The HKMC has
very high selection criteria to ensure its mortgage portfolio remains of the
highest quality. The historical default rate is very low, in the last quarter of
1999 being reported as only about 0.07 percent.
The HKMC successfully issued a total of HK$5.2 billion (US$0.7
billion) of unsecured debt in 1998 through its HK$20 billion (US$2.6
billion) Note Issuance Program (NIP) and HK$20 billion (US$2.6 billion)
Debt Issuance Program (DIP), making it the second most active issuer of
Hong Kong dollar xed-rate securities for the year. On 22 October 1999,
seven outstanding issues of its notes were listed on the Stock Exchange of
Hong Kong Ltd. with an aggregate issue amount of HK$3.5 billion (US$0.5
billion). Issue maturities ranged from one-and-a-half to three years. HKMC
debt securities were well received by banks and institutional investors, with
the notes issued under the NIP being oversubscribed by 4.5 times. HKMC
papers are considered to be low risk as they are e¬ectively quasi-government
papers.
The HKMC intends to launch a multicurrency Medium Note Issu-
ance Program, and the inaugural issue of mortgage-backed securities.
Overview 131
VIII. Policy Recommendations
In most of the ADCs covered in the study, e¬orts to develop their

bond markets, particularly government bond markets, have been under-
way for some time, although with greater urgency since the Asian crisis.
For most of them, the factors which have inhibited the development of
their bond markets may be classied into two broad categories: those
which have to do with scal and monetary policy harmonization and
with regulatory aspects, and those which are related to market infrastructure.
A. Fiscal and Monetary Policies and Regulatory Aspects
In several countries, various aspects of scal and monetary policy

and the lack of harmonization among the authorities were cited as among
the di¹culties. Fiscal policy will always be concerned with balancing
the government budget, while monetary policy is concerned primarily
with stabilization.
Past scal policy had preferred to utilize foreign loans to cover
scal decits, particularly in Indonesia. At the other extreme, a strong
aversion to scal decits and adherence to a conscious policy of bal-
anced or surplus budgets had characterized the PRC, the Republic of
Korea, and the two most advanced ADCs; Hong Kong, China and Singapore
(which because of their strong economies were in surplus most of the
time). This was responsible for the late development of the government
securities market in the Republic of Korea, for example, where the cor-
porate bond market led the way. There are also discussions on which
government body should take charge of the issuance of government
debt. In most countries, this has been performed by the Central Bank,
for the scal authorities, but this has implications on the independence
of the Central Bank. In the Philippines, this became an issue which led
to the revision of the Central Bank charter, removing its scal agency
functions and transferring the responsibility for government securities
issuance to the Bureau of Treasury. This led to some areas of dissent as
regards interest rate policy (the Treasury understandably wants to keep
the rates down, while the Central Banks responsibility for stabilizing
monetary aggregates may not always agree with this). In some other
countries, the scal authorities have failed to have a regular schedule of
issuances. Whether a country be in decit, balance, or surplus, a regular
and predictable schedule of issuances is important for the development
of a government bond market.
The government should issue a policy statement that it commits
itself to bond market development. As earlier stated, it is necessary to
move beyond motherhood statements. Following that, scal and mon-

etary policies should be coordinated, rather than working at cross-purposes
(for example, in the case of the yields of government bonds, the scal
and monetary authorities may have di¬erent views on interest rates).
Tax issues also a¬ect the development of the government bond
market. Except for Singapore and Hong Kong, China, which have delib-
erately maintained investor-friendly taxes, most of the other ADCs have
tax distortions, which impede market development, particularly of the
secondary market. There are also tax arbitrage opportunities because of
di¬erential treatments among various types of instruments or investors
(individual versus institutional in the case of Taipei,China).
In terms of legal and regulatory frameworks, a number of the ADCs
need to review their existing laws and regulations. Even a relatively
developed country, such as Hong Kong, China, is reviewing its anti-
quated legal system, based on its historical ties with the UK, with a
view to creating a framework more appropriate to the times. The Philippines,
on the other hand, has impediments in some provisions of its Corpora-
tion Code, resulting in the invention of creative methods such as long-term
commercial paper which e¬ectively are bonds.
Another important aspect for the development of an orderly bond
market is the existence of an enforceable and consistent set of rules and
procedures with predictable results. Common to all these ADCs is the
aim of promoting sound business practices, which would protect inves-
tors, but rules and procedures vary among the countries reviewed. The
Asian nancial crisis clearly emphasized the need for good governance
practices among nancial institutions, corporations, and the public sector.
B. Market Infrastructure Impediments
Included here are issues relating to the primary market, secondary

market, benchmarking, hedging instruments, issuance procedures, clear-
ing and settlement, credit rating, investment constraints, and other aspects
that a¬ect market development.
Most important is the need to accept the market as the nal arbiter
of transactions, and thus foster healthy competition.
1. Primary Market
In the primary market, an important consideration is the develop-

ment of systematic auction schedules for government bond issues.
Comments were made in the various country papers about the need for a
regular, announced schedule so that investors could plan and better manage
Overview 133
their investment programs. Most of the countries have already started to

move away from the private placement or captive market system, and
have begun to use auctions of one method or another. It should be
recognized that auctions are the most market-oriented and competitive
method of bringing the government bond market to maturity.
Also pointed out were the limited varieties of instruments avail-
able. Issuance of government bonds with a broader range of maturities
would be an important step towards the development of a benchmark
yield curve. For the corporate sector, too, a greater variety of xed-
income instruments was suggested to t their business requirements and
the needs of investors.
The government has to take an active role in the primary market.
It has to ensure a steady supply of securities, regardless of its scal
position. Countries that have enjoyed steady surpluses have tended to
lag behind, and may rectify the situation by publishing a schedule of
o¬erings in the market. Similarly, campaigns are needed to increase pub-
lic awareness of investment in bonds as an alternative saving vehicle,
especially in remote areas where saving is considered synonymous with
bank deposits. The PRC, with its huge pool of savings has little choice
in the instruments that individuals may access. Another proactive measure
is to enjoin those ADCs which have no PDs as yet to set up a dealer
network of market makers. The Government should also ensure transpar-
ency in the allotment of o¬ers, while credit rating agencies are important
for corporate bond development.
2. Secondary Market
A major impediment to secondary market development in most of

the ADCs is lack of liquidity, seen to arise from such factors as the lack
of market-making mechanisms, undeveloped technological infrastructure
in the Central Bank/Treasury, and the inability to access information.
Nontransparency has led to moral hazards, and creates inequitable premia
across instruments and investors.
It was noted, however, that the ADCs have moved to address some
of the constraints relative to secondary market development by estab-
lishing, among others, primary and secondary market dealers, bond
information exchanges, and electronic trading systems. Some have moved
faster in this respect, in particular, Hong Kong, China and Singapore,
but Thailand has also established a system that provides broad, easily
accessible coverage of market information obtained from the reports of
the dealers. The other ADCs need to improve the repo market to gener-
ate greater liquidity, and also enhance the retail base.
3. Benchmarking
The need to develop an appropriate benchmark was emphasized

consistently. A benchmark security is a government security of a certain
tenor that is so liquid that it has a market-determined yield at any point
in time. Without a true yield curve, there cannot be an active, liquid
discount or quote-driven market for securities. A su¹cient volume of
government securities with various tenors should thus be available to
ensure a true yield curve across a spectrum of maturities. Countries with
histories of balanced or surplus budgets would have to drop their aver-
sion to issuing government securities, and provide a schedule of issuances
so that such a benchmark yield may be generated.
4. Hedging Instruments
The derivatives market and hedging instruments are necessary tools

to stimulate bond markets. Among the products in this market are inter-
est rate options, futures, swaps, etc. With the use of derivative products,
some types of risks may be segregated and transferred among market
participants. Speculation need not necessarily be a bad word, as bank-
ing or hedging on future developments is really part of a healthy and
robust market, but the appropriate regulatory structure, transparency, and
information should clearly be in place for the protection of investors.
5. Market Participants
Sparse participation in the secondary market is common among

most of the ADCs. Most have relied on institutional participants, but
participation in the bond market is still somewhat constrained. For some,
the reason has been investment restrictions (pointing again to the need
to look at certain regulatory aspect, such as constraints on the types of
investments that insurance companies may get into). Likewise, there is a
need to encourage retail or individual participation. Some have opened
up portions of their auctions to individual participants. There may also
be a need to look at nonbank nancial intermediaries (such as develop-
ing mutual funds so that small investors can participate in the market).
6. Clearing and Settlement Mechanisms
Many of the countries covered do not yet have well-functioning

clearing and settlement mechanisms, although a few have started to set
up their own, which have still to be improved upon. The Philippines,
Overview 135
Thailand, and Malaysia, to cite a few of the middle-developed countries

in the study, have instituted registers for scriptless securities and meth-
ods of settlement on a real-time basis (still at initial stages). It is, however
clear that a more e¹cient and reliable clearing settlement system that
incurs minimal cost should be developed, as well as integration of trad-
ing, clearing, and settlement procedures.
7. Credit Rating
An important feature of developed bond markets is the existence

of credible rating agencies, that provide investors with an objective and
impartial opinion on the credit quality of debt issues. Many of the ADCs
have already taken the necessary steps to set up domestic rating agen-
cies, but these need to be upgraded to international standards. The need
for credit rating agencies has also been recognized by the more ad-
vanced countries in the study, i.e. Hong Kong, China and Singapore,
which utilize international agencies and have not put up their own.
Perhaps the most important lesson to be learned from two of the
fastest-growing bond markets in the study is the active espousal of the
governments of Hong Kong, China and Singapore of private sector free-
dom. Hong Kong, Chinas policy of positive noninterventionism has
provided a free, open, and competitive environment in which business
can ourish. Minimum intervention, however, does not mean that the
Government merely sits back as the private sector does its own thing.
The Government provides the necessary infrastructure and a stable legal
and administrative framework. Moreover, it has implemented a set of
prudent scal, monetary, and regulatory policies designed to enhance
growth. Singapore is keen to develop itself as an international debt cen-
ter in Asia. Towards this end, it has undertaken a program of major
reforms starting 1998/99, ranging from increasing the issuances of SGS
to concessions for foreign institutions doing business in Singapore, and
tax incentives to encourage debt origination and trading of securities in
Singapore, as well as other forward-looking changes to enable the devel-
opment of the secondary market.
BOX 3
Bond Market Reforms in Singapore (19981999)
Reforms Implemented
Singapore Government Securities Market
Increased Singapore Government Securities (SGS) issues (1998/99)
Announced regular calendar of issues (July 1998)
Issued 10-year SGS (January 1999)
Statutory Board Bonds
Jurong Town Corporation bond issues (1998/99)
Housing and Development Board (HDB) bond issues (1999)
Land Transport Authority bond issues (1999)
MAS Notice 757Non-Internationalization of S$ (1998)
Allowed foreign entities to issue S$-denominated bonds (1998)
Allowed banks to transact S$ repo of up S$20 million with nonbank
nonresidents (1998)
Removed S$ repo limit
Allowed banks to transact S$ currency and interest rate swaps with
special purpose vehicles for securitizing mortgages
Central Provident Fund (CPF) Investment Scheme (1998)
Allowed CPF Unit Trusts to invest in high-grade bonds
Tax Incentives (1998/99)
Introduced tax incentives to encourage debt origination and trading of
debt securities in Singapore
16 nancial institutions accorded Approved Bond Intermediary status (1999)
Reforms to be Implemented
Promote Asset-Backed Securities market
Resolve legal and regulatory issues relating to asset-backed securities
HDB may issue mortgage-backed securities
Introduce regulatory guidelines for underwriters and dealers and trading
rules for debt securities
Develop e¹cient clearing system for corporate bonds
References
Country Papers
Development of Government Bond Markets in ADCsHong Kong, China

Development of Government Bond Markets in ADCsIndonesia
Development of Government Bond Markets in ADCsRepublic of Korea
Overview 137
Development of Government Bond Markets in ADCsMalaysia

Development of Government Bond Markets in ADCsPeoples Republic of China
Development of Government Bond Markets in ADCsPhilippines
Development of Government Bond Markets in ADCsSingapore
Development of Government Bond Markets in ADCsSri Lanka
Development of Government Bond Markets in ADCsTaipei,China
Development of Government Bond Markets in ADCsThailand
Other References
ADB, Promoting Financial and Capital Market Development, Voluntary Principles

and Collaborative Initiatives, A Background Paper on the recommendations
of the Asia-Pacic Economic Cooperation (APEC) Finance and Central
Bank Deputies for the Fourth APEC Finance Ministers Meeting, 46 April
1997.
ADB, Creation of Market Based Financial Structures and Policy Instruments to
Facilitate Increased Capital Mobility in the APEC Region, November 1997.
ADB, Capital Market Development in the Asia-Pacic Region, Summary of Pro-
ceedings and Papers Presented at a Symposium held on 1416 January
1986, in Manila, Philippines.
Batten, Jonathan and Yun-Hwan Kim, Expanding Long-Term Financing Through
Bond Market Development: A Post Crisis Policy Task, Paper presented at
the ADB Conference on Government Bond Markets and Financial Sector
Development in ADCs, 2830 March 2000.
IMF, Annual Report 1998.

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Part 2

Overview and Country

For most of the Asian developing countries (ADCs) included in

II. Rationale for the Development of Bond Markets

The rationale for the development of a bond market rests on the

to short-term foreign exchange debt while funds were being used to

A. The Importance of Developing Bond Markets in Asia

Bond market development is important to ADCs for several reasons.

 First, it helps to diversify the sources of industrial and infrastructure

3. These two contrasting theories are ascribed to Professor Paul Krugman

Asian countries. Development of the bond market will contribute to

B. Role of Government Bond Market in Developing Overall Bond Markets

A treasury securities5 market can play a critical role in stabilizing

 First, a government may use a treasury securities program to nance a

5. In this paper, treasury securities refer to treasury bills of short-term

and nance ministry, investors will have condence in the interest

C. Role of Government Policy in the Development of Bond Markets

A sound macroeconomic environment, characterized by prudent s-

III. Fiscal Policy

Fiscal policy in the ADCs has usually been approached in the

nomic policy is achieved through various interagency committees. Sri

On the other hand, middle-level ADCs have been plagued with

IV. Monetary Policy

The choice of monetary policy stance, and monetary policy instru-

As nancial regimes have become more open and deregulated in

Monetary policy in Indonesia is implemented by Bank Indonesia

Meanwhile, in the Peoples Republic of China, monetary policy is

V. Regulatory, Supervisory, and Institutional

Apart from sound macroeconomic, scal, and monetary policies

7. ADB, Promoting Financial and Capital Market Development, Voluntary

and therefore provide little attraction. Disparities in the tax treatment of

As regards credit rating, it is important to have credible and inde-

VI. Overview of Bond Markets in the ADCs

Since the onset of the Asian nancial crisis, a major sea-change

In recent years, several Asian Developing Countries have established

led to a di¬erent view of budgetary decits as a means by which gov-

A. Government Bond Market in ADCs

The infrastructure of the market for government securities includes:

9. Batten, Jonathan and Yun-Hwan Kim, Expanding Long-Term Financing

subscription, private placements, underwriting and organized auctions.

Governments should schedule issuances in appropriate amounts so

B. Corporate Bond Markets in ADCs

Except perhaps for the Republic of Korea, corporate issuances in

variety of instruments that corporations could use, such as secured bonds,

ADC bond markets are composed of both government and private

D. Size of Domestic Bond Markets

Total Bond Market Composition (percent)

Note: n.a.  not available

Total Percentage of Total Financial Assets

China, Peoples Rep. of 151 15 1 9 75

Note: n.a.  not available

Institutional investors are the major investors in Hong Kong, China;

Di¬erent countries have various means of issuing their securities

Benchmarks play a crucial role in developing securities markets.

10. Types and Rationale of Primary Market Arrangements in 21 OECD

risk, and risks specic to the issues themselves. Thus it is essential to

H. Interest Rate Structure

levels, which, having experienced sudden hikes in 1997, gradually came

First, it helps to diversify the sources of industrial and infrastructure

First, a government may use a treasury securities program to nance a

and nance ministry, investors will have condence in the interest

A sound macroeconomic environment, characterized by prudent s-

As nancial regimes have become more open and deregulated in

Meanwhile, in the Peoples Republic of China, monetary policy is

Apart from sound macroeconomic, scal, and monetary policies

Since the onset of the Asian nancial crisis, a major sea-change

led to a di¬erent view of budgetary decits as a means by which gov-

Note: n.a. not available

China, Peoples Rep. of 151 15 1 9 75

Note: n.a. not available

risk, and risks specic to the issues themselves. Thus it is essential to

In several countries, various aspects of scal and monetary policy

move beyond motherhood statements. Following that, scal and mon-

Development of Government Bond Markets in ADCsHong Kong, China

Development of Government Bond Markets in ADCsMalaysia