FINAL TERM PAPER BOND MARKET IN NEPAL: IMPEDIMENTS TO GROWTH COMPARED TO BANK FINANCING (LOANS)

Submitted to: Mr. Sabin Bikram Pant, Course Instructor: Investment Management, Kathmandu University School of Management

Submitted by: Group 4 Shivshankar Yadav (12336) MBA, Term-IV May 30, 2013

Copy right 2013

All rights reserved. This report is exclusively a property of students of KUSOM and the school reserves all the rights. The report is authorized from KUSOM and any act of piracy will be subject to legal issue. No part of this report shall be transmitted, in any form or by any means, or reproduced without prior permission from the University. Any unauthorized use or copy of this report is strictly prohibited. Authors Manita Pokharel (12324) Murary Prasad Roy (12325) Nikkey Shrestha (12330) Shivshankar Yadav (12336)

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Acknowledgement
We express our sincere gratitude to our course instructor, Mr. Sabin Bikram Pant, for the continuous guidance, encouragement and valuable supervision in the completion of this report. We are thankful for providing us with insight on such an important topic that is useful not only for our study but also for understanding the Nepalese bond market from various perspectives. We are also highly grateful to the Director of Public Debt Management Dr. Gopal Prasad Bhatt for the time and information which has been highly useful for our study. We are highly indepted to all those supports from experts like Mr. Deepesh Vaidya( Kritika Capital) , Mr. Srijesh Ghimire (NMB Bank), Mr. Sudip Khanal (Nepal SBI Bank), Mr. Ishwori Prasad Rimal( President, Nepal Stock House), Mr. Bhawaneshwor Yadav (Manager, Agrawal Securities), Mr. Shalikram Adhikari (CEO, Ashitosh Brokerage Securities Pvt. Ltd.), Mr. Ashok K. Jha ( Shilpa Securities Pvt. Ltd.), Sunil Pokharel ( NIC Bank), etc. without whom this report would not have been accomplished. We are thankful to all those who directly and indirectly supported in our study by providing us with the valuable information, time and guidance. Date: 1st June, 2013 Sincerely, Manita Pokharel (12324) Murary Prasad Roy (12325) Nikkey Shrestha (12330) Shivshankar Yadav (12336)

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Table of Contents
Copy right 2013 ......................................................................................................................................... ii Acknowledgement ....................................................................................................................................... iii Executive Summary .................................................................................................................................... vii Chapter One .................................................................................................................................................. 1 Introduction ................................................................................................................................................... 1 Background of the Project ........................................................................................................................ 1 Problem Statement .................................................................................................................................... 1 Objectives of the study.............................................................................................................................. 2 Limitations of the study ............................................................................................................................ 2 Research Methodology ............................................................................................................................. 3 Literature Review...................................................................................................................................... 3 Chapter - Two ............................................................................................................................................... 6 Bond Market in Nepal ................................................................................................................................... 6 Introduction to Bond ................................................................................................................................. 6 Development of bond market in Nepal ..................................................................................................... 8 Government Bond in Nepal .................................................................................................................. 8 Current Situation of Nepalese Bond Market ........................................................................................... 11 Constraints on Development of Nepalese Bond market ......................................................................... 12 Chapter - Three ........................................................................................................................................... 14 Comparative Analysis ................................................................................................................................. 14 Bond Vs. Bank Loan ............................................................................................................................... 14 Comparative Analysis between different countries and Nepalese Bond Market .................................... 16 Bond Market of South Asia ................................................................................................................ 16 Bond Market of India .......................................................................................................................... 19 Bond Market of Bangladesh ............................................................................................................... 22 Chapter - Four ............................................................................................................................................. 24 Findings and Analysis ................................................................................................................................. 24 Quantitative analysis ............................................................................................................................... 24 Government development bond Yield curve ...................................................................................... 24 iv

Corporate bond Yield curve ................................................................................................................ 25 The Credit Spread ............................................................................................................................... 26 Chapter Five ............................................................................................................................................. 28 Findings and Analysis ................................................................................................................................. 28 Qualitative Analysis ................................................................................................................................ 28 Academician Perspective .................................................................................................................... 28 Bond Brokers Perspective.................................................................................................................. 28 Issuers Perspective on Bond Market.................................................................................................. 30 Public Debt Departments Perspective ............................................................................................... 31 Chapter Five ............................................................................................................................................. 33 Measures to Develop Bond Market ............................................................................................................ 33 How to Propel the Bond Market ............................................................................................................. 33 Recommendations ................................................................................................................................... 35 Role of NRB and SEBON................................................................................................................... 35 Role of institutional investors ............................................................................................................. 36 Role of Banking and Financial Institutions......................................................................................... 36 Role of investor ................................................................................................................................... 37 Chapter - Six ............................................................................................................................................... 39 Conclusion and Lessons Learnt .................................................................................................................. 39 Conclusion .............................................................................................................................................. 39 Lessons Learnt ........................................................................................................................................ 39 References ................................................................................................................................................. 1 Appendix ....................................................................................................................................................... 2

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Executive Summary
In a country like Nepal, the bank financing (loans) plays a much important role than the debt instruments like bonds. For the development of any national economy, the real sector development is very essential and for this different kinds of financial instruments are developed. As one of the popular debt instruments in the developed nations, bonds play a very important role in developing diversified investment environment which can act as a cushion against risk from the concentration in the bank loans and equity market. The Nepalese bond market is not well developed and the investors and borrowers still prefer bank loans against the bonds. Even within the bond market, the government bond composes higher proportion than that of corporate sector. The corporate sectors, public regulatory sector (NRB), brokers and other experts hold different views regarding the lack of incentive for bond market growth and development. Compared to some of the developing countries in South Asia, the bond market of Nepal is yet to develop in terms of investor awareness, proper implementation of regulatory framework, integration of efforts for bond market development among the regulatory body, issuers and traders. Even within the corporate bond issuers, the banks and financial institutions are the major players and this can create yet another concentration risk for the investors. The development of bond market is yet a long path to follow, but the progressive steps need to be taken by various sectors: regulatory bodies, potential issuers and the investors. The challenges for bond market can be tackled through steps in the forms of improvement in the public awareness, encouragement to the issuers for bond market development, proper implementation of the regulatory framework, support from the traders and building confidence about the security of the investments in bond market. The development and growth of bond market needs lots of exercise from every related sector.

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Chapter One Introduction

Background of the Project
The Financial Market is a specialized market that is responsible for channeling financial resources from the surplus units (savers) to the deficit units (those who needed additional funds) to carry out some form of economic activities. Financial markets play an important role in the mobilization of financial resources for long term investment through financial intermediation. A well functioning financial market allocates the resources and improves the efficiency of financial decisions that leaders to the better allocation of resources. When we talk about Nepal, the financial market is largely dominated by bank and other financial institution. The Nepalese financial market is largely concentrated on the equity and loan financing. The bond market which comprises of the government and corporate bonds covers a very small portion of the market. Although the issuance of bonds is feasible and beneficial for the organizations, the growth and development of the Nepalese bond market is in a slow pace. This project focuses on the current scenario of bond market in Nepal and the reasons behind preference of bank loans rather than debt instruments like bonds. Also, the challenges for the development of bond market are explored through the qualitative and quantitative analysis. The understanding of the hindrances have helped generate some suggestions for the various related sectors like regulatory bodies, issuers, investors and traders so that they can contribute to the growth of bond market in Nepal.

Problem Statement
A Bond market is one of the mechanism used to trigger economic development in any country. Nepal bond market is lagging behind showing its negligence presence in securities market. There are alternate source of funding used to raise capital by the companies and government offices. Here, the study group tried to find out why bank loan is preferred against bond issuance.

Objectives of the study

The study of Nepalese bond market has been conducted with the following objectives: To know the current situation of bond market and the steps taken for development. To understand the challenges for growth of Nepalese bond market. To analyze the bond market in comparison to the bank loans as well as well as the bond market in some South Asian nations. To get an overview of why Nepalese bond market is lagging behind by exploring perspective of players in Bond market. To make recommendations for the development of the bond market based on research findings and understanding of the Nepalese bond market.

Limitations of the study

There are certain limitations of the study among which some of the important ones are as following: The yield curve generation is based on the issue date rather than current date because of the lack of trading of bonds in secondary market. The qualitative analysis can be biased as it is based on the view of certain experts and traders which can be based on certain factors and beliefs about the market. The lack of adequate data from relevant source can also make some differences in the interpretation of the study. Nepalese bond investors are not much active and thus the study group was unable to take their opinion. For comparative study of bond market, the study group selected India, Bangladesh and South Asian perspective because of similarity in economy, investors base and geographical proximity. The study group does not considered countries beyond South Asia. The study group could not access the reliable source for getting data on Bangladesh Bond market, thus its comparative analysis is qualitative.

Research Methodology
The study group used both primary and secondary source of data to prepare the report. First secondary data were collected and studied to develop conceptual framework of the study and scope the study. After determining the scope of the study, primary data were collected i.e. the study group set open ended questionnaire (shown in Appendix: 1) for structured interview with bond brokers and corporate officers. Around 50% of the total bond brokers in Nepal were interviewed to understand the bond market from active market players perspective. Similarly, in order to understand reasons behind why bond market is not preferred in context of bank financing by companies in Nepal, the study group took interviewed Mr.Sudip Khanal, CA and Auditor, Nepal SBI bank; Srijesh Ghimire, NMB Bank and Dipesh Baidhya, Kritika Capital. In order to have roles and activities undertaken by regulatory body, the study group also interviewed Dr. Gopal Prasad Bhatt, Director of Public debt department, Nepal Rastra Bank. The study has been supported by secondary data such as research articles, newspaper clippings, bond data from NEPSE and SEBON, website materials, books, etc. This study is mainly descriptive in nature i.e. analyzing the views and opinions of concerned people in Nepalese bond market. It also includes quantitative analysis to support qualitative perspective of bond market. Finally, based on the findings and analyses, recommendations have made.

Literature Review
Bonds are mostly fixed-income capital market securities and one of the popular debt instruments. This study has been conducted with the objective of understanding the current situation and challenges for the Nepalese bond market through the perspective of issuers, traders and experts in the financial market and comparison with some of the countries in South Asia. Bond markets play an important part in diversified financial systems by linking borrowers that have financing needs with investors that are willing to place funds in interest-bearing securities (Sophastienphong, Mu, Saporito, 2008). The bond market not only serves particular borrowing needs efficiently but also helps in effective functioning of the financial market (Vaidya, 2010). Also, it is considered that a developed bond market will help reduce the concentration on banks and financial institutions for fulfilling the financial needs of the borrowers.
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In context of Nepal, bonds are largely inactive and occupy lesser portion of the total capital market. Bonds (government and corporate) constitute of 12.76% of the paid up capital of listed securities; equity being the highest in proportion (87.23%) and remaining in mutual funds (0.00583%) and preferred stock (0.00093%), (NEPSE, 2013). With high concentration of banks and financial institutions in financing the debt needs, the importance of bond market is even more eminent considering the need to invest for infrastructure development projects like hydropower, real estate, construction, transportation, etc. (Vaidya, 2010) The Nepalese bond market is growing very slowly and this can be attributed to various factors. According to a study of World Bank, the Nepalese bond market development has not been regarded as a top priority due to the civil unrest dominating policy makers concerns. (Sophastienphong, Mu, Saporito, 2008). The challenges for the bond market in Nepal is due to the factors like: shallow bond market, political situation and volatile economic environment, inadequate regulatory environment, Absence of money market, lack of institutional investors, absence of sufficient reliable data to build yield curve, absence of specialized market intermediaries, differential taxation in interest, lack of investors education, high cost of trading and high trading lots. (Vaidya, 2010) Comparatively, the South Asian corporate bond market (focus on ASEAN nations) has undergone significant changes in the aftermath of 1998 Asia financial crisis. Apart from the bond markets of Singapore which is already one of the Asias international financial centres, Malaysia has been successful in deepening the domestic bond markets and in further strengthening their equity markets, making them more internationalised than others in the region (Shimada & Yang, 2010). But the countries with similar economies like India, Sri Lanka, Pakistan and Bangladesh are yet to develop the bond market further, among them India being the one with most developed market. The factors like legal and regulatory framework, market infrastructure, lack of proper price mechanism, small investor base, lack of foreign investment, etc. have been lagging in the development of bond market in those countries. (Sophastienphong, Mu, Saporito, 2008). The development of Nepalese bond market can be initiated through the efforts of all the stakeholders of the capital market to increase breadth and depth of the market (Vaidya, 2010). The development of the bond market needs can be done in terms of improving money market,

improving market infrastructure, enhancing corporate governance through better regulatory framework, etc. (Sophastienphong, Mu, Saporito, 2008).

Chapter - Two Bond Market in Nepal

Introduction to Bond
A bond is a long-term contract under which a borrower agrees to make payments of interest and principal on a specific date to the holders of bond. Generally investors have many choices while investing in bonds. However, bonds can mainly be classified into four types namely Treasury bonds, Corporate bonds, Municipal bonds and Foreign bonds. Treasury bonds, also called government bonds are issued by federal government. It is assumed that government bonds have not default risk but it is not free from interest rate risks. Corporate bonds as the name implies are issued by corporations. Unlike treasury bonds, corporate bonds are exposed to default risks. Municipal bonds are issued by state and local government and are also exposed to default risk. Foreign bonds are issued by foreign governments or foreign corporations. Foreign bonds are exposed to default risk and in addition the risk exists if the bonds are denominated in a currency other than that of investors home currency. All these bonds are generally traded in a market which is called bond market. Features of Bond The basic features of bond are as follows:Maturity Date It is the date at which bond matures and holder receives the final payment of principal and interest. As per the CFA institute, there are three classes of maturity namely short term maturity (one to five years in length), intermediate term maturity (five to twelve years in length) and long term maturity (twelve or more years in length). Par Value/ Face Value Par value is the stated face value of the bond. It can be any amount but is typically $1,000 per bond. Coupon Rate

Coupon rate states the interest rate the bond will pay to the holders each year. To find the coupon amount, coupon amount is multiplied by the par value. Generally, the higher the rate, the less price sensitivity for the bond price because of interest rate movements. Importance of Bond Market Bond market is essence to accelerate any nations economy. The significance of bond market to its participate are as follows: Importance of Bonds to Investor Bonds pay interest semiannually and thus is considered to provide a predictable income stream. Generally the people invest in bonds for the expected interest income and also for preserving their capital investment. The bonds play major role in the in diversifying the investment portfolio for attaining the financial objective. Importance of Bonds to Corporation At some point the company faces the situation where it has to generate the fund in order to finance the new project or a plant expansion. Notes payable, leasing and the issuance of common shares are few methods of generating the funds. Notes payable and leasing does not help in generating huge money, as they involve finding individuals, companies or financial institutions who are willing to supply the needed funds. Issuing stock allows the share holder a certain measure of control, which not be in the interest of corporation. The other advantage is that the interest on bonds is deductible on the corporations income tax return. Hence, corporation issue bonds. Role of Bond Market in the Economic Development The development of bond market facilitates transparency i.e. pushing companies to disclose in public markets and forcing them to better understand themselves. It provides a competitive platform and thus demanding for effective management and practicing financial discipline. The development of bond market would serve investors with investment choice i.e. investing in bond or deposit in bank. It reduces the dominance of banking sector in Nepalese capital market i.e. creating competition between bond market and local banking. Bond market would promote efficient diversification and protects the investors from concentrated financial markets securities.
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It reduces reliance on and exposure to the banking sector in case of future shocks. It enables the allocation of available funds in the economy to the most productive uses i.e. funding essential economic activity such as funding of either ongoing general purpose business needs, or specific projects for innovation, investment, or growth by companies.

Development of bond market in Nepal

The floatation of shares by Biratnagar Jute Mills and Nepal Bank Ltd. laid the foundation for the development of securities market in Nepal. The government issued bond in 1964 for the first time in Nepal and it carried 6 percent rate of interest and had the maturity period of five years (shrestha, 2038). The transaction in secondary market begun at NEPSE in 15th December, 2006. During the mid early 90s, Nepalese economy faced high liquidity and government securities not sufficient to mop up the excess liquidity. Therefore, NRB issued bond in the name of NRB Bond for the first time in December 31, 1991. After the liquation was controlled, NRB bond was completely phase out in Nepal from April 1, 1998. Government Bond in Nepal The bond market in Nepal has not been developed much. Even the existing bond market is largely concentrated in the government bonds. The government bond is issued by Nepal Rastra Bank and traded in NEPSE (secondary market). The government bonds issued in Nepal are categorized under five types: Development Bond (DB), Citizen Saving Bond, Foreign Bond, Special Bond and National Saving Bond. The government bonds that are listed in the NEPSE along with the paid up capital are given as following: S.No Name 1 2 3 4 5 6 Bikas Rinpatra 2072 Bikas Rinpatra 2075 Bikas Rinpatra 2075 'ka' Bikas Rinpatra 2076 Bikas Rinpatra 2076 "ka" Bikas Rinpatra 2076 "Ga" Quantity 7500000.00 12000000.00 21000000.00 22000000.00 9000000.00 4600000.00
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Paid Up Value 100 100 100 100 100 100

Amount 750000 1200000 2100000 2200000 900000 460000

7 8 9 10 11 12 13 14 15

Bikas Rinpatra 2076 "kha" Bikas Rinpatra 2072 "ka" Bikas Rinpatra 2071 "ka" Bikas Rinpatra 2071 "Kha" Bikas Rinpatra 2073 "Ka" Bikash Rinpatra 2069 Bikas Rinpatra 2072 "kha" BIKAS RINPATRA 2072 "GA" BIKAS "GHA" RINPATRA 2072

10400000.00 15000000.00 20000000.00 30000000.00 27500000.00 15000000.00 25500000.00 49909000.00

100 100 100 100 100 100 100 100 100

1040000 1500000 2000000 3000000 2750000 1500000 2550000 4990900

30000000.00 50000000.00 35000000.00 2071 65000000.00 449,409,000.00 100 100 100

3000000 5000000 3500000

16 17 18

BIKAS RINPATRA 2071 "GA" Bikas Rinpatra 2070 "Ka" BIKAS "GHA" Total RINPATRA

6500000 44,940,900,000

Source: NEPSE, NRB Among the different types of bonds issued, the development bond is the most popular form of government bond and the foreign bond is the least popular one among the four types of bonds. Even the listed securities compose of the development bonds only. The trading of those bonds occurs very less due to which the yield curve generation and price discovery is a difficult process. The proposed and issued amount of the treasury bills and other long term government bonds as of the year 2068/2069 B.S. is as following: Rs. In Billion TB DB CSB Foreign Bond Proposed Amount
9

National Saving 5.00

Total

16

14

1.41

1.00

37.41

Issued Amount Issued % Source: NRB

17.283425 14

0.126566 .00866

5.00

36.418651

108.02%

100% 8.98%

0.866%

100%

97.35%

As given in the table, the treasury bills are oversubscribed and the citizen saving bond and foreign bond are undersubscribed. The unsubscribed amount of the citizen savings has been transferred to the treasury bills. Even though the development bonds are traded in listed secondary market, there is still no market for treasury bills. The treasury bills are traded among the parties that determine the interest rates themselves and then inform to NRB. The lack of secondary market for such money market instrument is also one of the impediments for the development of bond market in Nepal. The Treasury Bills still composes of the largest proportion (63.8215%) in the government debt issued to public and others. The bond is yet to be popular among the investors. The development bonds are the most issued long term bonds (27.8898%) as they have provision of trading in the secondary market. Total Government Bonds and Treasury Bills (Rs. in Billion, as of Ashadh end, 2069 B.S.) S.N. 1 2 3 4 5 6 Bonds Treasury Bills Development Bonds Citizen Savings Bonds National Savings Bonds Special Bonds Foreign Emp. Bonds Total Amount 131.624107 57.519400 4.1231 15.680000 0.157600 0.016040 209.1202 Percentage 63.8215 27.8898 2.3029 5.9058 0.0764 0.0036 100.00

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This shows that there is lot to be improved in the government bond sector too. The public awareness about the existing bond alternatives and their benefits is a must. Without making them aware, even the secure government bonds are not preferred in the market. Also, the secondary market for those bonds needs development. Only development bonds are being traded in the secondary market. The secondary market of Treasury Bills as well as the long term bonds should be developed for the improvement of liquidity improvement.

Current Situation of Nepalese Bond Market

The bond market in Nepal is relatively undeveloped where only a tiny corporate bonds and government bonds are under operation. The prices of these bonds are not market oriented i.e. not traded in secondary market. Currently, Nepal Rastra Bank issues five types of bond to meet short and long term needs of funds. These instruments are: Development bond, National Saving bond, Citizen saving bond, Foreign employment bond and Treasury bond (of 28, 91,182 and 364 days). Besides these government securities some corporate bonds are also issued to fulfill various long term financial needs. According to current data of NEPSE in 2012, total listed governments development bond is 18 amounting NPR 44940.90 million where as corporate bond is 16 amounting NPR 6275 million. See Appendix: 3. There are almost six million units of bonds listed at NEPSE but never traded. The absence of such trading has not only marred the prospect of bonds for small investors but also made difficult the actual valuation of bonds in market.

As of 2012, the government bond constitutes the majority with 88% of the total bond issued whereas the remaining 12% is issued by corporate sector. Within the corporate sector also, the majority is dominated by the commercial banks. This is because, banks seeks to increase Tier II ratio to maintain the capacity of extending loan. Moreover, the total bond to GDP ratios is 3.29% where as 31.7% for stock market capitalization to GDP ratio. Currently, stock market captures 92% of total security market in Nepal. See Appendix: 3 These above figures demonstrate that the size of capital market is relatively very small as compared to the stock market in Nepal.

Further, the rate of return on corporate bond is now in increasing trend than earlier days. According current data of NEPSE, rate of return on Nepal SBI bank rinpatra 2078 is 12.5%, on SBL debenture 2075 is 11% and 10% on Global bank ltd debenture issued in 2068-2070 as
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compared to 8% on Nepal Bidhut pradhikaran rinpatra 2069, 6% on BOK rinpatra 2069, and 6% on Nepal Investment bank bond issued in between 2062-2065. This inclines in rate of return may light the candles in the capital market of Nepal. Due to such increment in rate of return and some kind of public awareness of bond, in fiscal year 2012-2013, the amount of corporate debenture issued in the capital market is almost double the initial public offering (IPOs) held in fiscal year 2012-2013 compared to 2010-11 and 2011-12. See Appendix. 3
3.5 3 2.5 2 1.5 1 0.5 0 2010-11 2011-12 2012-13 0 1.78 1.3 1.2

IPO vs Debenture issue (Rs in billion)

1.97

2.9

IPO Size Debenture amount

Constraints on Development of Nepalese Bond market

Nepalese bond market has tiny operation and the factors hindering Nepalese bond market development factors are: Low Demand Nepalese bond investors comprises of 70% of private investors mainly insurance companies and remaining public investors. Lack of public awareness has negative influence over the development of Bond market. It affects the demand and acceptance of the product in the market. The issuer on bond may get de-motivated due to market acceptance risk and affecting reputation of the company if bonds are undersubscribed. Thus, inadequate supply base and low demand for the product create challenge in bond market growth. Volatility The volatility in share markets influences the investors perception. Such volatility can lead to a general erosion of investors confidence and flow capital away from share market as well as adversely affecting investment decisions in bond market.

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Capital Gain The Nepalese investors seeking for capital appreciation rather than fixed flow of income tends to prefer stock market. Unlike bond market, stock market is more liquid and has wide coverage. Alternative sources of debt financing The corporate house and listed companies in Nepal seek alternate source of debt financing i.e. borrowing from commercial bank to design their capital structure. Such tendency discouraged issuer from entering into bond market incurring relatively high cost. For instance, the number of banks form syndicate for financing large projects of companies. Borrowing companies find such source of funding cheap as well as flexible and tailor made. As a result of which, the corporate bond are less attractive to them. Illiquid Secondary bond market The trading of bond in secondary market is negligible creating liquidity problem for bond investors. This phenomenon discourages investors and thus acts as constraint in development of bond market. High transaction cost of bond issuance The transaction cost of bond is relatively higher than stock issuance due extra cost of annual trustee fees and promotion cost is also high because of lack of public awareness. Disclosure There are big corporate house such as Chaudhary Group, Khetan group, etc. The unwillingness of such companies to meet the disclosure requirements for listings on the exchange has reduced the supply of the corporate bonds. Yield Curve One of the limitations why government bond is lacking efficiency is inability to develop proper yield curve. An yield curve for government bonds facilitates government debt management as well as development of corporate bond too. Political Instability and Unpredictable macroeconomic environment Political instability is one of the factors leading to low confident and distrust in market and thus act as obstacle in development in bond market. Political stability and predictable microeconomic environment are the essence for creating and maintaining trust among investors, inducing financial discipline, etc.
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Chapter - Three Comparative Analysis

Bond Vs. Bank Loan
Contribution of banking and financial sector in distribution of funds in Nepalese market Many researches show that there is big hand of banking and financial sectors in development of bond market. An empirical test conducted by Jiang et al (2001) finds that bond issuance and bank lending are usually positively correlated, in both OECD and emerging economies whereas bank deposit are negatively correlated with bond issuance. Banks generally raised seeks to raise funds through issuing bond to maintain Tier II capital- supplementary capital that increase the banks capacity to float more loans. On the other hand, if banks issue bond then depositors may invest through holding bond than depositing money in bank at lower rate. By doing so banks can lure some of depositors to hold bond if bank want long term fund, but it depends on the cost of issuing bond and rate of return that investors can gain over interest rate on deposits.

In Nepal, we have found that banking sectors has 69.92% ownership on government securities whereas public sector has only 1%. See Appendix: 4. Further, bank lending to GDP ratio is 51.8% (deposit to GDP is 69.1%) that demonstrates that banking market is 20 times greater than bond market and almost 2 times bigger than stock market while comparing the fund disbursement through each sector. Base on above figures we can say that major part of fund mobilization in Nepal is through banking and financial sectors than band market and stock market.

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Ratio to GDP

Bond listed amount, 3.29% Stock market capitalization, 31.7%

Bank loan advancement, 51.8% Bank deposit, 69.1%

Regarding interest rate providing to the depositors, interest rates on deposit are higher than the rates of return providing to the investors (bond holder) by same banks for the same maturity period. We have compared interest rate of long term deposit and long term bond issued by some banks. In which we have found that investors can gain higher rate of return by holding bond than depositing in fixed deposit account in 2013 (2070 BS) as most of the banks provide higher return on bond issue than long term deposit. But barrier to reap such benefit exists due to lack of secondary market for trading of these bonds. Due to lack of trading in secondary market investors have limit choice i.e. to buy bond when it issue and hold until the maturity date. Thats why although corporate bond provide higher rate of return than fixed deposits it is not able to lure investors toward buying bonds.

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14% 12% 10% 8% 6% 4% 2% 0% Everest Bank 7% 6%

Rate of bond Vs long term deposit rate

long term deposit rate long term bond rate

12.50% 10% 9%

8.50% 6%

8% 8%

8% 7.50%

8.50% 8.50% 8.50% 8.50% 7%

Bank of HIMALAYAN Nepal NABIL BANK Laxmi Bank NEPAL SBI 10% Global Kathmandu BANK Investment LTD. BOND BANK LTD. Bank Ltd Bank

Comparative Analysis between different countries and Nepalese Bond Market

Bond Market of South Asia Introduction The South Asian bond market is in the developing stage. Although the East Asian market has been well developed in terms of bond, the South Asian market needs lots of efforts to make the debt market active. The Asian market crisis of 1998 was the initiative for the development of bond market in Asia. The large dependence on the bank financing during the time of crisis made most of those nations cautious about the financing structure. Mostly, the East Asian nations like Japan, Hong Kong, China have a very well developed market of bond. Slowly, the South Asian countries like Malaysia, Singapore and China are also developing their domestic bond market. The emphasis is in domestic bond market in local currency, so as to mitigate the risk of currency fluctuations. Comparatively, Nepalese bond market is not given high priority due to the unrest in the economy of the country.

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Development of Current Market Regarding the South Asian bond market in countries like Singapore, Malaysia, India, etc., local bond markets are being developed at a slow pace in the past 5-10 years. The development can be attributed to the need of diversification which cannot be provided by the banks and financial institutions alone. Some of the developments in the South Asian markets are: Malaysia issued Islamic government bonds and devised tax arrangements to develop the Islamic bond market. This has helped develop the bond market in recent years. The bond market in Singapore is mostly based on the government bonds. Singapore began to issue 15-year-governmentbonds in 2001 in addition to 7-year and 10-year government bonds which helped in development of benchmark yield curve. Also the improvements in legal arrangements, including a taxation system for the issuance of Islamic bonds led to the bond market development. Singapore has positioned itself as a regional financial hub for South East Asia in terms of fixed income investment. Singapore's government itself issues bonds actively (Singapore Government Securities) even though it does not require debt finance. The government's bond issuance program is partly designed to provide a benchmark bond price (due to its AAA credit rating), so that the corporate bond market can be developed. The corporate bonds can be bought on the bond market operated by the Singapore Exchange (SGX). The Chinese bond market is the largest among emerging economies in Asia. There are six major types of instruments traded: (i) Ministry of Finance (MOF)-issued China Government Bonds; (ii) Peoples Bank of China (PBC) paper; (iii) financial bonds issued by governmentbacked policy banks and financial institutions; (iv) corporate bonds issued by domestic corporations; and (v) commercial paper, issued by either securities firms or private corporations; and (vi) medium-term notes. There are two main bond markets: the interbank bond market and the exchange marketsShanghai Stock Exchange and Shenzhen Stock Exchange. The interbank bond market is Chinas over-the-counter (OTC) market. The Nepalese bond market comprises of government and corporate bond with higher proportion of government bond.

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Comparison Comparing the bond markets of Nepal with Malaysia, Singapore and China, the bond as % of GDP in domestic market, the following figures have been calculated: Country Bond as % Government of GDP Malaysia 105.5 Bond (%) 59.1104 Corporate Bond (%) 40.8896 Retail investors and institutional pension Investor Base

(e.g.,

fund, insurance companies, and asset management

companies) Singapore 90.1 58.884 41.112 Financial institutions and asset-pooling industries China Nepal 46.2 3.29 71.8071 87.75 28.1927 12.25 Institutional; Retailer Institutional and retailer

Source: NEPSE, NRB, Asian bond online As compared to the developing bond markets of Malaysia, Singapore and India, the bond comprises of around 3.29% (approximately, Appendix) of GDP only. Whereas, in the developed bond markets, the bond as % of GDP can even be more than 100% .It shows that, the bond market of Nepal has a lot to develop in terms of size and infrastructures. Comparatively, the government bonds are strong in those countries, with corporate sector somehow strong in Malaysia only. A concrete way of bond market development may not be implied for every country, but Nepal can learn from the experiences of other emerging market countries for progressing from emerging to emerged nations. The Nepalese Bond Market is composed of government and corporate bond instruments. The corporate bond market is very weak in terms of size of investment. Although bonds are listed in NEPSE, the investors and issuers lack interest in the bond trading. Also, the government bonds are preferred despite the less returns due to security issues. With very less trading, transparency in financial system and poor disclosure standards are also hindering the development of bond market in Nepal.
18

Limited liquidity, limited diversity in the investor base and limited access to debt markets by the lower-rated issuers remain as obstacles in the South Asian bond market which can be improved through creating public awareness and developing confidence level among the investors. Bond Market of India Introduction When we talk about India, mainly there are three segments of bond market in India namely, Government securities, Public Sector Units (PSU) bonds and private sector corporate bonds. As we know that India is a federal state so the Government securities are issued by the Central government of India as well as the state government of each state. As in most of the countries, Indian commercial banks are also required to maintain Statutory Liquidity Ratio (SLR) and the current rate of SLR fixed by RBI for 2013 is 23% (RBI). SLR is the amount that the commercial banks require to maintain in the form of gold or govt. approved securities before providing credit to the customers. This is the reason why government bonds have flourished over the years in India. Growth of Bond Market in India The equity market started transforming remarkably after the mid nineties due to the initiation of automated nationwide real-time trading facilities, depository mode of settlement, and widening investor base. However the bond market did not develop at the pace of the equity market. At present India has world class equity market but the bond market is still in the infant stage (as compared to US and European nations) and is hugely dominated by the government securities. Still Indian government bond market has been growing progressively as compared to Emerging East Asia (EEA). The most probable reason behind this is the need to finance the fiscal deficit. At 33.7% of the total GDP, the bond market of India is well developed above the neighboring countries (SEBI, 2011). In Nepal, the bond to ratio GDP was calculated to be 3.29%.

Composition of Bond Market (Government Bond vs. Corporate of Bond) of India and Nepal The outstanding amount government of India bond was estimated to be Rs. 30.3 trillion (68% of the total bond) by the end of 2012 and the outstanding amount of corporate bond was estimated
19

to be Rs. 11.6 trillion (32% of the total) by the end of 2012 (Bond Market in Asia, 2012). In Nepal the outstanding amount of Nepalese government bond was estimated to be Rs. 44,940.4 million (87.75 % of the total bond) whereas the outstanding amount of corporate bond was estimated to be Rs. 6275 million (12.25 % of the total bond). The calculation of the composition of the government bond and corporate has been shown in appendix. Structure of Government Bond Market in India The major issuer of the government bonds are central government or state government. The major players of government bonds are commercial banks, primary dealers and institutional investor. The other participants include co-operative banks, regional rural banks, mutual funds, provident and pension funds. Primary dealer play the role of market maker of the government securities. The total estimated borrowing for fiscal year 2013-14 stands at IRS4,840,000 million. Structure of Corporate Bond Market in India Corporate Bonds are Bonds issued by private or public sector companies in order to borrow funds from the market. In India corporate bonds are issued in the way of public issue or Private Placement. In Public issue the retail as well as institutions can participate whereas in Private placement only few numbers of investors can participate. Reasons for the Underdeveloped Corporate Bond Market in India There are numbers of factors which has constrained the development of corporate bond markets in India. The main reason behind the undeveloped corporate bond market is low issuance of corporate bond leading to illiquidity in the secondary market, narrow investor base, high cost of issuance, lack of transparency and so on. Measures Taken by Reserve Bank of India (RBI), to Develop the Corporate Bond Market The commercial banks of India have to maintain 23% Statutory Liquidity Ratio (SLR). Statutory Liquidity Ratio refers to the amount that the commercial banks require to maintain in the form of cash, or gold or govt. approved securities before providing credit to the customers. This increases the demand for government bonds. However, the corporate bonds have not developed as compared to the government bonds. SEBI, RBI and other stake holders have taken various
20

initiatives to develop the corporate bonds market. Particularly, RBI has taken following initiatives for the development of bond market in India.

i.

To promote transparency in corporate debt market, a reporting platform was developed by FIMMDA and it was mandated that all RBI-regulated entities should report the OTC trades in corporate bonds on this platform. Other regulators have also prescribed such reporting requirement in respect of their regulated entities. This has resulted in building a credible database of all the trades in corporate bond market providing useful information for regulators and market participants.

ii.

Clearing houses of the exchanges have been permitted to have a pooling fund account with RBI to facilitate DvP-I based settlement of trades in corporate bonds.

iii. iv.

Repo in corporate bonds was permitted under a comprehensive regulatory framework. Banks were permitted to classify their investments in non-SLR bonds issued by companies engaged in infrastructure activities and having a minimum residual maturity of seven years under the Held to Maturity (HTM) category;

v. vi.

The provisioning norms for banks for infrastructure loan accounts have been relaxed. The exposure norms for PDs have been relaxed to enable them to play a larger role in the corporate bond market.

vii.

Credit Default Swaps (CDS) have been introduced on corporate bonds since December 01, 2011 to facilitate hedging of credit risk associated with holding corporate bonds and encourage investors participation in long term corporate bonds.

viii.

The terms and conditions for the scheme for FII investment in infrastructure debt and the scheme for non-resident investment in Infrastructure Development Funds (IDFs) have been further rationalized in terms of lock-in period and residual maturity; and

ix.

Further, as a measure of relaxation, QFIs have been now allowed to invest in those MF schemes that hold at least 25 per cent of their assets (either in debt or equity or both) in the infrastructure sector under the current US$ three billion sub-limit for investment in mutual funds related to infrastructure.

21

Comparison of Indian and Nepalese bond market on the basis of composition of government and corporate bonds, bases of the investors and bond to GDP Ratio

Basis of comparison Composition Government

India

Nepal 87.75%

68% 12.25%

Corporate

32%

Investor base

Commercial Banks, Primary Institutional

investors,

Dealers, Institutional Investor, commercial banks, mutual funds. Co-operative Banks, Regional Rural Banks, Mutual Funds, Provident and Pension Funds. Bond to GDP ratio 33.7% 3.29% appendix) (as calculated in

Source: RBI, NRB and SEBON

Bond Market of Bangladesh The bond market in Bangladesh is in infant stage. Corporate bond markets in Bangladesh remains negligible in size. The Bond market of Bangladesh and Nepal are quite similar in following context: Like Nepalese Government bond, it issues national saving certificate, government funding instruments composed of treasury bills (28, 91, 182,364 days) and treasury bonds. Most of the buyers of treasury bonds are financial institutions. Commercial banks are obliged to buy government securities as approved security to meet liquidity requirement (SLR) under the Banking Companies Act.
22

their statutory

Lack of public awareness, lack of effective regulatory implementations, seeking relatively cheaper source of funding like bank loan, etc. hinders both market to propel further. Bangladesh securities market is also dominated by the commercial bank securities and corporate bond signifies for only 0.39% of total sectoral market capitalization the as shown in Appendix: 2

23

Chapter - Four Findings and Analysis

Quantitative analysis
In Quantitative analysis we have constructed yield curve for both government and corporate bond. It is graphic presentation of relationship between various times to maturity and yield of particular bond. Investors can use the yield curve for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. It is also indicator of economic condition of any economy. But in case of Nepal it is very difficult to construct feasible yield curve as bonds in Nepal have rare trading. So, we use total time to maturity rather than remaining maturity time from today date because we cant find todays market price and interest rate of bond as bonds are not trading in secondary market. Government development bond Yield curve GD bond yield curve as shown below is inverted shaped yield curve. This shape of yield curve is very rare, and it form during extraordinary market condition where the future are expected to offer lower yields than bonds with shorter maturities which is opposite to the pure expectation theory. This yield curve demonstrate two basic outcomes: first, investors are not benefited for holding long term development bond and second the economic condition will be down in future. In this situation the investors will be compensated few for taking more risk. This may also be a reason why investors are not choosing to purchase government development bond. However some investors may perceive this inverted curve as an indication that the economy will soon experience a slowdown, which causes future interest rates to give even lower yields. So it is better to buy long this government development bond at present yield because future yields will be even lower if economy will slowdown in near future.

24

Gov. development bond Yeild curve

10.00 8.00 YTM % 6.00 4.00 2.00 0.00 0 2 4 6 8 10 12 14 Time to maturity Series1 Fitted Value

Corporate bond Yield curve The corporate bond yield curve we constructed is mixture of normal and humped shaped yield curve. Generally this shape yield curve forms during normal condition in the expectation that beyond some slowdown in middle years, the economic condition will be continue toward improvement. This yield curve demonstrates that investors can gain benefit by holding long term corporate bond. In other words the market enforces long term bond issuer to provide higher return in long term than short term. So, as compare to GD bond corporate bond provide higher yield in long term.

14% 12% 10% YTM 8% 6% 4% 2% 0% 0 2

Corporate bond Yield curve 2012

Interest rate Fitted values

10

Time to maturity

25

The Credit Spread The credit spread, or quality spread, is the additional yield an investor receives for acquiring a corporate bond instead of government bond with similar maturity. As illustrated in the graph below, the credit spread is the gap between line of corporate bond yield curve and government development yield curve. Corporate bonds have more risk of default than government securities and so, the yield on corporate bond is higher than government bond while price is lower than those of government bond. It is clear in this graph that corporate bond is providing extra amount of risk premium to the investors in both short term and long term maturity period. So, corporate bond is lucrative for less risk averse investors who want higher return by taking more risk whereas GD bond is appropriate for more risk averse investor. Watching from economic condition side, the below graph shows that economic condition of Nepal will be contracting in long run thus corporate bond is compensating more in long term compare to government bond. Hence, it is better to hold corporate bond for long term whereas government bond for short term.

26

Credit spread chart

11% 11.00 10% 8.00% 8% 8% 6% 9.00 9.50 9 9.00 9.00 9 8% 8.50%

12.50%

14.00% 12.00% 10.00% 8.00% 6.00% 4.00%

8 7.00 1 2 3 4 5 7.5 6 7 8 9

2.00% 0.00%

GD bond rate Corporate bond rate

Finding and recommendation: Economic condition of Nepal in long term will be contracting and corporate bond will compensate for such slowdown of economy in future relative to government bond. Government bond is lucrative for short term whereas corporate bond for long term.

27

Chapter Five Findings and Analysis

Qualitative Analysis
Here, the study group tends to analyze the Bond market from perspective of relevant authorities. Academician Perspective The study group took personal interview with academician Mr. Dipesh Baidhya regarding current situation of bond market in Nepal and suggested solution for improvement. He said that the source of funding to be used depends on nature of funding needs and nature of business and companies reputation in the market. If company needs to raise fund for long term and company has strong brand image in market then it is better to issue bond that using other source of fund but again cost matters. Further he argued that for investor point of view bond is preferable in Nepalese market compared to stock and deposit in banks because return on stock in current market is more volatile meanwhile fixed deposit rates of many banks are lower than bond yield, again in this case security is main concern for which government has to implement investment protection policies. Moreover he opinioned that the main hindrance factors for not developing bond market in Nepal are lack of well managed infrastructure and secondary market for trading, lack of supportive and protective rules and regulations, and unavailability of various bonds type and institutional investors. So, finally he suggested that for the proper development of bond market in Nepal the first inherent step is to establish well managed secondary market that help to determine actual market price, interest rate of government bond and corporate bond. Bond Brokers Perspective Among the eight listed bond brokers of Nepal, the interview was conducted with 50% of the brokers. The interview from the brokers provided with differing responses for the reasons behind hindrance in growth of bond markets in Nepal. The responses can be explained to highlight the following findings:

28

Hindrance Factors: According to the responses, the majority of respondents supported the lack of public awareness to be one of the major reasons for growth hindrance. The lack of information to the public about the existing government and corporate bonds as well as the lack of priority to enhance the bond market has been one of the impediments. Apart from those responses, some other significant factors have been focused by the brokers like lack of confidence in the financial market, lack of additional options like convertibles that can help motivate the investors through the hope of turning the bonds into equity in some future time period, etc. The cost factor to issue bonds has been ranked the least strong factor for bond market development. One of the brokers (Shilpa Securities Pvt. Ltd.: Shalikram Adhikari, CEO) responded that they have been licensed since 2056/57, but a single trading has not been handled by them. They gave the reason that the trading procedures of bond need to be completed within a day, so, finding out the buying/selling parties is a difficult process. Similarly, one of the brokers (Ashutosh Brokerage and Securities Pvt. Ltd.(broker member no. 8): Ashok K. Jha) had been involved in bond trading after two years only. This shows the trading environment of bonds in Nepal. Development of Nepalese Bond Market: The response from the brokers have provided with the following suggestions for the development of the bond market of Nepal: Creating public awareness about the existing bonds and the reforms to be brought in the future. Establishing faith in public about the investment in the bond markets so that they feel secured about their investments and the returns. Strengthen the implementation process, i.e. the rules and regulations should be implemented properly so that the issuers and investors will be interested in investing. Train the institutional investors and issuers about the trading environment, procedures and benefits of the bond market.

29

Issuers Perspective on Bond Market The issuers base in Nepalese Bond market is dominated by commercial banks. The fundamental reason behind issuer seeking bond rather bank loan is the regulatory requirements. As per the BASEL II, Tier 2 capital supports the banks funding needs. The commercial banks in order to maintain the capital adequacy ratio issues bond and regard it as a relatively lower cost fund than equity. Bond issuance would assist to maintain CAR despite prevailing tight liquidity situation. Further, the issuance of bond prevents from ownership dilution and save the interest of shareholders. In contrast, the lack of awareness and insignificant market condition discourages from bond financing. The issuers largely depend on institutional investors base for subscription. Thus, they negotiate with insurance companies, mutual fund, etc. They focus on private placement (institutional investors) for 70% -80% subscriptions and only 20% to 30% are publicly placed due to risk that market may not accept it and would affect the organizations reputation if undersubscribed. Mr. Sudip Khanal pointed out the financial indiscipline as root cause behind bond market lag. He highlighted on urgency for financial discipline for development of bond market. The conceptual framework for developing bond market through financial discipline is given below: Financial Discipline (Practicing transparency, good corporate governance, accountability, compliance with rules and regulations, etc. while undertaking financial decisions) Financial Stability Create confidence and trust among investors

Create Demand and Curiosity to know alternate investment sources (seek information)

As Demand increases, Issuing firms are empowered to increase supply side

Increased in investors base and coverage of bond market enhances trading and liquidity in bond market
30

NRB Public Debt Departments Perspective Dr. Gopal Prasad Bhatt, Director of Public Department Management enlisted following reasons behind undeveloped bond market in Nepal: There are alternative source of raising capital such as syndicate bank loan, equity, subordinated debt, etc. As result of which, companies choose that source of fund which is relatively less costly and with high chance of fund proposal being approved. The market acceptance for bond market is low due to lack of public awareness on bond instruments. The fear of under subscription lower down the confidence companies to issue bond market. Behavioral problem i.e. those investors seeking for capital gain prefers stock market whereas regular income seeking investors prefers bond instrument. Most of the listed companies have adequate capital thus they tends to ignore bond issuance. Corporate bonds are mostly dominated by the financial institutions. They are entering into the bond market to fulfill the regulatory requirement. The nature of listed companies also influences on bond issuance decisions. Such as commercial banks dominate the corporate bond market. They enter into bond market as per the regulatory requirement of capital maintenance. Similarly, insurance companies collect fund as a premium from public. They have adequate capital thus rarely seek for alternative funding source. Hydropower Companies seek long term fund for investing its huge project. Basically Banks provide them loan through syndicated loan. The payment is made only after the project starts generating cash which is unsuitable for issuing fixed income instruments like bond. For further expansion, it prefers to go public and bank loan since it seems more convenient. The unlisted companies dont prefer to go public due to fear of disclosure. In addition, the bond issuance makes the company liable to numerous creditors whereas in bank loan, it is answerable to one or two creditors. It is easy to deal and negotiate with few compared to large investors group. Such convenience also motivates organization to prefer syndicated loan rather being obliged to large bondholders.

31

He further added that NRB has been focusing on effective formulation and implementation of regulations to improve the issuers base as well as assist in creating public awareness through different programs as mentioned in upcoming action plans of NRB to develop bond market.

32

Chapter Five Measures to Develop Bond Market

How to Propel the Bond Market
The factors that would propel the Nepalese bond market are as follows: Non-detachable Warrant Use bond as sweetener i.e. link stock and corporate bond with non-detachable warrant Nepalese secondary securities market is stock dominated whereas bond has minimal influence. Nepalese share market had experienced both bull and bearish trends overtime. But bond market has yet to see its proper trading in NEPSE market. Linking bond with stock would help bond to gain market and investors. As per the share analyst Rabindra Bhattarai, If listed companies can link stocks to bonds through non- detachable warrant, 'the bond market also could get movement i.e. adding investors have to feel bonds to be as lucrative as stocks for vibrant bond market.(Chalise, 2013) Developing the Government Bond Market The experience from East Asian countries like Hong Kong, China, and Singapore shows that successful government bond issuance work as a catalyst for corporate bond market. It provides a basis for valuation and pricing for corporate bonds. One the tool to propel the Nepalese bond market would be to develop a healthy government bond market that would serve as a benchmark for the corporate bond market. A government bond market should act as ideal. It should be truly market driven and well balanced in terms of maturity structure, with regular issuances of bonds with varying maturities. Develop market infrastructure The development of bond market can be triggered by upgrading the security market infrastructure i.e. Improving and automating depository, and clearing and settlement system, imposing significant credit rating agency, effective formulation and implementation of regulatory framework, etc. Broadening investor base One of the major obstacles that make Nepalese bond market illiquid is lack of volume or say insignificant size of corporate bond. Thus, it signifies for broadening the investors base. For
33

this, institutional investors such as mutual funds, insurance companies, etc. operating under effective prudential regulation and transparent rules should be encouraged to invest in corporate bonds with enough safeguards built in regulatory framework to ensure that the investment decisions of these institutions are based on commercial considerations. This tendency would further add enthusiasm and confidence in individual investors to invest in corporate bond. Developing a Yield Curve A well-developed yield curve enables the bond issuers to price borrowing instruments more competitively and provides pricing guidance to investors, particularly long-term investors, facilitating their portfolio management. Thus, the attention of concerned authorities should be dragged towards developing reference yield curve for developing bond market. Develop Awareness Program One of the major reasons behind corporate firm preferring bank loan over bond issuance is lack of confidence and fear of being unaccepted in the market. There is low investor base and individual customers are not much aware of bond instrument. One of the bond trader, Agrawal Securities, says that 25% of the active stock traders doesnot have any idea regarding what is bond and how is it traded. The lack of awareness is hindering from active bond trading and thus inversely affecting bond market liquidity. Thus, the awareness program is most for flourishing of bond market in Nepal. The following things can be articulated for creating awareness in public: Leaflet Distribution Preparing and printing leaflets containing contents that highlights on the benefits of the bond to investors. Distributing such leaflets would create curiosity and awareness among general public about existence of such instrument. Government and Corporate sectors should be actively involved in creating awareness by organizing seminar on bond securities. Use of social networking and blogs to discuss and solve the queries on the bond instruments.

34

Recommendations
Role of NRB and SEBON For the development of the bond market in Nepal, the regulatory bodies like NRB and SEBON need to put lots of effort. The role of NRB in the growth of bond market can be explained as following: Development of Secondary Market for T-Bill and Bond: For motivating the corporate sector for bond issuance, NRB needs to develop the secondary market for Treasury Bills and long term government bonds. Since, there is no secondary market for treasury bills, the liquidity is not effective. Also, the trading of bonds occurs less frequently in NEPSE which gives a picture that the bond market is very inactive. The corporate bond market also lacks proper benchmark due to this reason. For providing a standard yield to maturity, the government debt market needs to be made active. Development of Proper Yield Curve: The development of yield curve for the bonds is very difficult in Nepalese market as the trading of bond is very rare. But, NRB needs to generate proper yield-curve so that the management of government as well as private debt instruments can be done. Also, investors are facilitated for their portfolio management as it provides them with pricing guidance. This way, yield curve promotes savings, investment expansion and efficient resource allocation. Efforts to develop Scrip-less Securities Settlement System: NRB can also develop practice of scrip-less system which enable the electronic records, transactions in real time and reduces the time lag and cost of issuing certificates. This system can be useful to encourage the traders since the current provisions make the transaction a cumbersome process. Regulations for Additional Features: NRB can encourage the provision of additional features through regulatory framework for the issuers of bonds. The regulations for convertibles, warrants and such features in bond can be an incentive for investors since they open the door to the equity market. So, the link of bond with equity market can also be an important step through investor motivation. Similarly, SEBON can play a very important role through following activities:
35

Systematize the Transaction Process: SEBON can assist NRB in the implementation of scripless system and systematize the process effectively. NRB is the regulatory body to develop policies, but SEBON is the guiding and managing body. So, the transaction process can be made easier to encourage the issuers and investors. Ensure Transparency of Trading System: The bond market can foster in the environment where the transactions can occur transparently. Also, the transactional effectiveness of bonds improves if there is confidence among the investors in the bond market. So, SEBON needs to make efforts to improve the transparency in Nepalese financial markets. Role of institutional investors The institutional investors plays significant role in developing bond market by investing in locally issued fixed income instruments. The institutional investors are Mutual Fund Companies, Pension Fund Industry and Insurance Industry. Institutional investors should take initiation and empower corporate sectors by subscribing their bonds. This would reduce risk for issuing companies i.e. being unaccepted by market and thus create confidence in them to enter into market. The institutional investors by investing in bond market can act as role model for individual investors and empower their trust in bond market. Role of Banking and Financial Institutions As we have already mentioned in part III that banking and financial sector plays an important role in developing government and private sector bond market as banks are often among the most important issuers, holders, dealers, advisers, underwriters, guarantors, trustees, custodians and registrars in any capital market. But here, we have discussed role of banks as bond issuer and bond purchasers. Bank and Financial sector as bond holder As bondholder, bank can support capital market to develop bond market. In Nepal, B & F sectors use more than 60% of total assets in providing loans but only 17% for investment in various securities. So, it can utilize its some more % of assets for investment in government and corporate bond that help the banks to diversify its investment. Meanwhile it compels

36

corporate sectors to issue bond to raise need fund as proportion of loan provided by bank will be decreased. Further it benefits both banks and corporate sector to be more market driven and reduce risk of overpaying and underpaying because by operating through bond market rate will be determined by market (if traded in secondary market). by doing so bank as bond holder can take extra advantage over others in assessing information and reducing default risk if it was conversant with company who is going to issue corporate bond.

Bank and Financial sector as bond issuer Bank as bond issuer also has significant impact on development of bond market. it can use bond market to supplement deposits as a source of fund. Banking sectors can issue bonds for their mutual benefit. This step of banks can improves bond market by providing chances for investors to invest in fixed return security according to their needs and preference as various types of bonds can be issued and traded. On the other hand, it provides banks to maintain weighted risk exposure ratio. Further, banks can issue various types of bond, especially long term bond which will be better source of funding than long term fixed deposits as fixed depositors have prior claim than debenture and stock holders and so they can claim for refund of deposits when bank will be in liquidity crunch. The next most important advantage for banks is to reduce maturity mismatches, and enhance liquidity condition. So, banks to take above advantage can issue bonds to raise needed fund. As currently, more than 80 % of its funds are from deposits it also can diversify its credit exposure by increasing proportion of bond issuance in its liability side of balance sheet.

Role of investor At this stage when the market is highly volatile, and stock price often fluctuate, it is the duty of investor to access the risk before investing in any securities. During our project, we found out that the bonds are less risky as compared to stock as bond provides uniform return. We also found that return on the bond is higher than the return provided by the fixed deposit offered by the bank. As a rational investor, investor must use their rationality in their decision making. It is true that in the late 1980s and 1990s, some organization did default on the payment (both principal and interest) and still the government did not take any action. But the time has change now. Now the rules against the defaulter of payment are more robust
37

and the organization is more transparent as compared to 1980s and 1990s. Also, the new policy protects the rights of the investor. Hence, the investor must understand all these amendments and break their traditional belief that bonds are issued by the organization just to rob the money from investor. Investor must also think that they are the citizen of the Nepal as well and thus they must show their preferences towards the bond because it is the bond through which the organization collects the fund to finance these infrastructures.

38

Chapter - Six Conclusion and Lessons Learnt

Conclusion
Mostly, in the developing nations like Nepal, bond market is growing very slowly due to various reasons. Despite the ongoing efforts from the regulatory bodies, the development of the investment environment is hindered by several factors like lack of proper implementation of regulations, difficulty in generating interest among the investors and potential issuers, several complexities in issue and trading procedures, lack of information among the investors, etc. Compared to the South Asian bond markets in countries like Malaysia, Singapore, India, the bond market is not being prioritized for the investment even by the government sector. But there are similarities with countries like Bangladesh where the bond market is facing lots of hindrance like in Nepal. Nepalese bond market needs lots of reform for encouraging the issuers and investors to be actively involved in the primary as well as secondary market. Even the government bond as well as money market needs to be improved for providing initiatives to investors and issuers. The regulatory body needs to integrate their efforts with issuers, investors and secondary market. Even the benefits of bond market needs to be well communicated to all related parties. Also, public needs to be made confident about the investment environment. There are lots of steps required for the development of bond market in Nepal, but continuous efforts need to be made for this.

Lessons Learnt
From the study, some important lessons have been learnt: The development of economy can be brought through balance in the financing for real assets. For this a well diversified financial market is a must as it can help risk reduction posed from certain sectors.

39

Bond market development is one of the major steps to be introduced in developing economies like Nepal where bank loans are the most practically implemented instruments. The concentration in a single sector can be very risky and this step can be useful in the situations of economic crisis like in the Asian markets during the global financial crisis during the late 2000s.

The role of all related sectors like regulatory bodies, issuers, investors and traders need to be made active for the bond market development. Corporate bond is more lucrative in long run than government bond, whereas government bond more appropriate for short run. Hence investors can make buy and sell decision based on their preference of time horizon between these two types bonds.

Development in bond market, especially secondary market is more inherent that directs the determination of interest rate and price in free market. This practice will benefit both investors and issuers to lower l

40

41

References
(n.d.). Retrieved May 29, 2013, from asianbondsonline.adb.org Karunasena, D. A. (2004). Development of Government Bond Market with Special Reference to Developing A Yield curve: Experience of Sri Lanka. STAFF STUDIES , 96. Kiatchai Sophastienphong, Y. M. (2008). South Asian Bond Markets: Developing long term financing for growth. Washington D.C.: The World Bank. Toshiyuki Shimada, T. Y. (2010). Challenges and Developments in the Financial Systems of the Southeast Asian Economies. OECD Journal: Financial Market Trends . Vaidya, D. (2010). Bond market in Nepal. SEBON Journal , 118-125.

Appendix: 1
Questionnaire for Bond Brokers Name:-______________________________________________________ Designation:-________________________________ Organization name______________ 1.If you want to invest your money in Nepalese market, where do you want to invest, why? a. Stock b. Bond c. Fixed deposit in Bank Reasons:

2.Please Rank the hindrance factors to the growth of bond market in Nepal from most strong factor to less important: (1 Most Strong Factor and 7- Least Strong Factor)

General list of hindrance factors 1. Public awareness 2. Lack of well managed platform for trading 3. Cost factor (bond is more costly than other sources) 4. Lack of strong regulations to support bond market 5. Lack of sufficient number of institutional investors in bond market 6. Lack of rating company to rate the bond 7. Any other reason you think most important (please specify if any?)

Your Ranking

3.How bond market in Nepal can be developed effectively, please give your own opinion?

Questionnaire for Corporate Officers

2

1. Which source of funding would you prefer in Nepal, if you need to raise capital? Please specify the strong reason for selecting that source of funding?

Ans.

2. Please Rank the hindrance factors to the growth of bond market in Nepal from most strong factor to less important: (1 Most Strong Factor and 7- Least Strong Factor)

General list of hindrance factors 1. Public awareness 2. Lack of well managed platform for trading

Your Ranking

3. Cost factor (bond is more costly than other sources) 4. Lack of strong regulations to support bond market 5. Lack of sufficient number of institutional investors in bond market 6. Lack of rating company to rate the bond 7. Any other reason you think most important (please specify if any?)

3.How bond market in Nepal can be developed effectively, please give your own opinion?

Appendix: 2

Source : http://www.dsebd.org/gr_apr13.php

Appendix: 3
Total Listed Amount in Bond of securities Corporate Bond Government Bond Total amount of bond Stock market capitalization GDP Bond to GDP ration 229.0 Toal Listed Debenture 16 18 Rs. Million 6275 44940.9 51215.9 494,290.68 1558174.00 3.287% Amount in Billion 2010-11 IPO Size Debenture amount 1.78 0 2011-12 1.3 1.2 2012-13 1.97 2.9 Ratio to GDP 0.40% 2.88% 3.29%

Source: Security board of Nepal Sectors (2012) Bond listed amount Stock market capitalization Bank deposit Bank loan advancement GDP Amount in Rs million 51215.9 494,290.68 1076629.3 807579.3 1558174.00 Ratio to GDP 3.29% 31.7% 69.1% 51.8%

Appendix: 4
Ownership Structure of Government Securities As of Chait, 2069 (March/April, 2013) in % Development T.bills Special Citizen National bond Bond saving saving bond bond 0.68% 12.5% 70.71% 0.11%

S.N.

Ownership

2 3 4 5 6

7 8

9 10 11

NRB (including sec. mkt) Commercial bank Development bank Finance company Employees PF Citizen investment trust Nepal telecom Retirement fund & others Insurance company Public Others

Foreign Overall employment S. Bond 0.06% 9.36%

47.11% 2.72% 3% 13.25% 2.11%

84.96% 1.37% 1.11% 0.64% 0.06%

66.82% 1.6% 1.52% 3.59% 0.57%

4.29% 4.5%

1.16% 1.22%

19.69% 0.16% 2.49% 100% 28.65% 6.04% 93.85% 100% 100% 99.88% 100%

5.33% 1.00% 7.83% 100%

0.06% 100%

Others = Private non profit making org. & Business org. Source: NRB ownership report