Overview of Financial Market Structures in Asia - Cases of the Republic of Korea, Malaysia, Thailand and Indonesia

Shirai, Sayuri Working Paper Overview of Financial Market Structures in Asia - Cases of the Republic of Korea, Malaysia, Thailand and Indonesia ADBI Research Paper Series, No. 25 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Shirai, Sayuri (2001) : Overview of Financial Market Structures in Asia - Cases of the Republic of Korea, Malaysia, Thailand and Indonesia, ADBI Research Paper Series, No. 25, Asian Development Bank Institute (ADBI), Tokyo, https://hdl.handle.net/11540/4130 This Version is available at: https://hdl.handle.net/10419/111114 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/ ADB Institute Research Paper Series No. 25 September 4, 2001 Overview of Financial Market Structures in Asia — Cases of the Republic of Korea, Malaysia, Thailand and Indonesia — Sayuri Shirai II ABOUT THE AUTHOR Sayuri Shirai is a visiting scholar at the Institute working in the fields of developing capital markets and strengthening financial and exchange systems. She is also an Associate Professor at Keio University and was formely a staff economist at the International Monetary Fund. Additional copies of the paper are available free from the Asian Development Bank Institute, 8th Floor, Kasumigaseki Building, 3-2-5 Kasumigaseki, Chiyoda-ku, Tokyo 100-6008, Japan. Attention: Publications. Also online at www.adbi.org Copyright ©2001 Asian Development Bank Institute. All rights reserved. Produced by ADBI Publishing. The Research Paper Series primarily disseminates selected work of the Institute to facilitate an exchange of ideas within the Institute's constituencies and the wider academic and policy communities. The findings, interpretations, and conclusions are the author's own and are not necessarily endorsed by the Asian Development Bank Institute. They should not be attributed to the Asian Development Bank, its Boards, or any of its member countries. They are published under the responsibility of the Dean of the Asian Development Bank Institute. The Institute does not guarantee the accuracy or reasonableness of the contents herein and accepts no responsibility whatsoever for any consequences of its use. The term "country", as used in the context of the ADB, refers to a member of the ADB and does not imply any view on the part of the Institute as to sovereignty or independent status. Names of countries or economies mentioned in this series are chosen by the authors, in the exercise of their academic freedom, and the Institute is in no way responsible for such usage. ADB INSTITUTE RESEARCH PAPER 25 III PREFACE The ADB Institute aims to explore the most appropriate development paradigms for Asia composed of well-balanced combinations of the roles of markets, institutions, and governments in the post-crisis period. Under this broad research project on development paradigms, the ADB Institute Research Paper Series will contribute to disseminating the Institute’s works as a building block of the project and will invite comments and questions. I trust that this series will provoke constructive discussions among policymakers as well as researchers about where Asian economies should go from the last crisis and current recovery. Masaru Yoshitomi Dean ADB Institute IV ABSTRACT Since the Asian financial crisis, it has been increasingly recognized that one of the major factors behind the crisis was the aggravation of currency and maturity mismatches of financial institutions, particularly those of the banking sector. The massive, short-term capital inflows that took place prior to the crisis were largely in the form of short-term borrowing from foreign banks, which were intermediated through domestic banks. Therefore, there are those who stress that Asian countries should place less emphasis on bank loans and should develop capital markets, particularly domestic corporate bond markets, as alternative and more important sources of financing. While such views are understandable from an intuitive point of view, it is important to deepen our understanding of the current financial market structure and then examine whether a policy to develop domestic corporate bond markets can be implemented in the short term in Asian countries. In this context, it is also essential to recognize the extent to which these countries depend on the banking sector, and to carefully investigate the factors affecting the extent of such dependence. This paper undertakes an overview of the financial structures in the Republic of Korea, Malaysia, Thailand, and Indonesia. It stresses that while the Asian countries have lowered their dependence on bank loans, especially since the crisis, the banking sector has remained dominant. Given the fact that alternative financing sources have been limited and unstable, it suggests that commercial banks will continue to be dominant financial institutions, and to act as major financiers for the economy, in the foreseeable future. Moreover, this paper demonstrates that corporate bond markets in Asia are largely underdeveloped because issue sizes are small; maturity is concentrated on the shortto medium-term; and secondary markets are highly illiquid. The underdevelopment of corporate bond markets can be attributed to various factors, including underdeveloped government bond markets; tax and interest rate policies; stringent asset requirements imposed on institutional investors; a narrow investor base; and a narrow issuer base. The narrow investor base may be related to the low levels of income per capita and wealth accumulation, but it is also closely associated with the lack of adequate informational, legal, and judiciary infrastructure. These factors suggest that it may take time for Asian countries to develop viable corporate bond markets and that a policy to quickly develop domestic bond markets may not be feasible. This paper also emphasizes the importance of the role played by the banking sector as issuers, investors, guarantors, and underwriters in the corporate bond markets. V TABLE OF CONTENTS About the author II Preface III Abstract IV Table of contents V Executive Summary 1 1. Introduction 4 2. Dependence on the Banking Sector 6 2.1. The Size of the Banking Sector in Terms of GDP 6 2.2. The Size of the Banking Sector in Terms of Total External Finance 8 3. The Development of the Corporate Bond Market 10 3.1. Issue Size of Corporate Bonds 10 3.2. The Maturity Structure of Corporate Bonds 16 3.3. Liquidity of Corporate Bond Markets 17 4. The Role of the Banking Sector in the Corporate Bond Market 18 5. Factors Affecting the Underdevelopment of Corporate Bond Markets 27 5.1. Underdeveloped Official Bond Markets 27 5.2. Underdeveloped Institutional Investors 36 5.3. The Preference of Households for Bank Deposits 37 5.4. Underdeveloped Issuers 39 6. Conclusions 40 References 41 Tables and Charts Table 1: Maturity Structure of Corporate Bonds 17 Table 2: Liquidity of Corporate Bond Markets 18 Table 3: Role of the Banking Sector in Asia 19 Table 4a: Korea, Issuers in Corporate Bonds: 1995-1999 20 Table 4b: Malaysia, Issuers in Corporate Bonds: 1995-2000 21 Table 4c: Thailand, Issuers in Corporate Bonds: 1995-2000 21 Table 4d: Indonesia, Issuers in Corporate Bonds: 1996-2000 22 Table 5a: Korea, Investors in Corporate Bonds: 1995-1999 23 Table 5b: Malaysia, Investors in Corporate: November 2000 24 Table 5c: Thailand, Investors in Corporate Bonds: 1995 and 1999 24 Table 5d: Indonesia, Investors in Corporate: 1995-2000 25 Table 6: Guarantors of Corporate Bonds 25 VI Table 7: Thailand, Top Underwriters of Corporate Bonds: 1995 and 2000 26 Table 8a: Korea, Issuers of Official Bonds: 1995-1999 28 Table 8b: Malaysia, Issuers of Official Bonds:1995-2000 29 Table 8c: Thailand, Issuers of Official Bonds:1996-2000 30 Table 9a: Korea, Investors of Government Bonds: 1995-1999 31 Table 9b: Malaysia, Investors of Government Bonds: 1995-2000 32 Table 9c: Thailand, Investors of Official Bonds: 1995-2000 33 Table 9d: Indonesia, Investors of Government Bonds: March 2001 33 Table 10: Maturity Structure of Government Bonds 34 Table 11: Liquidity of Government Bonds: Turnover Ratio 35 Table 12a: Korea, Financial Asset Composition of Households: 1991-1999 38 Table 12b: Thailand, Financial Asset Composition of Households: 1993 and 1998 38 Table 12c: Indonesia, Financial Asset Composition of Households: 1998 and 1999 39 Chart 1a: Outstanding Bank Loans for Nine Countries: 1990–1999 Average 7 Chart 1b: Outstanding Bank Loans for Nine Countries: 1990–1999 Time Series 8 Chart 1c: Outstanding Bank Loans for Nine Countries: 1990–1999 Average 9 Chart 1d: Outstanding Bank Loans for Nine Countries: 1990 –1999 Time Series 9 Chart 2a: Outstanding Corporate Bond Issued for Nine Countries: 1990–1999 Average 11 Chart 2b: Outstanding Corporate Bond Issued for Nine Countries: 1990–1999 Time Series 11 Chart 2c: Outstanding Corporate Bond Issued for Nine Countries: 1990–1999 Average 15 Chart 2d: Outstanding Corporate Bond Issued for Nine Countries: 1990–1999 Time Series 16 Chart 3: Outstanding Government Bonds Issued for Four Countries: 1990–1999 Average 27 Appendix I. Case of the Republic of Korea 42 Appendix II. Case of Malaysia 83 Appendix III. Case of Thailand 112 Appendix IV. Case of Indonesia 139 Executive Summary 1. The Asian countries have lowered their dependence on bank loans, especially since the crisis, as a reflection of the transitory process of banking sector restructuring. Nevertheless, the banking sector has remained dominant. Given that alternative financing sources have been limited and unstable, this suggests that commercial banks will continue to be dominant financial institutions, acting as major financiers for the economy, in the foreseeable future. 2. Asian corporate bond markets are largely underdeveloped, since the size of issues is small; the maturity is concentrated on the shortto medium-term; the secondary markets are largely illiquid; and, corporate bonds are largely guaranteed or privately placed (this was especially true before the crisis). 3. The underdevelopment of corporate bond markets can be attributed to several factors: (1) underdeveloped government bond markets; (2) government interest and tax policies and minimum asset requirements; (3) a narrow issuer base; and (4) a narrow investor base. 4. First, the government bond market is underdeveloped because the size of issues is small and the issuing time is irregular; secondary markets are highly illiquid; and, the maturity is narrowly spread. The small issue size reflects sound fiscal policy, and consequently the lack of a need for the government to issue bonds for funding. The presence of diverse types of official bonds (leading to the small issue size per bond) and irregular issuing patterns also limited the development of government bond markets. These factors made it difficult for Asian countries to establish benchmark yield curves, which are necessary for pricing corporate bonds. 5. Second, a number of Asian countries have adopted low interest rates and transaction taxes, that have discouraged investors from transacting bonds in the secondary market. In some cases, institutional investors are subject to stringent minimum asset requirements, a fact which has also encouraged them to take a buy-and-hold strategy with respect to government bonds. 6. Third, there are few large, reputable non-financial firms that are able to issue bonds at reasonably low costs. This limits the issuer base and hence the development of corporate bond markets. This is true especially in Indonesia and Thailand. 7. Fourth, the investor base in Asia is narrow and limited. In many cases, individual investors are reluctant to diversify their asset portfolios and concentrate their funds in safe, liquid bank deposits. In addition, institutional investors are largely underdeveloped and concentrated. In Indonesia, the Republic of Korea, and Thailand, the major institutional investors are banks or other financial institutions. In Malaysia, in contrast, a single provident fund dominates the investor base. 8. A lack of large, diverse institutional investors may be associated with the low level of income per capita and wealth accumulation in some countries. More importantly, it is also attributable to the lack of adequate informational, legal, and judiciary infrastructure that ensures the confidence of public investors so that they are willing to make investment choices on their own and bear the risk of their investment. Such an infrastructure would protect public investors by promoting the availability to them of credible information about issuing firms; assuring them of debt repayments; penalizing accountants, auditors, and investment banks for disseminating false information; and, prohibiting insider trading and market manipulations. 2 9. Given the limited number of investors and issuers and inadequate informational, legal, and judiciary infrastructure in Asia, banks complement the narrow investor and issuer bases, thanks to their already dominant positions in financial markets, their reputations, and their informational advantages. Since banks already have inside information about borrowers, they can utilize the information when they underwrite (or guarantee) securities, and thus their underwriting costs can be lower than independent investment banks. This suggests that the role of the banking sector should not be dismissed when policy markers consider a concrete policy package to foster the development of domestic bond markets. 9 Overview Chart 1c: Outstanding Bank Loans for Nine Countries (Percent of Total External Finance): 1990–1999 Average 0 10 20 30 40 50 60 70 80 90 US Singapore Korea Malaysia Thailand Indonesia Philippines India China Note: External finance is defined as the sum of outstanding bank loans, outstanding corporate bonds issued and equity market capitalization. Source: DRIASIA; IFS, IMF. With respect to the crisis-affected countries, all have shown more or less similar patterns to those based on the first indicator. The shares of outstanding bank loans in total external finance increased steadily before the crisis, but have declined in the post-crisis period, particularly in 1999 (Chart 1d). This suggests that finance from capital markets has become important in relative terms in the post-crisis period, owing to the difficulties experienced in the banking sector. However, the relative size of bank loans did not decline below the pre-crisis level, supporting the view that banks continue to be dominant financial institutions. Chart 1d: Outstanding Bank Loans for Nine Countries (Percent of Total External Finance): 1990 –1999 Time Series 0 10 20 30 40 50 60 70 80 90 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Korea Malaysia Thailand Indonesia Philippines 10 0 10 20 30 40 50 60 70 80 90 100 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 US China India Singapore Source: DRIASIA; IFS, IMF. By contrast, the share of bank loans in the United States has consistently declined over the period of 1990-1999, reflecting the fact that securities increasingly substituted for bank loans. This suggests that the financial market structure in the United States differs from those of Asian countries and can be characterized as a full-fledged capital market-based financial one. The share of bank loans has increased moderately in India and Singapore in recent years. In the PRC, a moderate decline was observed, but the share of bank loans has remained dominant, at about 80% of total external finance. 3. The Development of the Corporate Bond Market The crisis-affected Asian countries experienced a cut in bank loans in 1999, leaving firms no choice but to depend on alternative external financing sources. In spite of the growing trend observed in some countries, corporate bond markets have been largely underdeveloped because of the small size of issues, relatively short maturities, and lack of liquidity in the secondary markets. 3.1. Issue Size of Corporate Bonds The Size of the Corporate Bond Market in Terms of GDP As with the size of the banking sector, two indicators are adopted to estimate the size of the corporate bond market: (1) the ratio of outstanding corporate bonds issued to GDP and (2) the ratio of outstanding corporate bonds issued to the sum of external finance defined above. In a sharp contrast to the United States, the size of the corporate bond markets (based on the first indicator) was small during 1990-1999, on average, in the eight Asian countries. While the shares were still relatively small, the corporate bond markets developed moderately in Korea and, to a 11 Overview lesser extent, Malaysia with the size accounting for 18% and 10%, respectively (Chart 2a). Since the crisis, the issuance of corporate bonds has risen in Korea, Malaysia and Thailand, albeit on a small scale (Chart 2b). This is because the financial difficulties caused by the Asian financial crisis and the recent enforcement of capital adequacy requirements have made it more and more difficult for commercial banks to continue or increase lending to firms; consequently, firms—particularly, large reputable firms—have turned to bond issuance. Chart 2a: Outstanding Corporate Bond Issued for Nine Countries (Percent of GDP): 1990–1999 Average 0 5 10 15 20 25 30 35 40 45 US Singapore Korea Malaysia Thailand Indonesia Philippines India China Source: DRIASIA; IFS, IMF; Flow of Funds Accounts of the United States. Chart 2b: Outstanding Corporate Bond Issued for Nine Countries (Percent of GDP): 1990–1999 Time Series 0 5 10 15 20 25 30 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Korea Malaysia Thailand Indonesia Philippines 12 - 1 2 3 4 5 6 7 8 9 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 0 10 20 30 40 50 60 China India Singapore US A xis for US Source: DRIASIA; IFS, IMF; Flow of Funds Accounts of the United States. Korea has been the front runner in the Asian corporate bond market owing to the fact that issuing corporate bonds began in a much earlier periods than other Asian countries. In Korea, (convertible) corporate bonds were issued first by Ssanyong Cement in 1963 and the issuance of corporate bonds increased rapidly in the 1970s. The ratio of outstanding corporate bonds issued to GDP rose from 20% in 1997 to 28% in 1998, reflecting the temporary boom in the corporate bond market. The Investment Trust Companies (ITCs) grew sharply from 1998 to the middle of 1999, and became major investors in corporate bonds. Their purchases of corporate bonds accounted for almost 80% of the total financing of non-financial firms during this period and thus compensated for the contraction in other financing channels. However, the corporate bond market collapsed in the middle of 1999 due to the bankruptcy of Daewoo—the third largest conglomerate in the county—triggering a collapse of ITCs and a subsequent substantial loss in investor confidence. A new wave of flight-to-quality phenomenon has emerged in the post-boom Korean bond market. Demand for higher quality corporate bonds (as well as government securities) rose sharply, and their interest rates declined accordingly. In contrast, firms with credit ratings of BBB or below faced difficulty in issuing corporate bonds, as investors became more sensitive to credit risk (Oh and Rhee, 2001). Furthermore, those bonds (mostly three-year bonds) that were issued and largely non-guaranteed in 1998, during the bond boom period, were maturing in 2001, and the issuers have found it very difficult to rollover their bonds. As a result, the bonds were transformed into non-performing debt, and at the same time credit crunch problems were exacerbated—mainly because the difficulties faced by the ITCs gave rise to systemic financial sector problems. In response to the serious credit crunch, the Korean government has intervened in the corporate bond markets since August 2000 by creating a primary “collaterized bond obligation” (CBO) program—securitizing corporate bonds held by ITCs through bundling maturing bonds, providing a partial guarantee and selling securities backed by those bonds to 13 Overview investors (Oh and Rhee [2001] and OECD [2001]). The government enacted the Asset Securitization Act in October 2000 for the purpose of helping the Korean Asset Management Corporation—an equivalent of the Resolution Trust Corporation in the United States—liquidate non-performing loans held by troubled banks. Under this regulatory framework, ITCs have heavily securitized non-performing bonds to meet their redemption requirements, which increased rapidly after the Daewoo crisis. This has given rise to a sharp increase in CBOs, which accounted for more than 60% of the total corporate bond issuance in 2000. CBOs are treated as corporate bonds on the ground that they are issued through “special-purpose vehicles” (SPVs). The guarantee is provided by the Korea Credit Guarantee Fund (KCGF), which charges a 1.5% fee for this service and screens the companies wishing to participate in this program and requires companies to have a bond rating of at least BB. The amount of bonds from an individual company is between 5% and 10% of the total CBOs in order to pool non-performing bonds and lower risk. Through these processes, most of these bonds, and particularly senior bonds, are rated at above A. By the end of 2000, 17 different consortiums had put together CBOs, which were then sold by securities companies. Junior bonds cannot receive principal payments until the entire principal of the senior bonds has been paid off. The Korean government purchased these junior bonds through government agencies, mostly the Small and Medium Industry Promotion Corporation. In addition, the government converted junior bonds to senior bonds by providing credit enhancement with the help of the KCGF and Korea Technology Credit Guarantee Fund.3 As another way to solve the credit crunch, the Korean government established a “collateralized loan obligations (CLOs)” scheme in December 2000, through which bank loans could be pooled, securitized, and thus liquidated. While the main objective of both CBOs and CLOs is to mitigate credit crunch problems by containing systemic financial problems, the increase in the issuance of these bonds has potential of fostering the development of the corporate bond market through the increased issuance of bonds during the transition period.4 In addition, the government introduced “An Emergency Measure for Script Underwriting of Corporate Bonds” in April 2001. Under this measure, the government has required the Korean Development Bank (KDB) to purchase one-year corporate bonds issued by troubled companies facing difficulty in rolling over their maturing debt. The candidate companies—mostly Hyundai affiliates—are selected by KDB and are expected to issue one-year bonds whose face value amounts to 8% of the debt due. KDB then pools these bonds and securitizes them with credit support provided by the Credit 3 Furthermore, the Korean government established the CBO funds in order to raise money and thereby increase demand for CBOs. These funds are required to invest more than 50% in junior bonds. The government compensated for the credit risk involved by providing tax relief on interest income or privileges to get allocations of over-subscribed initial public offerings. 4 However, the creation of CBOs and the quick underwriting program of the KDB—although being implemented to overcome market weakness, such as the bunching of maturities in a single year and the absence of a market for bonds with credit ratings below investment grade—has resulted in helping ITCs increase their liquidity and improve returns on their investments. This may generate moral hazard problems among ITCs and their investors (i.e. ultimate borrowers), and delay the restructuring process of the corporate sector. ITCs may increase risk-taking lending activities without worrying about liquidity problems when the invested assets become non-performing, and financiers of ITCs may have increased incentives to invest in ITCs without worrying about the risk involved. Thus, this approach should be regarded as a temporary solution. 14 Guarantee Fund. About 70% of the pool constitutes a senior tranche and thus can be sold to investors, while the remaining 30% is assumed by creditor banks of candidate firms and KDB itself (Oh and Rhee, 2001). The corporate bond (called private debt securities (PDS) market in Malaysia was almost nonexistent until the middle of the 1980s, when the government introduced a privatization policy with the aim of downsizing government operations and enhancing the role of the private sector. The privatization policy increased the need of the private sector to obtain long-term financing, contributing to a rapid increase in the issuance of corporate bonds between the late 1980s and early 1990s. The size of the corporate bond market rose rapidly in the 1990s, from 3% of GDP in 1990 to 25% in 1999, thanks to the government’s efforts to develop the market. These efforts included the establishment of Cagamas Berhad and the Rating Agency Malaysia Berhad. After the crisis, the corporate bond market played an important role in financing the restructuring process of the corporate and banking sectors. Most PDS are issued through a bought deal or private placements to avoid the lengthy approval process and high issuance costs (including issuing a prospectus) that issuers have to bear when issuing through the exchange. In Thailand, the corporate bond market was almost nonexistent before 1992, as the corporate law allowed only public and exchange-listed companies to issue bonds. In 1992, the government enacted the Securities and Exchange Act, which allowed limited companies to issue bonds. Since then, corporate bonds have become more common, although the size has been much smaller than bank loans. The size of the corporate bond market rose rapidly in 1999, because blue-chip companies increased their resources devoted to bond financing. Nevertheless, the relative size has remained small. Before the crisis, about 45% to 70% of Thai corporate bonds were issued abroad—in sharp contrast from Korea, Malaysia, and Indonesia. These overseas issues were denominated largely in US dollars or yen. Following the crisis, the issuance of corporate bonds dropped rapidly to B41 billion in 1997 and B36 billion in 1998, from B133 billion in 1996. However, it increased substantially in 1999, to B316 billion. Since the crisis, nearly all corporate bonds have been issued domestically in the absence of foreign investors. Compared with Korea, Malaysia, and Thailand, the size of the corporate bond market in Indonesia has been very small, remaining at below 5% of GDP throughout 1990-1999. The corporate bond market barely existed before 1987, owing to the strict regulations on issuance, such as a minimum 10% net income-equity requirement imposed on the previous year financial performance and high registration fees. Between 1987 and 1990, the government implemented various reforms in the financial and capital markets, including an opening to foreign investors, a relaxation of the net income-equity requirement, a reduction of registration fees, the establishment of an over-the-counter market, the approval of finance companies, a strengthening of disclosure requirements, enhancing investor protection, etc. Despite these measures, the corporate bond market remains underdeveloped. 15 Overview The Size of the Corporate Bond Market in Terms of Total External Finance The second indicator shows that the relative size of corporate bond finance is larger in Korea than in the United States and Malaysia (Chart 2c). Chart 1c and Chart 2c suggest that equity market capitalization accounts for about 65% of total external finance each in the United States and Malaysia, reflecting the strong stock market booms in both countries during the 1990s. In Malaysia, this partly reflects issuers’ preference for equity finance over bond finance because of the unlimited life of the former. Chart 2d shows that the size of the corporate bond market rose by just 7 percentage points in Malaysia, while it actually dropped by about 5 percentage points in the United States. Chart 2c: Outstanding Corporate Bond Issued for Nine Countries (Percent of Total External Finance): 1990–1999 Average 0 5 10 15 20 25 US Singapore Korea Malaysia Thailand Indonesia Philippines India China Note: External finance is defined as the sum of outstanding bank loans, outstanding corporate bonds issued and equity market capitalization. Source: DRIASIA; IFS, IMF; Flow of Funds Accounts of the United States. 16 Chart 2d: Outstanding Corporate Bond Issued for Nine Countries (Percent of Total External Finance): 1990–1999 Time Series 0 5 10 15 20 25 30 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Korea Malaysia Thailand Indonesia Philippines 0 5 10 15 20 25 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 US China India Singapore Source: DRIASIA; IFS, IMF; Flow of Funds Accounts of the United States. 3.2. The Maturity Structure of Corporate Bonds In Asia, corporate bonds have largely been concentrated on shortto medium-term maturities, and this tendency has been enhanced in the post-crisis period by the loss of confidence in the viability of firms and the lack of adequate informational, legal, and judiciary infrastructures. This also reflects investors’ preferences, arising from a lack of experience and consequent weak confidence in the corporate bond market. In addition, when commercial banks are major investors in bonds, they tend to hold short-term bonds to mitigate maturity mismatches given that their liabilities are comprised largely of short-term deposits. Also, issuing firms may prefer short-term bonds because of their relatively lower interest rates. 17 Overview In Korea, about 90% of corporate bonds were of three-year maturity throughout 1995-1999 (Table 1). The illiquid secondary markets resulting from the buy-and-hold strategy by ITCs induced investors to purchase and guarantors to guarantee bonds with the shortest legally-allowed maturity, which was three years. Table 1: Maturity Structure of Corporate Bonds (Weighted Average) Before Crisis After Crisis Korea Less than 4 years Less than 4 years Malaysia 4-5 years 6-10 years Thailand More than 10 years Less than 7 years Indonesia - 4-5 years Source: Appendices. In Malaysia, the maturity of PDS varies from two to three years to above 15 years. In the 1995-1996 period, the most common maturity was four to five years, accounting for about 55% of total issues. Since 1997, the share of PDS with maturities of six to 10 years increased from 46% in 1997 to 90% in 1999, but dropped to 24% in 2000. In Thailand, the maturity of corporate bonds issued before the crisis was concentrated on five years and below and 10 years during 1995-1996, with these periods accounting for 38% and 49% of total corporate bond issued, respectively. The average maturity shortened after the crisis, as evidenced by the increase in the maturity of five years and below to about 60% during 1997-2000. In Indonesia, corporate bond maturities were concentrated in four to five years in 1998-2000, accounting for 70% of total outstanding corporate bonds.5 3.3. Liquidity of Corporate Bond Markets The trading of corporate bonds in secondary markets has remained modest in Asia throughout the period. This is because most investors tend to hold bonds until maturity, reflecting the minimum asset requirements, taxes, interest rate policy, etc. Also, when the major investors are banks, they tend to hold shorter-term corporate bonds in order to minimize maturity mismatches given that their liabilities consist largely of bank deposits. In Korea, corporate bonds were not actively traded in the secondary markets in the past, because the prices of bonds were under government control. Until the early 1990s, the issuing rates of corporate bonds were determined by the government. In 1991, the government liberalized this regulation for corporate bonds with maturities longer than two years, and in 1993 for corporate bonds of all maturities and financial debentures. Even after 1993, however, the government has routinely intervened in the corporate bond market to 5 Data prior to the crisis are not available. 18 affect interest rates through quantity adjustment. Furthermore, the government exercised managing authority over institutional investors such as ITCs and banks, even though they are privately owned. The government has done this by requiring them to get approval with respect to the introduction of new products, pricing of products, opening of new branches, and appointment of board members. Moreover, ITCs did not engage in trading bonds in order to meet fixed payments to ultimate investors. When investors demanded redemption, ITCs paid cash based on the book value and then transferred securities to their own accounts rather than selling them on the market. These practices lowered liquidity in the secondary corporate bond market, while protecting public investors in the ITCs from market risk. After the crisis, the turnover ratio rose rapidly, from 92% in 1997 to 205% in 1998-1999, reflecting the temporary bond market boom. In Malaysia, the secondary market for PDS has been extremely illiquid and virtually non-existent. Many corporate bonds are bought and held to maturity by institutional investors, owing to a lack of market-making activities and a short supply. Following the crisis, the secondary market for PDS improved somewhat in 1999, reflecting lower interest rates and thus higher capital gains. In Thailand, the trading value of corporate bonds was limited except in 1996 and 1997. Trading activities dropped rapidly in 1998 and 1999, but improved in 2000. Similarly, in Indonesia, most investors hold corporate bonds until the maturity date. Furthermore, in December 2000 the government imposed a 0.03% tax on transactions of bonds traded at the exchange, which is likely to discourage trading activities even further in the secondary bond markets. Table 2: Liquidity of Corporate Bond Markets Before Crisis After Crisis Korea 96.5% 147.8% Malaysia 28.8% 30.5% Thailand 103.5% 32.5% Indonesia - 41.7% Source: Appendices. 4. The Role of the Banking Sector in the Corporate Bond Market The banking sector is already playing a crucial role in the corporate bond market in Asia. Table 3 shows that banks are not only major issuers of corporate bonds but also investors, underwriters and guarantors. On the supply side, in Malaysia the issuer base is more diversified than the investor base in various industries. By contrast, in Korea issuers are concentrated in the manufacturing sector, reflecting the presence of relatively large and 25 Overview insurance firms, pension funds, and mutual funds. However, their relative shares were very small considering that the size of the corporate bond market was less than 5% of GDP. Table 5d: Indonesia, Investors in Corporate Bonds (Percent of Outstanding Corporate Bond Issued): 1995-2000 1995-1996 Average 1997 1998-2000 Average Insurance 10.1 7.7 8.4 Pension Funds 12.7 9.2 11.5 Mutual Funds 14.0 16.3 12.6 Banking, etc. 63.2 66.8 67.4 Total 100.0 100.0 100.0 Total (Billions of Rupiah) 4,285 12,540 14,132 Note: Data refer to outstanding corporate bonds listed at the stock exchange, stock data. Source: Appendix IV. Guarantors and Underwriters of Bonds In the Korean corporate bond market, before the crisis most bonds were guaranteed by banks and non-bank financial institutions. The government introduced a guarantee system on corporate bonds in 1972 to ease financial constraints, initially authorizing the Korean Investment Corporation as the sole guarantor. It later allowed banks to also become guarantors, and about 50% of corporate bonds were guaranteed by banks in the 1980s. The relative importance of the banking sector as guarantors declined in the 1990s as non-bank financial institutions became major guarantors. However, most financial institutions ceased to guarantee corporate bonds after the crisis, in part because of the imposition in 1998 of a new regulation prohibiting securities firms from providing guarantees and in part because of the increased awareness of the risk involved in guarantee businesses (Table 6). Table 6: Guarantors of Corporate Bonds Before Crisis After Crisis Korea Guaranteed Funds, Surety Companies, Banks, Securities Companies, Merchant Banking Corporations None Malaysia Government, Banking Institutions, Top Credit-rated Corporations None Thailand None Parent Companies, Related Companies Indonesia Banking Institutions, Affiliated Firms, Parent Firms Banking Institutions, Affiliated Firms, Parent Firms Source: Appendices. 26 In Malaysia, about 50% of bonds were guaranteed in 1995, and about 10% in 1996. The guarantees were used to enhance credit ratings so that firms were able to issue bonds given a requirement imposed by Bank Negara Malaysia that all corporate bonds be rated at least at a minimum investment grade (BBB or above). The major guarantors were banks, though some share was held by the government and top-rated firms. After the crisis, most corporate bonds ceased to be guaranteed, since banks have limited their guaranteeing businesses due to the banking sector restructuring process, and because the government removed the minimum investment grade requirement in July 2000. In the case of Thailand, unlike Malaysia and Korea, the banking sector did not play a crucial role as guarantors before the crisis. This is partly because most bonds were asset-backed or secured, and were sold through private placement. After the crisis, some bonds have continued to be guaranteed, but mostly by parent companies or affiliated firms of the issuers. Instead, banks have become increasingly important underwriters in recent years. They have been permitted to underwrite bonds since 1993 (Table 7). Table 7: Thailand, Top Underwriters of Corporate Bonds: 1995 and 2000 Year Lead Underwriter Value No. of Issues Percent 1995 Phatra Thanakit Public Co., Ltd. 3,595 2 30.9 Thana One Finance & Securities Co., Ltd. 3,595 2 30.9 First Bangkok City Finance Co., Ltd. 1,750 2 15.0 Bangkok First Investment & Trust Public Co., Ltd. 500 1 4.3 Siam Commercial Bank Plc. 500 1 4.3 Finance and Securities as the Lead Underwriters 9,440 81.1 Banks as the Lead Underwriters 500 1 4.3 2000 Siam Comercial Bank Plc. 11,955 5 21.1 Citicorp Securities (Thailand) Ltd. 10,333 4 18.2 Thai Military Bank Plc. 7,650 4 13.5 ABN-AMRO Bank N.V. 6,500 3 11.4 Jardine Fleming Thanakorn Securities Ltd. 3,650 6 6.4 Finance and Securities as the Lead Underwriter 13,983 24.6 Banks as the Lead Underwriters 26,105 3 46.0 Source: Appendix III. Most of Indonesian corporate bonds were non-guaranteed before the crisis and this situation has not changed. In the post-crisis period, less than 5% of bonds have been guaranteed by banks, issuers’ affiliated firms, or parent companies. Since all bonds are rated, guarantees are used to enhance credit ratings when the ratings given to the guarantors are higher. Banks are allowed to guarantee bonds, but are not allowed to directly engage in underwriting, dealing, and brokerage businesses. Those businesses, however, can be undertaken by bank subsidiaries. 27 Overview 5. Factors Affecting the Underdevelopment of Corporate Bond Markets This section points out several factors that have contributed to the underdevelopment of corporate bond markets in Asia. These factors include underdeveloped government bond markets, government interest rate and tax policies, minimum asset requirements, narrow investor bases, and narrow issuer bases. 5.1. Underdeveloped Official Bond Markets Issuers of Government Bonds The sizes of government bonds (using, as a proxy, outstanding government bonds issued as a percent of GDP) have been small in Asia compared with those of the United States. This reflects the fact that sound fiscal policy that has been implemented by governments in Asia reduced the need to raise funds by issuing bonds. Indonesia did not issue government bonds prior to the crisis. Among the three Asian countries under examination, Malaysia has the largest government bond market, accounting for about 30% of GDP (Chart 3). Nevertheless, this is far below the level of the United States, where it accounts for 47% of GDP. In Korea and Thailand, government bonds accounted for just 8% and 3%, respectively, of GDP prior to the crisis. In the case of Korea, however, official bonds, including government bonds, accounted for about 23% of GDP, because the Bank of Korea (central bank) actively issued Monetary Stabilization Bonds (MSB). After the crisis, these governments increased the issuance of bonds in order to finance projects to restructure the financial sector and conduct expansionary fiscal policies. Chart 3: Outstanding Government Bonds Issued for Four Countries (Percent of GDP): 1990 – 1999 Average 0 5 10 15 20 25 30 35 40 45 50 US Korea Malaysia Thailand Source: DRIASIA; IFS, IMF. In Korea, official bonds—including government bonds, public bonds (bonds issued by municipal governments and public enterprises) and MSB—accounted for about 35% of total 28 outstanding bonds including corporate bonds throughout 1980-1999.6 Among the official bonds, public bonds and MSB were the major type, as the amount of government bonds was small (Table 8a). The share of official bonds increased from 38% of total outstanding bonds including corporate bonds in 1980 to 49% in 1990, and then dropped to 39% in 1995. However, the share increased again to 46% in 1999, reflecting the growing financing needs of expansionary government activities, social safety nets, and the process of restructuring financial institutions in the post-crisis period. In particular, the proportion of treasury bonds increased rapidly, from only 5% of total outstanding government bonds when first introduced in 1994 to 56% in 1999. Table 8a: Korea, Issuers of Official Bonds (Percent of Outstanding Official Bonds Issued): 1995-1999 1995-1996 Average 1997 1998-1999 Average Government Bonds 17.4 21.9 17.4 Public Bonds 42.5 35.2 40.4 Monetary Stabilization Bonds 40.1 42.9 42.1 Total 100.0 100.0 100.0 Note: Data refer to outstanding official bonds, stock data. Source: Appendix I. A more distinctive trend is observed in Malaysia. Official bonds include Malaysian Government Securities (MGS), Government Investment Issues, Khazanah Bonds, Malaysian Savings Bonds, Danaharta Bonds, and Danamodal Bonds. Until the middle of 1950s, the government bond (MGS) market was insignificant because there was no need to obtain funding. MGS were issued mainly to meet the investment needs of the EPF, which had been established in 1951. The government increased the issuance of MGS in the 1970s and 1980s to finance its rapidly growing development expenditure and fiscal deficit. Consequently, it became the dominant issuer in the bond market. While the value of outstanding MGS issued rose throughout the period except for 1994-1995, the share of MGS in outstanding bonds issued, including corporate bonds, dropped from more than 90% in the 1980s to about 70% in the first half of the 1990s, and further to about 50-60% in the second half of the decade. Since the onset of the crisis, however, the Malaysian government has increased MGS to meet the needs of an expansionary fiscal policy aimed at reviving the economy, and thus to finance the growing fiscal deficit. Furthermore, Danamodal and Danaharta Bonds were introduced; together they accounted for about 10% of total outstanding bonds in 1999. Danamodal was established in 1998 as a special purpose agency to recapitalize, strengthen and restructure banking institutions. Danaharta was established in the same year as a statutory company to purchase non-performing loans from financial institutions and manage 6 Monetary stabilization bonds are issued by the Bank of Korea (central bank) as an instrument for monetary policy operations. Owing to the lack of liquidity in the government bond market, the Bank of Korea began to issue bonds in 1961, using them for open market operations. 29 Overview them to maximize their recovery value. Among official bonds, thus, MGS accounted for 90% of outstanding official bonds issued during 1995-1997, but their share dropped to 74% in 1998-2000 owing to the issuance of Danamodal and Danaharta Bonds (Table 8b). Table 8b: Malaysia, Issuers of Official Bonds (Percent of Outstanding Official Bonds Issued):1995-2000 1995-1996 Average 1997 1998-2000 Average Malaysian Government Securities 92.0 93.4 74.3 Government Investment Issues 6.4 3.8 1.9 Khazanah Bonds - 1.4 6.7 Malaysian Saving Bonds 1.5 1.2 0.1 Danaharta Bonds - - 6.2 Danamodal Bonds - - 10.6 Total 100.0 100.0 100.0 Note: Data refer to outstanding official bonds, stock data. Source: Appendix II. In Thailand, the government ceased issuing new bonds in 1987 after it started running consecutive budget surpluses. In general, the issuance of government bonds is restricted by the budget law, which states that the government can only issue bonds when a budget deficit arises. Thus, the share of government bonds during 1996-1997 accounted for a mere 2% of all outstanding bond issues including corporate bonds. Among official bonds, government bonds accounted for 3.5% of outstanding official bonds during 1996-1997 (Table 8c). On the other hand, state enterprises, the Financial Institutions Development Fund (FIDF), and the Bank of Thailand (central bank) increased their share of outstanding bond issues to nearly monopolize official bonds in 1997. The FIDF is a financial vehicle aimed at providing liquidity to ailing banks and finance companies. Most of these official bonds are explicitly guaranteed by the government. The issuers of state bonds included the Electricity Generating Authority of Thailand, Telephone Organization of Thailand, Expressway and Rapid Transit Authority and National Housing Authority. The Thai government started issuing bonds in 1998, and became the largest issuer of bonds, with the share rising from 0.7% of outstanding official bonds in 1997 to 78% in 1998. However, the share then dropped to 61% in 1999 and further to 20% in 2000. The government used these proceeds to finance the liabilities of the FIDF and to recapitalize financial institutions. In 1998, all government bonds were recapitalization bonds issued for the FIDF. In 1999, about 90% of government bonds were racapitalization bonds, of which 84% were for the FIDF, 13% for banks, and 3% for finance companies. 30 Table 8c: Thailand, Issuers of Official Bonds (Percent of Outstanding Official Bonds Issued):1996-2000 1996 1997 1998 1999 2000 Government Bonds 6.3 0.7 77.9 60.8 19.9 State Enterprise Bonds 30.6 27.1 11.3 19.7 30.2 BOT Bonds and FIDF Bonds 63.1 71.9 10.8 - - Treasury Bills - - - 14.1 49.5 Property Loan Management Organization - 0.3 - 5.4 0.4 Total Bonds (Public & Corporate) 100.0 100.0 100.0 100.0 100.0 Source: Appendix III. In Indonesia, the government did not issue bonds, and thus the bond market was barely developed until after the occurrence of the Asian financial crisis. Since the crisis, however, the government has become a leading issuer of bonds, as part of an effort to recapitalize ailing banks and help them restructure their balance sheets. The government issued bonds to capitalize banks that did not meet the 4% capital adequacy requirement. The bonds were then purchased by Bank Indonesia (central bank) to generate funds. The government used the proceeds from these sales as equity to recapitalize banks. Then, the banks undergoing recapitalization were required to purchase the government bonds from Bank Indonesia. In this way, no new money was injected into the market. The government also issued promissory notes to Bank Indonesia to repay the cost of the blanket guarantees given by the bank. Investors in Government Bonds In the Korean government bond markets, banks including the bank trust department held around 50% of total bonds before the crisis, and have maintained this share even after the crisis (Table 9a). The most recent data—as of August 2000—indicate that 72% of government bonds were held by banks, 19% by ITCs, and about 3.5% each by insurance firms and securities firms (Park, 2001a). 31 Overview Table 9a: Korea, Investors of Government Bonds (Percent of Outstanding Official Bonds Issued): 1995-1999 1, 2 1995-1996 Average 1997 1998-1999 Average Banks 23.4 28.7 38.6 Bank-Trusts 31.4 13.6 19.7 Others 45.1 57.8 41.8 Total 100.0 100.0 100.0 Total (100 Bill. of Won) 241 285 514 Note 1: Treasury Bonds, Foreign Exchange Stabilization Fund, Grain Securities, National Housing Bonds, Treasury Bills. Note 2: Data refer to outstanding official bonds, stock data. Source: Appendix I. Among the different types of investors, it is the banking sector that has increased holdings of official bonds in Korea. This reflects an increased awareness of the need to improve internal risk management by increasing holdings of safer assets, the need to improve capital adequacy ratios, and the need to meet liquidity requirements. Since banks’ capital levels were already low, they invested in government securities and thereby escaped from the need to worry about capital requirements. Other major investors—which are categorized under “other,” and which include non-bank financial institutions, such as ITCs and securities firms—also increased their purchases of government securities, since they began to recognize the credit risks associated with corporate bonds and shifted their investments to higher quality bonds. Overall, the financial sector (together with the banking sector) has played a crucial role in the official bond market as the major investor. In the Malaysian official bond market, the EPF has been the dominant investor for more than 40 years. Table 9b indicates that it has held more than 50% of total MGS issued both before and after the crisis. It obtains its resources from mandatory contributions by employers and employees based on a percentage of the employees’ wages. It has been required to invest a specified portion of MGS in their asset portfolios. MGS are also eligible liquid assets for commercial banks, merchant banks, and financial institutions that need to meet reserve requirements. This may explain why financial institutions are the second largest investors, accounting for 17% to 23% of outstanding MGS issued during the 1990s. Among them, the banking sector has been the largest investor, accounting for 17% of total MGS issued during 1990-1999. MGS are also eligible assets for insurance companies that need to meet their minimum asset requirements. 32 Table 9b: Malaysia, Investors of Government Bonds (Percent of Outstanding Government Bond Issues): 1995-2000 1995-1996 Average 1997 1997-2000 Average General Government 0.7 0.6 0.2 EPF 59.2 57.5 64.9 SOCSO 2.7 2.4 2.2 Insurance Companies 8.0 7.9 7.5 Bank Negara Malaysia 0.2 0.2 0.1 Banking Institutions 15.2 19.1 16.9 National Savings Bank 3.2 2.1 1.3 Foreign Holders 2.9 2.6 0.5 Others 8.0 7.5 6.3 Total 100.0 100.0 100.0 Total (Millions of Ringgits) 65,815 66,262 80,878 Note: Data refer to outstanding government bonds, stock data. Source: Appendix II. In Malaysia, the EPF’s investment policies and portfolios have been determined by an investment panel comprising of members appointed by the Ministry of Finance. The panel is comprised of the EPF’s chairman, representatives from the Ministry of Finance, Bank Negara Malaysia, and three financial and investment experts. Since more than 50% of the EPF’s investable annual funds (flow resources) and no less than 70% of its total investment funds (stock resources) were required to be invested in MGS in the past, it maintained at least 70% of its investment funds in the form of MGS. In the 1990s, however, it was allowed to diversify into other safe and relatively high yielding instruments, given that the amount of MGS issues was declining owing to a sound fiscal policy. As of the end of June 2000, the EPF held 32% of its investment funds in MGS, 23% in corporate bonds, debentures, guaranteed loans, and promissory loans, 23% in the form of money market instruments, and 21% in the form of equity (Hamid, 2000). Following the EPF, the banking sector is the second largest investor in the official bond market, accounting for more than 15% of the total MGS issues. In Thailand, commercial banks are the major investors in the official bond market (including government bonds, FIDF bonds, and bonds issued for financial sector restructuring). Table 9c shows that the banking sector accounted for more than 60% of total official bonds issued in 1995-1996, although its holdings of official bonds dropped in terms of both relative shares as well as the absolute value after 1997, reflecting a severe deterioration of their balance sheets and a shortage of available funds. The Bank of Thailand and FIDF were the third largest investors after non-bank financial institutions before the crisis, but have become the second largest since the crisis. 33 Overview Table 9c: Thailand, Investors of Official Bonds (Percent of Outstanding Government Bonds Issued): 1995-2000 1, 2 1995-1996 Average 1997 1997-2000 Average Bank of Thailand & FIDF 11.3 25.9 20.4 Commercial Banks 64.3 54.9 40.4 Government Savings Bank 0.1 0.0 13.7 Other Financial Institutions 20.5 14.8 9.9 Insurance Companies 0.0 0.0 4.4 Others3 3.7 4.3 11.2 Total 100.0 100.0 100.0 Total (Billions of Baht) 31 14 11 Note 1: Government bonds, including Loan for FIDF and Loan for financial sector restructuring. Note 2: Data refer to outstanding official bonds, stock data. Note 3: investors, mutual funds, provident funds. Source: Appendix III. The dominance of the banking sector as investors in government bonds has also been observed in post-crisis Indonesia (Table 9d). As of March 2001, the latest month for which data are available, domestic commercial banks held 62% of total government bonds. Prior to the crisis, the government did not issue any bonds, since fiscal surpluses were maintained. After the crisis, it issued bonds to recapitalize weak banks, and these bonds were then purchased by Bank Indonesia and sold to commercial banks in exchange for their stocks. As a result, they did not cause any increase in money supply. For these reasons, most government bonds have been held by domestic commercial banks, although some of them were later sold in the secondary market. Table 9d: Indonesia, Investors of Government Bonds (Percent of Outstanding Government Bond Issued): March 2001 Billions of Ruppiah Percent Private National Banks 28,612 62.2 Foreign Banks 5,723 12.4 Securities Companies 2,519 5.5 Mutual Funds 100 0.2 Insurance 499 1.1 Pension Funds 66 0.1 Private Companies 155 0.3 Other 8,328 18.1 Total 45,993 100.0 Note: Data refer to outstanding bonds, stock data. Source: Appendix IV. 34 Maturity of Government Bonds In Korea, prior to 1994, all government bonds except National Housing Bonds were of a maturity of five years or below. In 1998, the government announced that three years would be the key maturity of government bonds, given that three years was the de-facto representative maturity. The government plans to extend this benchmark to a longer maturity once the three-year government bond is established. Table 10: Maturity Structure of Government Bonds (Weighted Average) Before Crisis After Crisis Korea More than 7 years Less than 3 years Malaysia More than 10 years 6-10 years Thailand Less than 5 years More than 5 years Indonesia N.A. 5-10 years Source: Appendices. In Malaysia, the maturity of MGS ranges from two to three years to above 15 years. Of these securities, those with a maturity of more than 15 years accounted for over 50% of the total outstanding MGS issued during 1995-1996. After the crisis, however, the rate of those with maturities above 15 years dropped from 52% in 1997 to 38% in 2000. In Thailand, the maturity of government bonds issued during 1998-1999 ranged from one year to 15 years, with a relatively high concentration in one-year, three-year, sevenyear, and 10-year periods. In Indonesia, the maturity of government bonds ranged from one to 10 years. Liquidity of Government Bonds In Korea, until 1994 government bonds were issued at fixed interest rates below market rates. They were also issued through allocations to financial institutions or were forcibly sold to agents (by obliging them to purchase bonds when they bought apartments, for example). Furthermore, issuance patterns were irregular. These factors contributed to low liquidity in the government bond market. These policies were reformed in 1994, when the government rationalized various funds that issued government bonds, merging them into the National Debt Management Fund, and began to issue treasury bonds. Furthermore, it formed an underwriting syndicate and introduced an auction system to the syndicate. Despite these reforms, the issuing terms did not become completely market-based, since the government continued to set a reservation price that did not necessarily reflect market conditions, sell bonds until the bid reached the reservation price, and ration unsold bonds to the syndicate. As a result, these reforms failed to improve the liquidity conditions in the secondary markets. 41 Overview References Asian Policy Forum and Asian Development Bank Institute, 2000, Policy Recommendations for Preventing Another Capital Account Crisis. Hamid, Norashikin Abdul, 2000, Guide to the Malaysian Bond Market, Rating Agency Malaysia Berhad. Organization for Economic Cooperation and Development (OECD), 2001, “OECD Economic Surveys: Korea,” August 2001. Oh, Gyutaeg and Changyong Rhee, 2001, “The Role of Corporate bond Markets in the Korean Financial Restructuring Process,” a paper presented at the Conference of the Korean Crisis and Recovery, Seoul, Korea, May 17-19, 2001. Park, Jae-Ha, 2001a, “Changes in the Role of Korean Bond Market after Financial Crisis, a presentation made at the Tokyo Seminar, Asian Development Bank Institute, April 3, 2001. Park, Jae-Ha, 2001b, “Korea’s Experience in Managing Financial Crisis,” a paper presented at a senior policy seminar organized by the World Bank Institute and the Center for Pacific Basin Monetary and Economic Studies at the FRB San Francisco, March 12-15, 2001. Shirai, Sayuri, 2001, “Searching for New Regulatory Frameworks for the Intermediate Financial Structure in Post-Crisis Asia,” a paper presented at the ADBI/Wharton School Joint Seminar, July 26-27, 2001. Yoshitomi, Masaru, and Kenichi Ohno, 1999, “Capital Account Crisis and Credit Contraction,” ADB Institute Working Paper No. 2. Yoshitomi, Masaru and Sayuri Shirai, 2001, “Designing a Financial Market Structure in Post-Crisis Asia: How to Develop Corporate Bond Markets,” ADB Institute Working Paper No. 15. 42 Appendix I. Case of the Republic of Korea Table of Contents 1. Introduction.....................................................................................................................................44 2. Patterns of Financing and Saving in Korea.....................................................................................44 2.1. Financing Pattern of Nonfinancial Firms..........................................................................44 2.2. Savings Pattern of Households ..........................................................................................47 2.3. ITC Crisis...........................................................................................................................48 3. The Korean Bond Market................................................................................................................49 3.1. The Market Environment ...................................................................................................49 3.2. Overview of Structure and Growth of the Market..............................................................51 3.3. The Korean Government Bond Market..............................................................................53 3.4. Corporate Bond Market.....................................................................................................58 4. Evaluation of Korean Bond Market Development..........................................................................61 4.1. The Government Bond Market...........................................................................................61 4.2. The Corporate Bond Market..............................................................................................62 References...........................................................................................................................................64 Tables and Charts Table 1: Korea, External Financing of Nonfinancial Firms, Composition of Stock: 1976-1999...............................................................................................................45 Table 2: Korea, External Financing of Nonfinancial Firms, Composition of Flow: 1976-1999...............................................................................................................45 Table 3: Korea, Financing of Manufacturing Firms’ Investment: 1981-1999..........................47 Table 4: Korea, Saving Pattern of Households, Flow: 1981-1999 ...........................................47 Table 5: Korea, Rise and Fall of ITCs, Outstanding Balance: 1994-2000...............................................................................................................48 Table 6: Korea, Growth and Composition of the Korean Bond Market: 1980-1999................51 Table 7: Korea, Offerings of Government Bonds by Maturity: 1991-1994..............................53 Table 8: Korea, Yield Curve of Treasury Bonds ......................................................................56 Table 9: Korea, ITCs’ Holdings of Corporate Bond: December 1999 .....................................60 Chart: Korea, Yield Curve of Treasury Bond: 1 November 2000 ............................................57 Reference Tables Ref. Table 1: Korea, External Financing of Nonfinancial Firms Stock: 1980-1999 ................65 Ref. Table 2: Korea, Financing Pattern of Nonfinancial Firms, Flow: 1980-1999...................66 Ref. Table 3: Korea, Financing Pattern of Manufacturing Firm, Survey Data: 1980-1999......67 Ref. Table 4: Korea, Saving Pattern of Households: 1980-1999..............................................68 Ref. Table 5: Korea, Outstanding Balance of the Korean Bond Market: 1980-1999...............69 Ref. Table 6: Korea, Government Bond Market, Outstanding Amount: 1980-1999................70 Ref. Table 7: Korea, Maturity Profile of Primary Market forTreasury Bonds: 1994-1998......71 Ref. Table 8: Korea, Turnover Ratio on Government Bonds: 1988-1999................................71 Ref. Table 9: Korea, Investors in Government and Public Bonds: 1980-1999.........................72 Ref. Table 10: Korea, Government Bond Holdings of Banks, 1980-1999...............................73 43 Appendix I Ref. Table 11: Korea, Offerings of Corporate Bonds by Maturity: 1980-1999........................74 Ref. Table 12: Korea, Offerings of Corporate Bonds by Type: 1980-1999 .............................75 Ref. Table 13: Korea, Guaranteed Corporate Outstanding Bonds by Guarantor: 1980-1999 ..76 Ref. Table 14: Korea, Offerings of Corporate Bonds by Company Size: 1980-1999 ..............77 Ref. Table 15: Korea, Corporate Bonds Issued by Industries: 1980-1999 ...............................78 Ref. Table 16: Korea, Overseas Securities Offerings by Type: 1985-1997..............................79 Ref. Table 17: Korea, Turnover Rate on Corporate Bonds: 1988-1999 ...................................80 Ref. Table 18: Korea, Investors in Corporate Bonds: 1980-1999.............................................81 Ref. Table 19: Korea, Bond Holdings of Investment Trust Companies: 1984-1999................82 44 1. Introduction The main purpose of Appendix I is to document the development of the Korean bond market, with a focus on the past two decades. Patterns of growth, market structure, and notable regulatory changes are described, and characteristics of the market summarized. The crisis of 1997 was a defining moment for the government bond market, proving a dividing line between a controlled stagnant regime and a liberalized active one. The corporate bond market has shown strong growth since the late 1970s and bonds have played a significant role in corporate financing. At the same time, despite solid growth in terms of quantity, the Korean corporate bond market has displayed features not typical of arm’s length debt. The boom-and-bust cycle in 1998 and 1999 provide the most dramatic illustration of this. The second purpose of this appendix is to evaluate the aforementioned observations and propose a hypothetical framework for understanding them. First, regarding the development pattern of the government bond market, this appendix suggests that it should be consistent with the political economy approach on regulatory reforms. Namely, fiscal needs of governments trigger government bond market reforms. For example, Kroszner (2001) has argued that recent government securities market reforms in many countries are fueled by public finance motives to decrease financing funding costs. The history of government bond market reforms in the Republic of Korea (henceforth, Korea) concurs with the argument. Second, this appendix attempts to define the nature of the corporate bond market in Korea, arguing that it was structured similar to the loan market in its risk-bearing mechanism where implicit insurance by the government played an important part. In this sense, bond financing in Korea can be regarded as de-facto loan financing and a cause of the boom and bust in 1998 and 1999. The rest of the appendix is organized as follows. In the first section, patterns of financing of nonfinancial firms are discussed, together with saving patterns of households. It is shown that bonds have been a significant source of funding for Korean firms in the last two decades. Also, the boom and bust in corporate bond financing in 1998 and 1999 is explained. In the second section, the development process of the Korean bond market is discussed in detail. The origins and structure of the market and regulatory changes are each explained. The third section evaluates the development process and contains concluding remarks. 2. Patterns of Financing and Saving in Korea 2.1. Financing Pattern of Nonfinancial Firms External Financing Pattern of Nonfinancial Firms (1) Before the Crisis The external financing pattern of Korean nonfinancial firms displayed four salient features before the crisis.1 First, loans from banks and nonbank financial institutions (NBFIs) 1 The following observations are made relying on data from “flow of funds.” 45 Appendix I have accounted for the largest portion of external funding over the past 25 years. In terms of stocks, the only exception was the latter five years of the late 1970s. Afterwards, the share of loans remained stable at about 35%. Second, the direct funding channel including equity, bonds, and commercial paper (CP) has accounted for about the same portion of external financing as loans. Equity has been a stable source of funds, providing about 17% of externally financed resources of nonfinancial firms. Bond financing had increased steadily over the years, rising from a mere 3.3% in the late 1970s to more than 15% in the 1990s in stock. Due to the strong growth of bond financing, the share of direct financing surpassed loans in the 1990s (Table 1). Third, in contrast, financing from foreign sources decreased from 13.6% in the late 1970s to 4.4% in the early 1990s. Even for the three years before the crisis and in terms of flow, the proportion of shares remained modest at around 5% in 1994 and 1995, and 10% in 1996. This may seem inconsistent with the view that the Korean crisis erupted as a result of the amount of unhedged funds owed to foreign creditors. But, it should be remembered that major domestic borrowers from foreign sources were banks rather than nonfinancial firms. Table 1: Korea, External Financing of Nonfinancial Firms, Composition of Stock (Percent): 1976-1999 1976-1980 1981-1985 1986-1990 1991-1995 1996 1997 1998 1999 Bonds 3.3 7.2 10.1 15.5 16.2 16.1 21.0 20.4 Equity 17.8 16.1 18.6 17.9 16.2 15.4 17.0 20.3 CP 1.4 3.0 4.0 5.2 8.6 7.4 6.1 4.2 Subtotal 22.5 26.3 32.7 38.6 41.0 38.9 44.1 44.8 Loans 29.7 33.5 36.1 37.5 36.0 36.1 33.3 32.1 Foreign 13.6 10.9 6.2 4.4 5.7 8.5 5.8 5.4 Others 34.3 29.3 25.1 19.5 17.3 16.6 16.9 17.7 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Flow of Fund, Bank of Korea. Table 2: Korea, External Financing of Nonfinancial Firms, Composition of Flow (Percent): 1976-1999 1976-1980 1981-1985 1986-1990 1991-1995 1996 1997 1998 1999 Bonds 6.0 12.2 16.3 18.8 18.0 23.9 180.0 3.4 Equity 12.2 15.9 21.7 15.6 11.0 7.8 53.0 7.6 CP 2.8 3.4 6.4 8.9 17.6 3.9 -45.8 -32.3 Subtotal 21.0 31.5 44.3 43.3 46.7 35.6 187.4 47.4 Loans 36.3 40.0 35.5 38.3 28.3 37.8 -63.9 4.1 Foreign 11.7 1.6 3.4 3.8 10.5 5.7 -38.5 19.7 Others 31.1 26.8 16.7 14.6 14.5 20.9 15.1 28.8 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Flow of Fund, Bank of Korea. 46 Fourth, another component in decline was “others,” including trade credit, whose share reduced from 34.3% in the late 1970s to below 20% in the 1990s. (2) After the Crisis Dramatic changes in the external financing pattern ensued after the crisis that can be best identified by focusing on flow data. First, among financial institutions in Korea, merchant banking corporations were hardest hit by the crisis. About 80% of merchant banking corporations are now liquidated or have been merged with securities companies. The mass demise of corporations had a devastating impact on the CP market, since merchant banking corporations handled most CP transactions. Consequently, firms had to repay matured CP, as is indicated by the negative financial flow of CP in 1998 and 1999 (Table 2). Second and most notable, a “boom and crash” in bond financing took place. In terms of flow, the amount of bond financing sharply increased in 1998 to W46 trillion from W27 trillion in 1997, accounting for almost 80% of the total financing of firms and compensating for contractions in other financing channels. However, the corporate bond market has literally been paralyzed since the middle of 1999 when Daewoo, the third largest conglomerate in Korea, went bankrupt. The boom and bust in the bond market after the crisis is a reflection of the investment trust company (ITC) crisis, as explained later in this section. Third, as a result of the currency crisis, Korean firms were forced to pay back their borrowings from foreign sources in 1998. But, as the Korean economy recovered rapidly in 1999, firms regained access to foreign financing. Financing of Manufacturing Firms’ Investment This appendix has been concerned so far only with overall liabilities of firms. However, one may want to know how firms finance specific components of assets, such as increases in fixed assets or investment. Since no such available data exist, this appendix attempts to estimate them based on balance sheet information. The Bank of Korea (BOK) publishes consolidated balance sheets of surveyed firms every year. Focusing on manufacturing firms, this appendix makes the following assumptions. First, only long-term liabilities and capital consisting of equity and retained earnings are used for investment. In other words, firms do not finance investment through short-term or liquid liabilities. Second, if the yearly change is negative in any of the long-term liabilities and capital, those components do not contribute to investment. Table 3 depicts the estimated financing pattern of manufacturing firms’ investment. The shares of each component fluctuate significantly, in particular, that for loans. Hence, it is difficult to take the estimate as being reliable. Nonetheless, it suggests that bonds and loans have contributed comparably to investment of manufacturing firms over the couple of decades leading up to the crisis. 47 Appendix I Table 3: Korea, Financing of Manufacturing Firms’ Investment (Percent): 1981-1999 1981-1985 1986-1990 1991-1995 1996 1997 1998 1999 Loans 19.9 27.3 17.5 22.0 59.2 0.0 0.0 Bonds 15.5 14.8 21.6 38.7 25.3 23.4 0.0 Equity 43.8 40.0 33.3 14.4 15.5 76.0 77.8 Retained Earnings 11.0 12.1 18.2 6.5 0.0 0.0 0.4 Others 9.8 5.8 9.3 18.4 0.0 0.6 21.7 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Estimates by the author; Financial Statement Analysis, Bank of Korea. 2.2. Savings Pattern of Households (1) Before the Crisis Savings patterns before the crisis exhibited the following three features. First, the major saving instrument for individuals had always been deposits, though there were changes in composition between bank deposits and NBFI deposits. The share of NBFI deposits, in particular merchant banking corporations’ deposits, kept increasing as markets were gradually liberalized and NBFIs attracted depositors by providing higher interest rates. Increased savings in NBFI deposits supported CP financing as well as NBFI loans. Second, increasingly larger amounts of savings flowed into ITCs and banks’ trust departments. In terms of a five-year average, their share rose from 14.5% in 1981-1985 to 25% in 1991-1995. Related to this, it is notable that households’ direct investment in bonds was almost nil (Table 4). Third, savings in insurance and pensions stayed stable at around 20% throughout the two decades before the crisis. Table 4: Korea, Saving Pattern of Households, Flow (Percent): 1981-1999 1981-1985 1986-1990 1991-1995 1996 1997 1998 1999 Deposits 39.9 41.0 45.5 46.1 35.1 55.7 74.2 Trust 14.5 17.6 24.9 19.1 25.1 32.4 -27.9 Insurance & Pension 18.8 19.5 16.9 23.3 20.7 3.3 18.9 Equity 14.5 10.7 5.7 8.2 11.7 9.6 20.7 Others 12.3 11.2 7.0 3.3 7.4 -0.9 14.1 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Flow of Funds, Bank of Korea. 48 (2) After the Crisis The savings flow after the crisis of 1997 reflects the order of occurrence of the troubles that struck the financial sector. Merchant banking corporations went bust in late 1997 and, as a result, deposits in those institutions flowed out, reducing their share of deposits that year. In 1998, a few insurance companies were found to be bankrupt, which resulted in a decrease in this sector’s share. As the government finished closing down problem merchant banking corporations and small banks by the middle of 1998, and made it clear that there would be no more bank closures, deposits savings surged rapidly in 1998 and 1999. The share expanded to 56% in 1998 and further to 74.2% in 1999. Probably the most interesting aspect concerns the pattern of savings in trusts, including savings in ITCs and bank trust departments, which showed a mild expansion in 1998 and a bust in 1999. 2.3. ITC Crisis In fact, the amount of funds mobilized by ITCs in 1998 up to the middle of 1999 exceeded households’ savings in institutions because banks also invested funds from their enlarged deposits in ITC products. Consequently, the funds accumulated in ITCs skyrocketed from below W100 trillion in 1997 to W250 trillion in June 1999 (Table 5). ITCs invested the funds in corporate bonds, which supported the boom in bond financing. In particular, a large amount of investment was made in corporate bonds and CP issued by Daewoo. As of August 1999, ITCs held W27.5 trillion in Daewoo securities (corporate bonds and CP) at face value, which was 10.7% of their total investment.2 When Daewoo went bankrupt in August 1999, investors began running to ITCs demanding redemption. In reaction to the crisis, policymakers intervened and improvised a de-facto ITC holiday. Financial institutions were informally “guided” by the supervisory authority not to seek redemption. As for individual investors, a scheme was devised to induce dispersed redemption: only 50% of investment in Daewoo bonds was paid to those who demanded redemption before 10 November 1999; 80% before 8 February 2000 and 95% after 8 February 2000.3 Nonetheless, the ebb from ITCs continued, shrinking their balance to W150 trillion by the middle of 2000. Table 5: Korea, Rise and Fall of ITCs, Outstanding Balance (Billions of Won): 1994-2000 1994 1995 1996 1997 1998 1999.6 1999.12 2000.6 Equity Type 14,144 14,442 15,134 12,413 8,671 30,916 56,667 65,693 Bond Type 43,272 50,148 59,148 81,707 189,983 215,434 132,965 84,091 Short Term 4,430 4,909 9,759 24,898 96,235 110,450 60,618 49,946 Long Term 38,842 45,239 49,389 56,809 93,748 104,983 43,135 21,155 Total 57,416 64,590 74,283 94,120 198,654 246,349 189,632 149,783 Source: Investment Trust, Korea Investment Trust Companies Association. 2 Financial Supervisory Commission (2000), p. 389. 3 Financial Supervisory Commission (2000), p. 391. 49 Appendix I The boom and bust experienced by ITCs implies that they experienced an investors’ run (sudden outflow), preceded by a reversed run (rapid inflow). This begs certain questions, since in theory ITCs should be free from such instability.4 First, how were ITCs able to attract such huge resources in a short period of time? And, why did the bankruptcy of Daewoo cause a sudden reversal in the flow? Answering these questions amounts to evaluating the development of the Korean corporate bond market. Hence, this appendix will return to them in the final section. 3. The Korean Bond Market 3.1. The Market Environment Origins of the Bond Market in Korea The origins of the bond market in Korea can be traced back to 1949, when the government issued “nation founding bonds.”5 In the 1950s, government bonds were issued to fund post-war reconstruction and the stock exchange was opened in 1956. Corporate bonds were introduced much later, when Ssangyong Cement issued convertible bonds in 1963. However, tangible increases in activity did not follow until 1972. In that year, facing a severe downturn in the economy and turmoil in the financial markets, the government introduced guaranteed corporate bonds to ease financial constraints facing companies.6 The new instrument became a turning point in the Korean corporate bond market, since explosive growth in new issuances followed and the outstanding balance of corporate bonds soared from W9.9 billion in 1972 to W1,840 billion in 1980. Emergence of Institutional Investors: Investment Trust Companies, and Bank-Trust Departments The corporate bond market was able to grow because it was preceded by a buildup of infrastructure, most notably the establishment of institutional investors. In 1968, aiming to promote both equity and bond financing, the Capital Market Promotion Act, a landmark piece of legislation, was passed. Part of this effort included the establishment of the Korean Investment Corporation (KIC), which was to engage in the investment trust business as well as other market-making roles. In order to facilitate its various functions, KIC was reshuffled over the next few years and in 1974 the investment trust business was transferred to the newly established Korea Investment Trust Company (KITC), the first ITC in Korea. Two other ITCs, Daehan and Kookmin, were established in 1977 and 1982, respectively. 4 ITCs are collective investment schemes (CISs) in marketable securities, such as US mutual funds or UK unit trusts. A CIS builds a fund by selling its own securities to investors and invests the fund in marketable securities, and so values of CIS-issued securities fluctuate depending on prices of underlying securities. Therefore, in theory, investors in such a CIS should not have incentives to run to the CIS in any circumstances, whether it is a sun spot driven run (Diamond and Dybvig, 1983) or information-based run (Jacklin and Bhattachrya, 1988). Indeed, Gorton and Pennacchi (1993) report empirical evidence that money market funds in the US were immune to investors’ runs when a large amount of CP defaulted. 5 Bank of Korea (1985). 6 The Korea Stock Exchange (1988). Specifically, the government authorized the Korean Investment Corporation to be a guarantor and extended the new business to banks. 50 Altogether, the three ITCs worked as prominent institutional investors in the corporate bond and equity markets throughout the 1980s. Further, in 1984 banks were allowed to engage in trust business.7 Subsequently, trust departments of banks formed a second group of institutional investors. As a result, since the late 1980s the corporate bond and equity markets have grown mainly based on the demand from ITCs and bank trusts. Trends in the Interface between the Government, Institutional Investors, and Final Savers The interface between the government and other players in the bond market may be summarized as “heavy market intervention and implicit insurance” by the government. First, since prices of financial products were under the government control, issuing interest rates of corporate bonds were decided directly by policymakers until the early 1990s.8 In 1991, when interest deregulation was pursued, the government announced as a first step that pricing of corporate bonds with maturities longer than two years would be liberalized. In 1993, liberalization was expanded to include corporate bonds of all maturities, financial debentures, and public bonds. However, aside from interest rate liberalization, conventions of market intervention continued and until the crisis of 1997, the government routinely intervened in the market to influence interest rates. In 1991, facing rising interest rates, the government introduced an explicit quantity control mechanism. Every bond issuer was required to submit its issuing plan one month in advance, and policymakers (namely, the Controlling Committee for Bond Issuance) decided the allowable issuing volumes. Second, besides direct market intervention, the government exercised de-facto managing authority over ITCs and banks, though most of the banks and all of the ITCs were privately owned.9 Most key managerial decisions such as the introduction of new products, pricing of products, and opening of new branches needed government approval, which was only discretionary. Moreover, probably based on this managerial power, which may be dubbed as “regulatory capital,” policymakers appointed board members in banks and ITCs. As a result, the government sometimes even utilized ITCs to bolster stock prices. Third, an implicit form of insurance was provided to ITCs and investors in them. As the government assumed de-facto managerial authority, naturally ITCs enjoyed governmental insurance against failure. In addition, assets of ITCs and bank trusts were not marked to market. Thus, when investors demanded redemption, ITCs paid spot cash according to book value, then transferred securities to their own accounts rather than selling them in the market. In this way, investors were shielded from market risk. In fact, fixed payment was promised to investors explicitly until 1990; and even afterwards the practice of guaranteeing certain 7 Trust business was first granted to regional banks in 1983, then to city banks in 1984 and foreign banks in 1985. Before 1983, only one special bank (Korea Trust Bank) was permitted to engage in trust business. 8 Issuance of Korean government bonds was through a non-market mechanism, as is explained later in this appendix, so the point is confined to the corporate bond market. 9 Ownership of Korean banks was dispersed due to the ceiling regulation that restricted maximum shares allowed to one person. And banks owned ITCs while the ownership structure was also dispersed. 57 Appendix I Chart: Korea, Yield Curve of Treasury Bond (Percent): 1 November 2000 6 6.2 6.4 6.6 6.8 7 7.2 7.4 7.6 7.8 8 3 m 6 m 9 m 1 y 1.5 y 2 y 2.5 y 3 y 5 y Investors (1) Before the Crisis Before the crisis, major investors in government bonds have been banks, bank trusts, and individuals. Data on the complete ownership structure of government bonds are not available. Hence, when focusing on government and public bonds instead, it can be seen that financial institutions held 55% to 65% of them before the crisis. Individuals constituted the second largest holding group with a 20% to 25% share. Among financial institutions, banks and bank trusts were dominant holders of government bonds. Specifically, government bond holdings of these two types of institutions accounted for about 60% of the outstanding balance of government bonds. This suggests that among government and public bonds, individual holdings were concentrated in public bonds, while financial institutions including banks and bank trusts invested in government bonds. The distribution of ownership was brought about by issuance procedures. As noted above, the government issued most government bonds to underwriting syndicates. Since banks and bank trusts were major members of the syndicate, they held the most government bonds. On the other hand, public bonds were issued through compulsory selling mechanisms in which individuals were forced to buy bonds in certain transactions. So this issuance procedure resulted in individuals holding a considerable amount of public bonds. In short, the holding structure of government bonds before the crisis was the mirror image of the captive market. 58 (2) After the Crisis After the crisis, continued reforms have enhanced the investment quality of government bonds. In addition, corporate sector restructuring has kept firms’ credit risk high. As a result, financial institutions have been voluntarily increasing holdings of government bonds. The share of financial institutions among holders of government and public bonds rose from 57% in 1997 to 67% and 74% in 1998 and 1999, respectively. As a consequence, the share of individual holdings has decreased from 24% to 13% over the same period. 3.4. Corporate Bond Market Primary Market (1) Before the Crisis (a) Issuance Procedure The issuance procedure of corporate bonds in Korea does not differ from international conventions. An issuing corporate usually designates a securities firm as the lead manager, who takes full responsibility for distributing the issue to the public. Terms of issuance are negotiated between the issuer and the lead manager. As mentioned in Section 2 of this Appendix, even after liberalization of interest rates, the government indirectly affected bond pricing by controlling volumes of issuance. But, since this intervention was at least through the market rather than through direct pricing controls, it could be said that rates were determined by market conditions, which the government largely helped to shape. (b) Fixed vs. Floating The overwhelming majority of corporate bonds issued have been fixed rate coupon bonds. Although data on floating bonds are not available, there has been essentially no issuance of floating bonds in the 1990s. (c) Maturity Throughout the 1990s and to this day, the three-year bond has been the most popular maturity for corporate bonds. More than 90% of corporate bonds have been of three-year maturity since 1990, with the exceptions of 1992 and 1993. In these two years, shares of three-year bonds accounted for 88% and 90%, respectively. Until 1987, three-year bonds accounted for less than half of newly issued corporate bonds, the rest being longer maturity bonds. It seems that the regime change in 1988 had a lot to do with deregulation. Until 1987, the government regulated the maturity structure of newly issued bonds, but this was abolished in 1988.17 17 Securities Supervisory Authority, Annual Report on the Capital Market, 1988, pp. 54-56. 59 Appendix I (d) Guarantees Before the crisis, the majority of corporate bonds carried guarantees from financial institutions. The share of guaranteed bonds had been around 85% to 90 % over the past two decades, except for the period 1992 to 1995, when the proportion fell to 60% to 70%. Government policy, once again, seemed responsible for the increases in the proportion of non-guaranteed bonds over those four years. The government (Controlling Committee for Bond Issuance) granted priority to non-guaranteed bonds when adjusting issuance amounts during the period. There were various guarantors. They included the Guaranteed Fund, surety companies, banks, securities companies, and merchant banking corporations. In the 1980s, banks were major guarantors, accounting for more than 50% of guaranteed bonds. However, their dominance faded while the Guaranteed Fund and surety companies emerged instead as prominent guarantors. In 1997, the Guaranteed Fund and surety companies accounted for 56% of guaranteed outstanding bonds, while banks accounted for only 23%. The declining dominance of banks as guarantors seems to reflect differences in the regulation and competition environment between banks and other guarantors. Nonbank guarantors were exposed to regulations to a lesser degree. In particular, from the late 1980s, banks were subject to capital regulations, so their opportunity costs for providing guarantee services increased relatively. Also, in the case of securities companies, entry into the industry had already been liberalized in the 1980s. In the face of severe competition, securities companies aggressively increased their guarantee provisions. (e) Issuers Large-sized manufacturing companies have been the dominant issuers. (f) Overseas Issuance Foreign placement of corporate bonds was rare due to regulations. Although the amount has increased in the late 1990s, it remained about US$2 billion. (2) After the Crisis Dramatic Decrease in Guaranteed Bonds The prominent change after the crisis was a drastic reduction in the issuance of guaranteed bonds. The share of guaranteed bonds in the primary market decreased from 85% in 1997 to 31% and 4% in 1998 and 1999, respectively. This decrease was partly due to a regulation in 1998 that prohibited securities companies from providing guarantees. But it reflects a more fundamental change in behavior of financial institutions toward “risk.” Threatened by bankruptcy for the first time, banks and other financial institutions became more cautious in taking risks. 60 Secondary Market (a) Trading Trading of corporate bonds remained modest, as was the case of government bonds in Korea. But, in contrast to government bonds, their trading activity increased in the 1990s. Turnover ratios almost quadrupled to 91% in 1997 from 24% in 1990. And the rising trend has been visibly greater after the crisis as turnover ratios reached more than two. Most transactions involving corporate bonds take place in the OTC market, with more than 97% of trading conducted this way in the last five years. Almost all corporate bonds are listed, because many institutional investors are restricted to investing in listed bonds. But, since most transactions are carried out at the OTC, listing is largely a formality. (b) Investors Institutional investors have dominated corporate bond ownership. Throughout the 1990s, financial institutions held about 90% of outstanding corporate bonds. Among financial institutions, ITCs form the largest investor group. However, until 1998, data on ITCs’ holdings of corporate bonds were not available and they did not distinguish corporate bonds from non-corporate. In terms of all bonds, disregarding issuers, the ratio of ITCs’ holdings to outstanding balances has fluctuated between 30% and 45% before the crisis. In 1999, the first year for which information on ITCs’ holdings of corporate bonds exist, ITCs held 38% of outstanding bonds of all kinds and about 60% of outstanding corporate bonds (Table 9). Aside from ITCs, other notable institutional investors include bank trusts, banks, and insurance companies. Table 9: Korea, ITCs’ Holdings of Corporate Bond (100 Billions of Won, Percent): December 1999 Corporate Bonds Non-Corporate Bonds Total 661.6 338.2 999.8 (55.3) (19.7) (37.5) Note: Numbers in ( ) are ratios to outstanding balances of each kind. Source: Investment Trust, Korea Investment Trust Companies Association. 61 Appendix I 4. Evaluation of Korean Bond Market Development 4.1. The Government Bond Market Summary of the Development Process Development of the government bond market in Korea appears to be dictated by the fiscal conditions set by the government. While fiscal soundness was maintained before the crisis, many of the financing needs had been absent. The government utilized bond financing for compulsory procurement of resources, which called for specific policies. In this sense, issuance of government bonds in Korea was another form of tax rather than borrowings from the market. There was some attempt at reforms when the government adopted the underwriting syndicate system and the multiple pricing auction system in 1994. But the effort turned out to be abortive, since the fundamental nature of the “captive” market remained intact. Thus, the secondary market for government bonds was stagnant and there was some distance between the government bond market and other financial markets. Using the government bond market as an instrument for developing the corporate bond markets was out of the question. After the crisis, fundamental changes occurred. The primary dealer system was adopted as a new issuance procedure and distortions in the market have been abolished. For the first time, the government bond market in the genuine sense has been formed. Hence, it may be said that the Korean government bond market has just begun its development and is about to play a positive role in supporting the growth of the corporate bond market, such as through providing a benchmark. Evaluation The development process of the Korean government bond market seems to support the political economy view on regulatory reforms: namely, the interpretation that fiscal needs of governments trigger government bond market reforms. For example, Kroszner (2001) has argued that recent reforms of government securities markets in many countries are fueled by public finance motives to decrease financing funding costs. While overall fiscal soundness was maintained and thus financing needs of the government were limited, the Korean government used government bonds as an implicit taxing instrument on financial institutions. This was feasible and did not create too much of distortion because the magnitude of the taxing was modest. However, after the crisis, fiscal conditions deteriorated and the government faced the need for large-scale resource mobilization, which was difficult to meet through traditional means of compulsory procurement. Incentives for genuine reforms came into existence, resulting in the aforementioned market reforms. 62 4.2. The Corporate Bond Market Summary of the Development Process The pace of development in the Korean corporate bond market has been impressive. From its virtual non-existence until 1973, its presence in external financing of firms has grown to be comparable to the bank loan market since then. The strong growth process has displayed the following features. First, most corporate bonds were guaranteed. Second, ITCs were the major investors. Third, assets of ITCs were not marked to market and they provided deposit-like products to final investors by promising certain payment. In practice, when investors demand redemption, ITCs transferred some of the assets to their own accounts instead of selling them on the market and paid spot cash. Through this mechanism, if losses occurred, they were borne by ITCs rather than final investors. Fourth, presumably due to this procedure, secondary market activity has been stagnant. Fifth, the government was the de-facto governor of ITCs. Hence, implicit insurance by the government existed for ITCs and final investors. Nature of the Korean Corporate Bond Market before the Crisis In theory, the key difference between bonds and loans rests in who bears (direct) risks. In bank loans, banks take all the risk, including credit and market risk. Depositors are immune to these direct risks, although they may be exposed to indirect defaulting risk of banks. But in reality, since deposit insurance exists in most countries, whether explicit or not, small depositors are effectively insured from even the indirect risk. In contrast, in the case of bond claims, all the risks fall on bondholders, in principle. Reflecting this risk-bearing structure, in the case of bank loans, banks perform the monitoring function. In the case of bonds, bondholders are supposed to be the monitors. But due to the free rider problem, monitoring is not provided as intensively as with bank loans. Hence, only the firms that are believed to have less of a tendency towards moral hazard obtain access to the bond market.18 There are also infrastructural factors. Good accounting practices and more than “limited participation” in the financial markets19 are required to develop a bond market. In view of this theoretical characterization of bank loans and bonds, we need to ask who bore risks in the Korean corporate bond market. Before the crisis, ITCs and guarantors (financial institutions) shared the risks. Guarantors took direct credit risks while ITCs bore market risks as well as the defaulting risk of guarantors. Final investors were immune to all the risks just as in the case of bank deposits. In short, ITCs in combination with guarantors formed de-facto banks. They accepted de-facto deposits as banks, but invested in bonds. However, although they invested in bonds, ITCs chose not to engage in trading. It seems that in order to meet fixed payments to final investors, they found that a “buy and hold 18 Holmstrom and Tirole (1997) have shown that enough monetary assets (net worth) enable firms to avoid the moral hazard problem. Diamond’s model (1991) has emphasized the role of reputation. 19 Diamond (1997) has shown that when there exists limited participation in the financial markets (so that some traders do not trade), investment in long-term assets will tend to be depressed, anticipating liquidity risk. 63 Appendix I to maturity” strategy worked satisfactorily. Moreover, less-than-transparent accounting practices and a limited number of market participants must have been another factor responsible for stagnant trading. Accordingly, ITCs’ bond-trading activity was low and the secondary market for corporate bonds remained underdeveloped. Given such conditions, ITCs and guarantors accepted bonds of shortest maturity allowed, which was three years. As a consequence, corporate bonds showed the characteristics of de-facto loans: they were purchased by a limited number of participants who held them to maturity, were not traded actively, and short-term. In retrospect, before the crisis in Korea there were two kinds of banking systems: the banking system proper and the de-facto banking system built around ITCs. What caused this evolution? The answer is government policy. While the infrastructure was immature, the government attempted to develop a corporate bond market. It devised the system of ITCs supported by guarantors and the system sustained the development of corporate bonds. Thus, stability was maintained, the same as with the bank system. Charter values were maintained as entry was regulated and the government directly controlled the amount of newly issued corporate bonds. The Korean corporate bond market grew in a similar way to the bank loan market; the ITC industry expanded as the banking industry did. Interpretation of the ITC Boom and Crash In 1996, the Korean government introduced an important measure: it liberalized entry into the ITC industry. Immediately, the number of ITCs increased to 23 that year and further to 29 in 1997. The newly opened ITCs were regulated to engage in only equity type business for the first business year and so, coincidentally, most new ITCs began to engage in bond type business at around the eruption of the crisis in 1997. With the entry liberalization, governmental monitoring and control over the expansion of the corporate bond market disappeared as did charter values of ITCs. Another new development was a surge in non-guaranteed bonds after the crisis as new regulations applied to securities companies and some guaranteeing financial institutions went under. Apparently, the old regime was in transition. However, the transition was not complete yet, and most final investors still believed that ITCs were immune from losses. In the presence of final investors’ moral hazard, the post-crisis environment provided an ideal opportunity for reckless ITCs to expand. While banks and merchant banking corporations were being restructured, financially distressed companies were trying to secure funds at any rates. Financial resources kept flowing into ITCs, which invested them in risky bonds such as those of Daewoo. The ITC and bond-financing booms continued for one and a half years, until the collapse of Daewoo burst the bubble. In sum, the Korean bond market experienced the familiar sequence of regulated growth, liberalization, boom, and bust. The sequence cannot start without government insurance and some degree of moral hazard, which is often prevalent in the banking sector. Thus, the ITC crisis confirms that the Korean bond market was similar to the Korean banking sector in terms of risk sharing arrangement. Further, it also shows that the Korean corporate bond market must face the same challenges as the banking sector: creation of a new risk sharing mechanism that can sustain more stable financial flows. Whatever the final form of the new system, clearly it will require the government to adopt a new role. 64 References Bank of Korea, 1985, Uri-Nara-Ui Chekwon Sijang (Bond Market in Korea), Bank of Korea, Seoul. Diamond, Douglas, 1991, “Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt,” Journal of Political Economy, Vol. 99, pp. 689-721. Diamond, Douglas, 1997, “Liquidity, Banks and Markets,” Journal of Political Economy, Vol.105, pp. 928-956. Diamond, Douglas, and Philip H. Dybvig, 1983, “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, Vol. 91, pp.401-419. Financial Supervisory Commission, 2000, Kumyoong Kiup Kujojojeong Baekseo (White Paper on Financial and Corporate Restructuring), Seoul: Financial Supervisory Commission. Gorton, Gary, and George Pennacchi, 1993, “Money Market Funds and Finance Companies: Are They the Banks of the Future?” in Structural Change in Banking, edited by Michael Klausner and Lawrence White, NewYork: NewYork University Press. Holmstrom, Benot, and Jean Tirole, 1997, “Financial Intermediation, Loanable Funds and the Real Sector,” Quarterly Journal of Economics, Vol. 112, pp.663-691. Jacklin, Charles, and Sudipto Bhattachrya, 1988, “Distinguishing Panics and InformationBased Bank Runs: Welfare and Policy Implications,” Journal of Political Economy, Vol. 96, pp.568592. Kim, Seokjin, Joohyeon Kim, Yongho Woo, Wonheum Lee, Beomsik Jang, and Myeongjoon Cha, 1997, Hankook Jeungkwon Sijang Ron (The Korean Securities Market), Seoul: Samyeong Press. Kroszner, Randall S., 2001, “Global Government Securities Markets: The Economics and Politics of Market Microstructure Reforms,” in The Debt Burden and Monetary Policy, edited by Guillermo Calvo and Mervyn King, London: Macmillan. The Korea Stock Exchange, 1988, Hankook-Ui Jeungkwon Sijang Jedo (Institutions in the Korean Bond Market), Seoul: The Korea Stock Exchange, Seoul. 65 Appendix I Reference Tables Ref. Table 1: Korea, External Financing of Nonfinancial Firms Stock (100 Billions of Won, Percent): 1980-1999 Direct Loans CP Bonds Equity Subtotal Banks NBFIs Foreign Others Total 1980 10.9 (2.0) 23.0 (4.3) 80.9 (15.0) 114.8 (21.3) 111.1 (20.6) 62.2 (11.5) 81.1 (15.0) 169.6 (31.5) 538.8 (100.0) 1981 20.4 (3.0) 35.6 (5.2) 96.9 (14.1) 152.9 (22.3) 133.2 (19.4) 83.5 (12.1) 91.9 (13.4) 225.5 (32.8) 687.1 (100.0) 1982 26.4 (3.1) 56.6 (6.6) 138.6 (16.2) 221.6 (25.9) 163.9 (19.2) 108.7 (12.7) 100.5 (11.7) 260.8 (30.5) 855.5 (100.0) 1983 35.1 (3.5) 70.4 (7.1) 164.0 (16.4) 269.5 (27.0) 185.4 (18.6) 134.1 (13.4) 115.8 (11.6) 292.4 (29.3) 997.1 (100.0) 1984 34.2 (3.0) 86.6 (7.6) 190.2 (16.6) 311.0 (27.2) 212.2 (18.5) 181.7 (15.9) 114.2 (10.0) 325.2 (28.4) 1,144.3 (100.0) 1985 34.8 (2.6) 108.6 (8.2) 215.6 (16.4) 359.0 (27.2) 259.5 (19.7) 211.2 (16.0) 123.9 (9.4) 364.0 (27.6) 1,317.5 (100.0) 1986 48.9 (3.3) 123.1 (8.3) 250.3 (16.9) 422.3 (28.5) 304.7 (20.5) 226.8 (15.3) 126.9 (8.6) 402.3 (27.1) 1,483.1 (100.0) 1987 45.5 (2.8) 137.3 (8.3) 298.4 (18.1) 481.2 (29.2) 332.5 (20.2) 267.3 (16.2) 115.9 (7.0) 450.1 (27.3) 1,647.0 (100.0) 1988 57.1 (3.1) 161.6 (8.9) 357.7 (19.7) 576.3 (31.8) 361.3 (19.9) 282.4 (15.6) 110.5 (6.1) 483.7 (26.7) 1,814.3 (100.0) 1989 108.4 (5.0) 221.6 (10.2) 428.4 (19.7) 758.4 (34.9) 418.0 (19.2) 362.0 (16.7) 108.0 (5.0) 526.5 (24.2) 2,172.9 (100.0) 1990 127.4 (4.8) 345.8 (12.9) 489.2 (18.3) 962.4 (35.9) 501.4 (18.7) 476.8 (17.8) 146.5 (5.5) 592.9 (22.1) 2,680.0 (100.0) 1991 105.3 (3.2) 501.1 (15.3) 567.6 (17.3) 1,174.0 (35.8) 622.3 (19.0) 618.6 (18.8) 180.2 (5.5) 688.0 (21.0) 3,283.1 (100.0) 1992 147.1 (3.8) 585.3 (15.3) 711.1 (18.6) 1,443.5 (37.7) 702.8 (18.4) 734.6 (19.2) 158.2 (4.1) 786.2 (20.6) 3,825.3 (100.0) 1993 237.3 (5.3) 702.1 (15.7) 815.0 (18.2) 1,754.4 (39.2) 790.1 (17.7) 853.5 (19.1) 169.9 (3.8) 903.8 (20.2) 4,471.6 (100.0) 1994 281.3 (5.3) 831.7 (15.6) 950.2 (17.8) 2,063.2 (38.7) 971.3 (18.2) 1,065.6 (20.0) 217.3 (4.1) 1,013.0 (19.0) 5,330.5 (100.0) 1995 442.3 (7.0) 975.8 (15.5) 1,103.9 (17.5) 2,522.0 (40.0) 1,123.7 (17.8) 1,235.1 (19.6) 288.1 (4.6) 1,129.6 (17.9) 6,298.5 (100.0) 1996 645.8 (8.6) 1,218.6 (16.2) 1,218.5 (16.2) 3,082.8 (41.0) 1,307.8 (17.4) 1,400.6 (18.6) 428.5 (5.7) 1,301.1 (17.3) 7,520.8 (100.0) 1997 690.0 (7.4) 1,498.9 (16.1) 1,433.8 (15.4) 3,622.7 (38.9) 1,611.4 (17.3) 1,746.7 (18.8) 789.6 (8.5) 1,544.2 (16.6) 9,314.7 (100.0) 1998 573.2 (6.1) 1,963.6 (21.0) 1,595.4 (17.0) 4,132.2 (44.1) 1,563.2 (16.7) 1,555.3 (16.6) 540.4 (5.8) 1,579.6 (16.9) 9,370.6 (100.0) 1999 408.3 (4.2) 1,980.4 (20.4) 1,972.4 (20.3) 4,361.2 (44.8) 1,703.2 (17.5) 1,417.5 (14.6) 526.6 (5.4) 1,723.3 (17.7) 9,731.8 (100.0) Source: Flow of Fund, Bank of Korea. 66 Ref. Table 2: Korea, Financing Pattern of Nonfinancial Firms, Flow (100 Billions of Won, Percent): 1980-1999 Direct CP Bonds Equity Subtotal Loans Foreign Others Total 1980 5.8 (4.8) 8.2 (6.8) 12.7 (10.5) 26.6 (22.0) 41.9 (34.5) 19.4 (16.0) 33.3 (27.5) 121.2 (100) 1981 9.5 (6.8) 12.7 (9.1) 15.0 (10.8) 37.2 (26.8) 40.6 (29.3) 5.8 (4.2) 54.9 (39.6) 138.5 (100) 1982 6.1 (4.2) 20.9 (14.3) 31.5 (21.5) 58.5 (39.9) 52.5 (35.8) 1.5 (1.0) 34.0 (23.2) 146.4 (100) 1983 8.7 (6.7) 13.8 (10.7) 23.8 (18.4) 46.3 (35.8) 43.5 (33.6) 9.3 (7.2) 30.3 (23.4) 129.4 (100) 1984 -0.9 (-0.7) 16.2 (11.8) 24.5 (17.9) 39.8 (29.0) 71.7 (52.3) -6.1 (-4.4) 31.6 (23.1) 137.1 (100) 1985 0.5 (0.4) 21.5 (14.6) 16.4 (11.2) 38.4 (26.2) 71.2 (48.5) 0.9 (0.6) 36.3 (24.7) 146.9 (100) 1986 14.1 (8.8) 14.5 (9.1) 21.5 (13.4) 50.1 (31.4) 61.9 (38.8) 8.1 (5.0) 39.5 (24.8) 159.6 (100) 1987 -3.4 (-1.8) 14.2 (7.5) 49.0 (26.0) 59.8 (31.7) 72.0 (38.2) -0.9 (-0.5) 57.7 (30.6) 188.7 (100) 1988 11.6 (5.4) 24.2 (11.3) 76.8 (35.8) 112.7 (52.6) 51.9 (24.2) 12.1 (5.6) 37.8 (17.6) 214.4 (100) 1989 51.3 (13.3) 60.0 (15.6) 95.8 (24.9) 207.2 (53.8) 136.6 (35.5) -1.8 (-0.5) 42.9 (11.2) 384.8 (100) 1990 19.0 (3.7) 124.2 (24.5) 71.9 (14.2) 215.1 (42.4) 194.7 (38.4) 32.5 (6.4) 65.2 (12.8) 507.5 (100) 1991 -22.1 (-3.8) 155.2 (26.7) 87.7 (15.1) 220.8 (37.9) 243.4 (41.8) 24.0 (4.1) 93.6 (16.1) 581.8 (100) 1992 41.8 (7.6) 97.9 (17.8) 87.4 (15.9) 227.1 (41.4) 199.1 (36.3) 25.3 (4.6) 97.4 (17.7) 548.9 (100) 1993 90.2 (14.7) 136.6 (22.2) 101.4 (16.5) 328.1 (53.3) 201.6 (32.8) -13.0 (-2.1) 98.6 (16.0) 615.3 (100) 1994 44.1 (5.1) 129.6 (15.1) 132.0 (15.4) 305.6 (35.7) 396.5 (46.3) 44.1 (5.1) 110.4 (12.9) 856.6 (100) 1995 161.0 (17.0) 149.6 (15.8) 144.4 (15.3) 455.0 (48.1) 318.7 (33.7) 55.7 (5.9) 116.6 (12.3) 946.0 (100) 1996 207.4 (17.6) 212.1 (18.0) 129.8 (11.0) 549.3 (46.7) 332.3 (28.3) 123.8 (10.5) 170.6 (14.5) 1176.0 (100) 1997 44.2 (3.9) 274.6 (23.9) 89.7 (7.8) 408.6 (35.6) 433.8 (37.8) 65.6 (5.7) 240.0 (20.9) 1147.9 (100) 1998 -116.8 (-45.8) 459.1 (180.1) 135.2 (53.0) 477.4 (187.4) -162.9 (-63.9) -98.1 (-38.5) 38.4 (15.1) 254.8 (100) 1999 -164.9 (-32.3) 17.3 (3.4) 389.8 (76.3) 242.2 (47.4) 21.1 (4.1) 100.4 (19.7) 146.9 (28.8) 510.7 (100) Note: “Others” includes trade credit, payables, etc. Source: Flow of Fund, Bank of Korea. 73 Appendix I Ref. Table 10: Korea, Government Bond Holdings of Banks (100 Billions of Won, Percent), 1980-1999 Banks Bank Trusts Total Outstanding Government Bonds 1980 9.5 (63.0) 0.2 (1.0) 9.6 (64.0) 15.1 1981 12.9 (54.1) 1.8 (7.4) 14.7 (61.5) 23.9 1982 18.9 (53.6) 4.9 (13.9) 23.8 (67.5) 35.3 1983 19.8 (52.9) 2.2 (5.8) 22.0 (58.7) 37.5 1984 17.5 (48.0) 1.3 (3.4) 18.8 (51.4) 36.6 1985 13.6 (41.5) 0.7 (2.2) 14.3 (43.7) 32.7 1986 21.0 (61.5) 1.1 (3.2) 22.0 (64.7) 34.1 1987 30.2 (47.3) 13.2 (20.7) 43.4 (68.0) 63.8 1988 37.5 (49.5) 15.2 (20.0) 52.7 (69.5) 75.9 1989 34.1 (33.1) 26.1 (25.3) 60.1 (58.5) 102.9 1990 43.0 (32.8) 44.0 (33.5) 87.0 (66.3) 131.1 1991 54.1 (33.5) 46.3 (28.7) 100.4 (62.1) 161.5 1992 36.0 (19.4) 60.5 (32.6) 96.5 (52.0) 185.5 1993 39.2 (20.5) 59.7 (31.2) 98.9 (51.7) 191.4 1994 46.9 (22.7) 73.5 (35.6) 120.4 (58.2) 206.7 1995 54.8 (24.3) 71.9 (31.9) 126.7 (56.3) 225.2 1996 57.7 (22.5) 79.1 (30.9) 136.8 (53.4) 256.4 1997 81.8 (28.7) 38.7 (13.6) 120.6 (42.2) 285.4 1998 153.3 (36.9) 79.9 (19.2) 233.2 (56.1) 415.7 1999 245.7 (40.2) 122.7 (20.1) 368.4 (60.2) 611.7 Note: Numbers in ( ) are ratios to outstanding amount of government bonds. Source: Monthly Bulletin, Bank of Korea. 74 Ref. Table 11: Korea, Offerings of Corporate Bonds by Maturity (100 billions of Won, Percent): 1980-1999 Less than 4 Years 4 Yearsless than 5 Years 5 Years and Over Total 1980 9.6 (100.0) - ( - ) - ( - ) 9.6 (100.0) 1981 10.2 (97.1) 0.3 (2.9) - ( - ) 10.5 (100.0) 1982 13.1 (61.2) 7.6 (35.5) 0.7 (3.3) 21.4 (100.0) 1983 6.2 (41.3) 7.8 (52.0) 1.0 (6.7) 15.0 (100.0) 1984 9.8 (52.7) 8.8 (47.3) - ( - ) 18.6 (100.0) 1985 14.9 (46.3) 13.8 (42.9) 3.5 (10.9) 32.2 (100.0) 1986 11.6 (42.6) 12.5 (46.0) 3.1 (11.4) 27.2 (100.0) 1987 15.1 (47.3) 15.2 (47.6) 1.6 (5.0) 31.9 (100.0) 1988 34.0 (80.2) 8.2 (19.3) 0.2 (0.5) 42.4 (100.0) 1989 52.8 (75.9) 14.8 (21.3) 2.0 (2.9) 69.6 (100.0) 1990 102.9 (92.8) 6.9 (6.2) 1.1 (1.0) 110.9 (100.0) 1991 119.0 (93.6) 4.4 (3.5) 3.8 (3.0) 127.2 (100.0) 1992 97.6 (87.5) 5.4 (4.8) 8.6 (7.7) 111.6 (100.0) 1993 140.3 (89.9) 7.8 (5.0) 7.9 (5.1) 156.0 (100.0) 1994 186.3 (92.9) 3.4 (1.7) 10.8 (5.4) 200.5 (100.0) 1995 221.7 (93.9) 0.5 (0.2) 13.8 (5.8) 236.0 (100.0) 1996 287.7 (96.2) 0.7 (0.2) 10.7 (3.6) 299.1 (100.0) 1997 338.7 (97.2) 0.3 (0.1) 9.3 (2.7) 343.3 (100.0) 1998 556.7 (99.4) 0.5 (0.1) 2.9 (0.5) 560.1 (100.0) 1999 287.7 (93.8) 2.9 (0.9) 16.1 (5.2) 306.7 (100.0) Source: Monthly Review of Securities, Securities Supervisory Board (before 1998); Monthly Financial Statistics Bulletin, Financial Supervisory Service (after 1999). 75 Appendix I Ref. Table 12: Korea, Offerings of Corporate Bonds by Type (100 Billions of Won, Percent): 1980-1999 Guaranteed Non-Guaranteed Total 1980 9.6 (100.0) - ( - ) 9.6 (100.0) 1981 9.7 (94.2) 0.6 (5.8) 10.3 (100.0) 1982 20.9 (99.1) 0.2 (0.9) 21.1 (100.0) 1983 14.2 (100.0) - ( - ) 14.2 (100.0) 1984 16.3 (92.1) 1.4 (7.9) 17.7 (100.0) 1985 29.1 (93.0) 2.2 (7.0) 31.3 (100.0) 1986 24.1 (88.9) 3.0 (11.1) 27.1 (100.0) 1987 27.8 (87.7) 3.9 (12.3) 31.7 (100.0) 1988 41.9 (99.3) 0.3 (0.7) 42.2 (100.0) 1989 61.6 (88.6) 7.9 (11.4) 69.5 (100.0) 1990 92.0 (83.1) 18.7 (16.9) 110.7 (100.0) 1991 109.7 (86.2) 17.5 (13.8) 127.2 (100.0) 1992 83.3 (74.7) 28.2 (25.3) 111.5 (100.0) 1993 111.9 (71.6) 44.4 (28.4) 156.3 (100.0) 1994 114.6 (57.2) 85.9 (42.8) 200.5 (100.0) 1995 164.7 (69.8) 71.3 (30.2) 236.0 (100.0) 1996 273.8 (91.5) 25.3 (8.5) 299.1 (100.0) 1997 291.9 (85.1) 51.3 (14.9) 343.2 (100.0) 1998 175.1 (31.3) 383.9 (68.7) 559.0 (100.0) 1999 12.8 (4.2) 293.4 (95.8) 306.2 (100.0) Source: Monthly Review of Securities, Securities Supervisory Board (before 1998); Monthly Financial Statistics Bulletin, Financial Supervisory Service (after 1999). 76 Ref. Table 13: Korea, Guaranteed Corporate Outstanding Bonds by Guarantor (100 Billions of Won, Percent): 1980-1999 Banks Guaranteed Funds and Surety Companies Merchant Banking Corps. Securities Firms Others Total 1980 14.8 (80.9) 2.4 (13.1) 1.1 (6.0) - ( - ) - ( - ) 18.3 (100.0) 1981 19.2 (76.2) 2.8 (11.1) 2.7 (10.7) - ( - ) 0.5 (2.0) 25.2 (100.0) 1982 26.0 (78.3) 1.8 (5.4) 3.9 (11.7) - ( - ) 1.5 (4.5) 33.2 (100.0) 1983 34.4 (76.8) 2.0 (4.5) 4.9 (10.9) - ( - ) 3.5 (7.8) 44.8 (100.0) 1984 35.2 (66.4) 2.4 (4.5) 7.2 (13.6) 1.6 (3.0) 6.6 (12.5) 53.0 (100.0) 1985 42.6 (61.8) 3.3 (4.8) 7.5 (10.9) 2.6 (3.8) 12.9 (18.7) 68.9 (100.0) 1986 49.4 (62.5) 3.9 (4.9) 6.9 (8.7) 4.0 (5.1) 14.8 (18.7) 79.0 (100.0) 1987 54.4 (59.8) 5.0 (5.5) 7.3 (8.0) 5.1 (5.6) 19.1 (21.0) 90.9 (100.0) 1988 57.9 (52.4) 6.5 (5.9) 8.6 (7.8) 15.5 (14.0) 22.0 (19.9) 100.5 (100.0) 1989 56.9 (38.2) 9.8 (6.6) 13.7 (9.2) 47.4 (31.8) 21.1 (14.2) 148.9 (100.0) 1990 73.9 (35.0) 27.6 (13.1) 16.1 (7.6) 71.8 (34.0) 21.5 (10.2) 210.9 (100.0) 1991 108.0 (40.3) 55.6 (20.8) 12.7 (4.7) 76.7 (28.7) 14.7 (5.5) 267.7 (100.0) 1992 130.0 (44.4) 65.9 (22.5) 9.9 (3.4) 75.7 (25.8) 11.6 (4.0) 293.1 (100.0) 1993 151.8 (49.3) 53.4 (17.3) 11.8 (3.8) 84.6 (27.5) 6.2 (2.0) 307.8 (100.0) 1994 145.2 (46.0) 36.7 (11.6) 25.0 (7.9) 105.5 (33.4) 3.5 (1.1) 315.9 (100.0) 1995 149.7 (37.2) 83.3 (20.7) 46.9 (11.6) 121.1 (30.1) 1.8 (0.4) 402.8 (100.0) 1996 174.0 (30.8) 218.4 (38.6) 69.7 (12.3) 101.7 (18.0) 1.9 (0.3) 565.7 (100.0) 1997 166.5 (22.6) 413.5 (56.2) 75.8 (10.3) 78.4 (10.7) 1.6 (0.2) 735.8 (100.0) 1998 132.5 (17.7) 520.6 (69.7) 50.7 (6.8) 41.6 (5.6) 1.5 (0.2) 746.9 (100.0) 1999 39.7 (12.3) 382.4 (78.6) 22.8 (4.7) 21.2 (4.4) 0.3 (0.1) 486.4 (100.0) Source: Monthly Review of Securities, Securities Supervisory Board (before 1998); Monthly Financial Statistics Bulletin, Financial Supervisory Service (after 1999). 77 Appendix I Ref. Table 14: Korea, Offerings of Corporate Bonds by Company Size (100 Billions of Won, Percent): 1980-1999 Large-Sized Businesses Small and Medium Sized Businesses Total 1980 9.2 (85.8) 0.4 (4.2) 9.6 (100.0) 1981 10.1 (97.1) 0.3 (2.9) 10.4 (100.0) 1982 20.5 (95.8) 0.9 (4.2) 21.4 (100.0) 1983 12.0 (83.9) 2.3 (16.1) 14.3 (100.0) 1984 14.4 (79.6) 3.7 (20.4) 18.1 (100.0) 1985 27.2 (85.5) 4.6 (14.5) 31.8 (100.0) 1986 21.9 (80.2) 5.4 (19.8) 27.3 (100.0) 1987 27.3 (85.6) 4.6 (14.4) 31.9 (100.0) 1988 36.7 (86.6) 5.7 (13.4) 42.4 (100.0) 1989 57.1 (82.0) 12.5 (18.0) 69.6 (100.0) 1990 83.4 (75.3) 27.4 (24.7) 110.8 (100.0) 1991 91.3 (71.8) 35.8 (28.2) 127.1 (100.0) 1992 93.7 (84.0) 17.8 (16.0) 111.5 (100.0) 1993 131.0 (84.0) 25.0 (16.0) 156.0 (100.0) 1994 174.5 (87.0) 26.0 (13.0) 200.5 (100.0) 1995 290.4 (91.6) 26.6 (8.4) 317.0 (100.0) 1996 265.2 (88.7) 33.8 (11.3) 299.0 (100.0) 1997 323.5 (94.3) 19.7 (5.7) 343.2 (100.0) 1998 552.9 (98.7) 7.1 (1.3) 560.0 (100.0) 1999 249.4 (95.1) 12.9 (4.9) 262.3 (100.0) Source: Monthly Review of Securities, Securities Supervisory Board (before 1998); Monthly Financial statistics Bulletin, Financial Supervisory Service (after 1999). 78 Ref. Table 15: Korea, Corporate Bonds Issued by Industries (Billions of Won, Percent): 1980-1999 Manufacturing Construction Wholesale & Retail Trade, Repair of Consumer Goods Transport, Storage Communication Financial Intermediation Others Total 1980 708.2 (73.5) 157.6 (16.4) 56.2 (5.8) 40.3 (4.2) - ( -) - ( -) 1.4 (0.1) 963.7 (100.0) 1981 687.9 (66.4) 239.2 (23.1) 58.4 (5.6) 29.9 (2.9) - ( -) 1.8 (0.2) 18.9 (1.8) 1,036.1 (100.0) 1982 1,354.5 (64.1) 415.1 (19.6) 155.0 (7.3) 143.9 (6.8) - ( -) - ( -) 44.2 (2.1) 2,112.7 (100.0) 1983 920.6 (64.5) 271.3 (19.0) 98.0 (6.9) 96.0 (6.7) - ( -) 12.5 (0.9) 28.1 (2.0) 1,426.5 (100.0) 1984 1,264.8 (70.1) 237.8 (13.2) 153.8 (8.5) 64.1 (3.6) - ( -) 43.4 (2.4) 40.2 (2.2) 1,804.1 (100.0) 1985 2,268.6 (71.4) 468.5 (14.7) 264.1 (8.3) 81.9 (2.6) - ( -) 48.0 (1.5) 45.6 (1.4) 3,176.7 (100.0) 1986 1,578.1 (57.8) 524.9 (19.2) 278.6 (10.2) 42.6 (1.6) - ( -) 253.4 (9.3) 51.3 (1.9) 2,728.9 (100.0) 1987 2,187.5 (68.6) 326.9 (10.2) 273.0 (8.6) 69.4 (2.2) - ( -) 238.0 (7.5) 94.8 (3.0) 3,189.6 (100.0) 1988 2,875.7 (67.8) 493.7 (11.6) 310.4 (7.3) 116.2 (2.7) ( -) 358.9 (8.5) 89.4 (2.1) 4,244.3 (100.0) 1989 4,724.3 (67.9) 930.8 (13.4) 624.9 (9.0) 116.0 (1.7) - ( -) 393.1 (5.6) 170.0 (2.4) 6,959.1 (100.0) 1990 5,054.8 (45.6) 1,429.6 (12.9) 1,063.7 (9.6) 134.9 (1.2) - ( -) 1,259.4 (11.4) 2,141.2 (19.3) 11,083.6 (100.0) 1991 8,229.5 (64.6) 1,232.7 (9.7) 727.9 (5.7) 180.8 (1.4) - ( -) 2,200.5 (17.3) 169.3 (1.3) 12,740.7 (100.0) 1992 6,151.6 (55.1) 1,232.8 (11.1) 776.5 (7.0) 131.0 (1.2) - ( -) 655.5 (5.9) 2,207.9 (19.8) 11,155.3 (100.0) 1993 11,226.0 (72.0) 1,925.7 (12.3) 1,078.0 (6.9) 177.1 (1.1) - ( -) 803.0 (5.1) 388.5 (2.5) 15,598.3 (100.0) 1994 13,260.6 (66.2) 3,400.0 (17.0) 1,641.3 (8.2) 213.3 (1.1) - ( -) 1,170.9 (5.8) 347.1 (1.7) 20,033.2 (100.0) 1995 16,004.6 (67.9) 3,197.3 (13.6) 1,667.9 (7.1) 198.5 (0.8) 142.0 (0.6) 2,042.9 (8.7) 328.0 (1.4) 23,581.2 (100.0) 1996 22,424.3 (75.0) 3,744.0 (12.5) 1,772.4 (5.9) 311.2 (1.0) 214.0 (0.7) 889.9 (3.0) 546.7 (1.8) 29,902.5 (100.0) 1997 24,862.6 (72.4) 3,612.2 (10.5) 3,406.8 (9.9) 424.3 (1.2) 668.0 (1.9) 716.8 (2.1) 631.4 (1.8) 34,322.1 (100.0) 1998 33,001.0 (65.5) 3,909.8 (7.8) 8,549.5 (17.0) 1,517.0 (3.0) 2,496.5 (5.0) 106.0 (0.2) 767.0 (1.5) 50,346.8 (100.0) 1999 14,469.1 (47.1) 2,192.8 (7.1) 5,018.4 (16.3) 1,696.0 (5.5) 1,385.0 (4.5) 4,246.7 (13.8) 1,703.4 (5.5) 30,711.4 (100.0) Source: Monthly Review of Securities, Securities Supervisory Board (before 1998); Monthly Financial Statistics Bulletin, Financial Supervisory Service (after 1999). 79 Appendix I Ref. Table 16: Korea, Overseas Securities Offerings by Type (Millions of US dollars): 1985-1997 CB BW DR EB Total 1985 20.0 - - 20.0 1986 60.0 - - 60.0 1987 30.0 - - 30.0 1988 30.0 - - 30.0 1989 - 50.0 - 50.0 1990 180.0 70.0 40 290.0 1991 594.5 270. 0 200 1,064.5 1992 424.0 65.0 150 639.0 1993 538.0 50.0 328 916.0 1994 639.6 45.0 1,168 1,852.6 1995 751.5 213. 0 1,310 2,274.5 1996 1,496.1 43.8 963 84 2,586.9 1997 1,175.2 - 630 75 1,880.2 Source: Monthly Review of Securities, Securities Supervisory Board. 80 Ref. Table 17: Korea, Turnover Rate on Corporate Bonds (100 Billions of Won, Percent): 1988-1999 Trading Value OTC Exchange Total Outstanding Amounts Turnover Rate 1988 47.1 (75.4) 15.4 (24.6) 62.5 (100.0) 118.9 0.26 1989 62.9 (89.1) 7.7 (10.9) 70.6 (100.0) 163.2 0.22 1990 99.3 (92.5) 8.0 (7.5) 107.3 (100.0) 222.3 0.24 1991 212.3 (96.8) 7.0 (3.2) 219.3 (100.0) 312.0 0.35 1992 326.1 (99.5) 1.5 (0.5) 327.6 (100.0) 358.4 0.46 1993 650.7 (100.0) - ( - ) 650.7 (100.0) 397.7 0.82 1994 846.3 (98.7) 11.4 (1.3) 857.7 (100.0) 477.6 0.90 1995 1,212.5 (99.0) 11.8 (1.0) 1,224.3 (100.0) 610.2 1.00 1996 1,405.2 (99.2) 11.9 (0.8) 1,417.1 (100.0) 760.1 0.93 1997 1,595.8 (97.7) 38.1 (2.3) 1,633.9 (100.0) 901.1 0.91 1998 4,514.5 (98.1) 89.7 (1.9) 4,604.2 (100.0) 1,226.8 1.88 1999 5,161.1 (97.8) 116..9 (2.2) 5,278.0 (100.0) 1,196.2 2.21 Note: Turnover Rate = (Trading value/2) ÷ outstanding amounts. Source: Securities, Korea Securities Dealers Association. 81 Appendix I Ref. Table 18: Korea, Investors in Corporate Bonds (100 Billions of Won, Percent): 1980-1999 Financial Government Corporate Private Foreign Total 1980 14.2 (76.3) 0.4 (1.9) 2.1 (11.0) 2.0 (10.8) - ( - ) 18.6 (100.0) 1981 24.1 (82.7) 0.8 (2.9) 2.8 (9.7) 1.4 (4.7) - ( - ) 29.1 (100.0) 1982 39.5 (82.9) 0.9 (1.9) 3.5 (7.3) 3.8 (7.9) - ( - ) 47.6 (100.0) 1983 53.8 (88.6) 1.7 (2.8) 3.3 (5.5) 1.9 (3.1) - ( - ) 60.7 (100.0) 1984 64.5 (86.4) 1.8 (2.4) 6.2 (8.3) 2.2 (2.9) - ( - ) 74.7 (100.0) 1985 83.3 (86.9) 1.8 (1.8) 7.3 (7.6) 3.4 (3.6) - ( - ) 95.8 (100.0) 1986 103.4 (94.2) 2.6 (2.4) 2.7 (2.4) 1.2 (1.1) - ( - ) 109.8 (100.0) 1987 117.2 (96.2) 1.1 (0.9) 2.3 (1.9) 1.3 (1.0) - ( - ) 121.9 (100.0) 1988 132.0 (96.9) 1.2 (0.9) 1.9 (1.4) 1.0 (0.8) - ( - ) 136.2 (100.0) 1989 177.2 (95.7) 1.2 (0.7) 4.3 (2.3) 2.4 (1.3) - ( - ) 185.1 (100.0) 1990 264.6 (90.0) 3.4 (1.2) 16.7 (5.7) 9.5 (3.2) - ( - ) 294.1 (100.0) 1991 363.8 (83.3) 5.4 (1.2) 45.7 (10.5) 21.8 (5.0) - ( - ) 436.7 (100.0) 1992 449.3 (89.5) 7.3 (1.5) 33.1 (6.6) 12.4 (2.5) - ( - ) 502.1 (100.0) 1993 544.4 (91.4) 12.4 (2.1) 29.5 (5.0) 9.1 (1.5) - ( - ) 595.3 (100.0) 1994 650.0 (90.1) 13.8 (1.9) 42.2 (5.9) 15.0 (2.1) 0.2 ( - ) 721.3 (100.0) 1995 828.0 (94.6) 14.4 (1.6) 26.3 (3.0) 5.8 (0.7) 0.3 ( - ) 874.8 (100.0) 1996 1,000.5 (88.7) 33.4 (3.0) 65.0 (5.8) 28.4 (2.5) 0.5 ( - ) 1,127.8 (100.0) 1997 1,349.3 (89.7) 24.2 (1.6) 84.3 (5.6) 43.5 (2.9) 3.2 (0.2) 1,504.5 (100.0) 1998 2,250.4 (96.6) 47.8 (2.1) 18.7 (0.8) 9.3 (0.4) 3.4 (0.1) 2,329.7 (100.0) 1999 2,348.2 (92.0) 105.4 (4.1) 58.7 (2.3) 36.5 (1.4) 3.0 (0.1) 2,551.8 (100.0) Note: ‘Total’ in this table is larger than that of ref. table 15 because of the following factors: 1. inclusion of privately placed bonds, 2. inclusion of ABS and 3. reclassification of certain public bond as corporate bonds. Source: Flow of Funds, Bank of Korea. 82 Ref. Table 19: Korea, Bond Holdings of Investment Trust Companies (100 Billions of Won, Percent): 1984-1999 ITC Holdings Outstanding Bonds 1984 42.2 (44.5) 94.8 1985 51.8 (43.2) 120.0 1986 66.4 (38.8) 171.1 1987 91.4 (36.6) 250.0 1988 105.8 (31.4) 336.8 1989 130.8 (30.1) 434.9 1990 164.1 (32.1) 511.2 1991 182.7 (29.7) 614.8 1992 286.4 (44.0) 651.5 1993 388.8 (49.3) 789.3 1994 448.3 (43.7) 1,025.0 1995 484.3 (38.4) 1,260.0 1996 564.0 (32.1) 1,755.4 1997 642.3 (28.7) 2,241.1 1998 1,280.1 (38.3) 3,340.3 1999 999.8 (37.5) 2,664.2 Note: Numbers in ( ) are ratios to outstanding balances; “Bonds” means bonds of all issuers. Source: Investment Trust, Korea Investment Trust Companies Association; Monthly Bulletin, Bank of Korea. 89 Appendix II also issues government-guaranteed zero coupon bonds and cash to financial institutions as payment for the purchase of NPLs. In 1998, funds mobilized through the PDS market exceeded (RM14.2 billion) those in the equity market (RM1.8 billion) mainly due to the issuance of RM11 billion by Danamodal to recapitalize banking institutions that were adversely affected by the crisis. The net funds raised via PDS stood at RM6.2 billion in 1998. In 1999, the net funds raised, amounting to RM13.8 billion in the PDS market, increased due to a higher value of new PDS issues of RM26.6 billion (from RM14.2 billion in 1998). This was due to the much larger amount of redemptions, which reached a record level of RM12.7 billion in 1999 (from RM8 billion in 1998), arising from the maturity and early redemption of PDS issued. However, as in 1998, the largest amount of PDS issued was for debt restructuring schemes. Due to lower interest rates, ample liquidity, growing demand and economic recovery, a total of RM10.2 billion was issued against redemption of RM4.8 billion as of July 2000. The pace of economic recovery has generated greater interest in the PDS market since the last quarter of 1999. Improved economic conditions and corporate debt restructuring exercises have ameliorated investors’ sentiment and led to rating upgrades for a number of corporate issues. This has, in turn, encouraged the participation of first-time issuers. Interest rate stability has also been a boon to the debt market as investors seek higher investment returns rather than simply keeping their money in fixed deposits with banks. As a consequence, an expansion of the issuer base is likely to materialize as new instruments such as asset-backed securities are launched in response to the widening risk-return profile of the market. In addition, the announcement of various government initiatives to boost the development of the ringgit bond market, such as the setting up of the National Bond Market Committee and the Securities Commission (SC) as the sole regulatory authority for the corporate bond market will lead to a more vibrant debt market in the next few years. In 1998 and 1999, the public sector once again emerged as the largest single issuer of debt paper, with the total value of government bonds issued exceeding that raised through the private sector. The government raised about RM25 billion in new MGS consisting of maturities ranging from three to 20 years. A total of RM6 billion of the new MGS was issued through private placement to the Employees Provident Fund (EPF). Until September 2000, a total of RM14.5 billion of MGS and Government Investment Certificates (GICs) were issued against redemption of RM3.6 billion. The large MGS issues were to finance the government’s fiscal deficit as it took the lead in reviving the economy, which had contracted in the aftermath of the Asian financial crisis. The role of the equity market has also increased in importance as a source of funding for the economy. Table 3 shows the increase in the amount of equities issued. 90 Table 3: Malaysia, Equity Raised in the Capital Market (Millions of Ringgits, Percent of GDP): 1990-1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 8,650 (7.3%) 4,391 (3.3%) 9,182 (6.1%) 3,433 (2.0%) 8,458 (4.3%) 11,438 (5.1%) 15,924 (6.3%) 18,358 (6.5%) 1,788 (0.6%) 6,073 (2.0%) Note: ( ) indicates percentage of GDP. Source: Bank Negara Malaysia. 1.3. Loans and Advances by the Financial System Overall, much of the financing was intermediated through the banking system. As a result, the risks associated with the cyclical downturn in the economy were concentrated there. However, loans and advances extended by the financial system amounted to RM98.3 billion (53%) of the total financing during 1988-1997. This impressive volume reflected the rapid economic growth experienced by Malaysia during this time. Nevertheless, the financial crisis, which started in middle of 1997, led to a sharp moderation in loan growth, with none recorded in 1998. The share of financing from the banking system also declined to 8% during 1998-1999. Table 4 shows the growth of bank loans in the last 10 years. Table 4: Malaysia, Outstanding Bank Loans (Millions of Ringgits, Percent of GDP): 1990-1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 115,932 (97.4%) 140,704 (104.1%) 153,608 (101.9%) 209,802 (121.8%) 242,498 (124.1%) 305,751 (137.4%) 384,261 (151.4%) 485,616 (172.3%) 484,333 (170.3%) 471,858 (157.1%) Note: ( ) indicates percentage of GDP. Source: Bank Negara Malaysia. 2. The Government Bond Market 2.1. Overview of the Bond Market: Pre-crisis In 1988, the outstanding value of debt securities stood at RM59.1 billion (68% of GDP). The PDS market (inclusive of Cagamas bonds) accounted for about 4% of the total debt. Government securities remained the largest segment at 96%, with MGS accounting for about 98% of the total government securities market (Chart 3). Over time, this has changed significantly in tandem with the shift in the country’s financing structure and also government policy. The growth of the bond market has been impressive, registering an average annual growth rate of 10% during 1988-1997. The total outstanding value of bonds was RM134.3 billion at the end of 1997. The share of PDS also increased significantly to 47% of total market size. However, the share of government securities dropped to 53% (Table 5). 91 Appendix II Table 5: Malaysia, Outstanding Debt Securities Issued (Millions of Ringgits, End of Period): 1990-1999 Y ea r MGS GICs Malaysian Savings Bonds Khazanah Bonds Total Govt. Bonds Danaharta Bonds Danamodal Bonds Cagamas Bonds Other PDS Total PDS Total Bonds 1990 62,106 900 - - 67,326 - - 2,900 2,980 5,880 73,206 1991 65,263 900 - - 70,483 - - 2,600 4,503 7,103 77,586 1992 66,643 1,000 - - 71,963 - - 5,137 6,436 11,573 83,536 1993 66,018 2,000 - - 72,338 - - 5,940 9,299 15,239 87,577 1994 64,969 4,800 - - 74,089 - - 9,485 12,459 21,944 96,033 1995 64,719 5,050 1,131 - 70,900 - - 9,312 22,701 32,013 102,913 1996 66,910 4,150 1,092 - 72,152 - - 13,227 33,528 46,755 118,907 1997 66,262 2,750 918 1,000 70,930 - - 16,756 46,594 63,350 134,280 1998 75,012 2,000 4 4,850 81,866 2,601 11,000 15,064 46,737 75,402 157,268 1999 78,336 2,000 379 8,980 89,695 10,344 11,000 13,019 77,413 111,776 201,471 Total 676,238 25,550 3,524 14,830 741,742 12,945 22,000 93,440 262,650 391,035 1,132,777 Note: Public debt securities refers to MGS, GICs, Khazanah bonds and Malaysia savings bonds. Total PDS refers to Cagamas bonds, Danamodal bonds, Danaharta bonds and other PDS. Source: Bank Negara Malaysia: Securities Commission. After the Crisis The size of the Malaysian bond market surged to RM241.7 billion (71.2% of GDP) in 2000 from RM157.3 billion (58% of GDP) in 1998. Outstanding PDS issued were relatively larger at 58% of outstanding bond issues including government bonds and PDS at the end of 2000, compared with government securities at 42%. The significant growth in the PDS market can be attributed to ongoing corporate debt restructuring activities and also the large demand for financing from private corporations. The issuer base has also expanded to include new issuers from quasi-government agencies such as Danaharta and Danamodal. Quasi-government bonds accounted for about 9% of the total bonds outstanding issued in 1998 and 2000. Chart 3: Malaysia, Composition of the Bond Market (Percent): 1988-2000 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1988 1989 1990 1992 1995 1997 2000 year Danamodal Bonds Danaharta Bonds Khazanah Bonds PDS Cagamas Malaysian Savings Bonds GIC MGS 92 2.2. Overview of the Government Bond Market Government bonds are issued either directly by the government or by governmentrelated institutions. Government bonds include MGS, GICs and Malaysian savings bonds (MSBs). MGS or Treasury bonds are debt instruments issued by Bank Negara Malaysia (BNM) on behalf of the government as a means of raising long-term funds from the domestic capital market to finance public expenditure. GICs, which are non-interest bearing securities, were introduced in 1983 following the introduction of Islamic banking in Malaysia and are issued to Bank Islam and other Islamicbased institutions for their liquidity and statutory requirements based on Islamic principles. In an effort to inculcate and promote a savings culture and to educate the public on investing in bonds, the first series of MSBs, RM1 billion of five-year tenure, was introduced in 1993. Incentives offered included a guaranteed return of 48% on maturity, tax-exempt returns and no limit on the amount purchased. Quasi-government bonds refer to bonds such as, Khazanah bonds, Kuala Lumpur International Airport bonds, Danaharta bonds and Danamodal bonds.1 Until the middle of 1950s, the government domestic debt market was insignificant. There was little need to borrow as the government generally kept the overall account of its budget in balance, reflecting the pro-cyclical stance of fiscal policy. The issue of MGS began mostly to meet the investment needs of the EPF, which was set up in 1951. The outstanding amount of MGS initially was small, reaching only RM120 million by the end of 1961. The government continued to rely on issuing bonds for the bulk of its domestic borrowings when it needed massive investment funds to finance the country’s development agenda, which was premised on economic diversification and industrialization. In the late 1970s and early 1980s, MGS were floated mainly to finance the rising level of public development expenditure and fiscal deficit. As a result, the amount of MGS issued increased steadily, from RM4.9 billion in 1971-1975 to RM12.3 billion in 1976-1980 and RM24 billion in 1981-1985. Table 6 indicates the amount of government debt securities issued in the decade beginning 1990. Table 7 shows the amount of outstanding public debt securities issued for 1990-1999. Table 6: Malaysia, Government Debt Securities Issued (Millions of Ringgits, Percent of GDP): 1990-1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 5,441 (4.6%) 3,800 (2.8%) 4,300 (2.9%) 3,748 (2.2%) 5,500 (2.8%) 2,750 (1.2%) 6,000 (2.4%) 3,794 (1.4%) 17,682 (6.2%) 14,975 (5.0%) Note: Government debt securities include Malaysian government debt securities, GICs, Khazanah bonds and MSBs. Source: Bank Negara Malaysia. 1 The investment arm of the Ministry of Finance. Khazanah benchmark bonds are government-guaranteed, zero coupon bonds structured to comply with Islamic principles. They were first issued in September 1997 with a first RM1 billion three-year tenure issue. Since this first issue, nine issues with maturity terms of three, five, seven and 10 years have been issued, totaling RM10 billion in nominal value. 93 Appendix II Table 7: Malaysia, Government Debt Securities (Millions of Ringgits, Percent of GDP): 1990-1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 63,006 (52.9%) 66,163 (48.9%) 69,046 (45.8%) 69,291 (40.2%) 70,946 (36.3%) 70,900 (31.9%) 72,152 (28.4%) 69,930 (24.8%) 81,866 (28.8%) 89,695 (29.9%) Note: Government debt securities include Malaysian government debt securities, GICs, Khazanah bonds and MSBs. Source: Bank Negara Malaysia. The MGS market expanded nearly five-fold to RM16.8 billion by the end of 1980, compared with only RM3.5 billion in 1970. After that, the MGS market expanded steadily to RM55.8 billion at the end of 1988. However, due to the downsizing of the government’s borrowing program, net issuance of MGS dropped to RM9.6 billion during 1991-1997 against RM25.5 billion in 1986-1990. Hence, total MGS outstanding issued rose marginally to RM66.3 billion in 1997 against RM62 billion in 1990. MGS have remained the largest component of the government securities market over the last three decades (Table 8). Table 8: Malaysia, Components of Government Debt Securities (Millions of Ringgits): 1995-1999 Year MGS Government Investment Issues Malaysian Savings Bonds Khazanah Bonds Total Government Bonds 1995 64,719 5,050 1,131 – 70,900 1996 66,910 4,150 1,092 – 72,152 1997 66,262 2,750 918 1,000 70,930 1998 75,012 2,000 4 4,850 81,866 1999 78,336 2,000 379 8,980 89,695 Total 351,238 15,950 3,524 14,830 385,542 Source: Bank Negara Malaysia. Table 9 shows the share of outstanding government debt securities issued as a percentage of all outstanding bonds issued in the domestic market. The situation improved in 1998 with the increased issuance of MGS to finance the government’s fiscal deficit as it promoted economic revival, after a contraction in the aftermath of the Asian financial crisis. New MGS issues increased from RM8.8 billion in 1998 to RM11.1 billion (a total of RM23.2 billion of MGS was issued for the period 19982000). The second series of MSB were launched in 1999 and RM2 billion in three-year tenure bonds was offered for sale. 94 Table 9: Malaysia, Components of Outstanding Government Debt Securities Issued (Percent): 1995-1999 Year MGS Government Investment Issues Malaysian Savings Bonds Khazanah Bonds Total Government Bonds 1995 62.9 4.9 1.1 0.0 68.9 1996 56.3 3.5 0.9 0.0 60.7 1997 49.3 2.1 0.7 0.7 52.8 1998 47.7 1.3 0.0 3.1 52.1 1999 38.9 1.0 0.2 4.5 44.5 Total 49.1 2.2 0.5 2.1 53.9 Source: Bank Negara Malaysia. 2.3. Investor Base for MGS The demand for MGS is captive to the extent that certain classes of investors have been and are required to hold them by statutory requirement. Investors are required by law to invest a specified portion of their funds in MGS, or to invest a specified portion of liquid assets in their asset portfolios. MGS are classified as eligible liquid assets of commercial and merchant banks and finance companies. MGS were also made a “trustee” investment for social security institutions under the provision of the Trustee Act, 1949. When the Insurance Act, 1963, was implemented, MGS were made eligible as “authorized” assets for the insurance companies to hold in meeting their minimum assets requirement. Social security institutions, the traditional holders, continued to absorb the major portion of outstanding MGS issued. The EPF remained the single largest holder, with a market share of 58-61% of total outstanding MGS issued before the crisis. The new EPF Act, 1991, permits the EPF to invest a minimum of 50% of its annual investible funds in MGS, compared with 70% previously, although it is still subject to a cumulative ceiling of 70%. Only 33% of EPF’s investible funds currently are held in MGS. But its holding of total outstanding MGS issued has increased to 66-68% following three new placements totaling RM8 billion by the government (Table 10, Table 11). The dominant position of the pension and provident funds in the MGS market poses a constraint to the development of a liquid and competitive bond market and, hence, benchmark yield curves. This concern relates not only to the sizeable volume that is held by them but also to the high concentration, which increases the possibility of market squeezes, thereby deterring other participants from entering the market. Before the crisis banking institutions remained the second largest holders, accounting for 13-19% of MGS outstanding issued. MGS are classified as eligible liquid assets of commercial and merchant banks, and finance companies, and as such a major portion of the supply is held long-term in the portfolios of these institutions. Their large holdings are also due to their role as principle dealers, as they are obliged to take up new issues of MGS, as 95 Appendix II well as the excess liquidity situation prevailing in the banking system. After the crisis, banking institutions’ holdings of MGS increased to 16-20%. Other financial institutions, including the National Savings Bank and insurance companies, which are also required by law to invest a specified portion of their funds in government securities and other approved assets, collectively held about 5% to 12% of the total outstanding. Holdings of MGS by insurance companies constituted about 2% to 8%, partly due to the amendments made to their statutory investment guidelines on 1 October 1990, whereby newly acquired government guaranteed loans will no longer qualify as investment in MGS. Their holding of MGS remained at 10% to 12% after the financial crisis. Holdings of MGS by BNM remained negligible, as it did not resort to deficit financing. The remaining 6% was held by a variety of other institutions, including Petronas, the government itself in the form of sinking funds and public authorities. Table 10: Malaysia, Investors in Malaysian Government Securities (Percent): 1990-1999 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Total Outstanding (Millions of Ringgits) 62,106 65,263 66,643 66,018 64,969 64,719 66,910 66,262 75,012 78,336 Government 1.0% 0.9% 0.8% 0.9% 0.8% 0.8% 0.6% 0.6% 0.2% 0.2% Others 8.2% 8.0% 7.0% 7.1% 6.8% 6.7% 6.4% 5.8% 5.3% 4.8% Total Public Sector 9.2% 8.9% 7.9% 8.0% 7.5% 7.5% 7.0% 6.5% 5.5% 5.1% EPF 58.2% 58.6% 59.5% 59.5% 62.0% 60.5% 57.9% 57.5% 60.9% 66.1% SOCSO 2.2% 2.1% 2.4% 2.4% 2.5% 2.6% 2.7% 2.4% 1.9% 2.2% Others 2.3% 2.9% 4.3% 5.7% 6.2% 7.9% 8.1% 7.9% 7.1% 7.7% Total Social Security Institutions 62.6% 63.7% 66.2% 67.6% 70.7% 71.0% 68.8% 67.8% 69.9% 75.9% Insurance Companies 2.3% 2.9% 4.3% 5.7% 6.2% 7.9% 8.1% 7.9% 7.1% 7.7% BNM 3.5% 1.9% 0.5% 0.6% 0.2% 0.2% 0.3% 0.2% 0.2% 0.1% Banking Institutions 18.1% 19.1% 19.1% 17.1% 12.7% 13.3% 17.0% 19.1% 20.4% 15.7% BSN 2.6% 2.5% 2.8% 3.2% 3.3% 3.3% 3.1% 2.1% 1.6% 1.2% Others 3.0% 3.1% 3.0% 2.6% 0.9% 0.8% 0.6% 1.0% 1.0% 0.9% Total Financial Sector 27.2% 26.6% 25.3% 23.4% 17.1% 17.5% 20.9% 22.4% 23.1% 17.9% Foreign Holders 0.03% 0.03% 0.03% 0.3% 4.0% 3.3% 2.6% 2.6% 0.8% 0.5% Source: Bank Negara Malaysia. 96 Table 11: Malaysia, Investors in Malaysian Government Securities (Millions of Ringgits): 1990-1999 Investor Type 1995 1996 1997 1998 1999 2000 (p) Total Percent of Total General Government 494 419 418 177 191 191 1,890 0.4% EPF 39,150 38,754 38,068 45,670 51,757 60,379 273,778 62.2% SOCSO 1,682 1,821 1,606 1,485 1,683 2,248 10,525 2.4% Insurance Companies 5,128 5,447 5,256 5,307 6,030 6,833 34,001 7.7% Bank Negara Malaysia 100 176 154 131 90 88 739 0.2% Banking Institutions 8,619 11,366 12,650 15,289 12,313 13,126 73,363 16.7% National Savings Bank 2,101 2,045 1,377 1,190 909 1,014 8,636 2.0% Foreign Holders 2,111 1,712 1,737 596 387 225 6,768 1.5% Others 5,334 5,170 4,996 5,167 4,976 5,181 30,824 7.0% Total 64,719 66,910 66,262 75,012 78,336 89,285 440,524 100.0% Source: Bank Negara Malaysia 2.4. Maturity Profile Reflecting the government’s efforts to promote an active secondary market in MGS following financial reforms in 1989, the maturity profile of total MGS outstanding shifted to shorter-term securities. The share of outstanding MGS issued with maturities of up to 10 years rose from 21.5% in 1990 to 28.4% in 1997. Long-term MGS with original maturities of more than 10 years continued to dominate the market, although their share declined from 78% in 1995 to 72% in 1997 (Table 12 and Table 13). Table 12: Malaysia, Maturity Structure of Outstanding MGS Issued (Billions of Ringgits): 1995-2000 Year 2 to 3 Years 4 to 5 Years 6 to 10 Years 11 to 15 Years Above 15 Years Total 1995 1 2 11 14 37 65 1996 1 4 14 13 35 67 1997 1 6 12 13 35 67 1998 2 7 15 15 37 76 1999 4 9 16 15 36 80 2000 7 12 24 12 34 89 Source: Securities Commission Capital Market Master Plan Appendix. 97 Appendix II Table 13: Malaysia, Maturity Structure of Outstanding MGS Issued (Percent): 1995-2000 Year 2 to 3 Years 4 to 5 Years 6 to 10 Years 11 to 15 Years Above 15 Years Total 1995 1.5 3.1 16.9 21.5 56.9 100.0 1996 1.5 6.0 20.9 19.4 52.2 100.0 1997 1.5 9.0 17.9 19.4 52.2 100.0 1998 2.6 9.2 19.7 19.7 48.7 100.0 1999 5.0 11.3 20.0 18.8 45.0 100.0 2000 7.9 13.5 27.0 13.5 38.2 100.0 Source: Securities Commission Capital Market Master Plan Appendix. The share of outstanding MGS issued with maturities of up to 10 years rose from 32% in 1998 to 48% in 2000. The share of long-term securities, however, declined from 68.4% in 1998 to 52% in 2000. 2.5. Issuance Process Prior to financial reforms in January 1989, MGS were issued at par and open to the public for subscription, with the coupon rates determined by the government. Following the reforms, a system of principal dealers (PDs) was set up for MGS and Cagamas bonds. The PDs are required to bid at auctions of all primary issues of MGS of maturities up to 10 years, with each of them bidding for not less than 10% of each issue. However, institutions and individuals wishing to purchase MGS from primary issues would have to apply through the PDs or purchase them in the secondary market. All primary dealers are required to quote a two-way price for bonds within a 15-sen spread. The coupons of the tendered portion of MGS issues are determined based on the weighted average yield of the successful bids of the auction. For MGS with an original maturity exceeding 10 years, the bonds are issued at predetermined coupons and sold at par value to selected institutional investors-namely, the EPF and the National Savings Bank. Historically, MGS were issued at least three times a year. However, starting from 1993, the annual frequency and size of the MGS issues were determined by the size of the federal government budget deficit for the particular year. There was only one new issue in each of 1993, 1994 and 1995. BNM announced the date of the MGS auction usually one to two weeks in advance, specifying the details of the issue, such as the size and tenure. A preannounced auction calendar for MGS was introduced in March 2000 (Table 14). Details of the new MGS to be issued for the whole year will be notified in advance to market participants. This is to enhance transparency and help in the formulation of investors’ strategies. 98 Table 14: Malaysia, MGS Auction Calendar for 2000 MGS Target Month Issue Date Millions of Ringgits 3 Year New Issue of MGS 5 Year Reopening of MGS 1/94 10 Year Reopening of MGS 4/99 3 Year Reopening of MGS 1/00 10 Year Reopening of MGS 4/99 First Second Second Third Fourth 31 March 2000 28 April 2000 30 June 2000 29 September 2000 1 December 2000 3,500 3,000 3,000 5,000 1,500 Source: Bank Negara Malaysia. 2.6. Market Infrastructure Before the crisis, almost all government debt securities are traded on the over-thecounter (OTC) market. The central bank introduced a computerized scripless trading system known as SPEEDS (Sistem Pemindahan Elektronik untuk Dana dan Sekuriti) to facilitate a faster and more efficient system of trading, registration and settlement of government securities. SPEEDS comprised two components: the Scripless Securities Trading System (SSTS) and the Interbank Funds Transfer System (IFTS). The IFTS was launched on 15 December 1989, enabling interbank fund transfers and settlement to take place within a system that had built-in security features and where all settlements took place automatically at the end of each business day. The SSTS was launched on 2 January 1990 as an on-line book entry system for MGS, Treasury bills, Cagamas papers and Bank Negara bills, in order to minimize the danger of loss, theft, destruction and counterfeiting of scrips, and to enable the system to handle a much larger volume of transactions. It was also designed to eliminate the delivery delays inherent in the previous system of paper certificates of ownership and to eliminate the consequential timing differences in the settlement of trades. To improve the process and enhance secondary market trading, BNM made it a requirement that all unlisted PDS must be issued scripless, with clearing and settlement executed electronically via SPEEDS, which was then enhanced to act as the Central Depository and Paying Agency for all unlisted PDS. In addition, the central bank established the Trading Practices and Market Development Committee in 1990, as provided for in the Code of Conduct and Market Practices for Scripless Trading in the Malaysian securities market. Generally, the Committee acts as a consultative and advisory body to guide the development of the scripless securities market. The code sets out in detail the code of conduct and market practices, and the associated clearing and settlement procedures for scripless trading in the Malaysian securities market. Subsequently, in 1994, the conduct of market participants in the wholesale and foreign exchange markets was formalized through the publication of the Malaysian Code of Conduct for Principals and Brokers in the Wholesale Money and Foreign Exchange Markets. This code governs the conduct of all participants in the wholesale markets in order to maintain the highest levels of professionalism and to protect the credibility of oral contracts. 105 Appendix II 3.4. Issue Size and Sector The issue size for PDS ranged from RM25 million to RM15.9 billion, with an overall average of RM343 million (RM159 million in 1997). Listed companies accounted for 62% of the total number of issuers (Table 23 and Table 24). About 36% of the 180 issuers are private limited companies while the remaining issuers are from state economic development corporations. About 60% of corporate bond issuers are public listed companies, which can be considered large-scale firms. The rest are private limited companies of which 80% can be estimated to be either affiliated, subsidiaries or holding companies of existing public listed companies. Many belong to the construction, infrastructure, utility and manufacturing sectors. Some issuers (a couple or so) are state development bodies and financial institutions as well. Table 23: Malaysia, Number of Corporate Bonds Issued By Issuers: 1995-2000 Year Commercial Banks Other Banks Nonbanks Nonfinancial Firms Total 1995 0 0 0 18 18 1996 0 0 0 30 30 1997 1 2 2 20 25 1998 0 0 0 7 7 1999 0 1 1 17 19 2000 0 0 0 14 14 Total 1 3 3 106 113 Note: The above data excludes CP, short-term notes and loan stocks; the data for 2000 covers January to June. Source: Bank Negara Malaysia; Outstanding Facilities as of 30 June 2000. Table 24: Malaysia, Value of Corporate Bonds Issued By Issuers (Millions of Ringgits): 1995-2000 Year Commercial Banks Other Banks Nonbanks Nonfinancial Firms Total 1995 – – – 4,400 4,400 1996 – – – 8,267 8,267 1997 800 675 710 7,482 9,667 1998 – – – 3,555 3,555 1999 – 250 – 33,279 33,529 2000 – – – 11,935 11,935 Total 800 925 710 68,918 71,353 Note: The above data excludes CP, short-term notes and loan stocks; The data for 2000 covers January to June. Source: Bank Negara Malaysia; Outstanding Facilities as of 30 June 2000. 106 Issuers were predominantly from the manufacturing, construction, and transport/storage and communications sectors. In the years immediately preceding the crisis, the financial sector was dominant (largely due to the issue of bonds by Danamodal and Danaharta). By 2000, the dominant sectors were transport/storage and communication, the financial sectors and utilities (Table 25 and Table 26). Table 25: Malaysia, Newly Issued of PDS by Sector (Millions of Ringgits): 1995-2000 Sectors 1995 1996 1997 1998 1999 2000 Agriculture, Forestry and Fishing 165 0 214 0 0 43 Mining and Quarrying 0 0 0 0 0 0 Manufacturing 878 3,245 3,604 125 1,115 1,133 Construction 1,883 2,598 2,069 1,473 9,011 1,869 Electricity, Gas and Water 1,530 1,017 2,237 529 64 4,564 Transport, Storage & Communications 2,424 2,886 2,260 0 20 7,320 Finance, Insurance, Real estate and Business Services 1,250 319 3,924 7,705 2,259 5,237 Government and Other Services 25 436 0 1,000 0 0 Wholesale, Retail Trade, Hotels and Restaurants 1,045 1,882 120 0 660 2,131 Total 9,201 12,384 14,428 10,832 13,128 22,296 Note: The above data refers to new issues of listed and non-listed PDS. Data excludes Cagamas Bonds. Source: Bank Negara Malaysia. Table 26: Malaysia, Newly Issued Private Debt Securities by Sector: 1995-2000 Sectors 1995 1996 1997 1998 1999 2000 Agriculture, Forestry and Fishing 1.8 0.0 1.5 0.0 0.0 0.2 Mining and Quarrying 0.0 0.0 0.0 0.0 0.0 0.0 Manufacturing 9.6 26.2 25.0 1.2 8.5 5.1 Construction 20.5 21.0 14.3 13.6 68.6 8.4 Electricity, Gas and Water 16.6 8.2 15.5 4.9 0.5 20.5 Transport, Storage and Communications 26.4 23.3 15.7 0.0 0.2 32.8 Finance, Insurance, Real estate and Business services 13.6 2.6 27.2 71.1 17.2 23.5 Government and Other Services 0.3 3.5 0.0 9.2 0.0 0.0 Wholesale, Retail Trade, Hotels and Restaurants 11.4 15.2 0.8 0.0 5.0 9.6 Total 100.0 100.0 100.0 100.0 100.0 100.0 Note: Data excludes Cagamas Bonds. Source: Bank Negara Malaysia, Monthly Statistic Bulletin, December 2000. 107 Appendix II 3.5. Guaranteed bonds Guarantors include the government, banking institutions or top credit-rated corporations. Before the crisis, the majority of corporate bonds carried guarantees from banking institutions. The bank guarantee means that the issuer has obtained a guarantee facility from a bank or a consortium of banks to fulfill its obligations upon any default in respect of payment of interest and principal. Part of the reason for their popularity resulted from a regulatory requirement that bonds had to carry a minimum investment grade rating of BBB before regulatory approval for issuance would be granted. From 1995 to 1997, about 17% of total PDS outstanding issued are guaranteed issues. Table 27: Malaysia, Guaranteed or Non-guaranteed Corporate Bonds Issued (Number, Millions of Ringgits): 1995-2000 Number Value Guaranteed Bonds Non-guaranteed Bonds Guaranteed Bonds Non-guaranteed Bonds 1995 6 12 2,168 1,898 1996 4 26 1,055 7,212 1997 4 21 280 8,587 1998 7 0 50 3,505 1999 0 19 – 33,529 2000* 0 14 – 11,935 Total 21 92 3,553 66,666 Note: The majority of the guaranteed bonds are guaranteed by banks. However, in 1995, one bond was guaranteed by the government; The above data exclude CP, short-term notes and loan stocks; The data for 2000 cover January to June. Source: Bank Negara Malaysia, Outstanding Facility as of 30 June 2000. As the regional financial turmoil became prolonged after the occurrence of crisis, banking institutions faced with economic uncertainties became cautious in extending credit. Tight and uneven distribution of liquidity further heightened the problem. Further, investors were also concerned over the weakening credit risk profiles of corporates. Hence, the share of guaranteed PDS declined to 0.1% in 1998-2000. It should also be noted that the minimum investment grade requirement was no longer required from 1 July 2000 onwards. 3.6. Utilization of Proceeds from PDS Issuance In 2000, 52% of PDS issued was for implementation of corporate debt restructuring schemes, followed by new activities (31.2%) and refinancing purposes (16.8%). 3.7. Rating Profile of PDS All corporate bonds issued in the domestic Malaysian market are required to be rated by a domestic rating agency. Almost all corporate bonds are sold via private placement, as bond investors in Malaysia are largely institutional. 108 In term of ratings distribution, based on a stand-alone basis, which measures the issuer’s inherent ability to repay the debt obligations, the bulk of the ratings are concentrated in the categories that reflect adequate capacity of the issuer to meet financial obligations. About 30% of long-term issues have a stand-alone rating of A, which reflects adequate safety of timely repayment of interest and principal. About 36% of the short-term papers issued have stand-alone ratings of P3, which reflects adequate safety on repayment of debt obligations. 3.8. Investor Profile for PDS However, due to the lengthy approval process and high issuance cost, public offers have not been attractive to issuers. Hence, most issuers issued their PDS via a bought deal or private placements since they could save on the high cost of issuing a prospectus and the approval process. Provident and pension funds, insurance companies, commercial banks, finance companies, merchant banks and discount houses absorbed about 81.1% (RM25.5 billion) of total PDS outstanding issued in 1995, against 69% (RM4.9 billion) in 1990 (Table 28). Financial institutions constituted about 25.1% of total PDS outstanding in 2000, while other institutions such as the EPF and insurance companies held about 73.4%. However, foreigners held about 1.4% of the total outstanding bonds issued. Table 28: Malaysia, Major Investors of Corporate Bonds: End of November 20001 RM (Millions of Ringgits) Percent Commercial banks 16,911 17.2 Financial companies 2,337 2.4 Merchant banks 3,389 3.5 Discount houses 2,016 2.1 All financial institutions 24,652 25.1 Foreign holders 1,426 1.5 Others2 72,115 73.4 Total 98,192 100.0 Note: 1 Data refers to investors’ profile based on total bonds outstanding in the market and excludes short and medium-term papers. 2 Others include major bond holders, i.e., EPF and insurance companies. Source: Bank Negara Malaysia. 3.9. Secondary Market for PDS The secondary market for PDS improved significantly in 1999 and 2000. Total volume traded of unlisted PDS amounted to RM54.3 billion or 46% of the total trading volume in 1999 and RM80.9 billion (63%) in 2000, compared to RM4.6 billion (19%) in 1995. 109 Appendix II The strong secondary market activity after the crisis was due to lower interest rates, ample liquidity, improving credit sentiment, growing supply of PDS, a bigger investor base and measures introduced by the government to boost bond market development (Table 29). Table 29: Malaysia, Turnover Ratios for Corporate Bonds: 1995-1999 Year Turnover of PDS (Millions of Ringgits) Outstanding amount of PDS (Millions of Ringgits) Turnover ratios for PDS (Percent) 1995 16,159 32,013 50.5 1996 3,311 46,755 7.1 1997 8,657 63,350 13.7 1998 7,376 75,402 9.8 1999 75,939 111,776 67.9 Total 111,442 329,296 33.8 Note: 1 Since bids have been available only after 1997, the turnover of PDS from 1995 to 1996 is based on data estimates from the RAM Newsletter. 2 Turnover ratio is determined by dividing turnover of PDS by the outstanding amount of PDS. 3 PDS include Danaharta bonds, Danamodal bonds, Cagamas bonds and others (listed and unlisted). Sources: Bank Negara Malaysia; Securities Commission. 3.10. Other Developmental Measures for the PDS Market After the Crisis • BNM launched the BIDS in October 1997. The BIDS is a centralised database providing information on the terms of issue, real-time prices, details of trades done and relevant news on the various debt securities. • A new liquidity framework was introduced in July 1998 to promote efficient liquidity management and promote development of the PDS market. Under this, the concept of liquidity is based on matching the short-term liquidity requirement arising from maturity mismatches in each individual banking institution. • A key measure to accelerate the development of the bond market was the establishment of the National Bond Market Committee (NBMC) and its various sub-committees in June 1999, to provide policy direction and rationalise the regulatory framework for the orderly development of the bond market. • A new legal framework was put in place in July 2000 centralising the issuance process for PDS with a single regulator to avoid fragmentation and duplicity. Powers over prospectuses and debentures now lie with the SC and a new issuance framework for the issuance of corporate bonds has been created. The SC’s Guidelines on the Offering of PDS has replaced the BNM’s Guidelines. • These new guidelines introduced provisions that liberalised regulatory requirements and facilitates a speedy approval process of 14 days. This framework introduces a disclosure-based scheme of regulation for the approval of PDS as laid out in the 110 Guidelines on the Offering of PDS. Approvals from BNM and the Registrar of Companies are no longer necessary in most cases. • To cater for the varied financial needs of issuers and promote access to a broad spectrum of financial instruments for fund raising, as well access to a diversity of investments for investors, active steps have been taken to promote securitization transactions in the bond market by the introduction of Guidelines on the Offering of Asset Backed Debt Securities by the SC. • At the same time, secondary market liquidity for PDS has been enhanced with the removal of the restriction that was imposed under the Banking and Financial Institutions Act, 1989, on a corporation that is not a licensed institution to engage in repo transactions in PDS. With effect from 1 July 2000, repo transactions may be entered into by all persons, whether or not the person is a licensed institution or corporation. 4. Issues Facing the Ringgit Bond Market The availability of a wide range of hedging instruments will help improve bond market liquidity and widen the investor base. The development of currency, interest rate and bond futures markets will enhance the underlying cash market. Bond lending facilities and the ability to short sell will facilitate leveraged long and short positions, thus increasing liquidity in the cash market. The interest rate risk premium can be reduced through improved opportunities for hedging via the cash or futures market. The captive demand for MGS must be reviewed. As a result of current regulatory requirements, provident and pension funds and financial institutions have to invest a significant portion of their resources in government securities, which they tend to hold until maturity. In line with the policy to promote the development of an efficient financial market, greater flexibility should be given to provident and pension funds, and financial institutions to manage their investment portfolios. Liquidity and maturity mismatch risks arise when markets are inefficient in matching the supply and demand across credits and maturities. The average tenure of PDS issues is generally five years. The lack of depth in the supply of long-term funding has often resulted in a funding mismatch between long-term funding needs and the bonds issued. Many of these aspects have been identified as requiring review and are the subject of recommendations made by the SC in its Capital Market Masterplan. 5. Conclusion If Malaysia is to meet the financing needs of recovery and future growth, the corporate sector’s past financing patterns, with its heavy reliance on bank financing and internally generated funds, must change rapidly. Banks can meet only a portion of funding needs due 111 Appendix II to asset-liability restrictions. Financing investments of a large magnitude will require the mobilization of resources on a large scale. Given the country’s large long-term savings, much of the investment can be drawn locally. However, this calls for accelerated development of the capital market so that intermediation of long-term savings and long-term investments can be performed efficiently. Bonds that allow disintermediation and offer various maturities will be the capital market instrument for increasingly discerning corporate borrowers. Several measures have been taken in recent years, but they need to be accelerated. The capital market is likely to grow rapidly based on the large requirements for financing growth, the increasing pace of privatization and growing capital intensity of industrial projects. There will also be a growing appetite among investors for fixed-income instruments from institutional investors. 112 Appendix III. Case of Thailand Table of Contents 1. Introduction .................................................................................................................................. 114 1.1. Development of the Bond Market.................................................................................... 114 1.2. Relative Size of the Bond Market .................................................................................... 114 1.3. Sources of Funds for Private Investment ........................................................................ 115 1.4. Household Savings Patterns ........................................................................................... 116 2. Government Debt Securities ........................................................................................................ 117 2.1. The Primary Market........................................................................................................ 117 2.2. The Secondary Market .................................................................................................... 121 2.3. Government Bonds Issued for Recapitalization.............................................................. 124 3. Corporate Debt Securities ............................................................................................................ 127 3.1. The Primary Market........................................................................................................ 127 3.2. The Secondary Market for Corporate Bonds.................................................................. 131 3.3. The Role of Banks in the Bond Market............................................................................ 132 3.4. Issues Concerning Bond Market Development ............................................................... 135 4. Conclusion.................................................................................................................................... 137 Tables and Charts Table 1: Thailand, Outstanding Values of Loans, Equity and Domestic Bonds: 1995-2000............................................................................................................ 115 Table 2: Thailand, Source of Funds for Private Investment: 1995-2000 .......................... 116 Table 3: Thailand, Household Savings Pattern: 1993 and 1998........................................ 116 Table 4: Thailand, Value of Government Debt Securities Offerings in the Primary Market: 1995-2000 .............................................................................................. 118 Table 5: Thailand, Proportion of Each Type of Government Debt Securities Offerings to Total Bonds: 1995-2000...................................................................................... 118 Table 6: Thailand, Government Debt Securities Offered in Domestic and Overseas Market: 1995-2000 .............................................................................................. 119 Table 7: Thailand, Currency Denomination of Government Bonds and State Enterprises Bonds Offered in Overseas Markets: 1995-2000 ................................................ 120 Table 8: Thailand, Maturity of Government Bonds Under the Bt. 500 Billions Program ............................................................................................................... 120 Table 9: Thailand, the Maturity Structure of State Enterprise Bonds: 1995-2000 ............ 121 Table 10: Thailand, Outstanding Values of Bonds in the TBDC: 1995-2000..................... 121 Table 11: Thailand, Trading Values of Bonds in the TBDC: 1995-2000 ........................... 122 Table 12: Thailand, Turnover Ratios of Bonds in the TBDC: 1995–2000.......................... 122 Table 13: Thailand, Investors in Government Debt Securities: 1995-2000 ........................ 123 Table 14: Thailand, Government Bonds Issued for Recapitalization: 1998-2000 .............. 124 Table 15: Thailand, Maturity of Government Bonds Issued for Recapitalization: 1998-2000............................................................................................................ 125 Table 16: Thailand, Investors in Recapitalization Bonds: 1998-2000 ................................ 126 113 Appendix III Table 17: Thailand, Values of Registered Recapitalization Bonds in the TBDC: 1998-2000.............................................................................................................126 Table 18: Thailand, Turnover Ratios of Registered Recapitalization Bonds in the TBDC: 1998-2000.............................................................................................................126 Table 19: Thailand, Values of Corporate Bond Offerings by Type: 1995-2000..................127 Table 20: Thailand, Values of Corporate Bond Offerings by Market: 1995-2000 ..............128 Table 21: Thailand, Currency Denomination of Corporate Bonds Offered in Overseas Markets, 1995-2000..............................................................................................128 Table 22: Thailand, the Maturity Structure of Corporate Bond: 1995-2000........................129 Table 23: Thailand, Coupon Payment of Corporate Bonds: 1995-2000 ..............................129 Table 24: Thailand, Values of Corporate Bonds Issued by Industry: 1995-2000 ................130 Table 25: Thailand, Investors in Newly Issued Corporate Bonds: 1995-1998.....................131 Table 26: Thailand, Outstanding Values and Trading Values of Corporate Bonds in the TBDC: 1995-2000................................................................................................131 Table 27: Thailand, Turnover Ratios of Corporate Bonds in the TBDC:1995-2000 ...........132 Table 28: Thailand, Values of Corporate Bonds Issued by Commercial Banks: 1995-2000.............................................................................................................133 Table 29: Thailand, Values of Government Debt Securities Held by Commercial Banks: 1995-1999.............................................................................................................133 Table 30: Thailand, Top 5 Underwriters for Corporate Debt Securities Registered in the TBDC: 1995 and 2000 .........................................................................................134 Table 31: Thailand, Most Active Dealer-members in the TBDC: 1998-2000 .....................134 Table 32: Thailand, Types of Secured Bonds: 1995-2000 ...................................................135 Chart: Thailand, TBDC Government Bond Yield Curve................................................124 114 1. Introduction 1.1. Development of the Bond Market Before 1992, there was a limited supply of bonds in Thailand. Under corporate law, only public and exchange-listed companies on the corporate side were eligible to issue bonds. Limited companies, which comprised the majority of business entities, were prohibited. As a result, government and state enterprises were the main issuers in the bond market. However, due to a budget surplus, the government did not issue any of its own bonds between 1987 and 1997. In addition, the demand for bonds was also limited. Before 1992, institutional investors, who are usually the major players in the bond market, were not yet developed enough to provide the market with needed demand. Last, several elements of the infrastructure necessary, such as an organized secondary market, credit rating agency, etc., were also not in place. The pace of development in the bond market accelerated after the enactment of the Securities and Exchange Act in 1992. Under the new law, limited companies were allowed to issue corporate bonds. During 1992-1997, the size of the corporate bond market expanded rapidly as increasing numbers of companies issued corporate bonds. In 1993, the first credit rating agency, the Thai Rating Information Service Co., Ltd., was established, and this was followed in 1994 by the establishment of the first organized overthe-counter (OTC) entity, the Bond Dealers Club. In addition, deregulation in the mutual fund industry in 1992 and the establishment of private funds and pension funds in 1997 have also broaden the institutional investor base for the market. 1.2. Relative Size of the Bond Market In 1995-1997, the total outstanding value of domestic bonds increased at a moderate rate—from B424 billion in 1995 to B547 billion in 1997 (Table1). But the outstanding value was only 5% to 8% of the total outstanding loans, equity and domestic bonds in 19951997. The growth of the bond market during this period was mainly due to the increase in the outstanding value of corporate bonds and state enterprise bonds, given that the government did not issue new bonds. 121 Appendix III Table 9: Thailand, the Maturity Structure of State Enterprise Bonds: 1995-20001 Maturity Value of Issues (Billions of Bahts) Proportion (Percent) 1995 1996 1997 1998 1999 2000 1995 1996 1997 1998 1999 2000 1 Year 2 0 1 0 0 0 4.9 0.0 1.9 0.0 0.0 0.0 2 Years 0 3 0 14 0 0 0.0 4.4 0.0 27.4 0.0 0.0 3 Years 15 1 0 9 3 8 38.0 0.9 0.0 17.6 4.4 6.7 4 Years 7 6 3 6 0 4 17.2 10.3 5.7 11.7 0.0 3.2 5 Years 9 14 17 8 12 13 21.2 23.1 31.8 15.3 17.8 11.0 6 Years 0 6 3 5 10 10 0.0 10.3 4.8 9.5 15.1 8.6 7 Years 6 16 12 6 16 14 15.2 27.8 22.5 11.6 23.2 12.2 8 Years 1 9 12 3 9 20 3.5 15.4 21.9 5.9 13.4 17.2 9 Years 0 0 0 0 5 10 0.0 0.0 0.0 0.0 7.8 8.6 > 10 0 5 6 1 12 38 0.0 7.8 11.4 1.0 18.3 32.5 41 58 53 51 68 116 100.0 100.0 100.0 100.0 100.0 100.0 Note: 1. Data refers to fiscal year. 2. “-” means no activity. Source: Bank of Thailand. 2.2. The Secondary Market Outstanding Value In 1995, the outstanding value of government debt securities in the Thai Bond Dealing Center (TBDC) was B8.5 billion, accounting for 8.7% of the total in the TBDC (Table 10). After the 1997 financial crisis, the outstanding value of government debt securities in the TBDC increased markedly due to the issuance of a substantial amount of government bonds in order to support financial reform measures. In 1999, the outstanding value of government debt securities registered in the TBDC was B930.2 billion, accounting for about 84% of the total bonds registered in the center. Table 10: Thailand, Outstanding Values of Bonds in the TBDC (Billions of Baht): 1995-2000 Type of Bonds 1995 1996 1997 1998 1999 2000 Government Debt Securities Government Bonds 1 - - - 330 539 586 % of Total Bonds - - - (43.3) (49.7) (46.2) State Enterprises Bonds 1 - - - 286 356 407 % of Total Bonds - - - (37.5) (32.9) (32.1) T-Bills - - - - 25 62 % of Total Bonds - - - - (2.3) (4.9) BOT/FIDF/PLMO 9 19 37 21 10 4 % of Total Bonds (8.7) (12.4) (21.6) (2.7) (0.9) (0.3) Total Government Debt Securities 9 19 37 638 905 1060 % of Total Bonds (8.7) (12.4) (21.6) (83.5) (83.5) (83.5) Corporate Debt Securities 89 130 133 126 179 210 % of Total Bonds (91.3) (87.6) (78.4) (16.5) (16.5) (16.5) Total Bonds 98 149 169 764 1,085 1,270 % of Total Bonds (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Note: 1. BDC was established in November 1994 and renamed TBDC in April 1998 following its status upgrade to ‘Bond Exchange’. Government and state enterprise bonds have been registered after TBDC operated. 2. “-” means no activity. Source: The Thai Bond Dealing Center. 122 Trading Value Trading value of government debt securities in the TBDC was B930 million in 1995, accounting for 1.8% of total trading value in the center (Table 11). In 1996-1997, trading value of government debt securities continued to increase but the proportion of government debt securities to total trading was still quite low. After 1997, government debt securities dominated the TBDC’s trading activity. In 1999, the trading value of government debt securities reached B398.4 billion, accounting for about 92% of the TBDC total, while the turnover ratio was about 43% (Table 12). Table 11: Thailand, Trading Values of Bonds in the TBDC (Billions of Baht): 1995-2000 Type of Bonds 1995 1996 1997 1998 1999 2000 Government Debt Securities Government Bonds - - - 43 341 1,028 % of Total Bonds - - - (59.8) (79.1) (75.7) State Enterprises Bonds - - - 8 51 208 % of Total Bonds - - - (10.4) (11.8) (15.3) T-Bills 2/ - - - - 4 47 % of Total Bonds - - - - (0.9) (3.5) BOT/FIDF/PLMO 1 5 15 13 3 1 % of Total Bonds (1.8) (2.4) (14.3) (17.4) (0.6) (0.0) Total Government Debt Securities 1 5 15 63 398 1,284 % of Total Bonds (1.8) (2.4) (14.3) (87.7) (92.4) (94.6) Corporate Debt Securities 51 196 91 9 33 73 % of Total Bonds (98.2) (97.6) (85.7) (12.3) (7.6) (5.4) Total Bonds 52 201 106 72 431 1,357 % of Total Bonds (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Note: 1. The BDC was established in November 1994 and renamed the TBDC in April 1998 following its status upgrade to 'Bond Exchange'. Government and state enterprise bonds have been registered after the TBDC operated. 2. “-”means no activity. Source: The Thai Bond Dealing Center. Table 12: Thailand, Turnover Ratios of Bonds in the TBDC (Percent): 1995-20001 Type of Bonds 1995 1996 1997 1998 1999 2000 Government Debt Securities Government Bonds - - - 13.0 63.3 175.3 State Enterprises Bonds - - - 2.6 14.3 51.0 T-Bills - - - - - 76.5 BOT/FIDF/PLMO 11.0 26.1 41.7 59.9 27.3 16.3 Total Government Debt Securities 11.0 26.1 41.7 9.9 44.0 121.1 Corporate Debt Securities 56.7 150.4 68.6 7.1 18.3 35.0 Total Bonds 52.7 134.9 62.8 9.4 39.8 106.9 Note: 1. Turnover Ratio = Yearly Trading Value/Outstanding Value. 2. “-” means no activity. Source: The Thai Bond Dealing Center. 123 Appendix III Major Investors Almost all government debt securities are held by institutions. The BOT, commercial banks, Government Savings Bank and other financial institutions are the main investors in the government debt securities market. In 1995-1996, this group of investors altogether held more than 90% of the total government debt securities (Table 13). Starting from 1997, the proportion held by investors in the financial sector declined while insurance companies and other investors gained larger proportions. As of June 2000, financial institutions hold about 78%, insurance companies 7% and other investors 15% of total government debt securities. Table 13: Thailand, Investors in Government Debt Securities (Billions of Baht): 1995-20001 Type of Investors 1995 1996 1997 1998 1999 2000 (June) Bank of Thailand & FIDF 12 21 75 215 153 134 Proportion (%) (4.4) (7.0) (24.4) (30.1) (15.9) (13.3) Commercial Banks 166 158 137 282 414 438 Proportion (%) (59.1) (53.2) (44.5) (39.6) (43.0) (43.4) Government Savings Bank 14 24 22 48 148 154 Proportion (%) (5.0) (8.3) (7.1) (6.7) (15.4) (15.3) Other Financial Institutions 71 75 42 72 62 60 Proportion (%) (25.2) (25.4) (13.5) (10.1) (6.4) (5.9) Insurance Companies 7 7 15 31 62 71 Proportion (%) (2.4) (2.2) (4.8) (4.4) (6.4) (7.0) Others 2 11 12 18 65 125 152 Proportion (%) (3.9) (3.9) (5.7) (9.1) (12.9) (15.1) Total 281 296 308 713 965 1,008 Proportion (%) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Note: 1. Government Debt Securities include Government Bonds, Treasury Bills and State Enterprise Bonds. 2. Other investors include non-bank institutional investors, such as mutual funds, provident funds, pension funds, etc., corporations and individuals. Source: Bank of Thailand. The Yield Curve The government bond yield curve was first developed by the TBDC in September 1998 following the relaunch of government bonds. Its construction was based on weighted average executed yield. However, since September 15, 1999, the yield curve has been constructed based on bidding yield of all government bonds quoted by nine primary dealers at minimum value of B20 million. Additionally, a set of government bonds was selected to represent benchmark bonds. The maturities chosen were close to one, two, five, seven and 10 years, according to their outstanding sizes and trading activities. The benchmark bonds are reviewed every three months. Chart 1 shows the TBDC government bond yield curves on 30 December 1999, and 30 June 2000. 124 Chart: Thailand, TBDC Government Bond Yield Curve 2.3. Government Bonds Issued for Recapitalization The Value of Recapitalization Bonds After the financial crisis (1998-2000), the government issued a substantial amount of bonds to support recapitalization of financial institutions. In 1998, the amount of government bonds issued was B400 billion. All of the bonds were issued for FIDF (Table 14). In 1999, the government further issued B297.8 billion of recapitalization bonds, of which 84% was for the FIDF, 13% for banks and 3% for finance companies. In total, recapitalization bonds accounted for 89% of total government bonds issued. Table 14: Thailand, Government Bonds Issued for Recapitalization (Billions of Baht): 1998-2000 Types of Government Bonds 1998 1999 2000 for FIDF 400 100 - % Registered in TBDC (100.0) (30.1) - for Reopen FIDF - 149 - % Registered in TBDC - (44.8) - for Tier 1 & 2 - - - - for Banks - 39 25 % Registered in TBDC - (11.0) (44.9) - for Finance Companies - 10 0.3 % Registered in TBDC - (2.9) (0.6) Total Recapitalization Bonds 400 298 25 Total Government Bonds 400 333 55 % of Registered Recap. Bonds to Total Recapitalization Bonds (100.0) (89.5) (45.4) Note: “-” means no activity. 1 Refinance for FIDF Bonds. Source: Bank of Thailand. 125 Appendix III In 2000, the amount of recapitalization bonds declined to B25 billion, accounting for 45% of total government bonds issued. Almost all the capitalization bonds were issued for banks. Maturity of Recapitalization Bonds The maturity of recapitalization bonds issued for the FIDF ranged from one to 15 years (Table 15), but the majority of the bonds (about 60% to 70%) have a maturity of less than seven years. On the other hand, recapitalization bonds issued for banks and finance companies were all 10-year bonds. Table 15: Thailand, Maturity of Government Bonds Issued for Recapitalization (Billions of Baht): 1998-2000 Years) FIDF Bank NonBank FIDF 1Bank NonBank FIDF Bank NonBank 1 150 - - - - - - - - 2 20 - - 49 - - - - - 3 50 - - 60 - - - - - 4 - - - 30 - - - - - 5 60 - - 40 - - - - - 6 - - - 30 - - - - - 7 50 - - - - - - - - 8 20 - - - - - - - - 10 50 - - - 39 10 25 0 12 - - - 20 - - - - - 15 - - - 20 - - - - - Total 400 - - 249 39 10 - 25 0 Note: “-” means no activity. 1. Including Bonds for Reopened FIDF. Source: Bank of Thailand. Investors of Recapitalization Bonds Commercial banks were the main investors in recapitalization bonds, holding 37% of the total outstanding value in 1998. This proportion further increased to 42% in 1999 and 46% in 2000. The Government Savings Bank also held a significant proportion of recapitalization bonds, accounting for 17% to 20% of the total issued in 1999-2000 (Table 16). The Secondary Market for Recapitalization Bonds All recapitalization bonds issued for the FIDF were registered in the TBDC and trading has been very active. The turnover ratio was 63% in 1999 and this further increased to 175% in 2000. In contrast to the recapitalization bonds issued for the FIDF, those issued for banks and finance companies were held to increase their capital base. These types of recapitalization bonds were not registered in the TBDC (Tables 17 and 18). 126 Table 16: Thailand, Investors in Recapitalization Bonds (Billions of Baht): 1998-20001 Type of Investors 1998 1999 2000 (Jun.) Bank of Thailand 55 86 72 Proportion (%) (13.9) (15.8) (12.7) FIDF 80 - - Proportion (%) (20.0) - - Commercial Banks 148 229 262 Proportion (%) (37.1) (41.8) (46.1) Government Savings Bank 28 107 99 Proportion (%) (7.1) (19.5) (17.4) Other Financial Institutions 60 45 44 Proportion (%) (14.9) (8.2) (7.7) Insurance Companies 7 32 35 Proportion (%) (1.8) (5.8) (6.2) Others 2/ 21 49 56 Proportion (%) (5.2) (8.9) (9.9) Total 400 547 568 Proportion (%) (100.0) (100.0) (100.0) Note: “-” means no activity. 1. Recapitalization bonds include bonds for the FIDF and bonds for financial sector restructuring. 2. Other investors include non-bank institutional investors, such as mutual funds, provident funds, pension funds, etc., corporations and individuals. Source: Bank of Thailand. Table 17: Thailand, Values of Registered Recapitalization Bonds in the TBDC (Billions of Baht): 1998-20001 Types of Government Bonds 1998 1999 2000 For FIDF 400 100 - % Registered in the TBDC (100.0) (100.0) - For Reopen FIDF - 149 - % Registered in the TBDC - (100.0) - Total Registered Recap. Bonds 400 249 - Total Recapitalization Bonds 400 298 25 % of Registered Recap. Bonds to Total Recapitalization Bonds (100.0) (83.6) - Note: 1. All Government Bonds (exclude Bonds for Tier 1 & 2) are automatically registered in the TBDC. 2. “-” means no activity. Source: The Thai Bond Dealing Center. Table 18: Thailand, Turnover Ratios of Registered Recapitalization Bonds in the TBDC: 1998-20001 Government Bonds 2 1998 1999 2000 Trading Values (Billions of Baht) 43 341 1,028 Outstanding Values (Billions of Baht) 330 539 586 Turnover Ratios (%) 13.0 63.3 175.3 Note : 1. Turnover Ratio = Yearly Trading Value/ Outstanding Value. 2. Since the outstanding value of Registered Recapitalization Bonds in the TBDC is almost equal to Total Government Bonds that registered in the TBDC, the Turnover Ratios of Registered Recapitalization Bonds are estimated from: Yearly Trading Value of Government Bonds/ Outstanding Value of Government Bonds. Source: The Thai Bond Dealing Center. 127 Appendix III 3. Corporate Debt Securities 3.1. The Primary Market Value of Corporate Bond Offerings The issuance of corporate bonds as an alternative source of funding became more important to business firms in 1995-1996. The total value of new issues was B86.7 billion in 1995 and B132.9 billion in 1996 (Table 19). However, during 1997-1998, the value of corporate bonds issued dropped sharply. In 1997, the value was B40.9 billion, a decline of about 69% compared to 1996. In 1998, the figure further declined to B36.3 billion, decreasing 72% from the high level of B132.9 billion in 1996. However, the downward trend has reversed since 1999, when the value of new corporate bonds issued was B315.9 billion, an increase of 771% from that of 1998. During the first three quarters of 2000, the value of new corporate bond offerings was still at a high level of B125.6 billion. Table 19: Thailand, Values of Corporate Bond Offerings by Type (Billions of Baht): 1995-2000 Type of Bonds 1995 1996 1997 1998 1999 2000 (Jan-Sep.) Straight Issues 71 92 38 30 308 119 Proportion (%) (81.4) (69.4) (93.2) (82.9) (97.5) (94.6) Convertible Issues 16 41 3 6 8 7 Proportion (%) (18.6) (30.5) (6.8) (17.1) (2.4) (5.3) Total 87 133 41 36 316 126 Proportion (%) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Source: Securities and Exchange Commission. Types of Corporate Bonds Issued Corporate bonds issued by companies in Thailand may be classified into two major types, as follows: (1) straight issues, and (2) convertible issues. Each type of bond may be sub-categorized according to whether they are secured or unsecured, and subordinated or unsubordinated. Straight issues are the major type of securities issued in the bond market. The issuance of convertible debentures used to be popular in 1995-1996, during which the value of convertible debentures accounted for 18.6% of the total value of new corporate bonds issued in 1995 and 30.5% in 1996 (Table 19). However, after the financial crisis, only a few companies issued convertible debentures in the primary market. In 1999, the value of convertible debentures issued in the primary market was 2.4% of total corporate bonds issued. The Markets for Corporate Bonds In 1995-1997, corporate bond offerings were placed in domestic and overseas markets. In 1995, the proportion offered in the domestic market was about 55% of the total value and about 45% in the overseas markets (Table 20). In 1996-1997, the 128 proportion of corporate bonds offered in the overseas market increased significantly to 67% to 69% of the total. However, after 1997, almost all new corporate bonds issued were offered in the domestic market. Table 20: Thailand, Values of Corporate Bond Offerings by Market (Billions of Baht): 1995-2000 Market 1995 1996 1997 1998 1999 2000 (Jan.-Sep.) Domestic 48 43 12 36 289 122 % of Total (54.8) (32.5) (30.5) (100.0) (91.6) (97.5) Overseas 39 90 28 - 27 3 % of Total (45.2) (67.5) (69.5) - (8.4) (2.5) Total 87 133 41 36 316 126 % of Total (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Source: Securities and Exchange Commission. Currency Denomination of Overseas Issues In 1995-1996, corporate bonds offered overseas were mainly denominated in US dollars, amounting to US$2.3 billion in 1995 and US$3.9 billion in 1996 (Table 21). The value accounted for more than 90% of the total corporate bonds offered overseas during each year. In 1997, corporate bonds offered in overseas markets included yen denomination bonds to a value of Y82 billion and US dollar denomination bonds to a total value of US$460 million. Yen denomination bonds accounted for 60% and US dollar denomination bonds 40% of the total corporate bonds offered overseas. After 1997, corporate bonds offered overseas were all in US dollars, amounting to US$700 million in 1999 and US$80 million in 2000 (January-September). Table 21: Thailand, Currency Denomination of Corporate Bonds Offered in Overseas Markets, 1995-2000 Value (Billions of Baht) % of Total Corporate Bonds Offered Overseas Currency 1995 1996 1997 1998 1999 2000 (Jan.-Sep.) 1995 1996 1997 1998 1999 2000 USD 2 4 0.5 - 1 0.1 97 92 42 - 100 100 Yen - 37 82 - - - - 8 58 - - - Baht 2 - - - - - 3 - - - - - Note: Data of 1995-1997 are approved values of bonds offered overseas; data of 1998-2000 are actual public offering and private placement values; proportions are calculated on US$ base. Source: Securities and Exchange Commission. Maturity Structure In 1995-1997, corporate bonds with a maturity of 10 years or more accounted for 40% to 78% of those issued. After 1997, corporate bonds were relatively short term, with maturities of two years, three years, five years and seven years forming the majority. In 129 Appendix III total, corporate bonds with maturities of less than 10 years accounted for about 89% or more of the total value of bonds issued each year in the period 1998-2000 (Table 22). Table 22: Thailand, the Maturity Structure of Corporate Bonds, 1995-2000 Value of Issues (Billions of Baht) Percent of Total Maturity (Years) 1995 1996 1997 1998 1999 2000 (Sep.) 1995 1996 1997 1998 1999 2000 (Sep.) 1 Year - - - 3 6 2 - - - 7.6 2.6 1.4 2 Years - 1 - 2 27 22 - 0.6 - 5.5 12.5 18.9 3 Years 6 6 4 7 35 35 8.8 4.9 11.0 20.2 16.4 29.8 4 Years 2 2 - - 8 3 2.4 2.0 - - 3.7 2.4 5 Years 31 14 17 2 61 20 46.3 12.1 48.8 5.0 28.5 16.8 6 Years - - - - 0.4 27 - - - - 0.2 22.6 7 Years 1 3 - 22 43 3 1.6 2.7 - 61.6 20.2 2.7 8 Years - - - - 10 - - - - - 4.6 - 9 Years - - - - - - - - - - - - 10 Years 28 65 9 0.1 12 3 41.0 56.5 24.3 0.1 5.4 2.8 10 Years up - 24 6 - 13 3 - 21.2 15.9 - 5.9 2.7 Total 68 115 36 36 215 118 100.0 100.0 100.0 100.0 100.0 100.0 Note: Data of 1995-1997 are approved public offering values and approved offering values in the overseas market; data of 1998-2000 are actual public offering and private placement values. Source: Securities and Exchange Commission. Coupon Payment Coupon payment of corporate bonds may be in the form of fixed rate coupons, floating rate coupons, or combined rate (with fixed rate and floating rate) coupons. The values of floating rate coupon issues were higher than fixed rate issues in 1995, 1997 and 1998, during which interest rates in the money market were high. After 1998, the money market experienced high liquidity and interest rates declined to stand at historic low levels over the past decade. This prompted business companies to issue fixed rate coupon bonds or combined rate coupon bonds. The proportion of fixed rate coupon bonds accounted for 81% in 1999 and 58% in 2000 of total corporate bonds issued, while combined rate coupons became more widespread in 2000, accounting for 33% of the total (Table 23). Table 23: Thailand, Coupon Payment of Corporate Bonds, 1995-2000 Value of Issues (Billions of Baht) Percent of Total Type of Coupon 1995 1996 1997 1998 1999 2000 (Sep.) 1995 1996 1997 1998 1999 2000 (Sep.) Fixed Rate 29 93 15 12 209 66 42.2 81.0 43.1 32.8 80.9 57.9 Floating Rate 39 22 20 24 29 10 57.8 19.0 56.9 67.2 11.4 9.2 Mixed with Fixed and Floating Rate - - - - 4 38 - - - - 1.4 33.0 Discount - - - - 16 - - - - - 6.4 - Total 68 115 36 36 258 114 100.0 100.0 100.0 100.0 100.0 100.0 Note: Data of 1995-1997 are approved public offering values and approved offering values in the overseas market; data of 1998-2000 are actual public offering and private placement values. Source: Securities and Exchange Commission. 130 Major Issuers During 1995-1996, banks were the major issuers of corporate bonds in the bond market, accounting for 26%-35% of the total that were approved to make public offerings (Table 24). Table 24: Thailand, Values of Corporate Bonds Issued by Industry: 1995-2000 Value of Corporate Bonds (Millions of Baht) Percent of Total Corporate Bonds Industry 1995 1996 1997 1998 1999 2000 (Jan - Sep) 1995 1996 1997 1998 1999 2000 1 Agribusiness 2,497 - - - 5,200 7,249 3.6 - - - 1.6 5.8 2 Banking 18,526 41,138 - 27,510 184,557 15,384 26.4 35.0 - 75.9 58.4 12.2 Commercial Banks 18,526 41,138 - 20,000 168,455 9,244 26.4 35.0 - 55.2 53.3 7.4 Non-Commercial Banks - - - 7,510 16,102 6,140 - - - 20.7 5.1 4.9 3 Building & Furnishing Materials 4,296 7,922 - - 56,800 41,300 6.1 6.7 - - 18.0 32.9 4 Chemicals & Plastics - - - 500 1,600 700 - - - 1.4 0.5 0.6 5 Commerce 26,213 5,333 3,933 - 12,570 - 37.4 4.5 11.0 - 4.0 - 6 Communication 6,187 24,886 5,667 6,420 4,500 10,000 8.8 21.2 15.9 17.7 1.4 8.0 7 Electrical Products & Computer 325 400 - - - 900 0.5 0.3 - - - 0.7 8 Electronic Components - - - - - - - - - - - - 9 Energy - 16,896 3,961 237 12,930 11,810 - 14.4 11.1 0.7 4.1 9.4 10 Finance & Securities 120 11,652 - 1,281 5,157 5,202 0.2 9.9 - 3.5 1.6 4.1 11 Foods & Travel Services - - - - 2,400 264 - - - - 0.8 0.2 12 Health Care Services - - - - - 2,000 - - - - - 1.6 13 Hotels & Travel Services - - - - 900 1,700 - - - - 0.3 1.4 14 Household Goods - 1,524 - - - 3,152 - 1.3 - - - 2.5 15 Leasing - - 17,427 - 350 17,500 - - 48.8 - 0.1 13.9 16 Machinery & Equipment - - - - - 370 - - - - - 0.3 17 Others - 1,016 - - 22,558 2,575 - 0.9 - - 7.1 2.1 18 Packaging - - - - - - - - - - - - 19 Printing & Publishing - - - - 500 500 - - - - 0.2 0.4 20 Property Development 8,098 3,682 - 309 1,421 5,001 11.5 3.1 - 0.9 0.4 4.0 21 Pulp & Paper - 3,047 4,722 - - - - 2.6 13.2 - - - 22 Textiles 2,497 - - - 1,700 - 3.6 - - - 0.5 - 23 Transportation 1,373 - - - 1,000 - 2.0 - - - 0.3 - 24 Vehicles & Parts - - - - 1,717 - - - - - 0.5 - 70,130 117,495 35,710 36,257 315,859 125,606 100.0 100.0 100.0 100.0 100.0 100.0 Note: Data of 1995-1997 are approved public offering values and approved offering values in the overseas market; data of 1998-2000 are actual public offering and private placement values. Source: Securities and Exchange Commission. Apart from the banking sector, businesses in commerce, communication, energy and property were also important corporate bond issuers. In 1997, there were only seven issues of corporate bonds approved to make public offerings, of which firms in the leasing sector were the dominant issuers. After the financial crisis (1998-1999), banks were the dominant issuers of corporate bonds, accounting for 76% of the total value of new bonds issued in 1998 and 58% in 1999. During the first three quarters of 2000, companies in the building and furnishing material sector became the most important issuers in the market. They issued about B41.3 billion in bonds, accounting for 33% of the total new bonds issued. The other main issuers were in the banking, leasing, energy, communication and agribusiness sectors. 137 Appendix III (3) Prudential Regulations Imposed on Asset Portfolios Institutional investors such as insurance companies, provident funds, mutual funds, etc., are subject to prudential regulations on asset portfolios. Prudential regulations impose restrictions on corporate bond investment and to a certain extent affect the trading activities of institutional investors in the secondary bond market. (A) Insurance Companies a) Investment in any particular company’s corporate bonds must not exceed 10% of the total value of bonds issued by the company. b) Investment in corporate bonds issued by insurance companies must not exceed 10% of total assets. c) Investment in corporate bonds issued by non-insurance companies must not exceed 30% of total assets. (B) Provident Funds Investment in any company’s corporate bonds must not exceed 5% of total funds. (C) Mutual Funds a) Investment in any company’s corporate bonds must not exceed 5% of total net asset value. b) Investment in corporate bonds that are not rated in the first four rankings from a credit rating agency are subject to an investment ceiling not exceeding 15% of total net asset value. 4. Conclusion The Thai bond market has developed significantly since the enactment of the Securities and Exchange Act BE 2535 in 1992. In 1995-1996, the market’s development was largely supported by rapid corporate bond market growth. Leading businesses increasingly started to issue corporate bonds as an alternative source of funding. The total value of corporate bonds issued increased markedly, reaching a high of about B133 billion in 1996. There was also active trading of corporate bonds in the secondary market, especially in 1996 when the turnover ratio of corporate bonds in the TBDC reached a high of 150%. In contrast to the corporate bond market, the government bond market was relatively inactive before the financial crisis. The government did not issue bonds between 1987 and 1997 due to the budget surplus. The holding of government bonds as liquid assets to meet liquidity reserve requirements by banks and finance companies further reduced the liquidity of government bonds in the secondary market. After the financial crisis (1998-1999), the government and businesses became important bond issuers. The government issued B400 billion of bonds in 1998 and B333 billion in 1999. Almost all of the government bonds issued in 1998-1999 were recapitalization bonds, intended for the FIDF, banks and finance companies. The value of 138 corporate bonds issued also reached a high of B315.9 billion in 1999. The Thai bond market grew rapidly after the financial crisis on the back of these massive issuances. There are several important issues that have to be focused on to promote future bond market development. These include addressing the limited number of corporate bond issuers, the government’s limitation of issuing of bonds only when there is a surplus budget, the tax system that discourages individual investors and trading by market dealers/makers, and the prudential regulations imposed on asset portfolios. 139 Appendix IV Appendix IV. Case of Indonesia Table of Contents 1. Introduction...................................................................................................................................140 2. Financial Pattern............................................................................................................................140 3. Household Savings Patterns..........................................................................................................146 4. Features of the Government Bond Market....................................................................................147 5. Major Characteristics of the Corporate Bond Market...................................................................151 6. Regulatory Impediments ...............................................................................................................158 7. Role of the Banking Sector ...........................................................................................................159 8. Supply and Demand ......................................................................................................................160 9. Some Constraints to Developing a Bond Market in Indonesia .....................................................163 References.........................................................................................................................................164 Tables and Charts Table 1: Indonesia, Total Issuance of Shares, Outstanding Bonds and Bank Finance: 1990-2000.............................................................................................................141 Table 2: Indonesia, Sources of Financing in Realized Investment of Manufacturing Industries: 1996-1998...........................................................................................142 Table 3: Indonesia, Transition to Market-based Debt and Monetary Management ...........143 Table 4: Indonesia, Development of Supporting Institutions in the Capital Markets: 1996-2000.............................................................................................................145 Table 5: Indonesia, Development of the Capital Markets: 1995-2000...............................145 Table 6: Indonesia, Household Saving Pattern: 1998-1999 ...............................................146 Table 7: Indonesia, Types of Government Bonds ..............................................................148 Table 8: Indonesia, Bonds Exchange Offer........................................................................148 Table 9: Indonesia, Maturity of Government Bonds..........................................................149 Table 10: Indonesia, Government Bond Investors: 2001 .....................................................150 Table 11: Indonesia, Government Bond Transactions: 2000 ...............................................150 Table 12: Indonesia, Issuers of Corporate Bonds by Industry: 1996-2000 ..........................152 Table 13: Indonesia, Bonds Issuance in 1998-2000 .............................................................153 Table 14: Indonesia, Major Investors in Corporate Bonds by Industry: 1996-2000 ............154 Table 15: Indonesia, Lead Managing Underwriters on Bonds Outstanding: December 2000.....................................................................................................155 Table 16: Indonesia, Corporate Bond Maturity Structure: December 2000.........................155 Table 17: Indonesia, Corporate Bonds Turnover Ratio: 1996-2000 ....................................156 Table 18: Indonesia, Corporate Bond Transactions: 1997-2000 ..........................................156 Table 19: Indonesia, Type of Interest Structure for Corporate Bonds: July 2000................157 Table 20: Indonesia, Corporate Bonds Issued in the Foreign Market: March 2001.............158 Table 21: Indonesia, Bank Assets: 1995-2000 .....................................................................160 Table 22: Indonesia, Profiles of the Top 15 Banks: December 2000...................................161 Table 23: Indonesia, Bond Ratings: 1996-2000 ...................................................................161 Table 24: Indonesia, Investment and Assets of the Insurance Industry: 1993-1999 ............162 Chart 1: Indonesia, Source of Financing in Manufacturing Industries: 1996-1998 ...........142 Chart 2: Indonesia, Time deposits by Maturity: 1995-2000...............................................147 Chart 3: Indonesia, Major Investors in Corporate Bonds: 1996-2000 ...............................154 140 1. Introduction Bonds are less popular as a source of corporate financing in Indonesia than bank or equity financing. Internationally, the market for Indonesian bonds is small when compared to other East Asian countries, while domestically, their development has lagged behind new emerging equity/stocks and traditional bank financing. Financial market deregulation since the 1980s has done little to promote bond market development. The value of bonds listed and traded in Indonesia is relatively small. In addition, there is little market liquidity, as bond investors are mostly institutional and hold them until maturity. Also, issuers tend to have weak credibility and this is reflected in the ratings issued. Further, the infrastructure—both physical and legal—is at an early stage of development. For instance, the bond clearing and settlement system is carried out by physical delivery. A broader issue to be faced is the relation between this underdevelopment and the low income per capita and income distribution of Indonesia. However, as was shown by the regional financial crisis, the bond market needs to be developed in order to deal with currency and maturity term mismatches. This appendix seeks to address some of these and other issues surrounding bond development in Indonesia. 2. Financial Pattern The Corporate Financing Pattern of Business Investment In analyzing the source of finance of firms according to total outstanding external finance, it can be seen that the post-crisis years of 1997-2000 present a special case. During this period, bank recapitalization has been taking place. As a consequence of government bailouts, the value of stocks has increased dramatically due to additional rights issues for recapitalization. About Rp125.5 trillion—or 65% of total rights issues in 1997-2000— comprised bank recapitalization. About 90% of those rights issues were securities or government bonds. The main source of financing for investment in Indonesia is banks. In 1990-1998, the percentage of bank financing in total financing varied between 81% and 91%. But it has tended to decline as use of other capital market instruments has grown. In subsequent years, as the crisis hit, bank financing declined in terms of nominal value. This decline was not only a result of the crisis, but was also caused by the central bank’s high interest rate policy. The percentage of corporate bonds, however, has increased by only a small amount, from 0.5% in 1990 to 4.4% in 2000. In term of nominal value, up to 1997—before the crisis—there was a significant growth (from Rp420 billion in 1990 to Rp15,605 billion in 1997). Yet right after the crisis, the amount decreased to Rp14.5 billion in 1998 before increasing again sharply in 1999-2000 (Table 1). 141 Appendix IV Table 1: Indonesia, Total Issuance of Shares, Outstanding Bonds and Bank Finance (Billions of Ruppiah, Percent): 1990-2000 Year Shares Bonds Bank Financing Total 1990 8,009 420 70,873 79,302 (10.1) (0.5) (89.4) (100.0) 1991 8,976 420 99,689 109,085 (8.2) (0.4) (91.4) (100.0) 1992 11,162 2,036 115,739 128,937 (8.7) (1.6) (89.8) (100.0) 1993 16,065 3,941 150,271 170,277 (9.4) (2.3) (88.3) (100.0) 1994 26,529 4,870 188,880 220,279 (12.0) (2.2) (85.8) (100.0) 1995 35,395 7,431 234,611 277,437 (12.8) (2.7) (84.6) (100.0) 1996 49,981 9,697 292,921 352,599 (14.2) (2.8) (83.1) (100.0) 1997 70,880 15,605 378,134 464,619 (15.3) (3.4) (81.4) (100.0) 1998 75,947 14,505 487,426 577,878 (13.1) (2.5) (54.4) (100.0) 1999 206,687 15,909 224,034 446,630 (46.3) (3.6) (50.2) (100.0) 2000 218,836 21,299 240,135 480,270 (45.6) (4.4) (50.0) (100.0) Note: ( ) refers to percent. Source: Pefindo database, collected from various sources. Despite the unusual figures for stocks due to the recapitalization program, it can be seen that after the crisis, all sources of financing declined. For instance, the amount of bank financing dropped significantly from Rp487,426 billion in 1998 to Rp224,034 billion and Rp240,135 billion in the next two years. Investment activities also slowed down due to the crisis as the impact of the central bank’s high interest rate policy took affect. Since 1997, there has been practically no issuance of bonds from the property sector. Yet there was a small swing towards this instrument that boosted the number of outstanding bonds, especially from consumer goods and agriculture firms. Those two sectors faired better than others during the crisis because of their smaller foreign exchange exposure. After the crisis, there have been few new issuances. Issuing bonds amid such economic uncertainty was expensive, as was reflected in the low stock price composite index in those years. As data for other instruments (retained earnings, private placements, etc.) for all industries are not available, the pattern can be observed from manufacturing industries data as proxy (Table 2). 142 Table 2: Indonesia, Sources of Financing in Realized Investment of Manufacturing Industries (Billions of Ruppiah, Precent): 1996-1998 Source of Funds 1996 Percent 1997 Percent 1998 Percent Private/Owners’ Fund Placement 13,373 22.6 20,527 16.8 29.1 20.2 Retained Earnings 7,364 12.4 13,673 11.2 23,404 16.3 Stocks/Securities 4,222 7.1 10,257 8.4 7,544 5.3 National Borrowing 19,973 33.7 37,295 30.4 44,548 31.0 Foreign Borrowing 8,900 15.0 28,035 22.9 27,174 18.9 Foreign Investments 2,813 4.8 8,410 6.9 8,305 5.8 Government Investment 1,956 3.3 3,231 2.6 2,176 1.5 Financial Market 678 1.1 1,110 0.9 1,338 0.9 Total 59,280 100.0 122,538 100.0 143,545 100.0 Source: Statistik Industri, Central Bureau of Statistics, Indonesia. For the three years of data that are available, the figures for manufacturing industry bonds as a proportion of total stocks and securities are small. In 1996, stocks and/or securities—including bonds—comprised only 7.1% of total investment. This figure increased slightly to 8.4%, but then, as the crisis kicked in, it declined to 5.3% (Chart 1). Chart 1: Indonesia, Source of Financing in Manufacturing Industries (Percent): 19961998 0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00 Private/ Owner's Fund Placement Retained Earning Stocks/Securities National Borrowing Foreign Borrowing Foreign Investment Government Investment Financial Market 1996 1997 1998 Source: Statistik Industri, Central Bureau of Statistics, Indonesia. Development of Financial Market Based on the indicators developed by Sundararajan et al. (1994) on public debt and monetary management in transition economies, Indonesia’s financial market could be said to be in transition. This is evident in the level of capital market liberalization, open fund flows, and integration of the interest rate and exchange rate. However, in some aspects, the market is still at a preparatory stage while in others, the market has already reached a developed stage. 143 Appendix IV Table 3: Indonesia, Transition to Market-based Debt and Monetary Management Yes No Undeveloped Stage - Limited or no domestic government debt outside the central bank - Fiscal deficit accommodated by money creation X X Preparatory Stage - Introduction of marketable securities, typically Treasury bills sold in auctions - Interest rates insufficiently flexible and largely controlled by the authorities - No secondary market, weak inter-bank markets - Development of debt management objectives - Introduction or testing of other indirect instruments of monetary policy (credit auction, bill rediscount, etc.) X X X X X Transitional Stage - Further development of market-based debt and monetary management instruments with greater flexibility in interest rates and more active liquidity management by the central bank - use of Treasury bills for monetary management - coordination of Treasury bills and credit auctions for monetary management - securitization of outstanding claims on government - replacement of bad loans with government securities - sterilization of excess reserves - Introduction of a comprehensive public debt management regime, including medium-term debt securities, with rates set administratively or tied to Treasury bill rates. Build up of volume and widening the range of holders - Strengthening reserve money and debt programming, and related treasury and monetary operations - Planning of regulatory and institutional arrangements for secondary trading (the central bank remains the major source of liquidity to government debt instruments) - Strengthening of inter-bank markets, and clearing and settlement arrangements - Review of the adequacy of banking supervision relating to asset-liability management X X X X X X X X X X X Developed Stage - Interest rates fully flexible - Expansion of institutional arrangements for secondary markets strengthened by appropriate regulatory and supervisory arrangements - Liquidity of government debt instruments ensured by the market, with the central bank managing market liquidity at its own initiative, using more flexible marketbased instruments - Auctions in mediumand long-term debt instruments - Further expansion of book entry clearing and settlement system, consistent with overall reforms of the payment system X X X X X Source: Sundararajan et al. (1994) and LPEM staff modifications. Before reaching the present stage of development, the market underwent a process of deregulation. As the important complementary of the banking sector, financial market deregulation worked in accordance with that of the banking sector. The purposes are to 144 promote the mobilization of funds, increase non-oil exports, improve the efficiency of banks and non-bank financial institutions, make monetary policy more effective, and create a climate for capital market development. Before deregulation, between 1983 and 1987, the Indonesian financial market was inactive. The number of issuers of stocks and bonds remained unchanged at 23 and three, respectively. This was due to strict regulations governing securities issuance that specified: - a minimum 10% net income equity ratio for the previous year financial performance; - pricing examined by Bapepam (Capital Market Supervisory Agency); - strict scrutinizing by Bapepam; and - prohibition of foreign investors. Three deregulation moves changed the financial and capital markets in Indonesia; the December 1987 package, the December 1988 package, and the December 1990 package. The first package brought in an open policy for foreign investors, relaxed the 10% limitation net income equity regulation, reduced the registering fee, allowed bearer stocks, and eliminated the maximum 4% price fluctuations limitations and the 30-day deadline for issuance permit processing by Bapepam. The December 1988 package marked another significant step. It included the establishment of a private stock exchange, the opening of the stock exchange outside Jakarta, establishment of an over-the-counter (OTC) market, and development of finance companies. It also imposed a tax treatment for deposits interest as well as for securities. Further, the package implies the easing of the listing process and allows the process to be managed by a capital market supporting institution, instead of the government. Last, the December 1990 package emphasized investor protection, requiring the full disclosure of any information needed by investors. These deregulation moves had a big impact on financial market development, especially before the crisis. The influence can be seen from the increased percentage of shares and bonds issued. The exponential growth of those instruments was 85.9% and 33% per annum, respectively. Therefore, comparing these two instruments, it can also be seen that deregulation had less impact on the bond market. Table 4 below charts the improvement of the financial markets. 145 Appendix IV Table 4: Indonesia, Development of Supporting Institutions in the Capital Markets: 1996-2000 No. Institutions 1996 1997 1998 1999 2000 1 2 3 4 5 6 7 8 9 10 11 Securities Companies - Broker-Dealers - Underwriters - Investment Managers Securities Company Representatives - Broker-Dealers - Underwriters - Investment Managers - Investment Fund Selling Agents Custodians Securities Administration Agencies Trust Agents Appraisals Law Partners Civil Law Notaries Accounting Partners Credit Rating Companies Investment Advisory Companies 111 100 62 792 489 249 - 25 13 13 47 102 41 208 - - 211 116 60 1,188 781 449 158 29 13 16 53 173 102 226 - - 205 112 61 1,595 937 571 177 27 12 16 61 232 119 236 1 - 201 110 65 1,805 990 677 253 23 11 16 66 251 159 239 2 1 211 119 70 2,465 1,146 765 573 19 13 15 88 338 167 256 2 1 Source: Bapepam. After the Crisis Since almost 60% of companies listed on the stock exchange and more than 60% of bond investors are in the banking sector, the crisis, which hit most of the banks, also had a significant impact on the stock exchange and bond market. Table 5: Indonesia, Development of the Capital Markets: 1995-2000 1995 1996 1997 1998 1999 2000 No. of Issuers of Shares 248 264 293 300 291 305 No. of Outstanding Issuers of Bonds 43 47 54 42 39 46 No. Of Private Banks 165 164 144 130 92 81 Composite Index -JSE 513.8 637.4 401.7 398.0 676.9 416.3 -SSE 366.1 568.6 352.0 351.5 566.6 267.9 Average Interest Rate (%)* -SBI 13.3 12.3 17.4 37.8 22.7 11.1 -Inter-Bank Call Money 13.6 14.1 30.5 64.1 23.6 10.2 -3 Month Time Deposit 17.2 17.0 23.9 49.2 25.7 12.3 -Working Capital 18.9 19.2 22.0 32.3 27.7 19.0 -Investment 15.8 16.4 17.3 23.2 22.2 16.7 Source: Pefindo database, collected from various sources. 146 During the crisis period (1997 and 1998), the composite index of the Jakarta and Surabaya stock exchanges decreased significantly (Table 5). The figure then rose as the political outlook improved. However, the situation deteriorated again in 2000 as new uncertainties surfaced and the economy showed no signs of significant improvement. Interest rates were high and the percentage of credit to total funds available in banks decreased significantly. The latter figure stood at 106%, 85%, and 40% in 1997, 1998, and 1999, respectively. This confirmed that banks had excess liquidity due to the high cost of funds; thus the potential of bond development, as an alternative source of investment placement, is large. However, bond transaction data showed a decline in terms of volume and frequency in these respective years. In addition, the numbers of outstanding issuers also declined. Despite the drop in the composite stock index, there has been a pick-up in bond issuances over the last two years. The business sector seems to be learning from the crisis that a high dependency on bank financing is not appropriate, due to the volatility of interest rates and maturity mismatches. This realization has gone hand in hand with the growth of better performing enterprises that inspire greater confidence in bonds as a source of financing. Recent issuances of corporate bonds seem to have received a positive response from the market. 3. Household Savings Patterns Data for household saving patterns are taken from the Special Survey on Household Consumption and Investment in 1998 and 1999. Despite incomplete questionnaires concerning savings alternatives, as well as unavailability of data for other years, the figures for bank deposits, securities, insurance, and direct investment can be summarized as shown below. It can be inferred that bank deposits are the most favored saving option, probably because banks have wide networks and thus access to the greatest number of households across the country (Table 6). In 1998-1999 there was a rise in the amount of savings in securities. Although there is no specific figure for bonds, it is estimated that these expanded in line with general securities. Unfortunately, the impact of the crisis is not shown due to the limitations of the data series. Table 6: Indonesia, Household Saving Pattern (Millions of Ruppiah): 1998-1999 Securities Year Bank Deposits Stocks/Shares Others Insurance Direct Investment 1998 539,735,320 2,042 0 6,436,482 35,045,085 1999 658,416,354 524,419 205,595 3,141,199 40,346,613 Source: Special Survey on Household Consumption and Investment, Central Bureau of Statistics, Indonesia. The time terms of savings deposits provide an indication of liquidity preferences. Prior to the crisis, there were only small variations among the time terms of deposits. After