Bond Market Development in Bangladesh: A Factor Analytical Approach

Abstract The present study was attempted to rank bond market development factors with respect to their importance in the context of Bangladesh through Principal Components Varimax Rotated Method . The study was complied with help of primary and secondary data. In this case, the researchers selected ninety companies from a list of different economically important sectors conveniently, and endeavoured to conduct interview of fifty five financial executives of fifty five selected companies. The opinions of fifty five respondents were captured on five point- Likert scale such as most insignificant (1) to most significant (5). The co-efficient values were all above 0.7, thus meeting Cronbachs (1951) and, Nunnally and Bernsteins (1994) recommendation of >0.7 as the acceptable reliability level. While academics assisted in assessing face validity, the financial executives verified content validity. The results show that six factors extracted from the analysis explain 86.16% of the total variance. These factors such as risk and return, liquidity and government policy, issue management, investment policy, macro-economic and regulatory, and market and issue related factor have been ranked as first, second, third, fourth, fifth and sixth respectively with respect to their importance. This study would hopefully benefit academicians, researchers, policy makers, and practitioners of Bangladesh and other similar countries. Keywords: Bond Market Development, Financial Executives, Factor Analysis.

1. Introduction The economic development of any country mostly depends on the establishment of sound, effective and efficient financial system in that country. A well-developed financial system plays 1

an important role in accelerating economic growth by mobilizing savings and facilitating investment in an efficient manner (Mu, 2007). Financial market is composed of different markets such as money market, capital market, and derivative market etc. All the markets

play an interactive role for the development of economy by formation of capital through mobilizing funds, industrialization of economy through supplying adequate funds, providing services, and linking investors to the industrial entrepreneurs etc. Besides, this requires sound regulatory framework and investment, administrative infrastructure, and fiscal supports for making their role effective for economic development. The financial sector of Bangladesh is characterized by the dominating presence of commercial banks, especially the National Commercial Bank (NCBs). Although, a paradigm shift in the degree of dominance has been observed of late with the emergence of private commercial banks-traditional and shariah based banking. Banking sector accounted for about seventy five percent of the total financial system. Most of the available funds go to the NCBs in the form of deposits and channelled into lending. However, the NCBs had substantial nonperforming loan (NPL) portfolios. Both insurance and mutual funds industries are very small. The debt market being an integral part of financial market plays a complementary role in developing economy through allocation of funds to the different deficit sectors. The debt market consists of money market, mortgage market, bond market and derivative market. The debt market of Bangladesh is very small. The size of domestic debt accounted for only twenty percent of the financial system. According to the World Bank, Bangladeshs bond market represents the smallest in South Asia, accounting for only twelve percent of the countrys gross domestic product (GDP). An efficient bond market is important for managing public debt, bank liquidity and for efficient conduct of the monetary policy. So far the bond market has played a limited role in the economy. The priority of the development of 2

Bangladeshs capital markets should be promoted to the bond market development. Without a functioning bond market, the monetary transmission processes of policy measures would be circumvented, and the desired impact on the real economy cannot be fulfilled, which compromises the effectiveness of the monetary policy operations. In view of this, the present study was undertaken in order to develop the bond market in Bangladesh. 1.1 Literature Review and Justification of the Study Bond market development was well established in the academic literatures and numbers of studies were documented the importance of institutional factors and macroeconomic policies in fostering the development of debt markets (La Porta, Lopez-de-Silanes, Shleifer, & Vishny 1997; Burger & Warnock 2006; Claessens, Klingebiel, & Schmukler 2007; Jeanne & Guscina 2006; Eichengreen & Luengnaruemitchai 2006; Mehl & Reynaud 2005). Dennis and Mihov (2003) and Santos and Winton (2008) argued that bond financing should be viable for firms with high profits. Burger and Warnock (2006) focused on the local currency bonds of at most forty nine countries and found roles for both creditor-friendly policies and creditor-friendly laws. Countries with better historical inflation performance (an outcome of creditor-friendly policies) and stronger rule of law had more developed local bond markets, both private and government. They also showed that the necessary conditions for bond market development are very similar to those that foster development of the banking system. Burger and Warnock (2006) also separately analyzed the size of government and private bonds markets. They found that at least as a first pass their determinants are quite similar:

Countries with better inflation performance and stronger rule of law have larger sovereign and corporate bond markets. This is not to say that the relationship between sovereign and corporate bond markets is identical across countries, as some countries with reasonably sized sovereign markets have exceedingly small corporate bond markets. Hale and Santos (2008) found that firms with more liquidity take longer to enter the public bond market due to the fact that they have substantial internal funds. Hirose,Mukarami,andOku, (2004)indicated that the scale of Government issues of bonds has increased over time with issues being made on a scheduled basis, which has helped to establish a benchmark yield curve off which other bond issues can be priced. In addition, the range of investors encouraged to participate in bond markets has widened to include institutional investors such as private pension funds, insurance companies, investment trusts and this has been aided by lowering the bureaucratic hurdles involved with registration and participation. Eichengreen and Luengnaruemitchai (2004) and Eichengreen et al. (2006) illustrated that bond market development has many dimensions, but size and liquidity are two major determinants that influence the incentive of firms to issue bonds. Torre, Gozzi & Schmukler (2006) studied capital market development using pooled data of ninety countries including Mongolia during 1975-2004. They showed that GDP per capita, financial openness (measured by stock market liberalization and equity flows over GDP), and shareholder rights are positively and significantly associated with market capitalization, while 3

Government deficits are negatively related to stock market development. The growth opportunities variable enters positively and significantly in the regressions. Based on the previous literatures, there are many researchers conducted in the field of bond market development. Most of the articles are concerned with the concerns of western countries and some are Asian countries, but no study is seen on the bond market development in Bangladesh perspectives. Therefore, the authors took interest to somewhat cover this wide research gap. This research gap induces the researchers to undertake the present study. 1.2 Objectives The following objectives were undertaken for the study. To determine a set of factors associated with bond market development in Bangladesh. To rank the factors of bond market development with respect to their importance. To offer some policy implications for the development of bond market in Bangladesh. 2. Material and Methods Materials and methods of present study were outlined below.

2.1 Sampling Strategy For the research study ninety companies were selected from a list of different economically important sectors (Chittagong Stock Exchange, 2007) conveniently, and endeavoured to conduct interview of fifty five financial executives of fifty five selected companies.

2.2 Data Sources and Instrumentation The study suitably used both primary and secondary data. The questionnaire was prepared on the basis of survey of existing literatures as well as discussions made with some executives associated with the stock market. Finally, researchers conducted interview of fifty five respondents personally. The opinions of fifty five respondents were captured on five point-Likert scale such as most insignificant (1) to most significant (5). 2.3 Reliability and Validity of the Scales Before going to field work, pilot study was conducted. The reliability value of our surveyed data was 0.786 for variables. If we compare our reliability value with the standard value alpha of 0.7 advocated by Cronbach (1951), a more accurate recommendation (Nunnally & Bernsteins, 1994) or with the standard value of 0.6 as recommendated by Bagozzi & Yis (1988). Researchers find that the scales used by us are highly reliable for data analysis. While academics assisted in assessing face validity, the financial executives verified content validity. 2.4 Statistical Tool Used This study used Principal Components Varimax Rotated Method of factor analysis in order to measure bond market development in Bangladesh. All statistical calculations were carried out by statistical package for social sciences (SPSS) 17.0 version. 3. Results and Discussion An exploratory factor analysis with an orthogonal varimax rotation and a Kaizer- Guttman criterion of eigen value greater than 1.00 was conducted for the 27-items of bond market development. For 27-items of bond market development, six components (factors) with eigen value greater than 1.00 were extracted with the total variance 86.16%. 4

However, the general criterion of eigen value greater than 1.00 may misjudge the most appropriate number of factors (Gorsuch, 1983). To facilitate easy interpretation, these factors were then rotated using the varimax criterion for orthogonal rotation. Only statements or items with factor loadings of 0.50 (Pallant, 2005) and above in the rotated factor matrix was considered as significant for interpreting the factors. Table-1 shows the factor matrix indicating the factor loadings and communality estimates (h2) of every variable (item) on these six factors. Factor-1(F1) to Factor-6(F6) comprised of nine; three; four; five; four and two items, respectively. By analyzing the items in the factors, some dimensions were identified and thus, Factor-1 was labelled as Market and Issue Related Factor and the like.

Table-1: Scale Items, Factor Loadings and Communality Estimates for Six-Factors of Bond Market Development in Bangladesh Item F1 X 24 X4 X21 X7 .987 .987 .987 .987 Factor loadings F2 F3 F4 F5 F6 .731 .726 .797 .827 h2

X2 X19 X3 X18 X8 X9 X12 X13 X5 X6 X15 X1 X11 X10 X26 X14 X22 X27 X25 X20 X17 X23 X16
Eigen

.987 .987 .987 .987 .975 .856 .856 .856 .916 .916 .708 -.615 .814 .814 .641 -.592 .482 .876 .748 -.561 .512

.741 .754 .774 .762 .896 .842 .714 .646 .613 .811 .684 .764 .823 .827 .814 .780 .803 .838 .825 .783 .827 .785.826 .739.811

X21, X7, X2, X19, X3, X18 and X8. This factor has significant factor loadings on these variables which are formed this major cluster. This factor belongs to macro-economic, industry and firm levels relating to bond market. So, this factor provides a basis for conceptualization of a dimension, which may be identified as Market and Issue Related Factor. Factor-II: Risk and Return Factor Factor-II explains 13.38 percent of the total variations existing in the variable set. This includes variables-X9, X12and X13. This factor has also significant factors loading on these variables which formed second important cluster with respect to the variation. This factor is concerned with the investors in the bond market. So, this has provided a dimension of conceptualizing investor related variables, which may be identified as Risk and Return Factor. Factor-III: Macro-economic Regulatory Factor and

9.89; 4.53;

3.39;

2.28;

1.71; 1.44

Variance 34.56; 13.38; 11.84; 11.12; 9.04; 6.22 Cum.Variance 34.56; 47.94; 59.78; 70.90; 79.94; 86.16 Source: Field Study Estimates. h2 = Communality

Factor-III explains 11.84 percent of the total variations existing in the variable set. This includes variables- X5, X6, X15, and X1. This factor is related to regulatory reform and macro-economic variables relating to bond market development. Hence, this factor has provided a basis for conceptualization of a dimension, which may be called Macro-economic and Regulatory Factor. Factor-IV: Investment Policy Factor Factor-IV explains 11.12 percent of the total variations existing in the variable set. This includes variables-X11, X10, X26, X14 and X22. This factor has provided a basis for conceptualization of dimension which may be called Investment Policy Factor. Factor-V: Liquidity and Government Policy Factor Factor-V explains 9.04 percent of the total variations existing in the variable 5

The rotated factor matrix was shown in Table-1. This shows that variables understudy constituted six groups (factors) which were discussed in the following paragraphs. Factor-1: Market and Issue Related Factor Factor-I explains 34.56 percent of the total variations existing in the variable set. This includes variables- X24, X4,

set. This includes variables- X27, X25, X20, and X17. This factor is concerned with the liquidity and Government Policy. This factor has provided a basis for conceptualization of dimension which may be called Liquidity and Government Policy factor. Factor-VI: Issue Management Factor Factor-VI explains 6.22 percent of the total variations existing in the variable set. This includes variables- X23 and X16. This factor has provided a basis for conceptualization of dimension which may be called Issue Management Factor. Finally, the rankings obtained on the basis of factor wise average scores were shown in the following Table-2. Table-2: Factor Wise Average Scores Serial No I Factor Factor Score Rank 6

economic benefits, lack of awareness program, and adverse perception by market participants of settlement. This has relay reflected the actual scenario of investor class in the bond market. The second most important factor is the Liquidity and Government Policy related factor. This factor includes variables such as poor marketability, high yielding government securities, political instability and high floatation cost. These variables have been found working as impediments to the development of bond market in Bangladesh. The third important factor is the issue management factor which includes variables such as poor disclosure of accounting information, and lack of intermediaries with professional expertise in debt products. Other important factors are investment policy factor, macroeconomic and regulatory factor, and issue related factor in order of magnitudes. 4. Conclusion The study employed both theoretical and empirical one. It used direct approach to the collection of primary data and consulted available existing literature for collecting secondary data and applied sophisticated multivariate technique for analysis of data collected for the study. The study has the following findings. The size of debt market is very low as compared to other South Asian countries. There are huge opportunities for growth and making money for bond market participants. The problems which draws attention of policy makers, professionals and market participants for the development of bond markets are shown as follows in order of magnitudes: 1) Risk and Return Factor; 2) Liquidity and Government Policy Factor; 6

Market and 1.711 Issue Related Factor Risk and 3.400 Return Factor Macro2.150 economic and Regulatory Factor Investment Policy Factor 2.350

II III

1 5

IV V

4 2

Liquidity and 2.80 Government Policy Factor Issue Management Factor 2.70

VI

Source: Filed study

The factor ranking show that Factor-II: Risk and Return is the most important issue that impedes the development of bond market in Bangladesh. This factor includes variables such as undefined

3) Issue Management Factor; 4) Investment Policy Factor; 5) Macro-economic and Regulatory Factor; and 6) Market and Issue Related Factor. 4.1 Policy Implications The following policy implications may be useful for overall development of bond market in Bangladesh. 1. Securities and Exchange Commission (SEC) can deregulate the existing laws and promulgate new laws for creating friendly regulatory environment for the development of Bond market in the country. 2. SEC can undertake both education and training programme for the market participants. This creates awareness among the market participants. 2. The Government should stop issuing securities offering interest rate higher than that market yield. 3. Government should encourage state owned enterprises for raising funds by issuing corporate bond from the market. 4. Government has to offer a define fiscal benefits like investment in equity market for the development of bond market in Bangladesh.

Dalla,I.(2003) Harmonization of bond market rules and regulations in selected APEC Economics, Asian Development Bank. Dennis, D. & Mihov, V. (2003) The choice among bank debt, non-bank private debt: evidence from new corporate borrowings, Journal of Financial Economics, 70 pp 3-28. Eichengreen, B. & Luengnaruemitchai, P.: (2004) Why doesn't Asia have bigger bond markets?, Working Paper 24/2004, Hong Kong Institute for Monetary Research. Eichengreen, B., &Luengnaruemitchai,P . (2006) Why doesnt Asia have bigger bond Markets? in Asian Bond Markets: Issues and Prospects (BIS Paper No. 30). Fabella,R.&Madhur,S.(2003)Bond market development in East Asia: Issues and Challenegs, Asian Development Bank, Manila. Hirose, M., Mukarami, T. & Oku, Y. (2004) Development of the Asian bond markets and business opportunities, Working Paper 82, Nomura Research Institute. International Organization of Securities Commissions(2002).TheDevelopme nt of corporate bond markets in emerging market countries May USA. Jeanne, O., & Guscina,A. (2006) Government debt in emerging market countries: A New Dataset. IMF Working Paper 06/98. La Porta, R., F. Lopez-de-Silanes, A. Shleifer, R. Vishny. (1997) Legal determinants of external finance, Journal of Finance, 52(3) pp 11311150. Mehl, A., & J. Reynaud (2005) Domestic original sin in emerging market Economies. ECB Working Paper No. 560. Mu,Y.(2007). South Asia bond markets and Bangladesh, World Bank, Dhaka. 7

References Burger, J., & Warnock,F.(2006) Local currency bond markets, IMF Staff Papers, 53 pp.115-132. Chittagong Stock Exchange (CSE) (2007). Annual Report. Chittagong, Bangladesh. Claessens, S., D. K., & Schmukler,S. (2007) Government bonds in domestic and foreign Currency: The role of macroeconomic and institutional factors, Review of International Economics, 15(2) pp 370-413.

Pallant,J.(2005). SPSS Survival Manual, Sydney, Allen & Unwin. Santos, J. and Winton,A.(2008) Bank loans, bonds, and information monopolies across the business Cycle, Journal of Finance, 63 pp1315-1359. Appendix-1: Variables of Bond Market Development in Bangladesh. [Based on five point Likert scale i.e., most insignificant (1) to most significant (5)] Se.No Descriptions of the Variables X1 X2 X3 X4 X5 X6 X7 X8 Moderate Economic Growth. Low Interest Rate Environment. Poor Savings and Investment Rate. Dominance of Banking System Absence of Interest Rate. Market-determined

X18 X19 X20 X21 X22 X23 X24 X25 X26 X27

No Hedge against Inflation. Compounding not possible. Political Instability. Financial Sector Vulnerability for Huge Non- Performing Loans. Unbundled Pension and Insurance Funds. Poor Disclosure of Accounting Information. Insignificant Contribution of NonBanking Sector. High Yielding Government Instruments Hindering Private Sector Bond Issue. Lack of Awareness and Confidence in Debt Products. Poor Marketability.

Regulatory Reform. Small Investor Base. High Time to Market for Time Consuming and Complicated Administrative Process. Undefined Economic Benefits. Investors Reluctance to Maintain Bond Portfolio. Conservative Policy of Investors. Lack of Awareness Program for Investors and Risk Associated Sequential Process. Adverse Perception by Market Participation of Settlement. Lack of Diversity in Features. Lack of Benchmark Bonds. Lack of Intermediaries Expertise in debt Products. High Floatation Cost. 8 with

X9 X10 X11 X12

X13 X14 X15 X16 X17