THE Government should exempt interest on Hong Kong dollar debt instruments from profits tax to boost the local capital market's development, a Standard Chartered Bank report says. The report contends that the current tax regime hinders local market development by discouraging Hong Kong corporate investors from holding Hong Kong dollar paper. ''Foreign currency debt instruments are not subject to profit tax, whereas most Hong Kong dollar instruments are,'' the report says. Although the Government has voiced concern about tax avoidance if the tax treatment of Hong Kong dollar debt instruments is changed, the report claims that ''a system by which local firms are encouraged to issue foreign currency debt and invest in foreign currency papers is obviously something that needs to be addressed as a matter of priority''. In recent years, the Government has made public its intention to assist the debt market's development and is now actively pursuing the establishment of a central clearing and settlement facility for Hong Kong dollar debt instruments. But the report urges the Government to do more on the tax side to encourage corporates to raise funds through the local currency market. It also says the market needs a broader investor base. The existing one consists mainly of banks, institutional investors, major corporations, charitable organisations, government and semi-government bodies and high net-worth individuals. The report recognises that changes to the investor base are forthcoming. It says: ''The gradual increase in acceptance by the public towards life insurance has helped to turn this around slowly.'' The promotion of provident funds and retirement schemes by the Government will generate a big pool of money which will be looking for long-term fixed income. The report says: ''It should broaden the demand for debt securities. The major weakness of the local currency debt securities market is its lack of depth.''