Government officials think Hong Kong needs a bigger local currency bond market. Neither the city's corporations, nor its investors seem so sure. In his February budget speech, Financial Secretary John Tsang Chun-wah announced government plans to issue up to HK$100 billion in debt 'to promote the further and sustainable development of our bond market'. This left a lot of people scratching their heads. It's not as if the government is short of money. It actually managed to turn in a budget surplus over the last financial year despite the recession. And with accumulated fiscal reserves of almost HK$500 billion, it won't need to borrow even if it runs a deficit. But Mr Tsang appears to be suffering from a bad case of bond envy. It is almost an article of faith among Asian government officials that you cannot be a developed economy without your own thriving local currency bond market. You can see where this belief came from. Before the 1997 financial crisis, Asian companies typically either borrowed in their own currency from local banks, or from the international capital markets in US dollars. When the crisis hit, however, shaky local banks stopped lending, and when regional currencies collapsed, foreign currency borrowing became prohibitively expensive. Suddenly, Asian companies found themselves starved of funds and staring bankruptcy in the face. The answer seemed obvious: by setting up local currency bond markets, Asian economies could recycle more of their savings at home and wean regional companies off their dangerous reliance on bank financing and foreign currency debt. In the last few years, however, Hong Kong seems to have fallen behind in the regional race to build local bond markets. As the first chart below shows, at the end of the first quarter, total debt outstanding amounted to a relatively puny 46 per cent of gross domestic product. That makes Hong Kong's local currency debt market among the smallest in East Asia; only the Philippines, Indonesia and Vietnam have markets that are smaller. Mr Tsang's answer is to issue more government debt, regardless of whether the government actually needs the money. The idea is that the government will act as a trailblazer, issuing enough bonds to provide a liquid benchmark across a range of maturities. Size and liquidity will attract more dealers and new investors, until the market acquires a critical mass and begins to attract corporate borrowers in its own right. That's the theory. Yet it is far from clear that Hong Kong either needs or wants a bigger local currency bond market. Certainly, retail investors do not appear very interested. Issues of new exchange fund notes already include quotas for the retail market, but they are seldom if ever filled. Yuan bonds are another matter entirely, with tens of thousands of retail investors snapping up issues as the only alternative to low-yielding yuan deposits. Institutional demand, too, is limited. Fund managers like investments they can sell easily, and are put off by the Hong Kong dollar debt market by its prohibitively wide spreads and low turnover. More to the point, there does not appear to be much demand from corporate borrowers either. As the second chart shows, the amount of Hong Kong dollar debt outstanding (excluding exchange fund bills and notes) has been falling over recent years. And almost all of that debt is issued by banks. Corporate bonds make up less than 10 per cent of the total market. Most local companies big enough and credit-worthy enough to run a bond programme go straight to the deep and liquid US dollar debt market, where they can snap out a US$500 million issue in a matter of days, safe in the knowledge that Hong Kong's pegged exchange rate insulates them from currency risk. In contrast, issuing a HK$1 billion bond in the local market takes months of careful - and expensive - preparation. As a result, the majority of companies find it quicker, easier and a lot cheaper to go to the syndicated loan market, where they can easily raise billions of Hong Kong dollars for terms of up to five years or even longer. The government's bond programme is not going to change that. Even if it can succeed in channelling some liquidity into the market, the number of potential corporate issuers is still going to be small. As one banker put it: 'If the only big issuer is the government, it won't make sense.' It seems people are still scratching their heads.