In the interest of bond market stability, future issuances of local currency government bonds warrant more attention on the absorption capacity of local investors.
The government has signaled it may sell more debt than initially expected in order to finance this year's budget deficit. This is in lieu of using the US$5.5 billion of standby loans previously secured.
The announcement comes as a surprise to many market participants, especially those who thought the Finance Ministry was already throwing-in the towel after having achieved around 85 percent of this year's bond issuance target.
With more debt in the pipeline, it is a good time to critique government debt management so far.
One point worth highlighting is the rise of foreign ownership in the local currency bond market over the past few years, which may not be conducive to long-term market stability.
As of September last year, for example, foreign investors owned nearly 20 percent of local currency bonds in Indonesia.
Using fixed rate bonds as the denominator, this figure nearly exceeds 30 percent.
These figures far exceed those of Thailand and the Philippines, and more mature markets such as Korea and Japan, all of which have foreign ownership rates in the 4 to 8 percent range.
Of course one has to acknowledge that nowadays the government does not have full control over who it borrows money from: Domestic or offshore investors.
In an active secondary market, local debt currency held by a local pension fund or a domestic bank today can easily be sold off to an offshore bank or a hedge fund tomorrow.
What the government can do is control the supply of local currency bonds, and this influences the availability of foreign inflows.
Basic economics say that when bonds are in excess demand, investors (domestic and local) will bid up the prices and send yields down.
These lower yields quickly reduce the incentive for "carry trades" by offshore investors, thereby limiting the amount of capital inflow.
Without participating in the never-ending discourse on protectionism versus foreign investment, it is important to acknowledge that capital inflow does provide liquidity in the market.
Our concern is that too much of anything is never a good thing.
The problem that emerges is volatility.
Spend time at the desk of a bond trader, and it shouldn't take long to realize that foreign investment flows play a significant, if not dominant, role in the pricing of government bonds today.
Most of the time they determine economic trends.
This makes the Indonesian bond market more susceptible to negative developments overseas.
With the world economy expected to be in turmoil for some time, this is an uneviable position.
For example, after the collapse of Lehman Brothers back in October 2008, Indonesian local currency yields shot up by magnitudes that exceeded anywhere else in the region.
As offshore investors scrambled for the exit, the 10-year bond yield rose by 6 percent within a month, implying a price drop of around 48 percent for an eight-year duration bond.
In contrast, the yield on similar tenor Philippine bonds only went up by 3 percentage points, whereas Thai and Malaysian local bonds didn't increase at all.
The government needs to consider the cost of this volatility.
Volatility makes it difficult and expensive for companies to issue corporate bonds, representing incalculable lost economic opportunities.
To avoid exacerbating the problem, the distribution of ownership between domestic and offshore investors should be kept in good balance.
In other words, the size of future rupiah bond issuances needs to be more aligned with the demand from domestic investors.
Of course estimating local demand is easier said than done. But one thing the policy makers could do is place emphasis on the gross instead of the net targets for bond issuances.
Focusing on the net target ignores the possibility that not all bonds maturing in a given year are rolled over, as is the case for variable rate bonds held by banks from the 1999 recapitalization era (of which there is still around Rp 145 trillion outstanding).
Over the past five-years, the money the government has paid out to banks to retire the "recap" bonds has not returned to the state coffers.
They have either been channeled by the banks to buy more liquid central bank papers or loans.
What emerged from this was a gap in the bond market which has mostly been filled in by foreign investors.
If the government had aligned their issuance target to domestic demand, perhaps the foreign penetration rate would not be as high as it is today, and maybe we would not have endured the turmoil of October 2008.
Going forward, the bond issuance strategy should be changed. We ought to make sure past mistakes are not repeated in the future.
The writer is an economist at Bank Danamon Indonesia; the views expressed herein are personal.
| 
|
|
|
|
|
|
|