Crowding-out effect of govt bond issuance

Andry Asmoro ,  Economist   |  Wed, 05/27/2009 1:40 PM  |  Business

The government, about two weeks ago, decided to amplify the gross bonds issuance target to Rp 142.3 trillion (US$14 billion) from Rp 99.6 trillion for 2009.

The proceeds will mostly be used to finance the fiscal stimulus, considered necessary to support economic growth which has been slowed down by the negative impact of the global economic crisis.

The fiscal stimulus has been set at Rp 73.3 trillion, leading to a budget deficit of Rp 139 trillion, or 1.6 percent of the gross domestic product (GDP).

Despite a wider deficit, the government is optimistic that it will reach the deficit financing target.

Apart from the bonds issuance, the deficit may partly or alternatively be financed by standby facilities from bilateral and multilateral donors. The government has managed to secure such credit facilities from the Asian Development Bank.

The better-than-expected economic outlook has produced positive sentiment towards the bonds market.

This is reflected in the lower bond yields by an average of between 5 and 8 percent for the short term, and 2 to 5 percent for long term bonds since early May.

This positive yield trend is well supported by the low inflation environment over the past few months. At the same time, this favorable rate has sent a positive signal for corporations to raise funds through bonds issuances.

As of the end of May, total corporate bonds had reached Rp 7.8 trillion. Supported by this positive sentiment, we believe that bond issuances would continue to become a focus of attention for corporations to raise funds in the second half of the year.

We should, however, note that competition for bond issuance is intensifying going forward.

Apart from the tight liquidity issue, these corporate bonds would also face competition from government bonds.

As risk may be the priority nowadays, the corporate bonds must set their pricing structures better, shifting the investors' attention away from the government bonds.

This would consequently create a *crowding-out effect', which refers to an economic theory explaining an increase in interest rates due to rising government borrowing in the money market.

Increased government borrowing tends to raise market interest rates.

The problem is that the government can always pay the market interest rate, but there comes a point when corporations and individuals can no longer afford to borrow.

With the sovereign bond's ratings, corporate bonds are likely to offer a wider spread than those of the government bonds to attract investors' attention.

Under the uncertain economics conditions, this can still be very costly to corporations.

Due to this default risk, investors would require bonds to be issued with a higher yield.

We therefore believe that the government's commitment to secure funding from multilateral and/or bilateral sources might produce more attractive avenues for government than the additional bonds issuance.

This would also provide room for the corporations to have greater flexibility to raise funds from the bonds market while tending to help government in supporting economic growth going forward.

It is worth noting that most corporations are currently finding it difficult to secure credit lines from banks, as banks are reluctant to lend aggressively from excess funds preferring temporarily to deposit them in central bank securities (SBI).

Most importantly, we foresee that the government needs to accelerate the budget disbursement to reinforce the growth of the real sector.

This would eventually reduce the unemployment rate to 7 percent and satisfy the expectations of the National Development Planning Agency (Bappenas).

The writer is an economist at Bahana Securities (the remaining space is dedicated for tables)

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