D

espite being a possible drag on growth, the interest rate increase by Bank Indonesia (BI) is a positive move to calm market turbulence and to encourage more foreign investors to put their money back into government debt paper, a Finance Ministry official said.

'Further to the new BI rate, inflation will become more manageable and the rupiah will be stronger. A stronger, more stable currency will make foreign investors comfortable and prevent them from exiting the bond market,' the Finance Ministry's debt management office (DMO) head Robert Pakpahan said on Friday.

BI this week jacked up its key interest rate by 25 basis points to 6 percent ' its first rate adjustment in one and a half years ' after pressure from huge sell-off across bonds and equity markets in Asian.

The outflow occurred after the Federal Reserve hinted in late May at the possibility of tinkering with its monetary stimulus.

This so-called quantitative easing has helped the flow of foreign funds into emerging markets. Uncertainty over fuel subsidies has also exacerbated investors, analysts say.

Over the last three weeks, foreign ownership of government bonds has declined by a staggering Rp 11.2
trillion (US$1.13 billion). Foreign investors previous held one third of all government bonds on the secondary market.

This week, the DMO bought back Rp 499.5 billion bonds in the secondary market to 'support government bonds that face selling pressure', the office stated on its website.

In an auction of sukuk this week the DMO failed to make a single rupiah.

'The yields of our bonds have been abnormal in recent days,' Robert said. 'But I think the situation will pass as soon as we solve our internal problems, such as the prevarication over fuel subsidies.'

Prior to the turbulence in the bond market, the government believed it was doing well in marketing its securities, with DMO selling debt papers with competitive yields. In April, the $3 trillion of dollar bonds were sold with historically low interest rates.

Strong demand for global bonds means the government plans to increase the allocation of dollar-denominated securities to around 18 percent of the gross target of Rp 332 trillion, Robert said. The maximum ceiling initially stood at around 15 percent.

Previously only offered to foreign investors, the global bonds will now be offered to domestic investors in the third and fourth quarter, he added.

Due to the uncertainty in the world economy, the government must carefully choose the right time to issue dollar bonds, warned Herdi Ranu Wibowo, head of debt capital market with BCA Sekuritas.

'It's not favorable to upsize bond allocations at turbulent times,' he told The Jakarta Post.

Mandiri Sekuritas fixed income analysts Handy Yunianto said that the bond market responded 'positively' to BI's tightening, but urged the central bank continue to stabilize the rupiah to maintain
confidence.

'Rupiah movement will be the most influential factor in the bond market in near-term,' he wrote in a research note.