With recent political and social events like the coronavirus, low interest rates may go lower. Most sovereign bonds in the European Union are below or near zero; in the United States, they are barely above 1.5 percent. Yet, Indonesia continues to pay a large market premium for sovereign bonds in both rupiah and dollars.

Paying more for only rupiah bonds would be understandable, but paying high premiums for US dollar denominated bonds, in a world awash with dollars due to overprinting or quantitative easing, is problematic. If Indonesia’s economy is as turbocharged as all the growth indicators show, there is no need to overpay on interest for bond subscriptions.

Does Finance Minister Sri Mulyani Indrawati understand the concept of Berkeley economist Barry Eichengreen’s “original sin”? Namely, developing countries that cannot borrow abroad in their own currency are forced to borrow more US dollars than a country can afford to repay is doomsday, as the international markets will hold her feet to
any shortfalls.

Consider Argentina, which defaulted and was chased around for 20 years to make dollar bond investors whole, with all interest due. Argentina is now trying to default again with its Peronist government, but runs the risk of having all hard currency loans dry up to finance future projects. Indonesia cannot afford this gamble of default.

Sri Mulyani is offering far too much in a world beset by negative and near zero interest rates. It is simply ridiculous to overpay. She should be considering market reality, not the out of touch academics from the World Bank. The examples below present what is actually happening in the world of sovereign debt instruments, in both Asia and in the developed world.

Consider Spain, Italy and Greece — the riskiest financial bets in the EU, with high unemployment, aging populations, and lagging economic growth. Greece is considered a “beggar economy”, highly dependent on loans from the EU and the International Monetary Fund. Yet it pays 10 times less on its sovereign bonds than Indonesia. In other words, burgeoning Indonesia is considered more risky than slow growth Greece!

No wonder debt investors are flooding in! Indonesia is paying too much when compared with other yardsticks. Minister Sri Mulyani could drive a much harder bargain but is not, why? Juicing the economy with dollars in the short term may be great headline investment news, but the piper will demand dollar dues soon after the current administration is out of power, so we benchmark 2025 as the baseline year, or five years from now, on rates of a five-year bond. (see, Table 1)

Is Sri Mulyani’s entire economic prescription to borrow her way in dollars out of Indonesia’s restructuring problem? If so, the Finance Ministry is paying for it. Here’s the proof, in a twofold reason:

• Currency appreciation: The rupiah has strengthened considerably (around 9 percent) for the past 18 months from roughly Rp 15,000 to a current Rp 13,700 to the dollar. The currency appreciation alone represents a huge windfall to rupiah bond holders. With such a large appreciation, bond yields should decrease, and also should be reflected in lower dollar bond issuance yields.

• Foreign money inflows: This rupiah appreciation is being driven by hot money inflows to bonds and other capital investments that pay more than comparable ASEAN countries, namely, Malaysia, the Philippines, Thailand and Vietnam. For regional balance we can also consider China. Outside Indonesia, only Thailand has had a larger currency appreciation, yet has held its five-year US dollar notes steady at less than 1.5 percent.

Note that we are not discussing corporate dollar bonds, which pay considerably higher interest and are more risky. For example, Lippo-Karawaci offers a US dollar bond with a >8 percent coupon rate. That means they are paying a lot for the money. Since this is property development, it has significantly more risk, than sovereign or “government” paper. (see, Figure 2)

Distorted sovereign bond prices exacerbate the carry trade, where money can quickly flow into or out of a country due to recent events. As of this writing, this is what is happening today, due to the novel coronavirus fears of a China slowdown. This will have a knockdown effect on all its economic activity in Indonesia.

China has been a large investor in Indonesia, pouring in cash for all types of projects from smelters to power plants and railways. With the epidemic, China may not continue to be so gung-ho with its largesse. Depressed investment will also weigh heavily on Indonesia’s 2020 projected growth as a supplier to China also of raw materials, like nickel and copper, and components.

What about the planned relocation of the national capital to North Kalimantan? If the administration is going to subscribe to US dollars to float the financing of an estimated cost of $33 billion while paying high bond rates, it will impose a large burden on Indonesians. Foreign content, consultants and contractors will demand payments in dollars for their work, not rupiah. Dollar bonds will need to be sold to finance this. Therefore, access to the US dollar bond markets remains crucial.

Markets in Indonesia are feasting on cheap money as seen in the construction boom, so again, why isn’t Minister Sri Mulyani seeking better bargains — in a world of low interest rates, particularly compared to the negative rates in the EU, with its weakening economy? This creates a circular effect of higher bond rates, causing higher foreign money inflows, thus appreciating the currency and then driving the currency downward with sudden outflows.

It is a fools’ bargain, however, as when the game of musical chairs stops, average people with their rupiah receipts will still have to make international investors and their dollars whole at the headline bond rates advertised. In one case, the INDON50 dollar government bond is paying 3.5 percent until 2050. This means that even if rates around the world go largely negative, Indonesia will still have to keep paying the coupon.

________

Visiting professor and distinguished ASEAN scholar, Guangdong University of Foreign Studies, Canton, China; author of The Sovereignty Game: Neo-Colonialism and the Westphalian System (2020)

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