Emerging Markets: Indonesia says not scared of outflows

Emerging Markets, May 2011

Indonesia is wary of the dangers of foreign fund flows out of its bond markets, but is capable of handling the threat, according to the most senior figure in the country’s debt management arm.

Rahmat Waluyanto, Director General of Debt Management in the Ministry of Finance, told Emerging Markets that the high level of foreign ownership of Indonesian rupiah government bonds – over 30% – “basically reflects investors’ confidence on Indonesia’s long term economic fundamentals. Yes, we are also very aware of any potential reversal risk. But we are very ready to prevent such an event happening.”

Waluyanto’s confidence stems from the composition of foreign engagement in the markets, and his own policies. “Most of those foreigners are buy and hold or real money account investors and are holding long tenors of bonds,” he said, adding that 70% of foreign bond holdings are in maturities of five years or greater. “I’ve heard that many of those are Indonesian money kept in overseas accounts.”

In terms of policy, he believes a newly-established bond stabilization framework – which includes crisis management measures established with state owned financial companies and the central bank – will insulate the country from shocks, as will a steady deepening of the domestic bond market.

Waluyanto also argued for Indonesia to be granted investment grade status by the world’s major credit rating agencies, all of whom have the country exactly one rung below that level today. “Indonesia has already been perceived as having an investment grade rating by the market, as indicated by the CDS [credit default swap] rate and its bond price,” he said. Japan’s credit rating agency gave Indonesia an investment grade rating two years ago, he said. “We just need to convince the agencies such as S&P that we are able to manage inflation and to secure funding from domestic market sources.”

The point on inflation will be crucial, having been highlighted by all international rating agencies in their most recent upgrades. Standard & Poor’s, the most recent to upgrade in March, said that high inflation and vulnerability to external shocks posed a hurdle to a further upgrade. “The positive outlook reflects the likelihood of an upgrade if inflation is tamed while balance sheet improvements continue,” said S&P credit analyst Agost Benard in announcing the March rating change. Inflation remains the core concern of sovereign analysts too. “We believe that core inflation will continue to drift towards 5%,” said Barclays Capital analyst Prakriti Sofat on Tuesday. “This suggests that the need for policy tightening remains.”

Despite that, Waluyanto said: “The investment grade rating is just within reach.” From his perspective, an upgrade would mean cheaper funding. “We expect that we can attract more long-term investors so that we can be sustained to finance more infrastructure projects more efficiently.”

Improved sentiment towards Indonesia was illustrated by last week’s successful US$2.5 billion 10-Year bond from the Indonesian sovereign, although Mr Waluyanto said part of the strategy of this bond was to allocate more than usual to domestic investors – three times higher than in previous issues. “This is due to extra US dollar liquidity in the domestic market, as well as a result of heavy capital inflows,” he said. “We created price tension by allocating more to local investors.” The bond achieved an all-time low yield for national 10-year funding.

Mr Waluyanto also said that Indonesia was making progress in developing its sukuk market, the Islamic equivalent of a bond; Indonesia has historically lagged Muslim neighbor Malaysia considerably in this field. He said his office was preparing two new types of sukuk: one using government projects as underlyings, and one to finance new infrastructure projects.