Disaster wake-up call: Indonesia sets the stage for cat bonds
The terrible earthquake and tsunami that hit Indonesia’s Sulawesi island last month has served as a wake-up call for the country’s Ministry of Finance, which is now looking at issuing catastrophe bonds.
“Indonesia has tended to be more reactive and less proactive. But now we’ve received a wake-up call to be more proactive,” Luky Alfirman, director-general at the finance ministry, told GlobalMarkets.
Indonesia, infamous for its location on the Ring of Fire where many volcanic eruptions and earthquakes take place, suffered a devastating earthquake and tsunami on September 28 that killed more than 2,000 people. The total economic damage is expected to approach or surpass $1bn.
That has sparked the government into action to build fiscal resilience to such disasters. Indonesia’s finance minister Sri Mulyani Indrawati unveiled its National Disaster Risk Financing and Insurance Strategy on October 10.
But preparation for this programme kicked off at the start of the year when the ministry decided to put together a comprehensive strategy to deal with tragedies.
“This is what we need,” Alfirman said. “We need a disaster risk strategy where we design different kinds of risks and identify different layers of risks from low to medium and high risk, and also look at the frequency and likelihood of these risks. At a later stage, the different layers might have different strategies and different instruments to use.”
Catastrophe bonds are high up on the list of risk mitigation instruments. Alfirman classified them into two types. One is a traditional cat bond, either sold directly by the Indonesian Ministry of Finance or with the support of multilateral development agencies such as the World Bank.
The other is a catastrophe deferred drawdown option. This is similar to standby loans provided by multilateral development banks — effectively a kind of credit line — that is triggered in case of an emergency.
But he warned that the plans were still in their nascent stages. “We are working on the regulatory aspects of catastrophe bonds right now,” he said. “It requires co-ordination with other ministries and agencies within the government.”
There is no clear timing as to when the cat bond plans will be implemented, but Alfirman said it would be done only in a gradual fashion. Nevertheless, the urgency to put such a plan in place does not escape him.
A low volume of catastrophe bonds covers perils in the Asia Pacific region. Singapore has indicated it would like to become a hub for issuance of the instrument.
But in Indonesia, an archipelago of more than 13,000 islands, the need to safeguard the budget from a big dent due to natural calamities is clear. Sean Kidney, chief executive of the Climate Bonds Initiative, said: “If ever there is a country that needs cat bonds, it’s Indonesia.”