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Emerging Markets

Republic remains a dollar devotee

Any concerns about Indonesia’s fiscal position are belied by the continuing popularity of its sovereign debt, as September’s sukuk issue demonstrated. Indonesia’s international funding is still heavily dominated by the dollar, but if that is where it can find an adoring investor base, why go further afield? By Chris Wright.

If sentiment towards Indonesia has turned toxic, nobody told investors in the Republic’s US$1.5bn sukuk on September 10. The deal pulled in a $5.7bn order book from 300 accounts and attracted truly global demand. 

“Appetite was extremely strong, there was a broad base of investors, diversified demand, and no indication that people are worried about the sovereign,” says Aaron Russell-Davison, Standard Chartered’s global head of bond syndicate and acting head of capital markets for southeast Asia. The bank was a bookrunner on the deal alongside Citi and Deutsche Bank. 

It was a welcome demonstration of enthusiasm for a country that has suffered a lot of negative press in recent months, with a widening current account and trade deficit, falling currency and volatile bond market (see Economic Overview on page 3). 

Whatever else has happened, there is still no shortage of ardour for the country’s sovereign debt. Although its rating is still split either side of the investment grade divide (Moody’s has it at Baa3 and Fitch at BBB-, but Standard & Poor’s BB+), it now appears to be an essential fixture for investors.

The geographical spread of the latest bond was illustrative. Some 24% of the deal went to the US, well up on previous sukuk issues, 20% to Islamic and Middle East investors, 15% Indonesia, 25% to the rest of Asia and 16% to Europe. By investor type, funds took 51%, banks 34%, central banks and sovereign wealth funds 7%, private banks 4% and insurers 4%. 

“There was a lot of demand on the sukuk from US investors because they take comfort in the sukuk structure,” says Indrawati Darmawan, head of capital markets for Indonesia at Standard Chartered. “This is something we have not seen in previous transactions.” She admits the demand was unexpected given the pressures on the sovereign. 

“It is something of a surprise,” she says. “If you look at the movement in Indonesian sovereign prices, you might have expected demand to be weaker.” 

Indonesia certainly had to pay up for its funds. This, the country’s fourth sukuk, paid 6.125% — inside initial guidance of 6.375%, which would have been a 75bp new issue premium over existing sukuk from Indonesia — for 5.5 year money, much shorter than the usual 10 year. 

This was the highest coupon on an Indonesian international sukuk since the first, an 8.8% $650m borrowing in March 2009. But the demand was still striking. 

“The order book showed $5.7bn of orders from more than 300 accounts,” says Julyasari, head of debt capital markets for Indonesia at HSBC. “That allowed the borrower to tighten the coupon and led to a 25bp reduction in new issuance premium from the initial price guidance. That indicates that, from a foreign investor’s perspective, be it sukuk or conventional, Indonesia remains a good credit or investment.”

This reflects a sense that recent concerns about the country’s health, which are predicated mainly on the climbing current account deficit, are overdone. “As a country, overall, Indonesia is much healthier than it was in 1997,” StanChart’s Darmawan says. “Then, most corporates were highly geared, and this time around they are not. And the banking sector in Indonesia is now very healthy, mainly because of the central bank’s policies on reserve requirements and loan to deposit ratios. Overall, the only concern investors have is on the trade deficit.”

Who needs variety?

The sukuk may well have brought to an end funding for Indonesia for 2013, in which case it will have done all of its offshore borrowing in dollars. In April, it raised $3bn in 10 and 30 year funding through Standard Chartered, Deutsche and JP Morgan, then followed it with $1bn more of 10.25 year funding in tougher economic times in July, this time with Barclays rather than Deutsche as a bookrunner. 

The year 2012 looked similar, with a $1bn sukuk and $2.5bn of 10 and 30 year bonds, plus a $1.75bn deal at the start of the year. In fact, since 2011, there has been just one non-dollar international deal from Indonesia: a Samurai in November 2012 raising ¥60bn through Mizuho and Sumitomo Mitsui Financial Group, the first Samurai the sovereign had done in two years. 

This year, there won’t even be a Samurai, it seems. “If you look at Indonesian funding, it only involves three currencies, and this year Indonesia has not issued a samurai so it is all local or dollar,” says Darmawan at Standard Chartered. 

Is this focus on one currency wise? “Indonesia is a sophisticated issuer, and it will look at any market as long as it is in line with its strategic objectives,” says Julyasari at HSBC. She says that today, 72.37% of total government securities are in rupiah, 26.25% in dollars and 1.38% in yen. In her view, the dominance of the dollar in external funding is simply a reflection of where the investors are. 

“If you look at the market liquidity from the investor perspective, it is still concentrated very much in US dollars, so it’s quite natural for the sovereign to consider the dollar for the time being,” she says.

It should be said, though, that a sukuk issue does bring a degree of diversification for an issuer. “As part of the offshore funding strategy, Indonesia has diversified funding sources and investor bases by issuing structures like the global sukuk,” says Avanti Save, vice president of credit strategy at Barclays. “This is a very supportive development.” 

For a start, a sukuk opens up a clear investor market in the Middle East, one with a lot of capital to deploy and not all that many places to put it. On top of that, it has knock-on effects on the behaviour of conventional investors too. Bankers say that a sukuk has particular advantages over a conventional bond in marketing. 

“The sukuk element is very powerful as a selling point, because many sukuk investors are buy and hold, and conservative by their nature,” says Russell-Davison. “They don’t inflate orders: they are a deep pocket of genuine investors. In turn, other investors take comfort from that because they know it’s firmly anchored by a handful of accounts that aren’t going to sell it.” Julyasari says that sukuk now account for 20% of the Republic of Indonesia’s total realised funding as of mid-September.

Some might question how much diversification sukuk represent to a borrower that mainly funds in dollars. Herman van den Wall Bake, head of debt capital markets for Asia at Deutsche, which has been a bookrunner on the last two Indonesian sukuk, admits there is a big overlap. 

“If you look at the typical distribution, about 40% will go to Islamic investors, and 60% to conventional buyers,” he says. But that’s not to say that the variety is not welcome, even if it doesn’t bring 100% new investors. “It does bring diversification if you can sell nearly half your bond to a different investor base.”

The rest of the world looks neglected, however. Should Indonesia want it, there is probably a willing base of buyers in euros, although the costs may not come out as competitive. And, having issued JBIC-guaranteed Samurais in 2009, 2010 and 2012, that option is still open too, even if the sovereign didn’t avail itself of it this year. 

“Certainly the euro has the depth to accommodate incremental demand,” says van den Wall Bake. “And yes, in the long run, it could be a viable market for them to look at. But then again, their economy and most of their trade flows are dollar denominated. Asia remains USD-centric and few sovereigns in the region have borrowed in euros.”

Russell-Davison agrees. “The real depth for Asian credit remains in US dollars,” he says. “They’re not sufficiently rated to be at a level that gathers a specific euro investor base: SSA investors aren’t of that ilk. The dollar market still provides bigger size and finer pricing.

“At some stage they will consider other currencies — they are a very sophisticated sovereign borrower — but for now they are sticking to what is most cost effective,” he says.

Save at Barclays adds that the largest index benchmarks are in dollars rather than euros or sterling, and since investors following or measuring themselves against those benchmarks are the key investor base for these bonds, there is little incentive to go elsewhere. 

Nonetheless, it is worth looking at the most recent Samurai for an illustration that Indonesia can be popular in other currencies if it chooses to go down that route. Its November 2012 ¥60bn 10 year, with a guarantee from the Japanese Bank for International Cooperation (JBIC), paid a coupon of 1.13% with a spread of 30bp over swaps, the tight end of guidance, and was almost twice covered. (The borrower has not disclosed what it paid for the guarantee, but it is likely to have been 50bp-70bp.) 

The deal raised a lot of conjecture that Indonesia could have come to market in its own name, without a JBIC guarantee: after all, Mexico, which is also rated BBB, has issued a Samurai in its own name this year. Indonesia may need Standard & Poor’s — the one agency that still holds it below investment grade — to make a change before it ever does that, but in any event there is clear Japanese appetite for Indonesian credit. 

And even if the coming months do not bring more currencies, they may bring different tenors. “In recent years, in line with other emerging market countries, Indonesia has issued long dated bonds to extent the tenor of their debt profile,” says Save at Barclays. “Going forward, we would probably start seeing issuance in the front end of the curve, given the moves in US rates.” 

Indonesia’s ventures into longer-term funding have so far proven enormously popular, so it would be interesting to see how pricing and appetite would stand up in shorter durations. In April, Indonesia’s two tranche $3bn 10 and 30 year deal generated an enormous $13bn of demand, apparently evenly split between those two tranches. Those close to that deal say that 255 investors placed orders for the 30 year tranche, with diverse distribution: 56% to the US, 27% to Europe and 13% to Asia. 

Similarly, when Pertamina, which is seen as a quasi-sovereign, issued $3.25bn of 10 and 30 year paper in May, this was also considered a resounding success, with avid appetite (see the Corporates chapter on page 24). 

Foreigners hold steady

Even if offshore funding has declined slightly in recent years, it would be wrong to suggest there has been less foreign involvement in Indonesian paper, since 30% of the local currency market is held by foreigners in any case. “Demand for these will also be a function of flows into EM funds,” says Save. “If demand for local currency bonds softens in 2014, then the foreign currency component of the total sovereign borrowing mix is likely to be increased.”

The question of fund flows is discussed in greater detail in this report’s Economic Overview chapter, but it does have clear implications for public sector debt in general. There have been outflows, but they have been nothing like as bad as might have been expected, and that 30% figure for foreign ownership of local debt has held steady. Fears of a wholesale desertion of this capital have so far proven unfounded. 

But one important sub-plot to this is the question of why that is the case. If it is because these bonds are held by sticky, real money that believes in Indonesia in the long term and has no interest in fleeing at the first sign of trouble, that is very positive. If, on the other hand, the money is stuck there because the market is too inefficient to allow it to get out, that’s another story.

“The recent outflow started after Bernanke’s statement last May about tapering,” says Darmawan. “All emerging markets were sold off during that period and Indonesia was not an exception. Recent outflows of foreign funds from Indonesian local currency bonds and shares have caused our currency to depreciate, and sometimes it is hard for these investors to convert it to US dollars.” 

Whatever the reason, by late September the mood was already looking brighter in Indonesia, in particular after the September 18 FOMC comments suggesting that tapering is still way off. 

“Last night’s news from the FOMC on tapering will help to improve the bond market,” says Julyasari, speaking on September 19. “Yesterday, before the Federal Open Market Committee (FMOC) meeting, 10 year government paper traded at a cash price of 99, with a yield to maturity of 5.45%. Today, after the news, the yield to maturity has moved to 5.21% with a cash price of 101 and a quarter. You can see that just based on one piece of news, it is already very positive.”

After all, the long term story for Indonesia remains a good one, says van den Wall Bake at Deutsche. “Obviously the tone for emerging markets as a whole has changed, and there is investor scrutiny on the countries that have twin deficits, Indonesia being one of them. Investors are concerned about the sustainability of maintaining twin deficits, and about what inflation will look like. But if you look at the overall Indonesia story and private sector, it’s still very robust.”

Russell-Davison agrees. “Indonesia is still a solid investment grade country with bright prospects for the future,” he says. “It’s possible that in the market exuberance earlier this year the pricing got out of sync, and that was representative broadly of emerging markets rather than just Indonesia. 

“In many respects, the situation in Indonesia remains the same: it’s just people’s perceptions about how emerging markets are faring, and rate discussions globally, are having a bigger impact.”s

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