Funding Indonesia’s future
There is little doubt that, by now, international investors have become familiar with Indonesia’s story. The country’s steady rise in credit ratings, as well as the debt management office’s sizeable — and deftly managed — dollar bond issuance over the last decade has meant that it is arguably the stand-out Asian issuer around today. But few Indonesian companies have chosen to follow the sovereign into the international market, relying instead on a domestic debt market that is making strides forward but still has a lot more room to grow. EuroWeek talked to high-profile bankers, analysts and funding officials — including Robert Pakpahan, director general of the country’s debt management office — about what investors can expect in the future, and what changes need to happen to make the domestic market move into the next stage of development.
Participants in the roundtable were:
Alexi Chan, head of DCM origination, Asia, HSBC
Setio Anggoro Dewo, chief financial officer, Perusahaan Listrik Negara (PLN)
Eddy Handali, rating director, Fitch Ratings
Atul Jhavar, director, DCM, HSBC
Robert Pakpahan, director general, Debt Management Office, Republic of Indonesia
Eva N Muis, senior director, business and relationship management, Fitch Ratings
Yudi Nurhadi, head of corporate finance,
Aneka Tambang (Antam)
Ali Setiawan, head of global markets,
Ken Wei Wong, head of bond syndicate,
Asia ex-Japan, Barclays
Matt Thomas, moderator, EuroWeek
EUROWEEK: Let’s start the discussion by taking a look at the Republic of Indonesia’s approach to funding. The country has become one of the most important sources of bond supply in Asia over the last few years and it is clear Indonesia can now rely on billions of dollars of demand for its offshore deals. What is the Debt Management Office’s strategy for funding the deficit — in both the offshore and onshore markets?
Robert Pakpahan, Indonesia: The number one source we use to fund the government deficit is the issuance of rupiah domestic bonds. After that, we turn to the foreign currency bond markets, which make up between 15% and 20% of our funding target each year. Then, we turn to the foreign currency loan markets. The main strategy for us when issuing rupiah bonds is the use of regular auctions, and we issue in both conventional and Shariah-compliant format.
In the past, the funding source for the government deficit was all from foreign loans. But beginning in 2002, we began to develop the domestic bond market, and now every year the amount of loan funding overseas is becoming less and less.
Rupiah domestic bonds may have become by far our biggest source of funding, but we still like to use the global bond markets, not just dollar bonds but also Samurai issues. We have sold Samurai bonds a few times, and although the guarantee agreement with JBIC [the Japan Bank for International Cooperation] has now run out, we are hearing from bankers that we could possibly get demand if we came on a stand-alone basis. That is now an option for us.
EUROWEEK: What’s the main priority for you when you turn to the dollar market — pricing, or developing a yield curve that other Indonesian issuers can make use of?
Pakpahan, Indonesia: My priority has to be funding the budget, and clearly pricing is a big part of that. But the most important thing is finding the best timing to ensure that the deficit can be financed smoothly. I understand that we need to be present in the global market for the benefit of other issuers — and we will always be present in the global market — but the first priority has to be funding the deficit.
EUROWEEK: Let’s bring in the bankers for a moment. How does Indonesia compare to other sovereign borrowers in Asia, or even in the rest of the world?
Alexi Chan, HSBC: Indonesia has established a tremendous reputation in the international markets, with many highly successful offerings in recent years. It has reached a position where it is now one of the most highly-regarded issuers not only in Asia, but across all emerging markets globally.
Investors have been reassured by the robust economic policy framework of the country, the ratings upgrades to investment grade in recent years, the liquidity of its global bond offerings, and the steps that the sovereign has taken to diversify its investor base.
Ken Wei Wong, Barclays: The Republic of Indonesia now has one of the most liquid curves out of all emerging market sovereigns. The key objective going forward is not just going to be to meet that funding requirement, but to expand that investor base. That is something we are looking to achieve every single time for the sovereign, for state-owned borrowers, and for privately-owned corporations.
EUROWEEK: Given that Indonesia is already a multi-billion dollar borrower in the global market, how much appetite is there from investors to take more supply?
Wong, Barclays: We are not going to hit the ceiling anytime soon. There is definitely more to come on the demand side. Indonesia has mainly been issuing in Reg S/144A format, whereas the Philippines, for example, has been issuing in global bond format. You can add that latent demand of a few billion dollars simply by switching to a global format, since so many investors are following global bond indices.
Chan, HSBC: The sovereign transactions from Indonesia that we’ve been involved in have all been heavily oversubscribed, and the investor base is going to open up further, as more and more investors become familiar with the credit strengths of Indonesia.
A further consideration will be in respect of managing the shape of the offshore sovereign yield curve. We have seen in other emerging markets that there has been a focus on liability management exercises, which typically involve terming out into longer maturities and thereby freeing up incremental capacity from investors. We’re very optimistic about the country’s prospects in the international markets.
Pakpahan, Indonesia: We were thinking about a liability management exercise this year, but two factors have made this less likely. The turbulence in the global financial market is one key factor, but a revised budget and an increase in our financing needs was perhaps an even larger factor. But even though we might not be launching a liability management exercise this year, we are certainly looking into doing this in the future.
EUROWEEK: We’ve heard that there is certainly demand out there for Indonesia to increase its borrowing in the global market, but from a ratings perspective what sort of impact would a big increase in offshore borrowing have?
Eddy Handali, Fitch: There would likely be no issue from a rating perspective if the government sold more bonds in the international market. The key question is how the government is managing the deficit, and if the deficit is being well managed even as foreign currency borrowing is being increased, Indonesia would likely keep its strong rating.
Eva N Muis, Fitch: Government bond issuance has been steadily increasing, and during the first half of this year, issuance from the corporate bond side has been increasing very quickly as well. Corporations pay a lot more attention to pricing than the government. The sovereign sees the need first, and the pricing second. But a lot of corporate bond issuance is so pricing dependent that as pricing changes, the appetite to borrow changes dramatically.
EUROWEEK: We are fortunate enough to have officials from two state-owned companies, PLN and Antam, on the panel. Can you tell us a little about your approach to the funding markets and how you prioritise your financing between offshore and onshore?
Setio Anggoro Dewo, PLN: The first priority is to meet our funding requirements, whether for financing generation, transmission or distribution. We analyse the percentage of our funding needs that will come in different currencies, as well as what sort of maturities we are looking at for our projects, and then after that we talk to a government committee if the funding is in a foreign currency and give them assurance that the funding we are planning to do will go to specific projects.
We soon start thinking about the covenants we are happy to use in financing each different project — since different projects may need different covenants — and then we can start deciding whether we’re better off funding in the bond market or in the bank loan market.
We only started going to banks for loans around two years ago, so there was a bit of a learning period for these lenders. But they have become very familiar with us now, so if bond yields look a bit too high for us we can always go to the banks.
We deal only with big, local banks because they have room for plenty of lending before hitting their limits, and they tend to be much more familiar with the electricity industry. We need to invest around $4bn every year to keep developing the electricity infrastructure, so you can imagine how quickly smaller banks can hit their limits. This funding need has made us want to go offshore not just for bonds but for loans, and we have approached the central committee about turning to offshore loan markets to help us hit our funding target.
Yudi Nurhadi, Antam: The last time we went to the international bond market was in 2003, and due to changes in the tax regime, we exercised our call option and repaid the bond. We haven’t issued any international bonds since then.
Some banks approached us a few months ago and tried to convince us to issue dollar bonds, because at the time offshore rates were quite attractive. But being a state-owned enterprise, we need to get government approval for any offshore debt [this goes through the offshore loan approval committee, known locally as PKLN], and that can take some time.
We now have Indonesian rupiah bonds, for which the approval process is much simpler. Currently, we also have an ECA-backed loan from JBIC for our subsidiary, and several onshore dollar loans.
EUROWEEK: What would be required to make you turn to the offshore bond market again?
Nurhadi, Antam: We have to go through the PKLN approval process, as I mentioned, and that can slow things down. But generally speaking, if the pricing is very good it is worth the effort. We have managed to achieve very attractive rates in the local market, but the deals we sell are relatively small.
If the offshore market will prove more attractive, from a size as well as a pricing point of view, we may decide to sell a much bigger deal in the offshore market.
We do plan to use offshore loans or bonds for the equity portion of our largest capital expenditure, but we are still awaiting government approval. It’s likely still a long way to go before we obtain the approval, though, since there are still many considerations before the capex will go ahead given the current challenging pricing of our end products.
Dewo, PLN: The approval process takes us a few months — as long as we’re not using a guarantee — so we make sure that we are processing our requests well before we want to tap the market. We usually have the approval in place for several weeks before we tap the market, giving us time to watch the market for a while and wait for the best time to strike.
The process of two-step loan [subsidised loan agreement] from the government is even slower. We need to go through parliament if we want to draw down the loan.
Wong, Barclays: There are a number of SOEs that are US dollar-denominated businesses and, as a result, they need funding in dollars. These are big companies and their financing needs are pretty large. But the process for them getting approval for their offshore borrowing takes a long time because they need to get signatures from six different ministers before they can tap the offshore market. This significantly reduces the ability of state-owned corporations to tap the market when an opportunity arises. They cannot hope to tap the market at the perfect moment, and this is something that should be revised by the government.
Then there is the issue of withholding tax as well. That is an area of uncertainty that a lot of issuers have to face. No company is really sure what the best structure is for them from a tax perspective, and that is definitely a hurdle they face when they come to the market.
Nurhadi, Antam: There is another option available to some companies, which is to issue rupiah domestically and then swap that into dollars. That is something that we probably would have done if we were a private company, but being a state-owned enterprise, when we do a swap or a derivative, since our financial statement is still in rupiah, marking those contracts to market causes us a lot of problems.
For others though, it makes sense. Many companies will find that they are rated higher onshore than they are offshore, so if they want to get the cheapest dollar funding a swapped bond may be the best route.
EUROWEEK: That depends, at least in part, upon the liquidity of the swap market. How liquid is it at the moment?
Nurhadi, Antam: There are plenty of Indonesian companies which are predominantly rupiah-denominated, but which borrow dollars. If we borrow rupiah and swap the loan to dollar, there should exist a counter-party transaction for the bank to match with it.
EUROWEEK: Foreign investors own more than 30% of outstanding government bonds, a sizeable percentage compared to most other southeast Asian countries. How important is the role foreign investors play in the Indonesian rupiah market?
Pakpahan, Indonesia: The presence of foreign investors, in the primary and secondary markets, has improved liquidity, deepened the market, and helped decrease yields. It is very obvious when we are not getting enough foreign demand for an auction; they have a big influence on pricing.
The presence of foreign investors in the market is, then, very beneficial, but there are clearly risks associated with too many foreign investors as well. The main thing for us is to maintain macroeconomic stability so these foreign investors keep their view that Indonesia is not a risky country. But we also want to deepen the domestic investor base at the same time.
We have looked into ways to increase the domestic investor base, and we have found out that many local pension funds and insurance companies have quite high yield targets, and furthermore they are unable to use our bonds for repo purposes.
We are working with the government to cure these problems, so perhaps soon insurance companies will be able to obtain repo facilities from the central bank by using our bonds — and there is a chance that rules will change to ensure that all pension funds need to hold a minimum percentage of government bonds. This is still in brainstorming mode at the moment, but it would help to ensure a minimum base of demand for government bonds from local accounts.
Wong, Barclays: Pension funds tend to be a big anchor in other emerging markets, so the strategy of imposing a minimum government bond holding makes a lot of sense. The tricky part is finding the right balance, but getting these investors involved is crucial. It is also important for us to think about getting domestic investors interested in the government’s offshore issuances as well, because in difficult times it is always useful to have that anchor bid from local accounts that you can rely upon.
Pakpahan, Indonesia: We always sell part of our global bonds to local investors, usually somewhere between 15% and 20%. The next step may be to launch a US dollar bond within the domestic market. That is something we are certainly considering.
Ali Setiawan, HSBC: This is certainly an option that could be explored. There is a lot of dollar liquidity in Indonesian banks, although most of it has a tenor of less than one month. We have seen the amount of dollar holdings grow this year. The activity, though, is not very high. Much of this money is held in large banks, and once the one month deposit expires the money is just rolled over.
Over the last few years, we have seen the size of the investor base growing in the onshore market. It was not uncommon six years ago to see only a few big names dominating almost every deal, but nowadays there are many new names coming into the market. They might not all be coming in big size, but there are new names and that is undoubtedly a good start.
EUROWEEK: What impact have you seen on Indonesian borrowers from the comments Ben Bernanke made on May 22 about the tapering of quantitative easing? Perhaps more importantly, what impact do you expect this to have on funding rates for the next few years?
Chan, HSBC: There has clearly been a process of significant market adjustment that was triggered in late May when the prospect of a near-term tapering of QE was first raised. This led to a major move in the global rates environment and market participants are still in the process of adjusting to that. Of course, the change in the interest rate environment that we’re seeing is something that everyone knew was coming at some point. It was always really a question of the extent and timing of the change, as well as the speed at which adjustment takes place.
We have seen knock-on effects in emerging markets. If one looks into the pattern of capital inflows into emerging markets over recent years, there have been both pull and push factors at work. The pull factor has been the rapid economic growth and increasing importance for global trade of many emerging markets, which we’re seeing clearly in Indonesia, and which is also reflected in the creation of new political forums like the G20.
This has been coupled with a push factor in recent years, driven by anaemic growth rates in developed markets and consequent low rates of return in those markets. That second factor is changing now, but from our point of view the pull factor remains intact, particularly in the case of Indonesia, where the fundamentals are robust.
There is certainly still a period of adjustment that will need to take place, but I would argue that most of the volatility in emerging markets that we’re seeing now reflects natural cyclical forces. The longer-term investment case for Indonesia and most other markets in Asia remains robust and many of the actions that have been taken at the sovereign and the corporate level have put issuers in a strong position.
Nurhadi, Antam: We have certainly noticed that the financial markets have become more volatile. However, it is not just the volatility in the financial markets that has affected us, but also the volatility in commodity prices, particularly nickel and gold, which is pushing our Ebitda margins lower, and forcing us to reduce our costs. That means less capital spending. Combined with the high interest environment, this is causing us and probably many other companies to slow down investment a little bit.
We have an Indonesian rupiah programme, which totals Rph4tr. We have already issued Rph3tr of the programme so far this year, so we have only Rph1tr left to do. But part of the Rph3tr has not been fully absorbed, so we still have some negative carry from that. The question that faces us now is whether we should have issued the extra Rph1tr while interest rates were lower — but take on that extra negative carry — or wait until the whole of the previous deal was absorbed.
There are, of course, different viewpoints on an issue like this but the suggestion of some of our bankers is that the rate widening has overshot and funding rates will be lower in the fourth quarter of this year or early next year.
Wong, Barclays: It is easy for a lot of people to feel pessimistic given everything they have seen in the markets, but if you take a step back things are not so bad right now. We knew the tapering was going to happen sooner or later. We knew that China’s growth was slowing down, and we knew that would affect not just Indonesia but economies throughout Asia. These things should not have caught anyone by surprise.
But when I look at the long term potential of the country, I’m very optimistic. This period of adjustment will take a while, but the markets will find a new equilibrium, and US Treasury rates will reach a new balance.
Indonesian corporate borrowers are still a lot less active in the international markets than issuers from Brazil, Turkey or Russia, for instance. That shows us there is a lot of potential left to tap in this country, and once we have stability in the US Treasury market, we will be able to bring a lot of these borrowers to the market. Many investors are waiting for that stability before they return to the market in full, so you’ll see a big impact on fund flows, and a big impact on volumes.
Dewo, PLN: We met some investors of ours that came from the US a few months ago, and they told us their maturity horizon is shorter now. They are not so worried about the political changes that will happen next year, but the global volatility has definitely made them want to stick to the short end of the curve.
Wong, Barclays: There is clearly a growing risk aversion right now. Investors are waiting for stability in rates, and given the volatility at the moment, investors are growing their cash balances. For many investors, the cash balances are three or four times higher than they were in April. Is that going to last for a long time? I don’t think so, personally, because once rates become stable, investors will once again be able to look at long duration. Exactly when that day will come is hard to tell but the market should normalise in the next six to nine months.
It is important to look at the global economic issues alongside the volatility in the financial markets. This adjustment has created a lot of volatility in the market, and this uncertainty is making a lot of issuers wait and see what will happen, since they do not know what their chances of success will be. But Indonesia is in a far better position now to deal with volatility than it was in the past.
Indonesia has been through the financial crisis of 1997/1998, and managed to recover strongly and come to the great position it is in now. One of the key things that has helped this recovery is the growing role of consumption in driving GDP growth.
In a way, Asia was fortunate to go through its own financial crisis because it has put us in a much stronger position to deal with global turmoil, whether looking at fiscal conditions or the corporate side. That does not mean, of course, that there will be no impact. The period of adjustment that is happening now should have an impact on how corporates look to spend money. Many corporates are looking at their capex spend right now, and that is something that is going to happen more and more. But the fundamentals are very good in Indonesia, and in much of Asia.
Atul Jhavar, HSBC: One of the factors behind some of this turmoil is fairly positive — stronger growth in the developed world, which has been through a prolonged slowdown. This is going to affect the emerging markets positively because part of the slowdown we’ve seen in Asia — the weaker GDP numbers in Indonesia recently, for example — has been driven by weaker export demand from the developed world. Indonesia has a strong economic base in terms of consumption and the investment story, and with a cyclical upswing in developed world growth rates, the country should benefit from stronger demand for its exports.
EUROWEEK: Is this because the experience of emerging market debt has been good enough for global fund managers to make them stay even when global conditions change?
Jhavar, HSBC: Portfolio allocations towards emerging markets have become more important than they were before the global financial crisis, and this is likely to remain true going forward. There is an argument that without QE and with a progressive tightening of liquidity, there will be a reduction in the amount of fund flows to emerging market debt, and that may be valid. But on a relative basis and in the long term, we should still see a shift of asset allocations towards emerging markets.
HSBC’s view is that marginal GDP growth over the long term will be defined by emerging markets, so even though we are seeing volatility due to a rising rate environment currently, the emerging markets will continue to be attractive investment destinations in the long term.
EUROWEEK: The high yield market used to be practically synonymous with Indonesian supply, but high yield supply has now largely been taken over by China, and supply across the credit curve from Indonesia is not hitting the levels that many market participants have been hoping for. Why are we not seeing more Indonesian issuers in the international bond market?
Chan, HSBC: The supply from Indonesia into the international markets has been modest relative to certain other big economies in the region, particularly China — there has been a huge growth in issuance from China over the last few years that includes both SOEs and privately-owned companies. In the case of Indonesia, the bulk of the country’s offshore bond issuance comes from the sovereign itself, with only modest amounts of supply from SOEs and private-sector corporates.
The government has worked hard to establish an offshore yield curve as a reference point for other Indonesian issuers, which has benefited the country and its companies significantly over the years. There is now a lot of structural demand out there from global investors for Indonesian credits. The next steps in terms of growing the market will be to facilitate timely access to the international markets for a wider range of Indonesian issuers.
I do believe there are a significant number of offshore bond markets that Indonesian issuers have available to them at the current time. This is clearly a major positive. I look forward to seeing an increasingly diverse range of international funding sources being tapped by Indonesian issuers.
Wong, Barclays: The Asian financial crisis meant that a lot of corporates learned to be wary about a currency mismatch. Most of them are, at this point, rupiah earners and they have the loan market, the rupiah bond market, and elsewhere for funding.
The typical dollar bond issuers from Indonesia at the moment are dollar earners, predominantly commodities companies. We are still relying on these natural resources companies not just for bond supply, but more importantly, also for a big part of economic growth.
Those companies love the dollar bond market because the pool of demand is bigger. Among the others, there are companies that need to refinance old deals and some infrastructure companies that have certain contracts that require dollar payments. The interesting source of demand emerging in the last few years is the property sector. Property companies need to grow by acquiring land, and getting the financing to do that is not always cost efficient in the domestic market.
But we need to have a better infrastructure in place before we will start seeing all types of companies across the economic sphere coming to the offshore bond markets. That is where we will see the more active issuers, rather than just a few names. We already have a good base in Indonesia, but the proper infrastructure would get the economy going faster and that would lead to a big knock-on effect in terms of bond supply.
EUROWEEK: Is there a risk that the steady — and sizeable — issuance from the sovereign crowds out other issuers?
Wong, Barclays: I don’t think so. There is demand for the Indonesian sovereign and there is a separate bucket of demand for Indonesian corporates, simply because the credit profile of those issuers is very different. There is space for both in the global market. The weightings of Indonesia in global bond indices are still a lot lower than a lot of other emerging markets, so there is scope for more financing and a latent demand for more Indonesian debt.
Corporations have increased their financing in the dollar market, but because of the way the market has grown, there is more demand now than there has ever been before for more supply from Indonesian corporations.
Jhavar, HSBC: We have also seen a change in the profile of Indonesian corporates that are coming to the dollar high yield market. It was not long ago that a large number of the non-sovereign issuers from Indonesia were from the coal and power sectors, but now we’ve seen a number of companies from the real estate, manufacturing and consumer sectors access the market as well. Most of these transactions have been well received and that bodes well for a broader development of the market.
EUROWEEK: One of the issues that arguably needs to be tackled across the Asean market is pushing flows from government bonds into corporate bonds. How can that be achieved?
Jhavar, HSBC: The Indonesian rupiah government bond market already sees significant participation from foreign investors. From the perspective of these foreign investors, the government bond market already provides the interest rate or currency exposure they desire, and they may not want to add the additional element of corporate credit risk by investing in rupiah-denominated corporate bonds.
This is not something that will change overnight, but there is certainly scope for those at the higher end of the credit spectrum — for example, the SOEs — to attract more foreign investors as the market becomes deeper and more liquid over time.
Chan, HSBC: Indonesia has had tremendous success in attracting foreign investors to the domestic government bond market. There has been greater foreign participation in that segment in recent years than we have seen in many other Asian bond markets. At times of volatility, high foreign participation can give rise to its own challenges, but in the long term this has to be seen as a very strong positive for the development of the market.
One of the lessons we’ve learned over the last decade and a half is the importance of developing a robust local corporate bond market. This can help cushion against global volatility by continuing to offer companies access to the capital markets at a time when other sources of finance may be unavailable or at least hard to obtain. The developments in the rupiah corporate bond market in recent years have all been very positive — sizes are increasing, tenors are lengthening — but this remains a work in progress, and there is still a way to go in terms of tenors and structures.
Emerging market investors around the world have shown a desire to invest in Indonesia and its markets in recent years, and that has helped increase foreign participation in the local bond market. The key steps forward are going to happen domestically, in terms of developing the investor base, increasing the issuer base and continuing to enhance the issuance framework.
Wong, Barclays: Liquidity in local bond markets needs to get a boost from the assets under management in Indonesia, because local investors are without doubt the main supporters of rupiah bond issues. There is a limit for any one firm to be able to invest in new issues, and that limits the ability of the domestic base to absorb issues. But the overall investor base is definitely growing, and what’s interesting is that we’re seeing a lot of fund managers become more flexible with the types of assets they are willing to buy. We’re also getting a lot of enquiries from overseas firms about setting up asset management companies in Indonesia. These things will help us pull off a greater shift from the government bond market to corporate bonds.
The government bond market has come a long way. The proportion of foreign investors in the government bond market is about 35% now, which is a huge development from what we saw just a couple of years ago. The development of the corporate bond market will take time. We need to see, first of all, some more issues from SOEs. That will help us start to set a proper curve away from government benchmarks. We also need to see deal sizes grow. The most important thing for international investors is liquidity.
We do need to develop the domestic market, but there are examples in Asia showing that this is certainly possible. Singapore, for example, has done extremely well. The Monetary Authority of Singapore, back in 2010, encouraged banks to provide two-way quotes, and that has helped the market tremendously to grow over the last few years.
Nurhadi, Antam: We understand the need to set benchmarks for investors, but on the other hand, we need to look at our need as well. It is difficult to justify issuing a bond with a size that leaves us with a negative carry, even if that size might make the transaction a lot more attractive to investors.
Chan, HSBC: Minimum liquid issuance sizes are not always as important in local currency bond markets as they are in the international markets. There is certainly one approach to market development, which calls for liquid benchmarks, a diversified investor base including foreign investors, and the development of a yield curve.
But that is only one approach, and we have also seen that domestic bond markets can take on other characteristics, sometimes offering relatively small sizes via a small pool of investors. In Indonesia, there is scope for further diversifying between these two approaches.
EUROWEEK: How diverse is the investor base right now?
Jhavar, HSBC: The domestic corporate bond market in Indonesia is developing, and the investor base is currently not as deep or diverse as in the US dollar market. The latter allows corporate issuers right across the credit spectrum to access liquidity from a mix of private banks, fund managers, hedge funds, banks, insurance companies, etc.
Generally speaking, demand in the domestic corporate bond market is a bit more concentrated to asset managers and banks in the shorter tenors up to three years, and insurance companies and pension funds in the longer tenors. Currently, there is limited direct private banking participation and limited investor depth as you go down the credit spectrum.
EUROWEEK: How much of a ratings cliff is there in the Indonesian market? Are you able to find demand for single-A borrowers, or even those below this level?
Wong, Barclays: Investment grade is not really enough for many investors. It has to be double-A rated, or above. Those companies rated below this level do have funding options, but they are largely relying on bank loans to finance. There are also some funds — growing in popularity — which are offering loans to these companies.
There is much less flexibility in terms of ratings here, and that is all a consequence of what we’ve just talked about: the lack of diversity in the investor base. The supply of lower-rated credits will grow as the investor base grows, but it does take time.
Jhavar, HSBC: The ratings cliff is a phenomenon we see in some other southeast Asian markets as well. But many companies that cannot tap their local bond markets due to their credit or ratings profile are often able to attract good demand in the dollar high yield market.
EUROWEEK: Indonesia is heading into an election next year, creating the possibility of capital market activity slowing down as state-owned companies put their plans on hold and privately-owned companies wait to find out if there are going to be any major policy changes. Do you expect this will happen — or will it be business as usual?
Pakpahan, Indonesia: I don’t think we will encounter any funding troubles because of the election. Indonesia has been successful in funding in election years in the past, even in 2009 when there was also a global financial crisis making things difficult. The result of the election is also unlikely to make much of a difference to our funding availability. Investors are comfortable with us at this point, and they have faith in the credit standing of the government.
Chan, HSBC: Indonesia has a very solid economy and one that global investors have strong conviction in. While market participants will closely follow developments relating to the upcoming election, the robust policy framework and strong credibility in the markets certainly inspires investor confidence.
Political trends can move with the times, but there is an underlying core of stability when you have consistency in policy frameworks and a commitment to market best practices. As long as there is broader stability in global markets, I firmly believe the international bond markets will be open to the sovereign and to Indonesian corporates both during and after the election.
Wong, Barclays: The concern is not really the election, it is the global economic slowdown and how that affects the Indonesian economy. Corporations are, following the election, going to be looking at the growth prospects of the country and even though that will be affected in part by who is in charge of the economy, it is the global issues that are really key.
Jhavar, HSBC: People are certainly keeping an eye on developments regarding the election, but it is probably not top of their minds yet. There are a lot of things for investors to focus on right now given the volatility in US rates and emerging markets asset prices more broadly.
If you talk about Indonesia, the market has recently focused on the current account, the currency and the slowdown in growth, but the element of political risk may start to build up over the next few months.
From an issuer perspective, some have considered whether they should pre-fund before the election. Some also view this as a potential opportunity, because if it has a negative impact on asset prices, it could provide good long term investment opportunities.
Nurhadi, Antam: The political risk arising from the Indonesian election is much less compared to some other risks faced by investors investing in Indonesia. Indonesia is now considered by international investors as a much more stable democracy compared to its situation a couple of years ago. The bigger concern for us is on the volatility of commodity prices, which squeezes our Ebitda to such an extent that it is not prudent to pre-fund.
Wong, Barclays: Investors will still look at the fundamentals. There are still a lot of quality corporates with very stable businesses, particularly when you look at commodities and power companies. They have stable Ebitda generation, regardless of who is the president of Indonesia. The demand will be there for these companies if they decide to come to the market. Investors want to see more from Indonesian corporates.
EUROWEEK: Indonesia was upgraded to BBB- by Fitch in December 2011 and by Moody’s to Baa3 just a month later. What has been the impact of these upgrades on the sovereign’s yield curve? Was much of the tightening already priced in?
Chan, HSBC: The moves from the rating agencies had been expected in the market for some time, so that mitigated the immediate impact of the upgrades. But moving to a point where two of the big three rating agencies rate the country as investment grade certainly had a big impact on the investor base for the country’s global bonds. That also helped other issuers in the country, and many of them moved quickly into the market to take advantage of that.
Wong, Barclays: The upgrades meant there was an investor base that was not previously able to buy the sovereign’s bonds but all of a sudden joined order books.
There has been a clear augmentation with every deal we have done for the sovereign, or for PLN and the other state-owned companies that we have been involved with.
EUROWEEK: What is the key next step that needs to be taken to develop the domestic bond market right now?
Dewo, PLN: The biggest challenge I see right now is that demand is too concentrated among a few big investors. That is why we try to not only cater to the big investors, but spread our bonds among as many institutions as possible. There need to be more accounts in the market.
Muis, Fitch: That is definitely a hurdle we need to overcome. Most investors in Indonesia are pension funds and most of those funds tend to have a double-digit target. Yet they can only invest in double-A or single-A bonds. In order for them to hit their targets, the government should consider allowing them to invest in bonds rated below single-A on a domestic scale.
That would increase the options for investors, and could in turn increase the number of investors looking to tap the market.
Handali, Fitch: I’d agree with that point. That could give investors a much better capability to manage their portfolios. There is a bit of inconsistency here because the regulations, which are only designed for risk controls, forbid pension funds from investing in triple-B paper. But at the same time, they are allowed to buy equity. The potential risk with equities is higher, so that is something you could see changing.
Chan, HSBC: There are two things that stand out for me, besides what has been mentioned already. The process that corporate issuers need to follow to tap the local bond market is quite involved. It would certainly be beneficial to consider whether there is scope to streamline this process in order to provide issuers with enhanced flexibility to tap into positive issuance windows, while at the same time maintaining due processes and standards. The other element that is important is to enhance secondary market liquidity in all of Asia’s local bond markets.
That typically needs to happen organically, but regulators may also look to put various schemes in place to incentivise market-makers to provide liquidity more actively in the local market.
Setiawan, HSBC: Regulators can certainly make changes to support corporate bonds; for instance, tax breaks on bond investments. That could help not just institutional demand but also bring in more retail investors. As a separate point, banks are — at this point — not able to sell bonds to their retail clients. If we could open up the bond market to retail clients, we would have a much bigger investor base and much more scope to offer a diverse array of products.
Wong, Barclays: These are all ideas I agree with, but looking more at short term issues, one thing that a lot of investors are focusing on at the moment is inflation. Policymakers need to step in and anchor inflation expectations. That would certainly help to bring local investors into the bond market.
There are lessons that can be learned from India, where there has been very impressive development of the fund management industry over the last few years.
The big benefit of bringing hedge funds and mutual funds into the market is that they have much less restrictions than pension funds and insurance companies in terms of what they can buy. That is one development that I would like to see happen in Indonesia over the next few years.