Indonesia faces tough bond market

As the rupiah slides, analysts weigh in on Indonesia inc''s health

Last week, Indonesia took some hits from analysts across the region. UBS and Credit Suisse First Boston cut their Indonesian rupiah forecasts, ING told investors to "steer clear" of the nation's financial assets and JPMorgan told investors to expect more near-term volatility. "Indonesia 2005 bears uncomfortably close parallels" to the Asian financial crisis of 1997 and 1998, wrote Tim Condon, a Singapore-based ING economist in a research reporter. He added: "We believe the challenges to rupiah stability posed by rising oil and a strong US dollar are more than mere short-term blips." UBS predicts the Indonesian rupiah will drop to 10,400 to the dollar within a month. However, Ashley Davies, a UBS analyst, cautions that perhaps the media is blowing some of Indonesia's woes out of proportion. After pointing out that his 10,400 rupiah prediction is just a 100 rupiah move from his last forecast, he added: "We are expecting Indonesian authorities to take credible steps towards stabilizing its currency in the coming three months. But for now, the emerging-market currency is caught in a vicious circle where declines in the currency cause further panic selling rather than opportunistic buying."

Not all bears

Others, such as Ray Farris of CSFB add, "I strongly disagree with assertions that Indonesia today looks like Indonesia in 1997. The current account is in surplus, the banking sector has a net foreign-asset position, and central bank forex reserves more than cover short-term debt, all of which is opposite the situation that existed in 1997." He argues that the current rupiah weakness is a highly tractable problem. "We assess that if the central bank were to tighten monetary policy sufficiently to convince markets that it would reduce inflation, despite oil prices, this would likely stabilize the rupiah." Erwan Teguh, an analyst at PT Danareksa Sekuritas, adds that Indonesia's "lower loan-to-GDP ratio, more prudent corporates and pretty robust banks" are all good signs. "And though the budget deficit may widen, it is still far from critical levels." He says that what we are seeing now is a "sentimental over-swing" that may be "good market pressure for the government to act on immediately." Last week, Bank Indonesia, the central bank, raised the interest rate for rupiah deposits for up to seven days by a quarter percentage point to 7.5%. It had previously raised the rate in April.

And the bond issue?

Indonesia also invited banks to bid for the right to handle a $1 billion sovereign bond. There's no timeframe yet for the bond, but the government needs to trim a budget shortfall estimated at Rp40 trillion ($3.87 billion) thanks to record oil prices, slumping investor confidence and a slide in its currency to the lowest in 3½ years. "Given the timing the clear inference is that they're doing it to prop up the rupiah," says ING's Condon. "If this is not supported by policies aimed at fixing the sources of rupiah weakness, this is a bad idea. In any case the lesson of the last two sovereign issues is to avoid them in the primary market and pick them up after they plunge in the secondary market. That said, I expect investment banks to compete fiercely for the business."

Indonesia last issued 10-year dollar-denominated sovereign bonds in April, raising $1 billion to help plug the budget deficit in the spring. Citigroup, Deutsche Bank and UBS managed the sale. But Indonesia has since had to buy US dollars, dipping into its foreign exchange reserves thanks to high oil prices. In an effort to boost confidence, the coordinating minister for the economy, Aburizal Bakrie told reporters last week that the foreign reserves "are still safe." This despite the fact that for the past year, the central bank, has tried to meet the demand for US dollars by selling dollars - forex reserves have declined $300 million for almost every $1 rise in the price of oil. They have fallen by almost 10% from $36 billion to $32 billion on August 23. Much comes down to the oil problem. High prices hit the nation particularly hard given that it heavily subsidizes fuel - subsidies paid to local oil companies could widen the deficit to 1% of GDP from a targeted 0.8%. Ironically, Indonesia is the only member of the Organisation of Petroleum Exporting Countries that's a net importer of the fuel.

But the greater problem is in terms of the balance of payments. Before the oil crisis, Indonesia oil imports were absorbing $1 of every $10 of export proceeds. Now they're absorbing $1 of every $5 of export proceeds, thanks to the high prices and high subsidies. "Investors have been betting that continued increases in oil's claim on export proceeds, which would follow rising oil prices, would not be sustainable and that something would have to give, namely the currency. So far they've been right," says Condon. To be fair, Indonesia is attempting to come to grips with the problem. Couple the resolution of the Cepu oil field (in which state oil-and-gas firm Pertamina and subsidiaries of ExxonMobil will develop the oil-rich Ceput contract area of Java) together with expectations that there will be management reshuffles at the Pertamina, ridding the company of executives who opposed the ExxonMobil deal, one could and read this as a sign that the government intends to reform the oil sector, notes Sin Beng Ong, an analyst at JPMorgan.

Others, though, caution that we need to wait and see who the new management is. Plus, domestic premium-gasoline prices are poised to increase by as much as 41% in September, while domestic regular gasoline prices are likely to be increased by 30% after the Hari Raya holidays in November. This could ease some of the subsidy pressur - but it should not be forgotten past fuel increases have been the demise of Indonesian governments. If this happens, it will mean Indonesia won't just be taking some critical hits from analysts - but from the masses as well.