Indonesia weighs infrastructure finance options

Jakarta must encourage greater development of Indonesia's domestic bond market if it is to finance its ambitious infrastructure programme.

Infrastructure is the watchword for Indonesia as it targets Rp5.5 quadrillion ($385 billion) of infrastructure spending over the next five years to build an efficient transportation network that can foster higher economic growth and lift the country to middle income status. 

Since President Joko “Jokowi” Widodo came to power last summer he has pushed through numerous measures to ease the bottlenecks that kept infrastructure projects pinned to the drawing board. These include changes to the land acquisition law, which makes it easier to requisition farmers’ land, and a new one-stop shop for business licences.

How successful they prove to be remains to be seen, however, given that only about one third of the government’s $20 billion 2015 infrastructure budget had been allocated by the end of August. Yet if it is to bridge the gap between its ambitions and budgetary limitations, what the government really needs to do is attract global capital and mobilise domestic savings.

So far it appears to have enjoyed some success tapping Chinese financing channels, notwithstanding the Indonesia’s Investment Board’s recent revelation that only 7% of China’s investment pledges were realised over the past decade compared with 65% of Japan’s.

Local newspapers say China Development Bank and Industrial & Commercial Bank of China are each committing $20 billion to Indonesian infrastructure projects. Some of this money will be funnelled through state-owned banks, which have the ability to complete the necessary due diligence.

The government has also used equity markets to channel state funds by injecting capital into listed state-owned entities through rights issues.

However, the domestic debt market remains a very noticeable absentee.

While the Philippines spent the last decade trying to deepen its domestic bond market, Indonesia did very little as it revelled in a commodities boom. As a result, it has the shallowest domestic bond market of any of the five founding Asean nations.

According to the Asian Development Bank’s recent Local Currency Bonds and Infrastructure Finance Guide, rupiah-denominated corporate bonds accounted for just 2.1% of GDP at the end of 2014. By contrast, the Philippines has developed a domestic corporate bond market that amounts to 6% of GDP even though it only has 32% of Indonesia’s GDP.

Indonesian companies have raised debt by issuing bonds but they’ve largely done it offshore.
The ADB guide shows that whereas 38% of the Philippines’s corporate bonds are foreign currency-denominated, in Indonesia that figure is 49%. At the end of August, Indonesia’s overall foreign currency debt, including bilateral loans and export credits, stood at $304.3 billion, with private sector entities accounting for $169.7 billion.

According to research by CIMB, Indonesia’s external debt now amounts to 34% of GDP. That is nowhere near the 61% level it reached during the Asian financial crisis of 1997-98 but is enough to present a potential repayment problem in the face of the rupiah currency’s 17% fall against the dollar in the year to mid-September.

The government has attempted to limit foreign debt by banning double-B rated companies from accessing international bond markets and insisting all companies hedge at least 20% of their foreign exchange exposure.

Pension Deficit
There are two measures the government could take to encourage companies to make better use of the domestic debt market, experts believe.

The easy one involves equalising tax treatment. 

At the moment corporate treasurers are unlikely to choose a rupiah bond over a bank loan when interest expense is only tax-deductible on loans.

The bigger issue concerns the mobilisation of domestic savings through pension funds and the insurance industry so they have assets to recycle into long-term bonds to fund infrastructure projects.

In Malaysia, the Employees Provident Fund alone accounted for 121% of GDP at the end of 2014. In Indonesia, the entire insurance, mutual fund and pension fund industry amounted to just 18% of GDP. In the Philippines, the same three industry sectors account for 26.3%.

Capital markets consultant Mike Andrews co-wrote the ADB guide. He told FinanceAsia that Indonesia needs to move from a pay-as-you go pension scheme to either a partially-funded one as the Philippines has done, or the fully-funded schemes that Malaysia and Singapore run.

“This really is the key issue,” he said. “Countries need to create large pools of domestic investors and deploy external managers to broaden the investor base even further.”

There are some signs of progress, with universal health insurance being phased in through BPJS Ketenagakerjaan, the country’s biggest institutional investor. It has about $13.8 billion in assets under management, although it has some way to go before it reaches the $160 billion AUM of Malaysia’s EPF.

Bankers said Indonesia should embrace project bonds as well. Traditionally the instrument has found little favour in a region awash with bank liquidity.

“Basel III and the new capital requirements have changed the landscape,” Aaron Russell-Davison, head of global debt capital markets at Standard Chartered, said. “Project bonds should be taken seriously as an alternative to traditional financing sources.”

Returns and trust
For investors, the key issue surrounds returns on projects that do not generate cash flows for a number of years. Credit guarantees are one answer via the ADB’s Credit Guarantee and Investment Facility and the government’s Indonesia Infrastructure Guarantee Fund.

There is also Indonesia Infrastructure Finance, which the government established alongside the ADB, International Finance Corp, and a couple of private sector shareholders to provide advisory services and funding for infrastructure projects. In an interview with FinanceAsia, President Director Sukatmo Padmosukarso and chief financial officer, Ari Soerono, said the group would like to use its balance sheet to purchase project bonds and act as a market maker.

A second key challenge surrounds the sanctity of legal contracts. That is an area where Indonesia does not have a sterling reputation. During the Asian financial crisis, for example, textile company Polysindo was re-named Polyswindle by irate bondholders after it defaulted on $2 billion of debt.

Clarinda Tjia-Dharmadi, a partner at law firm Latham & Watkins specialising in infrastructure and energy, believes investors learnt some tough lessons. This means they still treat Indonesian corporates that abused their international relationships with a lot of caution.

“Now security arrangements for underlying debt are structured offshore wherever possible,” she told FinanceAsia. “Within Indonesia there’s still a problem with the wide discretion vested in judges and the vagaries of local courts.”

Others disagree. “Many investors were still at business school during the crisis,” one banker said. “That institutional memory has been bleached clean. Until very recently everyone was caught up in the new hubris of Indonesia as the next superpower.”

A good example is a $225 million debut bond issue by property developer Bumi Serpong Damai, which attracted $750 million in orders from 70 investors this April. Perhaps fund managers were unaware it shares the same owner as Asia Pulp & Paper (APP), which became the emerging market’s largest ever defaulter when it stopped re-paying its $13.9 billion debt-load in 2001.

Lucror Analytics noted that the new deal carries a similar guarantee structure to one the controlling Widjaya family successfully challenged through the Indonesian courts during the crisis. International investors ended up losing hundred of millions of dollars.

“Many Indonesian families had the capacity to re-pay their debt during the crisis, but opted to stick the money in their Swiss bank accounts instead,” one banker argued. “What they’ve now realised is that if they re-pay their debt in full they can borrow even more and grow their businesses exponentially.”

Standard Chartered’s Russell-Davison concurred that Indonesian corporates have learnt their lesson.

Islamic Finance
In addition, the sovereign has done a good job cultivating international investors for both its sukuk and conventional borrowing programme, he said.

Indonesia still lags Malaysia in developing Islamic finance. Yet a new push in this direction makes sense not only because Indonesia has a large Muslim population but also because it can tap into a deep pool of Middle Eastern money.

In 2016, the government plans to double its sukuk bond programme to $1.4 billion. Market players also believe it is about to amend regulations to enable investors to hold shariah bonds in their available-for-sale portfolios rather than as hold-to-maturity instruments. That way they could record capital gains.

Some bankers said the government should draw more investors into the market by following Malaysia’s lead and removing interest income taxes on sukuk bonds and infrastructure bonds.
Edward Gustely, co-founder of Jakarta-based Penida Capital has been working at the sharp end of infrastructure financing in Indonesia for over 20 years.

“It’s definitely moving in the right direction,” he said. “Could it have moved faster? Yes. But I think it’s very important people remember this country of 253 million people is not homogenous, but heterogeneous and spread over an archipelago of 14,000 islands stretching the distance of New York to LA."

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