Indonesian paradox

The local rupiah debt market is tipped by some to be massive. But a recent CSFB research report raises some paradoxical questions.

Over an evening of racing at Hong Kong's Happy Valley, a banker I know was enthusing about the potential of the Indonesian local bond market. He cited the recent Rp1 trillion ($116 million) bond deal for Indofood, and noted that there were 1,000 people at the roadshow presentation in Jakarta.

Certainly, no country needs a local bond market more than Indonesia. But there may be a problem. For at the heart of every successful debt market is a government bond market, off which the corporate sector can price its issues. The impression I had after reading a recent CSFB report is that the Indonesian government is going to find it difficult to sustain a liquid yield curve.

Here are the numbers. According to CSFB, total public debt is $178.1 billion, or 103% of GDP. This puts debt servicing at just over 40% of government revenues.

To meet this stream of debt servicing costs û while lowering the public debt/GDP ratio (that is, putting public debt back on a sustainable path) û Indonesia must maintain primary fiscal surpluses of about 2% of GDP over the next 10 years. In addition to this, it must keep growth at 6% and sell the Indonesia Bank Restructuring Agency's (IBRA) assets and then it might get the debt to GDP level down to 67% by 2005.

However, running these fiscal surpluses effectively means it cannot issue new debt. It can only issue new bonds to refinance the existing debt û mostly at the short end. Clearly, savvy debt management will be an enormously important role, and if done well could save the Indonesian taxpayer a lot of money.

But the stock of debt û by definition û must decrease if the public finances are to improve. The stock of debt must decrease by 2% of GDP each year (thanks to the budget surplus) plus whatever IBRA can provide in the way of cash.

Not positive

Yet this very attempt to switch to prudent fiscal management is not positive for the corporate bond market. It will almost certainly disrupt the liquidity of the government bond markets. Government issues will be less frequent, and opportunism (via clever debt management) will creep in. Though taxpayers ought to be pleased, corporate borrowers may find different parts of the yield curve more or less liquid and prone to sudden shifts in rates thanks to technical factors.

Shrinking the government debt û as the US Treasury is discovering û is a scary thing for those who use the debt markets. For example, pricing off the 30-year US Treasury is becoming less and less common.

So will budget surpluses be a bad thing for the Indonesian local bond market? I am left with a sense of deja vu. It was, after all, thanks to the fact that Asian governments wed themselves to budget surpluses that Asia failed to develop decent local bond markets in the first place. 

In Indonesia's case, its debt situation is so bad it has no choice but to run these surpluses. It will have to hope its companies find some innovative way around this problem û when it starts to become a major issue in the next few years. Are there any suggestions for what Indonesian companies can use for a benchmark in the absence of a deep liquid government bond market?

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