Indonesian Fixed Income: S&P’s denial is bond investors gift
    Category: Column By : Rainer Michael Preis Read : 1773 Date : Sunday, July 10, 2016 - 20:02:01

    “God’s delays are not necessarily God’s denials.”

    This adage might apply as well to sovereign credit rating upgrades. The market was expecting a credit upgrade to investment grade for Indonesia by S&P. Fitch and Moody’s already have Indonesia as investment grade but rating agency S&P has decided to deny Indonesia an upgrade and stick to its junk sovereign rating. S&P affirmed its BB+ rating and positive outlook on June 1 and said an upgrade could occur over the next 12 months if Indonesia cuts deficits and implements fuel subsidy changes fully.

    Some commentators and indeed the Indonesian Finance Ministry itself criticized S&P’s decision, saying it was “not appropriate” and lacked a thorough analysis. Accused of not appropriate might be ok for a major credit rating agency but implying it of “lacking thorough analysis” might disturb S&P. For investors in Indonesian bonds, however, this could be a blessing in disguise as it will motivate the Indonesian government to continue to pressure for economic reforms while at the same time deepen the capital markets.

    Bank Indonesia is already working on preparing new instruments to deepen financial markets. The central bank is seeking to boost corporate bond sales while targeting the equity market to grow to become 78% of GDP, from its current 49%. The central bank is also preparing rules to allow structured products for use in FX hedging to lower costs for institutional and private clients. Bank Indonesia targets FX derivatives to account for 48% of all FX trades in 2016 up from 40% in May. In addition, Bank Indonesia will reportedly soon issue new rules on money markets.

    Indonesia’s ratio of debt to gross domestic product is already the lowest in Asia after China. Whether global investors can trust the Chinese numbers is not entirely certain but at the least on paper the comparison is favorable because many investors rightly or wrongly still consider China to be a lower risk than Indonesia. With regards to returns however, Indonesian bonds are Asia’s best performers. According to Bloomberg data, Indonesian bonds have gained more than 10% this year, making it the best performing Asian fixed income segment. The yield on Indonesia’s 10-year notes has dropped 92 basis points this year to 7.83%, compared with a 23-basis point decline to 3.94% for similar-maturity Malaysian securities. After adjusting for inflation, Indonesian bonds offer the highest yield in Southeast Asia.

    Because of this, rupiah-denominated sovereign debt has lured $4.7 billion of inflows so far in 2016. “Jokowinomics” and a pickup in government infrastructure spending is further bolstering investor sentiment as three interest-rate cuts this year are helping boost growth from a six-year low. Bank Indonesia now sees 2017 GDP growth at 5.2% to 5.6% and inflation is seen at about 4%. If the short-term S&P denial of investment grade status leads to further economic reforms coupled with fiscal discipline, it can only help investors in Indonesian fixed income. Over the long-term the country’s credit quality will surely rise as a result.