My OperaSelling bonds in turbulent times
Wednesday, January 30, 2008 11:18:01 AM
Helmi Arman, Economist
As long as oil prices remain elevated, the government may be better off focusing its bond issuances on domestic investors.
A couple of weeks ago the Finance Ministry issued US$2 billion of dollar-denominated government bonds to help plug this year's budget deficit, in a sale that drew criticism from local media given the perceived high yields.
Whether or not the bond was fairly priced will not be discussed here. However, it is important to highlight how the changing dynamics of global financial markets are implicating the financing of this year's fiscal deficit.
The market today is much different from, say, six months ago. The global credit crunch from the U.S. mortgage market collapse late last year has only started to emerge. Risk aversion and volatility in financial markets have risen.
For example, in the U.S. yields on Treasury securities have generally declined, reflecting expectations of aggressive rate cuts by the Federal Reserve going forward. The yield on the 10-year U.S. Treasury note, which was floating at around 4.7 percent mid-last year, has dropped by more than 1 percentage point to around 3.6 percent.
Unfortunately the lower borrowing costs in the U.S. haven't been followed by lower borrowing costs in Indonesia. As risk aversion rises, credit default swap spreads on emerging market bonds — which is basically the cost of insuring against default risk — have been constantly on the rise.
Concurrently the differences in yields between Indonesian government-issued securities and U.S. Treasury securities have been widening.
Volatility too has been exorbitant. Let's consider the six-month rolling standard deviation of weekly returns on the Indonesian government bond maturing in 2017. Back in January 2007, the figure stood at around 0.5 percent. It has persistently risen since June last year and has now doubled to over 1.0 percent.
What are the implications to Indonesia of these changes in market conditions? Firstly, the financing of the deficit — in terms of both rupiah and dollar bonds — has become a more complicated task.
Not only will the government have to issue a higher amount of bonds in net terms (i.e. Rp 91.6 trillion vs. Rp 58.5 trillion last year), it also has to do so in times of increased uncertainty.
Dollar-denominated bond issuances have become a more challenging sell, as the U.S. dollar is set to depreciate amid an economic slowdown. It is therefore no wonder the bulk of buyers from the last sovereign bond auction was reportedly U.S.-based, as opposed to Asia-based, investors.
While the dollar is exposed to currency risk, so too is the rupiah. Indeed, rupiah government bonds of various tenors are currently yielding 8-10.5 percent; they do offer relatively attractive increments over bond yields of many developed countries.
However, investors have to weigh this against the currency risk stemming from a shrinking trade surplus.
Trade data reveals the highly anticipated growth in non-oil commodity exports so far hasn't been able to counterbalance the burgeoning import bill.
In November, data from the statistics office showed Indonesia's trade surplus dropping to US$2.3 billion, a three-year low. This at least partially explains the 2 percent depreciation of the rupiah against the dollar during the month.
So without a substantial pull-back in oil prices, currency risk will remain elevated; this in turn may hold back foreign investors' appetite for rupiah-denominated government bonds.
At this point it is unclear whether more dollar issuances are planned. What's clear is that rupiah issuances have only just started and have some way to go.
The need for further diversification of the domestic investor base has been acknowledged by officials. But in spite of that, domestic investors obviously do not have the capacity to absorb all the issuances.
Given this limitation, and the currency volatility holding back foreign investors' appetite, the risk for the government having to give away higher yields in its auctions is quite substantial.
So is it doomsday for the government? Not yet. The tables may turn if oil prices retreat. A substantial pull-back in oil prices would be good for inflation expectations and would also reduce currency risk. This may be able to help boost foreign investors' appetite for rupiah bonds.
The good news is that many, including the government itself judging by its $60-per-barrel oil price assumption in the budget, believe oil prices will ease from current levels as global economic growth decelerates.
Should this be the case, then it could be a good strategy for the government in the meantime to focus on issuances geared to domestic audiences, such as retail bonds (which suits the needs of domestic individual investors) or even zero-coupon bonds and treasury bills (which are sought by banks).
Only after the expected decline in oil prices materializes would it make better sense to go full-throttle on regular fixed-rate issuances.
Indeed, as the past few weeks have demonstrated, timing the market is difficult, if not impossible. But the government needs a clear strategy to avoid being "cornered" by investors.
If policymakers truly believe oil prices will ease, what can be a better option than to act upon it?
The writer is an economist at PT Bahana Securities
Source : The Jakarta Post
As long as oil prices remain elevated, the government may be better off focusing its bond issuances on domestic investors.
A couple of weeks ago the Finance Ministry issued US$2 billion of dollar-denominated government bonds to help plug this year's budget deficit, in a sale that drew criticism from local media given the perceived high yields.
Whether or not the bond was fairly priced will not be discussed here. However, it is important to highlight how the changing dynamics of global financial markets are implicating the financing of this year's fiscal deficit.
The market today is much different from, say, six months ago. The global credit crunch from the U.S. mortgage market collapse late last year has only started to emerge. Risk aversion and volatility in financial markets have risen.
For example, in the U.S. yields on Treasury securities have generally declined, reflecting expectations of aggressive rate cuts by the Federal Reserve going forward. The yield on the 10-year U.S. Treasury note, which was floating at around 4.7 percent mid-last year, has dropped by more than 1 percentage point to around 3.6 percent.
Unfortunately the lower borrowing costs in the U.S. haven't been followed by lower borrowing costs in Indonesia. As risk aversion rises, credit default swap spreads on emerging market bonds — which is basically the cost of insuring against default risk — have been constantly on the rise.
Concurrently the differences in yields between Indonesian government-issued securities and U.S. Treasury securities have been widening.
Volatility too has been exorbitant. Let's consider the six-month rolling standard deviation of weekly returns on the Indonesian government bond maturing in 2017. Back in January 2007, the figure stood at around 0.5 percent. It has persistently risen since June last year and has now doubled to over 1.0 percent.
What are the implications to Indonesia of these changes in market conditions? Firstly, the financing of the deficit — in terms of both rupiah and dollar bonds — has become a more complicated task.
Not only will the government have to issue a higher amount of bonds in net terms (i.e. Rp 91.6 trillion vs. Rp 58.5 trillion last year), it also has to do so in times of increased uncertainty.
Dollar-denominated bond issuances have become a more challenging sell, as the U.S. dollar is set to depreciate amid an economic slowdown. It is therefore no wonder the bulk of buyers from the last sovereign bond auction was reportedly U.S.-based, as opposed to Asia-based, investors.
While the dollar is exposed to currency risk, so too is the rupiah. Indeed, rupiah government bonds of various tenors are currently yielding 8-10.5 percent; they do offer relatively attractive increments over bond yields of many developed countries.
However, investors have to weigh this against the currency risk stemming from a shrinking trade surplus.
Trade data reveals the highly anticipated growth in non-oil commodity exports so far hasn't been able to counterbalance the burgeoning import bill.
In November, data from the statistics office showed Indonesia's trade surplus dropping to US$2.3 billion, a three-year low. This at least partially explains the 2 percent depreciation of the rupiah against the dollar during the month.
So without a substantial pull-back in oil prices, currency risk will remain elevated; this in turn may hold back foreign investors' appetite for rupiah-denominated government bonds.
At this point it is unclear whether more dollar issuances are planned. What's clear is that rupiah issuances have only just started and have some way to go.
The need for further diversification of the domestic investor base has been acknowledged by officials. But in spite of that, domestic investors obviously do not have the capacity to absorb all the issuances.
Given this limitation, and the currency volatility holding back foreign investors' appetite, the risk for the government having to give away higher yields in its auctions is quite substantial.
So is it doomsday for the government? Not yet. The tables may turn if oil prices retreat. A substantial pull-back in oil prices would be good for inflation expectations and would also reduce currency risk. This may be able to help boost foreign investors' appetite for rupiah bonds.
The good news is that many, including the government itself judging by its $60-per-barrel oil price assumption in the budget, believe oil prices will ease from current levels as global economic growth decelerates.
Should this be the case, then it could be a good strategy for the government in the meantime to focus on issuances geared to domestic audiences, such as retail bonds (which suits the needs of domestic individual investors) or even zero-coupon bonds and treasury bills (which are sought by banks).
Only after the expected decline in oil prices materializes would it make better sense to go full-throttle on regular fixed-rate issuances.
Indeed, as the past few weeks have demonstrated, timing the market is difficult, if not impossible. But the government needs a clear strategy to avoid being "cornered" by investors.
If policymakers truly believe oil prices will ease, what can be a better option than to act upon it?
The writer is an economist at PT Bahana Securities
Source : The Jakarta Post
