Indonesia’s borrowers ready to harvest deeper debt markets

Participants in the roundtable were:

Robert Pakpahan, director general of budget financing and risk management, Ministry of Finance, Republic of Indonesia
Aaron Gwak, head of capital markets, Asean, Standard Chartered
Aldian Taloputra, senior economist, Indonesia, Standard Chartered
Iman Rachman, finance director, Pelindo II
Orias Petrus Moedak, chief executive, Pelindo III
Silvano Rumantir, president director, Mandiri Sekuritas
Susiwijono Moegiarso, acting executive director, Indonesia Eximbank
Toby Fildes, managing editor, GlobalCapital

GC: Let’s begin by talking about Indonesia’s growth and growth prospects. 

Aldian Taloputra, Standard Chartered: From the market’s perspective, the country has one of the fastest rates of growth of all G20 countries. Only China and India have faster rates of growth.

To give some perspective, the economy bottomed out in 2015 after starting to slow in 2009 after the financial crisis. Only in 2016 did it start to pick up.

The country’s economic performance moved in line with the global slowdown and decline in commodity prices. But since 2015 and the arrival of the new administration, the government has been trying to revamp the investment climate to move from a commodity-based economy to a more value added industry one. It has forced the country to take some short term, bitter pills such as the not very popular policy of cutting the fuel subsidy, which resulted in higher inflation and forced Bank Indonesia to increase interest rates.

After those difficult measures, the economy now appears to be in a good position, having stabilised. We saw momentum begin to build in 2016.

For this year we believe the prospects are better. Commodity prices have started to show some recovery and although we don’t expect oil to be back to $100 per barrel and revive strong investment on mining sector, it at least provides relief because the economy is still heavily reliant on the commodity sector. However, we believe reforms like infrastructure and structural reform will be the backbone of growth in the medium to long term. So, while the government probably thinks growth can be better, compared to other countries in the region and elsewhere, it is not at all bad. 

Aaron Gwak, Standard Chartered: The Indonesian Republic recently conducted a number of roadshows in the US, London, the Middle East and Asia. The reactions we got from institutional investors, globally, were very positive, not only on the economy, but also on the bond issuance programmes that the Indonesian Republic has been maintaining. And if secondary asset prices are any guide in terms of their satisfaction, one of the most recent issuances by the Republic of Indonesia — the $3bn dual tranche sukuk — is trading a good shade above par in today’s market. Since the beginning of the year, from an asset price perspective, it is one of the best performing assets across the Asian curve.

Susiwijono Moegiarso, Indonesia Eximbank: Quoting the finance minister during her interview in Cebu, Philippines, in early April, the government is confident in its strong growth levels and is supported by the fact that Indonesia has become one of the three countries among G20 members with the highest growth rate in recent years. It will be challenging to achieve the 6% growth rate in 2018, for it will need not only growth from the domestic economy, but also a conducive global macroeconomy.

GC: Robert when you are on your roadshows, what kind of questions are you fielding about the country’s economy?

Robert Pakpahan, Republic of Indonesia: Regarding the previous statements about the performance of the economy, I myself as the official from the Ministry of Finance am quite proud of the achievement of economic growth in recent times. If you look at the data of the last 10 years the average economic growth has been 5.7%, even though in the last two years — 2016 and 2015 — the economic growth was lower than forecast. The lowest was 2015, 4.8%, and that was the bottom. Last year we achieved 5.0% and in 2017 the government is targeting 5.1% in the budget. Looking ahead we think we should be able to do slightly better than 5.1%, perhaps as much as 5.4% in 2017. For 2018 we are looking at between 5.4% to 6.1% but likely to be around 5.6%, and then above 6% in 2019. Some forecasts have put us at 7% for 2019 but this might be a bit high.

Now regarding the performance of our economy in the eyes of our investors on our roadshows, most of them appreciate and think we are quite far ahead compared to many other countries.

Some of them even think that we should be able to achieve higher economic growth if we are willing to increase our borrowing and relax our spending limits. However, other investors are appreciative of our efforts and think we are doing the right thing because economic growth above 5% is quite remarkable at the moment, compared to many other countries.

Investors on our roadshows appreciated our prudence and our consistency to maintain the deficit below 3%. Last year the deficit was 2.46%, and then this year, according to our State Budget, it is set to be 2.41%. Maintaining the deficit below 3% is something that really is a positive point for the government and helps gain investors’ trust. The debt to GDP level of 28% is also something that, according to investors, is comforting to them.

Investors also see positive signs from the direction of fiscal policy. We have addressed the subsidy issue. We are now addressing revenues through tax reform, which is now a priority. In terms of the spending side investors are quite happy with the direction we’re taking but now they really want us to look at our revenue side because our tax ratio is quite low.

GC: Do any of our other issuers agree or 

disagree with this prognosis?

Orias Petrus Moedak, Pelindo III: From the market’s perspective it’s correct, but from the real sector — I come from the ports business side — the challenge is not about the growth itself but how the wealth generated from that growth is distributed among the remote areas of the country. We are in Surabaya and we have the small islands in the southeast of Indonesia that really need to see the impact of that growth. East Java has had good growth — higher than the overall country’s growth I think — but the present challenge is the eradication of poverty.

Iman Rachman, Pelindo II: One indicator of the growth is export-import growth. It is beginning to pick up and we have seen this in the cargo volumes over the last year. Another contributing factor is the development of our ports. We have to complete the work on our Kalibaru and Kijing ports by 2019. By having some of the big ports completed we will be supporting the growth targets of Indonesia.

Taloputra, Standard Chartered: That also reflects the regional growth in the eastern part of the country — as Orias said, it’s faster than the national level, for instance. For example, Sulawesi was growing by close to 7% year on year in Q4 2016. 

GC:  We have seen fantastic conditions in global capital markets over the last three months. However, the wider world has many challenges. A new US administration, elections in Europe, a slowing China, a tightening Fed, trade deals in decline, geopolitical tensions in North Asia. But what are the key external risks as far as Indonesia is concerned, Robert?

Pakpahan, Republic of Indonesia: The depth of the domestic financial sector in Indonesia is one issue because it is not as deep as we would like it, at least when held up against the size of our economy. The total assets in the banking sector — such as savings, assets under management for pension funds, insurance etc — are not as high as in other countries. A result of this is that foreign ownership in the local currency equity and bond markets is high. This is a risk, as it makes us vulnerable to money moving out of the country quickly when there is a big external event.

So all those risks you mentioned could be felt here in Indonesia through capital flight. This is why it is so important for us as a country to maintain very consistent and credible economic growth with the right direction of fiscal policy and also very stable monetary policy to make sure the effects of any external issue or shock are minimised.

So far we have shown that our fiscal policy is going in the right direction. We are addressing our spending. We are maintaining our deficit at a safe level, while our monetary authority is maintaining stability. Inflation is now quite tame at a level of between 3% and 4%, the current account deficit also has been maintained at a level of below 2.5%. These things are very important for us to work on, to make sure that external risks will not severely hurt us and that flows of funds in and out are kept to a minimum. 

GC: When you say the flows in and out are you referring to foreign ownership of government bonds or are you talking about all products across the financial sector? 

Pakpahan, Republic of Indonesia: Both, and I’m really talking about hot money. We are not that concerned about foreign direct investment because that tends to stay in the country, but rather portfolio investment that tends to build up but then rush out when there is a problem.

Moegiarso, Indonesia Eximbank: The key external risks for Indonesia among others are: the global economy that has not fully recovered; the global financial market which is still highly influenced by uncertain policies of the US government; and China’s rebalancing economics. 

Silvano Rumantir, Mandiri Sekuritas: On the macro side a key external risk factor we see is China. China is the top three for both export destination as well as direct investment into Indonesia. Our sensitivity analysis shows that every 1% increase in China’s economic growth has an impact of, or a contribution of 0.11% to Indonesia’s economic growth. If you look at Japan and US for us it’s only half of China’s impact.

GC:  Is it the same going down as well?

Rumantir, Mandiri Sekuritas: Yes, either way.

Taloputra, Standard Chartered: If I have to choose between the risks mentioned earlier, the rate hike poses the biggest risk for the country, mainly because it runs a current account deficit that makes it rely on external financing. We have seen the vulnerability of the country decline in the last few years given the prudent fiscal policy that Robert mentioned, as well as the monetary policy, which is very prudent.

Bank Indonesia has not hesitated in increasing the interest rate to stabilise inflation and has become more flexible in managing the exchange rate. A more flexible exchange rate provides a buffer to external shocks. Bank Indonesia has also introduced a hedging requirement for companies that borrow abroad and also imposed a rupiah transaction requirement to lower the demand for US dollars by residents in conducting domestic transactions.

However, we are still running a current deficit of around 1.8% of GDP. While this is a very manageable level — the safe level is 3% — if there is a risk-off event it could trigger an outflow, which would result in pressure on the currency.

GC:  You wouldn’t notice, though, would you, the impact of a rate rise by the Fed on your bonds? You issued after the rate rise and you have cheaper debt than you would have done the week before the rate rise, so explain that to me!

Pakpahan, Republic of Indonesia: The market had got a little ahead of itself and probably priced too much in ahead of the rate rise. After the FOMC announced the higher rate US Treasury yields declined. Sometimes this financial market confuses us all! But anyway, the government of Indonesia is happy. We launched the US dollar sukuk deal after the FOMC decision and we got a better deal than we would have done before the rate rise.

Sometimes it is difficult dealing with a Fed Fund hike, but in general we know the general direction of travel — the interest rate is going to increase. That’s why one of the strategies of the government of Indonesia is to complete all of our international bond market activities in the first semester of 2017. 

GC:  Excellent timing nonetheless.

Gwak, Standard Chartered: Over my career I’ve wanted the issuer to have a little bit of luck in picking markets and windows. Sometimes there’s obviously a general plan behind it, but sometimes it’s just that particular day. But what I’ve noticed through meeting with investors globally is that the fundamental appetite for Indonesia is very strong. So, yes, where the Treasuries trade on a particular day will influence the ultimate coupon and the price that Indonesia has to pay, but overall demand for Indonesia risk is robust.

If you look at the two recent transactions, for example, that Indonesia did — the December transaction which was a conventional five, 10, 30 year combination deal and the recent sukuk which was a five, 10 year combination — the 30 year that we priced in December is trading at 107.875. So it’s basically gone up almost eight points in three months, which obviously is a reflection of the continued strength and support for Indonesia as a credit, despite everything that’s happening on a global level, such as all the noise from the triggering of Article 50, the Fed hike, and all the political noise that’s coming out of the US. Fundamentals I think do still play a big part and the fundamentals of Indonesia are currently in fashion.

GC:  The Indonesian government has, of course, established itself as one of the most sophisticated sovereign borrowers in the international markets. How is this important for the development of debt capital markets in Indonesia?

Moegiarso, Indonesia Eximbank: It is very important as this reflects the credibility of the sovereign in the eyes of international investors. To develop our debt capital market, we still need influence from international investors’ investment to attract domestic investors. 

GC: What are the opportunities for other Indonesian borrowers to access the international markets?

Rachman, Pelindo II: We issued a global bond in 2015, a 10 and 30 year $1.6bn deal. We have a natural hedge because some of our income is in US dollars, so that is why we can issue in dollars rather than solely Indonesian rupiah bonds. Secondly, our port development projects require longer term debt, which is not always available in the local currency bond markets but can be found in international dollar markets. Additionally our ratings are very similar to the government of Indonesia so we can issue at very similar rates to the sovereign.

Moedak, Pelindo III: Yes, it is fortunate for Pelindo II that they have long term contracts with US dollar income. Right now for us we cannot use the US dollar market because the exchange rate versus the rupiah is not favourable and our funding needs are in rupiah. So if port companies want to issue dollar bonds I think the challenge will be the exchange rate.

GC: Because it will need an expensive derivative.

Gwak, Standard Chartered: Asset-liability and length-maturity matching are some of the reasons why a lot of issuers, pan-region, look to the international bond markets to issue. It’s a market where 30 year liquidity is plentiful, and in fact 30 year liquidity is sometimes more plentiful than shorter term liquidity. But as Pak Orias has mentioned, the new requirements to invoice in rupiah have reduced some of that natural hedging ability.

GC:  What role has the sovereign played in setting a benchmark for the non-sovereign borrowers?

Pakpahan, Republic of Indonesia: Certainly one of the roles that the government plays is to provide a reference to potential corporate borrowers when we issue in the dollar market.  

Gwak, Standard Chartered: For example, Indonesia Eximbank was the most recent issuer and when they came to market, they very successfully priced at a premium of about 25bp-35bp over the sovereign. But the fact that it is referenced is really thanks to Pak Robert and his team’s efforts to establish a yield curve that is not only out there, but also actively traded and therefore a very good reflection of the current risk premiums that you need to pay. The Eximbank deal was announced right after the sovereign sukuk’s pricing and was very well priced, which was a reflection of the strength of the credit as well as the benchmark that Indonesia has formed.

Rumantir, Mandiri Sekuritas: From our perspective at Mandiri, obviously we deal with a lot of local corporates as well as state-owned enterprises [SOEs]. As Aaron said, the more established the sovereign curve is, the more reference is available for non-sovereign issuers. Typically, with very few exceptions, the non-sovereign can only access tenors less than what the sovereign can access. Even Eximbank issued a seven year as opposed to a 30 year — not because they cannot but they want to match on the LM side of things. If you look at the private sector corporates, the sweet spot is even less — five, maybe seven years. So clearly there is a direct role that the government is playing by becoming a regular issuer of local bonds.

Rachman, Pelindo II: It’s always good to go the market after the government.

Moedak, Pelindo III: Yes, it’s easier to talk about.

Rachman, Pelindo II: Yes, especially the same rating.

GC: Despite the local currency requirements, can we expect the non-sovereign issuer base to continue to grow over the next couple of years?

Gwak, Standard Chartered: One of the things that we did hear being asked, when going out to meet with investors and through our trading platform, was the participation of SOEs in terms of issuance because it’s been quite a while since the SOE sector has been prolific in issuance. Obviously I would love to hear from you gentlemen what are some of the issues around that. But from an international investor perspective, now that we have a very liquid and well established yield curve for both conventional bonds as well as sukuk set by the Republic of Indonesia as well as the euro curve that it is building, why aren’t more people taking advantage of it? We have a few that have very good liquid points in the market, but we just haven’t seen more of it and investors are keen to see more of it.

Rumantir, Mandiri Sekuritas: The market has noticed that some of the previously regular non-sovereign SOE issuers have not been in the market for a few years — the Pertaminas, the PLNs, for example. Although I’m sure they’re looking at the market on a regular basis they have not been active recently. But we probably should look at this in a positive light, because: one, maybe they don’t need as much liquidity from the external offshore bond market; and two, they have alternative sources of funding.

GC: Are the much-vaunted reforms that are coming into the SOE sector, by which I mean the consolidation of various industries, making people pause to see what’s going to happen?

Rumantir, Mandiri Sekuritas: It depends on the industry sector. In the case of Pertamina, for example, obviously there’s a global commodity price that is affecting their capex. Whereas, for Perusahaan Listrik Negara (PLN) the reasons are very different. It’s very domestic. It’s very budget-driven. It’s very affordability-driven as well. So it very much differs between one SOE and the other. Another example is Bank Mandiri, which has not issued global bonds since August 2002, but has started to issue rupiah bonds totalling Rph5tr in 2016. The demand is also still high as liquidity in rupiah is ample following the tax amnesty programme, thus making issuance costs also lower. 

Gwak, Standard Chartered: Liability management activities should also be considered as part of this discussion. Standard Chartered and Mandiri Sekuritas jointly helped Pertamina do open market repurchases of some of their bonds that were a little undervalued. It wasn’t a huge amount but it was substantial enough. It was the first that an SOE had done, which we think is helpful to not only keep tabs on the market and be involved, but also to see the actual liquidity of the secondary market as well.

GC: Do you expect to see more of that?

Gwak, Standard Chartered: Liability management is always opportunistic because asset prices do go up as well as down but, yes, it is something that we feel more people should have an eye out for.

GC: Robert, why have the SOEs been so quiet over the last couple of years?

Pakpahan, Republic of Indonesia: For Pertamina they don’t have liquidity issues. They have had enough money over the last two years, despite declining oil prices. 

PLN does actually need financing because it has got assignments to build 35GW of power capacity, although they got a loan from a multilateral, which might partly explain why they have not come to market yet. But I think soon they will come to the market.

Pelindo has come in, Eximbank has come in and we will see more come in. If you look at the infrastructure development in Indonesia, around 40% will be handled by our state budget but around 25% will be built and financed by the SOEs. The state can help them with capital injections but they will need to go out and raise capital as well.

There is a lot to do — a lot of assignments have already been handed out and will be handed out that will need private financing, such as power, toll roads, ports, water, airports, rail links.  

So certainly, the demand for financing will be there. If the revenues are in rupiah then they will probably have to issue in local currency. But if they have some revenues in US dollars, like Pelindo and Pertamina have, they can issue in US dollars. But whether it’s in the domestic market or the global market, soon we will see more and more demand to issue bonds.

Moedak, Pelindo III: For Pelindo III, at this stage of our infrastructure development we don’t need foreign financing because most of the expenditure will be in rupiah. Maybe at a later stage when we need to pay for equipment such as cranes and things like that, then we will issue dollar bonds or we may use export credit agency financing also. 

Gwak, Standard Chartered: I agree with Silvano’s earlier point about looking at it from a positive perspective, and as Orias has mentioned as well, I think there are a lot of liquidity alternatives to a dollar bond. Gone are the days when a dollar bond was the only option for Indonesia. Now there’s quite a prolific domestic rupiah bond market that a number of construction companies, for example, have accessed, or are in the process of accessing. And although the tenor hasn’t yet extended all the way to that of the international bond markets, at least there’s certainly some scope for that. And we shouldn’t forget the loans and bonds discussion. The ability for banks to lend in domestic currency, as well as foreign currency onshore, has increased greatly in recent times. 

One of the things though that I do want to comment on is that, unlike some of the other emerging countries, Indonesia started out without a guarantee for its SOEs. So back in 2006 when PLN, for example, first issued, there was a debate as to whether government guarantees should be provided. But the no-guarantee option was taken, and that’s how the markets really started out. This has been very helpful on a lot of levels — it has encouraged the SOEs to stand on their own two feet and strive for good ratings, so that they can issue at better rates. And it has been good for the government from a budget perspective. It is something that is very commendable to the pioneers of the capital markets.

GC: That brings us on to the standards and requirements in international markets and the concept of ratings. Aaron: what are the extra requirements for issuers contemplating international markets. What are international investors looking for in terms of structures, maturities, ratings?

Gwak, Standard Chartered: International investors are obviously chasing one thing — yield. So the higher the yield the better. Obviously, there is a fine balance between yield and credit appetite. But in general, because there’s an underlying demand for Indonesia as a credit, that’s been very helpful. So even across different maturities, in fact, investors are very willing to participate.

Now, one of the things that we have really yet to see, from a structural perspective, is corporate hybrids, a type of deal that gives equity accounting credit for corporates that issue perpetual bonds. But most of the Indonesian companies and especially the SOEs have quite prudent leverage policies and so are not really in a position to have to contemplate such deals. 

Investors are generally incredibly liquid and looking for opportunities to invest.

GC: Does that mean their standards might drop a little?

Gwak, Standard Chartered: No, it’s not so much a question of standards. It doesn’t mean that investors are willing to see covenants start to fall away. It’s less from a demand pool perspective but more from a supply perspective.

GC: But let’s say if there was that supply, what are the requirements that the international investor will be needing from the issuers?

Rumantir, Mandiri Sekuritas: It depends whether we’re talking about first time issuers or repeat issuers. For debut issuance in the international markets but those who have access to domestic bond markets, it will still be an upgrade in terms of requirements, but it will not be as cumbersome as for a company who has never entered any bond market. 

Some of these offshore requirements are similar to domestic requirements, including ratings, documentation and disclosure, marketing materials, physical roadshows and obviously some extensive work from third parties including rating agencies, legal counsel and auditors. To some extent all these components are also required for domestic bonds but the level of disclosure is a little bit different.

Rachman, Pelindo II: I have a quite interesting experience regarding roadshows. We did a non-deal roadshow after we issued in May 2015, then last October we did a non-deal roadshow for the investors. Before we did the latest roadshow our pricing was below par, while on other issuers’ bonds the pricing was above par. However, once we had completed our non-deal roadshow we noticed our pricing had moved into line with others’. We concluded that investors value communication with the issuer, and they like it on a frequent basis. 

Gwak, Standard Chartered: That’s right. The Republic of Indonesia is certainly a beneficiary of consistent investor outreach; they have been going out to meet investors on a regular basis, and at the same time, investors feel there’s a clear channel of access to information when required. This has been the mantra Robert’s team has consistently built for many years, even through some of the more difficult times for the economy. A few years ago when the economy was going through current account issues, it didn’t stop them from going out to engage with investors. People remember that and obviously give them credit for that. So I absolutely agree that a consistent outreach and the fact that people feel comfortable that they can always access the management and get information they need, are key.

Moedak, Pelindo III: All the SOEs that want to issue foreign bonds can fulfil the requirements of international institutional investors. But another issue is the approval process for offshore borrowing. In the past we needed six high level officials including the central bank governor and maybe that made many Indonesians a bit reluctant to go through that process. Now I hear the process only requires three senior officials but I think that’s still a challenge. I suppose it means that if the company really needs the financing then the management will be prepared to go through that process.

GC:Given the amount of funding that’s going to be required over the next couple of years is that a process that people are happy with? Three is better than six I suppose.

Moedak, Pelindo III: If the company needs the funds then it will go through the process. It is a simple process, but it just needs time.

Pakpahan, Republic of Indonesia: The government is revising the regulations — they realise the need for the process to be simplified. But from the government’s perspective it is just trying to keep an eye on the amounts being borrowed — it is part of the risk management process.

Gwak, Standard Chartered: On the subject of risk management, it has been interesting to see how Indonesia has, in recent years, learned to be naturally hedged.

One of the things that could possibly open up more avenues for external borrowing is a deeper swap market for Indonesian companies. A deeper swap market can be a cost-effective way for Indonesian companies that have domestic currency needs to have access to international markets, for example.

One of the things we’ve seen is that the changing regulations have increased demand for domestic currency bonds, and that’s been very helpful. But, as with most countries, just relying on one pot of liquidity often creates challenges in the long run. Given the pace of growth Indonesia is looking at, we think having different avenues for fundraising is important.

GC: How do we go about making a deeper, more effective swap market?

Gwak, Standard Chartered: Unfortunately there is not a silver bullet solution — it will take time. But it is beginning to improve and it will certainly continue to improve going forward.

GC: Orias, you mentioned earlier that you would probably raise domestic currency bonds because your revenues are in rupiah. But if there was a deep and efficient swap market would you consider going down that route?

Moedak, Pelindo III: When I was back at Pelindo II we discussed swaps and hedging. We agreed that if the total cost was close to the domestic market we would probably stick to the domestic market. Size is of course important though — if your requirement is over Rph10tr then you are better going overseas.

GC: We’ve mentioned ratings a fair amount so far, but is an international rating always necessary when contemplating international markets?

Gwak, Standard Chartered: If you look at Asia more broadly, we have seen more unrated issuers come to market recently. Certainly, there have been a lot of Chinese names, the Lenovos of the world, for example, doing very big transactions in Reg S-only format on a non-rated basis. 

For Indonesia, certainly from an SOE perspective, the rating has helped. Having said that, Standard Chartered was involved, in 2015, with Garuda when it did a highly successful unrated $500m sukuk. Incidentally, if an issuer is not rated, having a developed yield curve very much works in its favour as investors have the platform to judge your pricing and credit. 

So is a rating useful? Absolutely. But we are increasingly finding, especially for shorter tenor issuance, that liquidity is so deep and plentiful that investors who require a rating are being outweighed by those who do not necessarily need a rating to invest, but are looking for more value.

GC: That presumably isn’t necessarily a sustainable model, though. We’ve got very benign markets at the moment, but that can change very quickly.

Rumantir, Mandiri Sekuritas: As a general rule, the liquidity pool inherently shrinks when the issue is unrated. This is due to the simple fact that a large group of investors globally, and to some extent domestically, have an internal requirement for rated issuance. Having said, that there is also the private placement market or MTNs where liquidity is not as deep as the public market but it may suit some unrated issuers. The tenor is also a bit more restricted, but it works quite well for some companies that do not yet have a ready access to the international capital markets.

Rachman, Pelindo II: One reason why we need a rating is that as an SOE we are sometimes audited by the state auditors. Having a rating for a global bond or local bonds makes it easier for us to be compared with others and explain why our pricing is higher than the government’s. 

GC:Standard & Poor’s still has Indonesia at below investment grade. It doesn’t sound like everybody’s waiting for a full house of investment grade ratings to issue — demand is such that you could probably do deals whenever and wherever you wanted. But do you think it has had an impact?

Pakpahan, Republic of Indonesia: It may have had an impact — there are some funds that have internal rules that prevent them from buying us without an investment grade rating from S&P. But I must say that so far it feels like we have been treated as an investment grade issuer by investors if you look at the high demand for our bonds and the pricing we have been able to command in the market. 

GC:Indeed, you were able to attract a huge oversubscription for your recent sukuk, despite not having an IG rating from S&P. 

Taloputra, Standard Chartered: Most of the bond indices that fund managers follow already put Indonesia at an investment grade weighting. So, like the JP Morgan EMBI index, most conventional fund managers already treat Indonesia as investment grade. Some do not of course, but that is mostly due to the degree of currency tradability and US Securities and Exchange Commission registration rather than the lack of an S&P investment grade rating. When S&P does upgrade the country we will probably see some additional inflow from non-conventional funds such as pension funds and insurance companies, especially from countries with low interest rates like Japan.

Moegiarso, Indonesia Eximbank: With regard to S&P’s rating, the Republic of Indonesia has already proven its successful sovereign global bond issuance by using its two international ratings as required for the bond issuance. So far the republic has four investment grade and positive outlook ratings — Moody’s, Fitch, JCR, and R&I.

GC: What tax reforms could help the Indonesian bond market develop?

Pakpahan, Republic of Indonesia: The tax amnesty certainly should help because there has been more than Rph100tr of assets repatriated. I know most of these assets are still placed in the banking system. According to the law they have to stay invested in Indonesia for at least three years. Some of them are still in foreign currency. They’re trying to find the instruments to channel out the asset. But slowly this money will be invested: some of it will go to government bonds or corporate bonds. So, there is potential there I think from the tax amnesty.

Other than that, there is also a simplification in the real estate investment trust sector, which in the past was subject to double taxation in Indonesia. Now the double taxation has been removed and it has reduced the tax burden significantly. That also may help capital markets, especially the liquidity in this type of instrument.

Moegiarso, Indonesia Eximbank: Perhaps some tax incentive mechanism can be considered for domestic investors, whereby the bigger amount of investment in the capital market, the bigger tax discount can be applied to the investment gain. 

GC: Aaron, you mentioned hybrid bonds earlier. But what about high yield issuers? How responsive are international markets to high yield issuers from Indonesia?

Gwak, Standard Chartered: A case in point was Indika Energy’s successful deal in early April, which was testament to the re-opening of the high yield market as a cost-effective source of funds for Indonesian corporates. Demand for Indonesia continues to be good and with the recovery of commodity prices in general, I think investors are becoming even more comfortable in putting money down. 

GC: Do you expect to see a lot more over the next six months?

Rumantir, Mandiri Sekuritas: The honest answer is: we sure hope so. But the real answer is that corporates are reviewing their options very carefully. Some of the most sophisticated corporates are fully aware of what’s happening in global markets. I think they are anticipating some asset reallocation, also in the equity side of the market  — a flight to quality and more allocation to the US. We have seen a lot more high yield issuers from Indonesia in the last two or three months than we have in the last two years perhaps and all of them, I daresay, have met with very good responses.

You have companies who went through restructuring or who come from so-called depressed industries such as mining and they’ve been able to come to the bond market with flying colours. So, if that kind of market backdrop continues that is certainly going to motivate a lot of other corporates to either consider refinancing early or just take funding from the table before the market changes. This is especially true considering the dynamic on the Fed’s policy stance, where the issue now is not only on policy rate normalisation, but also the possibility of the Fed reducing its balance sheet. 

GC:We’ve obviously had fantastic conditions in the last two or three months and I think the realists in all of us do worry that markets can turn. As I said earlier, there are plenty of reasons out there to be careful and fearful. Is there a sense that the markets will have to change sooner rather than later or can they carry on?

Gwak, Standard Chartered: In general it’s difficult to say because, as you said, the realist in you will note that cyclicality is inevitable. It depends on just how long that cycle, or curve, continues for. And there’re many reasons why one should be a little bit cognisant of what’s happening globally. We have seen that underlying demand sometimes doesn’t always go hand in hand with sentiment. So it doesn’t seem to be a concern around liquidity per se, which would support the view that this will continue for quite a while. But if you take the view that sentiment unfortunately can move quickly, then that’s what worrying more people.

GC: Is Indonesia more vulnerable to that quick shift in sentiment perhaps than other countries within its rating bracket?

Gwak, Standard Chartered: No, I don’t think so.

Pakpahan, Republic of Indonesia: Looking at the general levels of appetite and activity, investors are quite consistent — they like our credit. I remember the taper tantrum when there were outflows but things rebounded very quickly. Liquidity was always there and it was only a matter of months before things got back to where they were. 

Rumantir, Mandiri Sekuritas: Market shocks will inevitably continue to be there. We can’t be under any illusion that Indonesia will be totally isolated from market shocks. However, despite the 37% or 38% foreign ownership of government local currency bonds and roughly 50% of foreign funds in the IDX on the equity market, you have to look at the fundamentals. This is evidenced by the support from the rating agencies — despite S&P’s stance. If you look at Moody’s and Fitch they not long ago revised their outlooks on their already investment grade ratings to positive outlooks. This means that Indonesia’s rating has the chance to be upgraded to BBB in the next six to 12 months. 

GC: We’ve already mentioned sukuk and of course the sovereign recently did its blowout deal. But what can be done to further develop the market and broaden its appeal to both issuers and investors?

Rachman, Pelindo II: The issue with us, as I’ve mentioned earlier, is that our funding needs are around 13 to 15 years but the sukuk market’s sweet spot is shorter than that, around seven years. Size is also an issue — I’m not sure the sukuk market could cater for large deals such as our $1.6bn global deal of 2015. I think we would still have to go to the global conventional market for that size of funding. The local market has the same problems.  

Gwak, Standard Chartered: You diversify when you want to expand the different pockets of demand you have access to. Which is what the Republic is doing. It has access to the US dollar conventional market, it has developed the sukuk market, it has developed the euro market and the yen market. So it now has a very diverse pool of pockets of investors that it can tap into.

But if fundamentally you’re not coming to the markets often enough, then the reasons to access international sukuk are less compelling. Unless there’s a specific demand pool that once in a while presents itself, for example when Garuda came to market and accessed the sukuk markets, because Middle East investors were less dependent on ratings and there was ample liquidity support of the government SOE. But that is a specific situation. 

One of the things that have changed in the sukuk market, most recently, is the inclusion of Islamic deals into a lot of the bond indices. Previously, sukuk issues were not included in the EMBI, for example, but now they are. Indonesia’s recent sukuk was the first that was issued on a primary basis that acceded into the index. If you look at the five year tranches, the spreads of the conventional and sukuk are flat. 

Pakpahan, Republic of Indonesia: From the supply side the government of Indonesia has shown a persistence in continuously supplying sukuk, both in local currency and in dollars. Sukuk now make up 29% of our total issuance.

GC: Do you expect yields to carry on falling in Indonesia, Robert?

Pakpahan, Republic of Indonesia: I hope and I want them to fall because one of the assignments given to me by the minister of finance was to lower our cost of financing! If we look at the economic fundamentals of Indonesia I think the yield should continue to come down for our issues, for both local currency and US dollars.

Economic growth is consistently stable and high, but the most important number is inflation, which has declined dramatically since 2014. It is now slightly above 3%, which means now we have the right to ask for cheaper funding.

Gwak, Standard Chartered: Inflation and stability of the FX are contributing factors to a slow decline in yields. This begs the question of whether falling yields will put off some investors who are just chasing yield. But declining yields is a global trend so it’s all relative.

GC: Is Indonesia in that sweet spot where the ratings are good but the yields perhaps slightly richer than similar credits?

Gwak, Standard Chartered: This is correct, and inflation is under control so the real interest rate portion of it is actually quite ‘yieldy’.

Rumantir, Mandiri Sekuritas: At the end of the day, investors will calculate their risk-return analysis with other EMs. If we compare Indonesia with other EM local currency bonds, Indonesia’s government bond yields have fallen on average 80bp year to date. The 10 year nominal yield and the real yield, by which we mean the nominal yield minus the inflation rate, for Indonesian government bonds are still very attractive, as Robert was mentioning. It ranks approximately number five — the same as last year compared to other EMs in both nominal and real terms. Moreover, the rupiah is currently one of the most stable EM currencies year to date. So, there is merit for the government to ask for a bit more tightening or compression. 

GC: But will much lower yields drive SOEs into the market? It’s not so much a demand problem, more of a supply one — you don’t necessarily need to borrow money at the moment.

Moedak, Pelindo III: Yes, it comes back to the needs and at present, despite excellent borrowing conditions, we have no real foreign currency borrowing need.

Gwak, Standard Chartered: One of the things that we could see, for example, in the domestic bond markets is that as yields drop and people get more comfortable with the sovereign as a credit, then more foreign investors come into the local currency bond markets for corporates, including the SOEs. Basically going down the value chain, so to speak. It would be very positive if we, for example, saw more foreign investors coming into a Pelindo domestic currency deal. 

Those are some of the things we have yet to see, but if that happens, it would be very encouraging and would be one of the results of a very sharp or constant depression of yields. Because people would be comfortable with the country, they would understand the dynamics of the currency and inflation, but want more yield.

GC:Orias, as a domestic issuer of rupiah bonds, would you like to see foreign investors in your domestic deals? Would you care?

Moedak, Pelindo III: I think we just care about the money… but foreign investors coming in would be a good thing — it could create price tension. We are issuing bonds actually this year, we are aiming for Rph5tr in the domestic market. So foreign investors are most welcome!

GC:We’ve touched on infrastructure finance already, but it’s such a crucial issue for Indonesia, given the amount of infrastructure investment required. How can we get the bond market involved in financing Indonesian infrastructure?

Pakpahan, Republic of Indonesia: We will soon see an increasing number of SOE and corporates issuing bonds because the infrastructure projects are now beginning to be started. As I mentioned, there are several SOEs that have got assignments from the government so need to start financing. In addition, we have the PPP [public-private partnerships] projects, which I also oversee. These are the non-budget infrastructure projects. Last year 16 PPP projects were signed. Six of them have already reached financial close. These include electricity, water, toll road and fibre optic PPPs. In the pipeline, there are 21 PPPs for this year. So the combination of the SOEs and corporates and the PPPs will create huge amounts of supply in the bond markets.

Gwak, Standard Chartered: The model of recycling of capital for infrastructure projects is something that we hope to see more of going forward. Project bonds are certainly something that from an Asean Forum perspective is an important part of the agenda. We believe that investors looking for very long term investments would find it very attractive, especially because of the asset base it has. Markets will develop to get there because it makes sense for both the project owners and investors.

Rumantir, Mandiri Sekuritas: OJK [Indonesia’s Financial Services Authority] last year introduced a regulation requiring insurance and pension funds to hold at least 20% of their assets in government bonds and that will increase to 30% this year. Clearly this should increase onshore participation in government bonds. And also SOEs.

The comment I wanted to make with respect to government bonds is that this has helped stabilise the level of foreign ownership in government bonds. If you look at the net buy last year it’s roughly the same between state-owned insurance and pension funds and foreign buyers, which is why if you observe 2015, 2016 the level of foreign ownership in local currency government bonds has been stable at 37%-38%. So clearly I think this regulation is contributing.

As Robert mentioned, the second point I wanted to comment on is SOEs. OJK also introduced a rule to allow pension funds and insurance companies to invest in SOE corporate bonds to fulfil at maximum, half of the 30% requirement in government bonds. So out of the 30% requirement 50% of that they can invest in SOE bonds. 

Now clearly this will help the SOE segment and year to date there is approximately Rph3.3tr of SOE infrastructure-related bond issuances and all of this has been oversubscribed and coupons have been relatively attractive. So, the point I wanted to make is that I think the government is actively reviewing its policies to boost domestic participation in infrastructure and long dated instruments.

Financial deepening, which is a national initiative, should include not just the depth of liquidity, but also the variety of the instruments, depending on the nature of the use of the proceeds.

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