Mon, 07 Mar 2005

Fuel price hike to have little effect on bond market

Urip Hudiono, The Jakarta Post, Jakarta

With sound monetary policies in place to keep inflation and the local currency under control, the recent fuel price hike is unlikely to create major ripples in the local bond market, an analyst says.

The bond market's yields and prices, Standard Chartered Bank economist Fauzi Ichsan said, would therefore continue to be attractive to investors seeking an alternative to putting their money into low-interest time deposits and the riskier stock market.

"The reaction of bond yields is likely to be modest," Fauzi said in the bank's latest economic report on the country's economy.

"Yields will spike up a bit, but will then come down again."

The bank is predicting that the yield on the 5-year government bond will continue to decline to 9 percent by the end of the year from the current 9.5 percent, and 10.1 percent at the end of 2004.

A rise in inflation resulting from the fuel price hike could create a domino effect as regards prices and yields -- or rate of return -- of bonds.

If inflation rises and forces the central bank to raise interest rates, bond yields would eventually have to rise to keep them attractive.

Indonesian Bond Traders Association chairman Yudhi Ismail is predicting such a scenario, saying this would result in a greater burden on the government in redeeming its sovereign bonds, which would require more taxpayer's money.

Fauzi explained, however, that the government's recent decision to hike domestic fuel prices would only result in a modest rise in inflation as it had actually been widely expected.

"The rise in inflation itself will only be temporary -- perhaps for only three months after the hike -- as it is only a one-time administrative action rather than sustained pressure on the prices of goods," he said.

Estimating March's year-on-year inflation to rise to 8.5 percent -- as compared to February's year-on-year rate of 7.15 percent as recently reported by the Central Statistics Agency, Fauzi said that year-on-year inflation would fall back again to 6.8 percent by the end of the year.

Inflation would be kept in check as Bank Indonesia has consistently maintained its tight monetary policy by absorbing excess liquidity and avoiding having to raise interest rates, he added.

"As long as the rupiah can be maintained at a safe level below Rp 10,000 per dollar -- which is highly likely -- then inflation will remain in check," he said.

"Last week's weakening of the rupiah was not due to the fuel price hike, but more to external factors in the form of rising global oil prices and the tug-of-war between the dollar, the euro and the Japanese yen," he said, predicting that the rupiah would likely strengthen to below Rp 9,000 to the dollar by the end of the year.

The rupiah closed at Rp 9,350 last Friday, down from Rp 9,270 the previous day.

The government plans to hold its third bond issue later this month on March 29, the finance ministry's Director General of the State Treasury Mulia Nasution recently said, targeting Rp 2 trillion (some $215 million) in proceeds.

In two earlier bond issues, the government managed to take in Rp 3 trillion in 12-year fixed-rate bonds last month, and Rp 5 trillion in 10-year bonds in January.

The government also plans to issue $1.5 billion worth of dollar-denominated international bonds later this year.