Bullish corporate actions to spur growth in capital market

Indonesia has just wrapped up its first direct presidential election, raising optimism over the country's economy under the new government. With such confidence, the corporate sector is now gearing up for expansion and seeking fresh funds from the capital market to finance their activities.

To get an expert opinion on how the country's capital market could develop in the next couple of years, The Jakarta Post's Rendi A. Witular spoke with Suresh L. Narang, managing director/ chief country officer of Deutsche Bank Indonesia.

The following are excerpts from the interview.

How do you see the bond market industry in Indonesia?

This year, as you know, we have led two U.S. dollar-bond deals, one is the government US$1 billion sovereign issue and a $300 million bond issue by Bank Danamon.

The unique feature about the government's sovereign bonds was that people tend to look at country ratings, and the rating for Indonesia is B according to Standard & Poor's (S&P). When we went to the international bond market, Indonesia is not a frequent issuer of such bonds. This is the first time after 1996 that the country has actually joined the market again.

The deal was priced at 277 basis points of the U.S. Treasuries, and the spread was tighter than other countries that were rated higher in paying the rate for their bonds.

For example, there is a country in Southeast Asia which is rated BB+, but it has been consistently paying more than what Indonesia has paid.

Of course once the sovereign bond is priced, it will serve as a benchmark, and all other issues from the corporate sector will benefit from the competitive rate given.

This is a resounding success and shows confidence by investors towards Indonesia. With 277 basis points, investors believe that Indonesia is closer to a BB or BB+ rating than from the current rating of a straight B.

There is a large gap between how investors see Indonesia and how the rating agency rates the country. It is quite possible that the rating will rise after this election.

If you look at 1997 and 1998, almost all capital market investors shut down for Indonesian issuers because the country had a rating of below C, and confidence was a bit shaken.

But after Megawati Soekarnoputri took power, there was a return in stability with three factors seen as essential in returning the confidence; currency stabilization, lower interest rates and easing inflation.

It is difficult to predict whether it is going to be higher or lower next year, but I imagine it will be higher because of a better business climate after the election. Normally, when the investment climate gets better, companies feel confident in expanding. They will need funding for their plan, whether through bonds, loans or equity.

How do you see the impact of another possible increase in the U.S. interest rate on the capital market?

Well you can look at two things, one is the Fed Funds, which is 1.75 percent now and one is the U.S Treasury yields, of which the 10-year yield is 4.03 percent, lower than in the beginning of the year.

When we priced the government's sovereign bonds, the 10-year yield was 4.07 percent. The yield after having gone up and down a bit in May and June, has actually remained at the same level.

So what happened is the gap between the short-term rates and the longer-term rates in the United States have actually come down.

To what extent it affects Indonesian interest rates? I think we have to watch and see. Most Asian central banks, not just Bank Indonesia, have been able to afford not to raise the interest rates because they think that it may impact the economic recovery.

However, the impact of the rate hike in the United States will still be manageable, and it depends on the U.S. Treasury yields, because if the gap between short-term rates and long-term rates starts shrinking, the borrowing cost of companies may not go up because if you issue 5-year bonds or 10-year bonds the price is based on U.S. Treasuries and not U.S. Fed Funds.

How about the position of the Indonesian bond market in Asia?

If you look at the profiles of issuers in terms of volume, South Korea is the largest issuer of foreign currency bonds in Asia, excluding Japan and Australia, close to 50 percent. Indonesia, with a total of about $1.9 billion has 5.3 percent of the total Asian bond market.

I think the market share of Indonesian issues in Asia tends to increase because the level of corporate activities -- mergers, acquisitions and expansion -- will increase. I believe bond issues from Indonesia will reach more than 5 percent next year.

On the local side, the bond market will still be dominated by government issues. The total amount of recap bonds and treasury bonds issued in the last three years has reached between $45 billion and $50 billion.

So with such market capitalization, the Indonesian bond market is actually larger than many others in the Asian market, such as Thailand and Malaysia. I see bigger prospects for the development of government bonds.

Why are you interested in the equity business in Indonesia?

We have already secured a seat at the Jakarta Stock Exchange now. Maybe in the next two or three months all the operational arrangements for starting the equity business will be completed and we will launch our equity businesses.

Generally, we will focus on institutional investors from offshore. The essential thing for us is to propagate the Indonesian market to the foreign investors as we are confident with the country.

In terms of valuation and future multiple earnings, the Indonesian stocks are still undervalued. So there is still room to go up.

Our decision is prompted by the availability of our infrastructure in Indonesia. We already have supporting operations here such as commercial banks, debt capital market businesses and custody business. Since we have all the infrastructure needed, why not expand?

The attractive sectors in the equity market are palm oil, oil and gas, mining and resources. These are the sectors where you will continue to see either expansion or acquisition for the next couple of years.

What problems do you see in the equity market?

On corporate governance, I think in terms of transparency it is getting better with many companies disclosing their annual report via the media. In terms of law enforcement, that will take a long time. This is not a problem that can be sorted out in one day.

I think the important thing is that as long as the direction is positive, and as long as the government is taking action to mitigate the hardship of an unpredictable legal system with questionable decisions, I think it will remain positive for the investors.

It takes conservative, yet sustained efforts to improve the market. As long as the government appoints the right people in the right places and makes the right decisions and actions to improve that, and as long as the perception is there, I think it will continue improving.