Floating treasury bonds

Floating treasury bonds

The Indonesian government's offering of Rp 2 trillion (US$223
million) in eight-year treasury bonds (T-bonds) reflects the
confidence that its overall creditworthiness is now high enough
to attract long-term investors.

Unlike the Rp 646 trillion in bonds the government issued in
1999 and 2000 directly to buyers at par to recapitalize banks and
to fund the blanket guarantee on bank deposits and claims, the T-
bonds are being assessed by buyers against the government's
credit risks. The higher the risks or the lower the government's
credit rating, as perceived by bidders during the book keeping,
the higher the costs will be for sovereign borrowing.

Finance Minister Boediono is confident that the yield-to-
maturity or average return on the T-bonds based on its interest
income and capital gains could be checked to as low as a range of
14.5 to 15 percent. Obviously, the bidding prices will determine
the fixed coupon rate the government will set for the T-bonds
that are scheduled to be issued on Dec. 24 and will be listed on
the Surabaya stock exchange on Dec. 27.

Certainly buyers are analyzing the T-bond prices against all
important factors that may contribute to sovereign default, the
most important of which are economic and political risks.
Economic risks address the government's ability to repay its
liabilities on time while political risks are related to the
government's willingness to repay debt.

A government's ability and willingness to service its local-
currency debts are primarily determined by its taxing power and
control of the domestic financial system, which provides it with
potentially unlimited access to local currency resources. These
factors in turn are influenced by the fiscal, monetary and
inflation results of government policies that support or diminish
incentives for timely debt service.

There have indeed been significant improvements in the
macroeconomic, legal and political environment that decreased the
government's credit risk.

The House of Representatives enacted, in late September, a law
governing the issuance of sovereign debt instruments that provide
a strong legal foundation for the government to issue treasury
bills (short term) and T-bonds.

The government's total debt (foreign and domestic) as a
percentage of the gross domestic product has declined sharply
from almost 100 percent early this year to about 72 percent at
present. Likewise its debt service ratio against tax revenues is
projected to decrease from 33.4 percent in 2003 to 30 percent in
2006. The rupiah exchange rate has steadily strengthened since
early this year with a cumulative appreciation of around 17
percent in the first 11 months relative to the U.S. dollar. This,
in turn, will ease the pressures from imported inflation and
reduce foreign debt service burdens.

The autonomous Bank Indonesia that is mandated to ensure price
stability will also make investors comfortable that there will be
a strong check on fiscal balances and that the government will
not monetize its budget deficit.

On the political front, the stability of political institution
and degree of popular participation in the political and policy-
making process have been improving. This, in turn, will
strengthen the stability and credibility of the government.

A successful issuance of T-bonds, which will be followed next
year by the auction of T-bills, not only will add new market-
based sources of funds for the government but also will create
real market benchmarks for long and short-term interest rates.

The country, at present, does not have such benchmark interest
rates. Bank Indonesia Certificates of Deposit (SBIs) of 1-3
months do serve as a benchmark for working capital loans (short-
term loans), but these instruments are fundamentally a monetary
intervention instrument used to soak up excess liquidity from the
banking system.

Nor are the fixed and variable-rate bonds issued to
recapitalize banks able to function as a benchmark for long-term
interest rates because they were issued at par directly to the
buyers, not through competitive bids, thereby not reflecting the
sovereign risk.

The government benchmark will in turn serve as a risk-free
reference parameter for the relative risk profile of ordinary
debtors like corporations or banks.

However, the level of T-bond prices and a steady decrease in
sovereign credit risks are important to make the debt instruments
attractive to investors. In addition, the liquidity of T-bonds,
as a trading instrument, is similarly crucial for a successful
issuance of the bonds.

Hence, the government should see to it that adequate market
infrastructure, including an efficient clearing and settlement
system for bond trading and a book-entry registry, be in place
soon to facilitate the development of a secondary market to make
bonds highly liquid.