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.