Government expects new bond law by March

Berni K. Moestafa, The Jakarta Post, Jakarta

The government said it expected legislators to pass a new law on bonds during their third hearing ending late March, to allow the refinancing of some Rp 3.9 trillion (about US$378 million) in bonds that mature in July.

Finance minister Boediono said on Monday the new law on bonds would provide the legal basis for the government to refinance old bonds.

The present law on bonds dates back to 1950 and requires the government to retire the bonds, meaning to pay the bearers.

"We expect the deliberation of this bill within the third hearing, given the urgency of managing domestic debts and developing a market for government bonds," Boediono said on Monday.

He was presenting the bill for the new law before the House of Representatives Commission IX, which oversees financial affairs.

Managing domestic debts is turning into a pressing issue since the government issued some Rp 659 trillion in bonds to bail out the banking sector from the economic crisis of the late 1990s.

Efforts to redeem these bonds proved to be difficult in part because of a slow healing banking sector that still relies on revenue from government bonds.

Bank Indonesia has said government bonds made up 44 percent of local banks' revenues, compared to 34 percent made on loans.

This year, the state budget must set aside Rp 59.52 trillion on interest payments for government bonds. Local banks enjoy the larger part.

Some banks have begun returning the bonds, but the government rechannels most back to other banks that are ailing.

As retiring the bonds may prove hard for the cash-strapped government, it can instead refinance them. This means issuing new bonds to cover the payment of the maturing ones.

But the success of bond issuances will depend largely on the availability of a market to absorb the new bonds.

The development of a secondary bond market is as seen crucial.

A liquid and active secondary market allows investors to buy the bonds without fear of getting locked up in their investment.

Trading in the secondary market sustains demand for the bonds, making it easier for the government to issue new ones if needed.

"Efforts to develop a secondary bond market that is active, liquid, efficient and transparent has become very important in the strategy of managing government debt papers or bonds," minister Boediono told legislators.

In time, the trading of government bonds, which carry zero risk, also helps the rating of the riskier corporate bonds.

A working rating system of corporate bonds will boost investor confidence in the bond market, generating new demand.

As demand for bonds grow, companies gain a wider access to funding sources other than those from banks and the stock market.

On the downside, refinancing government bonds instead of redeeming them requires the continued payment of interest.

Issuing new bonds on top of the existing ones also increases the state budget's exposure to fluctuation in the inflation and rupiah exchange rates.

Bonds often carry floating interest rates, the movements of which depend on Bank Indonesia's benchmark rates.

Boediono said under the bill, the government could issue new bonds only to pay for short-term financing needs, to cover the state budget deficit, or to manage its debt portfolio.