Indonesia's bond market escapes E. Timor turmoil

Indonesia's bond market escapes E. Timor turmoil

HONG KONG (Dow Jones): Indonesia's dollar-denominated bonds haven't shown much reaction to the turmoil in East Timor, but the debt market remains concerned about events in the troubled Southeast Asian country, say analysts.

Spreads for Indonesian sovereign bonds, which aren't widely traded, have widened mildly since rioting broke out in the distant Indonesian province over the weekend.

Thursday, the Indonesia 7.750 percent 2006 was quoted at 630/600 basis points over Treasurys, up from Friday's 600/570 basis-point spread.

While the debt market's reaction is far less than the 13 percent drop the rupiah has seen since Monday morning, it comes amid a broadly pessimistic mood already settling onto the market. Indonesia's critical presidential elections, the Bank Bali scandal and lagging economic growth were already weighing heavily on sentiment, say analysts.

Before the chaos in East Timor broke out, Salomon Smith Barney's sovereign analyst Stephen Taran predicted spreads on the Indonesian bonds would gradually widen in the second half "until political certainty returns."

"In the short-term, the possibility (for worsening spreads) is definitely there," says a Singapore-based Asia strategist with a U.S. investment bank. "Things are not going to get a lot better in the next two to three months."

The turmoil in East Timor comes just as investors and analysts were growing more comfortable with the country's economic story.

"If it weren't for the uncertainties raised by East Timor, I would say there's real positive movement in the economy," says one Hong Kong-based fixed-income analyst with a major U.S. investment bank who asked not to be named.

"It's almost a shame that these developments in East Timor have occurred. It revives a lot of uncertainty and investor skepticism, just when things on the economic side were looking brighter," this banker says.

Earlier this year, some market watchers and investors were growing increasingly positive on Indonesia. The sentiment was punctuated by the smooth conduct of national elections in May.

Looking to the short-term, analysts say they'll be closely watching any moves by international aid agencies to suspend disbursements to Indonesia, as well as the government's plans to renegotiate US$6 billion in Paris Club debt.

Both the International Monetary Fund and the World Bank have raised the possibility of withholding previously approved loans to Indonesia, which are critical to keeping Indonesia's economy going.

The World Bank Wednesday warned Indonesia that a failure to resolve the chaos in East Timor could threaten about US$5.9 billion in international donor aid for Indonesia pledged last July, while the IMF said Indonesia has "every interest" in ensuring the process in East Timor unfolds smoothly and without violence.

A mid-September IMF mission now appears to be in doubt, which suggests the next planned disbursement of around $460 million of the IMF's $12.3 billion loan is also in doubt.

Any postponement in multilateral loans could raise questions about Indonesia's ability to meet interest payments on outstanding dollar-denominated debt, including the Indonesian bonds, some analysts say. However, others play down this possibility, saying Indonesia's foreign exchange reserves, at US$15.82 billion, are adequate for meeting any interest payments on public debt.

Investors are also troubled by the prospect of Indonesia technically defaulting on its publicly traded floating rate note due February 2001.

Although such a possibility was raised earlier this year, Coordinating Minister for Economy and Finance Minister Ginandjar Kartasasmita this week was quoted saying the government is formally requesting Paris Club creditors to reschedule $6 billion in bilateral debt for the period up to the fiscal year ending March 30, 2001.

The Paris Club, if it follows a precedent established last year with Pakistan, is expected to demand eurobond holders, which are normally excluded from such rescheduling, to be included. Indonesia has already rescheduled $4.2 billion in debt that fell due in the current fiscal year.

Nevertheless, analysts say that while they expect some weakness in Indonesian bonds, the paper is likely to hold up relatively well despite serious questions about the country's political and economic direction.

"Investors (in Indonesia) have a pretty healthy risk appetite. They're not going to panic. They're in there looking for significant upside," says Scott Wilson, sovereign analyst at Warburg Dillon Read, adding that debt restructuring could provide that upside.

"You're going to see some marginal weakness, but I don't think it's going to be a lot of selling," he said.