Investing in bonds in the Year of the Rooster

Investing in bonds in the Year of the Rooster

Erwin Este, Contributor, Jakarta

It took only 20 minutes for tsunamis to destroy on Dec. 26,
2004 parts of Aceh and North Sumatra. Survivors, however, may
never forget the devastation of that day.

The government has divided post-tsunami relief efforts into
three stages: the emergency stage, the phase of rehabilitation
and, finally, reconstruction.

It is expected that the entire process will take about eight
years. Though people directly affected by the tragedy will take
much longer to come to terms with it.

Obviously, both manpower and funds are essential to rebuild
Aceh. In this regard, several important questions are raised:
What will the impact of the tragedy be on the national economy,
and on the international market? Moreover, what will the impact
on the bond market be, which has lately shown signs of renewed
vitality.

Economic indicators throughout 2004, as shown by data released
by several financial institutions, were very encouraging.

The finance ministry's year-end evaluation showed economic
growth of 5 percent, higher than many observers' predictions of 4
percent. Bank Indonesia has suggested that in 2005 the country's
economic growth will reach 6 percent.

Though this year's growth figures can only be predicted, stock
market activities have shown rapid developments. The stock price
index could back this argument.

Toward the close of 2004, the Jakarta Stock Exchange's
Composite Index reached 1,000.23 points -- an outstanding
achievement not previously matched. The index jumped by 44.56
percent from 691.90 recorded in the previous year.

When President Susilo Bambang Yudhoyono was sworn in, the
JSX's Composite Index fell by 6.63 points from 840.79 recorded
the day earlier (Oct. 21, 2004). This did not last long, however,
as since October last year, the index has jumped to 1,000.

The tsunami catastrophe did not alter the position of the
price index. On Jan. 7, 2005, almost two weeks after the tragedy,
which claimed over 100,000 lives in Indonesia, the index hovered
around the level of 1,032, up by 32 points from the beginning of
the week.

The bond business has also shown positive signs over the past
two years, a condition that is expected to last.

Reports released by a number of financial institutions have
supported this trend. According to the Indonesian Pension Funds
Association (ADPI), there is a downtrend among its members to
invest their pensions in bank deposits.

Two years ago, pensioners felt more secure investing their
pensions as deposits. As many as 70 percent of ADPI members
preferred to deposit their money. However, this activity has now
shown a downturn.

In 2003, as many as 57 percent of the association's members
deposited their pensions, and in 2004 that percentage was even
lower at 30 percent. The ADPI has predicted that in 2005 the
percentage will drop further to just 20 percent.

Where do these pensioners invest their money? Of course, in
bonds. As much as 12 percent of the total funds were invested in
bonds in 2003 and, this year, the figure is expected to reach 25
percent.

Not just corporate bonds but government bonds are attractive
to investors. Two years ago, only 8 percent of the funds were
invested in the government bonds. A year later, the figure
reached 31 percent. As for this year, the ADPI predicts that it
will further rise to 35 percent.

Therefore, Bank Indonesia governor Burhanudin Abdullah said
that the country's macro-economic condition would be stable
throughout 2005. He said that the inflation rate would be about 6
percent, as the government has predicted.

The tragedy in Aceh has put huge financial demands on the
country. Minister of National Development Planning Sri Mulyani
Indrawati said that the period between 2006 and 2009 would be a
critical period of financing.

According to her calculation, some US$4.5 billion is needed.
Half of this would come from the state coffers. So far, the
government has channeled Rp 50 billion to Aceh from the state
budget.

Where will the other half of the funds come from? It is
expected that they will come from foreign aid. The countries in
the Consultative Group on Indonesia (CGI) have agreed to extend
US$5.1 billion in aid to Indonesia, a commitment expressed in the
14th meeting of the CGI held on Thursday Jan. 20, 2005.

This commitment does not include various grants and aid from
many other programs. However, not all these funds will be
allocated to Aceh. Part of the funds will be spent on covering
the 2005 budget deficit, which is expected to be around US$3
billion.

The government will also rely on the issuance of treasury
bonds. The target is that this bond issuance will bring in Rp 2
trillion. If everything goes smoothly, said Director General of
the State Treasury at the Finance Ministry Mulia Nasution, the
government would issue these treasury bonds late this month.

Short-term bonds will be an option to serve as a source of
funds. Mulia said the government was gearing itself toward
issuing these bonds, better known as treasury bills. Of course,
the market will happily absorb them.

As in the past, investment managers will shortly include the
issuance of government bonds in their working agenda.
International debt portfolio hunters in the global market will do
likewise.

These people are very fond of short-term one-year bonds, like
the Indosat foreign exchange bonds, which rose in price from 103
to 106 (or from 3 percent to 6 percent of the nominal value)
within a short period. Medco foreign exchange bonds have also
increased in price from 101 to 104.

The prospect becomes even better as Standard and Poor's raised
Indonesia's debt rating from B to B+ on Dec. 22, 2004. It is just
a slight increase but it shows foreign investors' positive image
of Indonesia. "Aside from the tsunami, Indonesia's performance is
still attractive," stated a report in the International Herald
Tribune on Jan. 11, 2005.

Nevertheless, investors still have to practice prudence if
they wish to deal in bonds in the Year of Rooster. The
government's burden of payment plus bond interests is getting
bigger. According to the finance ministry, up until Dec. 2004,
debts from government bonds reached US$ 1.4 billion.

Director of the World Bank for Indonesia, Andrew Steer, openly
said that they included the problem related to government bonds
in state banks as among future investment problems.

He said, a "poor tendency" had been shown in the management of
these state banks as the banks were still worried about
channeling loans. In fact, loan channeling is needed to set the
real sector in motion. Once the real sector is moving, it will
fuel the growth of the capital market.

Therefore, members of House of Representatives have begun to
suggest that the government should be frugal in its spending. If
necessary, the government should cut "unnecessary" spending
altogether. It can, for example, postpone the payment of bank
recapitalization bond interest, which totals Rp 60 trillion a
year, although the bonds have entered the market.

If this suggestion is heeded, of course this will have its own
impact on the banking sector. At least, the banking sector would
lose some of its stability, given the fact that these banks, even
after they have been recapitalized, still rely on the
government's recapitalization bonds.

Another problem in investment will be the government's plan to
increase fuel prices by 40 percent. This fuel price hike will
negatively influence a number of other factors that determine the
course that investments take. The inflation rate, for example,
will increase following the fuel price hike.

A higher inflation rate will in turn trigger the movement of
the interest rate and an increased interest rate would prompt
Bank Indonesia to take action. These factors will later determine
how you should invest your funds. --- The writer is a Jakarta-
based capital market analyst.