Legislating debt
Legislating debt
It is hard to understand why President Megawati Soekarnoputri
has not yet ratified the law on government debt instruments more
than one month after its enactment by the House of
Representatives. That only further reflects the lack of a sense
of urgency on the part of the government in its economic-crisis
management.
There is no legitimate reason whatsoever for delaying the
enforcement of the law, especially since the legislation had
originally been planned to come into force in June to provide
stronger legal foundations for government borrowing from the
domestic and international financial markets.
The government has set November as the new schedule for the
issuance of treasury bills and treasury bonds to refinance the
bonds issued by the government in 1999 and 2000 to recapitalize
banks. But this new schedule is again quite doubtful now after
the delay in the ratification of the law.
The law should be welcomed as the first legal foundation for
the public sector's borrowing as it governs all matters
pertaining to government debt instruments whether they are
treasury bills or such longer-term promissory notes as treasury
bonds.
The law reaffirms the people's control of the public sector's
borrowing by requiring the government to obtain House approval
for the issuance of debt instruments. Funds for bond interests
and redemption have to be allocated in the annual state budget.
Equally important are the stipulations that oblige the
government to consult the central bank (Bank Indonesia) before
floating debt instruments.
Consultations between the government and Bank Indonesia are
indeed essential to better coordinate fiscal and monetary
policies because treasury bills or treasury bonds will be issued
not only to raise funds for the state budget but also to serve as
the benchmarks for short and long-term interest rates.
The country, at present, does not have debt instruments that
can function as the real market benchmarks for short and long-
term interest rates. Bank Indonesia Certificates of Deposits
(SBIs) of one to three month tenures do serve as a benchmark for
working capital loans (short-term loans), but these instruments
are fundamentally a monetary intervention instrument used to
absorb excess liquidity from the banking system.
The government issued more than Rp 646 trillion (US$72
billion) in fixed and variable-rate bonds to bail out the banking
industry in 1998-2000. But none of these bonds can function as a
benchmark for long-term interest rates because they were issued
at par directly to the buyers, not through competitive bids.
These bonds do not reflect the sovereign risk and therefore are
not attractive to investors.
A government benchmark is needed to give bond investors a
realistic and computable assessment of risk. Without a risk-free
reference parameter given by the sovereign entity, the relative
risk profile of ordinary debtors like corporations or banks
cannot be quantified. If risks cannot be quantified, learned
investors may avoid the market altogether.
The legislation will help provide more depth to the financial
market because government bonds will become more attractive as
long-term investment vehicles for such institutional investors
with long-term liabilities as pension funds and insurance
companies. At present, domestic pension funds and insurance firms
still invest the bulk of their funds in bank time deposits.
However, the objective of creating benchmark interest rates
will not materialize if the secondary bond market remains
moribund as it is now. Additionally, investors are not interested
in holding instruments with little or no liquidity.
The new legislation therefore also stipulates rulings on the
establishment of market infrastructure to facilitate the
development of secondary markets to make bonds highly liquid. It
specifically governs the role of Bank Indonesia in developing the
bond market, especially the clearing and settlement system, to
ensure timely settlement of bond trades.
However, the enactment of the law is only the first, though
very important, step towards the development of a viable market
for government debts. Certainly, the law has yet to be
supplemented with regulations on such technical details as the
role of Bank Indonesia as the central registry and the
establishment of other market infrastructure such as trading
systems and rating agencies.
Yet more important is the establishment of an efficient
clearing and settlement system for bond trade and book-entry
registry, rather than physical delivery of bonds, to facilitate
smooth bond trade but with minimum risks.
As Indonesia now has only one rating agency (Pefindo), which
does not yet have official international accreditation,
government bonds have to be rated by international institutions
to attract foreign investors as it is these ratings that will
primarily set the bonds' discount rates.