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.