Market shuns T-bonds

Market shuns T-bonds

Indonesian enterprises, which sorely need working capital to
raise production rates amid heightened consumer confidence, may
have to wait a longe time before significant bank lending
resumes. The reason being recapitalized banks seem unable to sell
the treasury bonds (T-bonds) which currently sit on their balance
sheets as quasi capital.

Even though the government, beginning on Feb. 1, allowed the
trading through the Surabaya stock exchange of about Rp 19
trillion (US$2.6 billion) of the Rp 282 trillion in treasury
bonds issued last May to recapitalize banks, the market sentiment
seemed very weak. The stock exchange's director Anton
Natakoesoemah said last week there had so far been only one bid
for the government bonds, but no transaction was closed as the
bidder, wanting Rp 5 billion in bonds, asked for a 20 percent
discount. That seems strange, especially since the bank
recapitalization bonds are the first rupiah debt instruments
issued by the government since the 1950s.

Moreover, both the political and macroeconomic conditions now
appear conducive for reviving the bond market, which has been
virtually lifeless since mid-1997 when the rupiah melted:
political stability has been strengthening; the central bank's
benchmark interest rate has fallen to 11 percent from as high as
25 percent last June; inflation is down to less than 3 percent
last year from more than 70 percent in 1998; and the rupiah rate
has been stabilizing at a range of Rp 7,000 to Rp 7,300 to the
American dollar. The central bank has forecast inflation this
year at 5 percent to 7 percent, economic growth at 4 percent and
the rate of the rupiah at an average Rp 7,000 to the dollar.

What went wrong? Natakoesoemah shared analysts' views that
lack of familiarity with the scriptless trading process for bonds
and the low yield on T-bonds, compared to that offered by
corporate bonds, were the biggest barriers to bond sales.

The 12 percent interest rate on the fixed-rate T-bonds and the
2 percentage-point to 3 percentage-point premium over the central
bank's one-month benchmark rate set for floating T-bonds seem
unattractive indeed, compared to 17 percent to 17.5 percent
yields offered by corporate bonds.

There seems to be three alternative ways out of this impasse.
Either the banks sell the bonds with a large discount; the
government raises the yield on the fixed-rate bonds to decrease
the gap between the yield on the T-bonds and corporate debt paper
to a maximum of 2 percentage points; or, the central bank itself
goes to the market to buy the bonds.

But none of these solutions appears feasible now. Selling
bonds at big discounts means raising bond prices and pressuring
interest rates at the expense of the central bank's concerted bid
to steadily push down interest rates. It is, likewise, almost
impossible for the government to raise the bond's yield, as this
would sharply increase its domestic debt service burden, which
for the next fiscal year (April 2000 to Dec. 2000) alone is
estimated at Rp 42.3 trillion. Neither can the central bank
absorb the bonds by itself, as such a move would surely cause
tremendously strong inflationary pressures and unsettle the
rupiah rate.

The dilemma, though, is that if banks cannot sell a portion of
the bonds soon, they will have to rely mostly on the bond's
interest income, which is certainly not adequate to enable them
to resume lending -- so far still the biggest source of income
for most banks in the country. In fact, a longer delay for banks
to get additional liquidity by selling the bonds would threaten
to erode their capital base and eventually devastate the costly
bank restructuring program. It should be remembered that the
recapitalized banks, though in number only accounting for less
than 10 percent of the whole banking industry, make up more than
80 percent of the whole industry's assets.

Given the urgency of the problem and the real threat to the
survival of recapitalized banks, the government should intervene
immediately to kick start T-bond trading. Ordering cash-rich
government institutions such as the Jamsostek labor welfare fund,
the Taspen civil servant pension fund and several state
insurance companies to soak up a great portion of the bonds would
be an effective first step to break the ice.

Increasing the liquidity of T-bonds through active trading
would not only inject fresh funds to recapitalized banks to
generate lending, but would also set a long-term yield curve or a
long-term benchmark interest rate for rupiah debts because the
longest maturity period of the central bank's debt papers
(certificates, or under its local acronym SBI), currently the
only benchmark for interest rates, is only three months.