Municipal bonds: A feasible strategy?

By Achmad Mukhtar

JAKARTA (JP): When the laws on regional autonomy and fiscal balance were announced, two new catchwords become popular -- autonomy and municipal bonds. What do they really mean, and are they workable in the domestic bonds market?

Income per capita has fallen sharply, unemployment has risen steadily, and political dilemmas loom -- all this seems to contradict the promotion of municipal bonds, which has increasingly worried the International Monetary Fund.

There are a number of reasons why the issuance of municipal bonds needs much better preparation and time before being put into action. Firstly, our domestic financial market is declining.

The market for domestic bonds had not functioned well even prior to the crisis, and with a falling income per capita, bonds are unlikely to attract investors. Demand has declined significantly and the new issue of bonds has had to offer higher interest rates, and implicitly higher risks too.

Consequently, domestic interest rates will rise, and when local governments issue their municipal bonds, known as munis in the market, there will be fierce competition in the bonds market among local governments, as well as between the government and the private sector.

As a result, there will be a crowding-out effect in domestic investment in the sense that some private companies cannot compete, and will delay or even cancel their planned investment.

Other factors that are worth considering include the fear of the impact of municipal bonds, alongside the unstoppable increase in the domestic minimum wage and poor domestic labor management, which has aggravated some companies in the manufacturing sector of shoes, toys and garments. They have now relocated factories to other countries such as Cambodia, Vietnam, or China.

In addition, the independence of the central bank is still a question mark among investors. "Independence" (kemandirian) could mean a "semi independent" central bank -- a signal for higher inflation, for the simple reason that the central government has its own budget constraints.

Given the government's tough burden in keeping to the budget, and given a budget deficit, along with restricted sources of income from printing money and issuing new bonds, a non- independent central bank could easily finance the deficit.

This is a real threat to economic stability as domestic interest rates will rise further, to keep the real interest rate acceptable to investors.

On the other hand, a policy of rigid capital movement will only stimulate currency counterfeiting and substitution, diminishing hope for a full recovery.

A further reason is that if we look carefully at the laws on regional autonomy and fiscal balance, it seems there is no autonomy at the regional level except autonomy in issuing municipal bonds.

Local government autonomy means freedom for local governments to utilize their economic resources to maximize productivity through sound economic management.

When freedom to utilize economic resources is still unclear, issuing municipal bonds becomes a boomerang for the whole economy. It is not a self-fulfilling prophecy that we will have another economic and political disaster, though it is likely to occur from a misconception in economic policy.

Finally, foreign capital is still the prime engine of the economy whether we like it or not, and most foreign investors are worried about the rule of law in this country.

Uncertainty will continue to keep foreign investors away as any research will prove a waste of time, be it for direct investment in the real sector or a portfolio investment in the capital market.

As one struggling in the private sector, I really wonder what the government is doing to crank up the engine of the economy, to get back on track to compete with the reviving economies of regional competitors, notably Thailand and South Korea.

It seems that we are wasting valuable time.

The writer is an investment strategist at Evergreen Capital, Jakarta.