RI begins to rely on the market for its funding needs
Kahlil Rowter, Head of Research, Mandiri Sekuritas, Jakarta
Next year, for the first time in the last four decades, the Government of Indonesia will rely on bond issuance to finance its budget deficit. To a lesser extent the same will also take place this year. Despite its probable mild impact, the GOI need to put in place several mechanisms to ensure this exercise is successful.
In its revised 2003 budget, the government was being realistic in accepting that the deficit will probably be larger than expected. The deficit is expected to be 2 percent instead of 1.8 percent earlier expected. To a large extent the main reason will be the lower nominal GDP growth, due to a significantly lower inflation (down to 6 percent from 9 percent) while real GDP growth will probably remain at 4 percent as expected. The nominal deficit itself will increase about Rp 660 billion.
Nevertheless it is worth noting that one item in expenditure that will increase significantly is fuel subsidy. The addition of about Rp 13 trillion results from the increase in international oil prices. The bulk of subsidy is borne by the central government while the additional revenues must be shared with regional governments. Therefore the central government bears the brunt of international oil prices above the budget assumption.
More significant changes are taking place in the financing part of the budget. The lower international aid disbursement plus shortfall in privatization proceeds mean that domestic bank financing, mainly in the form of government debt operations will have to take up the balance.
In total domestic financing will increase by Rp 9.4 trillion, the bulk of which comes from debt operations. Bond issuance will be increased by Rp 4 trillion to Rp 11.7 trillion while the bond buyback program has been scaled back by about Rp 4.2 trillion to Rp 9.4 trillion. In total, therefore, government debt operation will contribute about Rp 8.2 trillion or 87 percent of the increase in domestic financing.
Next year, the amount of buyback will also be reduced to only Rp 5.6 trillion. This plus the maturing government bonds amounting to Rp 18.9 trillion will mean that the government has to prepare at least Rp 24.5 trillion for debt operations. This is why bond issuance is set at Rp 28 trillion, leaving the net addition from domestic debt operations at Rp 3.5 trillion. Add to this the planned international bond issuance of Rp 3.5 trillion to come with total net increase in government debt of Rp 7 trillion.
Although the net amount of increase in debt appears small, it should be noted that this represents a shift in debt strategy. Whereas until this year the level of debt has actually decreased due to smaller issuances compared to maturing amounts, in the future this amount will either increase or at the most maintained. Another change is the way in which debt level changes are financed. Until now cash from outside debt operations has been used to pay down the debt level.
But starting next year, due to pressure on revenues, maturing bonds will be financed by new issuances. The debt operations unit will, therefore, have to manage its cash flow internally. And, despite its size, the net addition of Rp 3.5 trillion means that for the first time debt operation will actually contribute to budget revenue.
In the future foreign financing might still be constrained by several factors, not the least of which is our own absorption capacity. And should economic growth not pickup significantly, tax revenues may not be able to sustain non-debt expenditure requirements, let alone providing enough amounts to re-pay maturing government bonds. Hence, the reliance on the market as a source of re-financing for maturing bonds, naturally increases.
The government has probably realized this early on and has prepared the primary as well as the secondary market well. Enactment of the government bond and state finance laws certainly adds to government debt credit strength. And the creation of the association of bond dealer (HIMDASUN) along with its trading platform have helped increase trading liquidity and price efficiency as well as transparency. These measures go a long way in enhancing the secondary market, which also positively impacts the primary market, mainly because the HIMDASUN is effectively a primary dealership group, although not called so.
This is made possible through having a liquid secondary market among players with similar risks and building a relationship among the group with Bank Indonesia as well as the Ministry of Finance. Not less important is the network built between HIMDASUN members and other players in the market. Although not yet acting as underwriters HIMDASUN will help ensure that any bond issuance will be successful, as long as it appeals to the market.
With a higher reliance on the market for its finance the government needs to put more consideration on the market appetite and put proper balance on this factor along with other requirements such as the goal of reducing re-financing risk. One way to do this would be to aim the buyback operations at those bond series that are less liquid and not just focusing on series that fall in certain maturity ranges.
Another would be to consider issuing shorter maturity series and in the longer term filling in the yield curve with benchmark issues. Having a more regularly scheduled auction for both the buyback as well as new issuance will also add to market certainty. It should be noted that having a more frequent auction does not necessarily tie the government's hands in issuing or buying back at pre-specified amounts. Therefore, this balances degree of freedom with a more certain and regular market. It will also impose discipline on the market as well as the government itself, both of which increase efficiency.
Like or not, without much fanfare, the government is starting to rely on the market for its funding needs. In the longer term this should be codified into a broader program of funding through the market and relying less on bilateral as well as multilateral support. This shift entails a major requirement for revamping the government's own debt as well as cash management systems and operations. And most importantly, relying on the market means catering to what the market wants.
This article is written in personal capacity