RI's debt spurs bond market development

RI's debt spurs bond market development

JAKARTA (Dow Jones): Indonesia must push ahead to develop an active bond market as the cost of bailing out the crippled banking sector on the government becomes almost unmanageable, analysts say.

State coffers are straining from the burden of a massive bank sector bailout which began in 1998, after decades of profligate lending brought most institutions to their knees.

The finance ministry has issued around $65 billion worth of bonds to recapitalize ailing banks. The cost of servicing the bonds is forecast to total a quarter of government revenues next year, expanding the budget deficit, and making Indonesia more dependent on foreign donor loans to fill the gap.

By developing a more active secondary bond market, Indonesia could attract the private sector to help refinance government recapitalization bonds which start coming due in the next couple of years, analysts say.

"The secondary bond market is very important to deal with refinancing problems two years down the road," says Bert Hofman, the World Bank's chief economist in Jakarta.

But Indonesia has fallen behind other crisis-hit Asian countries in promoting its bond market, analysts say.

While Thailand's central bank, for example, has won plaudits for its development of a bond market, Indonesia has been slower to get its act together, partly due to the severity of its political and economic crisis.

Government bonds currently account for a whopping 50 percent of Indonesian banks' total assets after one of the largest government-led financial sector bailouts in history.

The banks are unable to sell the bonds, as even the most risk- prone investors would demand huge discounts on book values as a sweetener to buy Indonesian assets at a time when the country remains in political chaos.

A bomb in the Jakarta stock exchange, which left 15 dead earlier this month, has hurt sentiment toward President Abdurrahman Wahid's government, and kept the rupiah off 20 percent from levels at the start of the year. Any investment in rupiah-denominated assets at the moment carries a huge currency risk, analysts say.

"I don't think investment will come from foreign investors because of volatility in the rupiah," says Pieter van der Schaft, a fixed-income analyst at Barclays Capital.

Selling at current market prices is impossible, as it would lead to capital losses for the banks, and the need for more government assistance.

This means banks are unable to turn bonds into liquid cash, and get back to the business of lending again as the economy recovers.

Between February and July there were only seven government bond trades on the secondary market, the central bank says. In August there was a pick up to 30 trades, but this is still pitifully little compared to the likes of Thailand.

Bond market illiquidity also means the government could face huge refinancing problems over the next couple of years when the first of the recapitalization bonds start coming due.

Indonesia is already stretched to meet the current interest payments on its debt, and remains largely reliant on foreign donor aid to meet its budgetary needs.

Indonesia's central bank could make greater efforts to create a more liquid bond market, which might attract back braver foreign investors in search of high yields, analysts say.

Most of the recapitalization bonds come due in three and five years, which is deterring foreign investors that don't want to get stuck with illiquid assets.

Under its September commitment to the International Monetary Fund, Indonesia has promised to issue shorter-term government securities of six and 12 month tenures to replace some of the recapitalization bonds.

"What they're trying to do is sell shorter-term bonds which will hopefully be much more market friendly," says Sumiyoshi Toru, a Japan government-sponsored adviser to Bank Indonesia.

Foreign investors may be interested in the one-year bonds if they carry yields of around 15 percent-16 percent, which would offer a risk premium over comparable Asian sovereign debt, says Vincent Low, a credit analyst at Merrill Lynch in Singapore.

Paying higher rates on government debt will, however, further increase the pressure on state finances, analysts point out.