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.