T-bonds well received

The positive reception toward the Rp 2.7 trillion (US$300 million) in eight-year Treasury Bonds, which were issued on Tuesday through the first public auction the government has ever held, reflected a higher market confidence in the government's willingness and ability to repay its debts on time.

No further details were immediately available as to which of the 42 bidders finally got the T-bonds that were about three times oversubscribed. But the composition of the bidders -- 10 foreign banks, two joint venture banks, 21 national banks and nine non-bank finance companies -- shows the wider mix of investors in the government securities.

The higher confidence in the government's ability and willingness to service its local-currency debts means stronger credibility of its fiscal and monetary management and inflation control.

There have indeed been significant improvements in the macroeconomic and political environment that affect the government's credit risk. The law on government securities that was enacted last September has provided a stronger legal foundation for the government to issue debt instruments. The government's total debts (foreign and domestic) as a percentage of the gross domestic product has declined sharply from almost 100 percent early last year to around 70 percent at present.

Likewise the government debt service ratio against tax revenues is estimated to decrease from 33.4 percent in 2003 to 30 percent in 2006. The rupiah exchange which last year appreciated by around 17 percent against the American dollar has continued to strengthen this year. This in turn will ease the pressure from imported inflation and reduce foreign debt service burdens.

The politically autonomous Bank Indonesia, which is mandated to ensure price stability, makes investors confident that the government will not be able to monetize its budget deficit.

On a negative note, though, the over-subscription also reflects the high level of excess liquidity in the banking industry, a much lower than-expected rate of credit expansion and the severely limited number of feasible viable business opportunities for investment.

The good market reception will nevertheless create a virtuous circle within the government fiscal management because it will further encourage further T-bond issues and this in turn will enable the government to repay large sums of bonds maturing within the next three years, thereby improving its debt sustainability through longer maturities. In fact, the government is scheduled to issue Rp 2.5 trillion in T-bonds and Rp 2.7 trillion in T-bills (short-term instruments) within the next few months.

A larger volume of securities will at the same time increase the liquidity in the secondary market, especially after the launching of the inter-dealer market through the Indonesian Government Securities Trading System last month. Transactions in government bonds have indeed increased from Rp 10.8 trillion a month last year to Rp 35.2 trillion a month during the first three months.

The weighted average yield of 12.21 percent resulting from the competitive bids for the T-bonds that carry a fixed coupon of 12 percent was slightly lower than the 12.40 to 12.50 percent range expected by analysts but was slightly higher than the 12.10 to 12.20 percent yield of government bonds in the secondary market one day before the auction. The yield also was 81 basis point higher than the central bank's benchmark one-month interest rate last week.

The yield reflects investors' expectations that inflation will be checked at a single digit, the rupiah exchange rate will remain stable at best or slightly depreciate at worst, and the central bank will further slow the incremental decrease in the interest rate.

So all in all, as the yield is an average of expected future interest rates plus some sort of risk premium, the new primary issue of government securities through a competitive bidding should be welcomed as they created a new market gauge to predict economic trends such as the rate of economic growth, inflation and changes in monetary and fiscal policies.

The government benchmark will in turn serve as a risk-free reference parameter for the relative risk profile of ordinary debtors like corporations or banks.