Indonesia has long been a source of both excitement and dashed hopes for debt bankers and bond investors. The sovereign is highly-regarded in the international bond market, and Indonesian corporations are a strong source of dollar bond supply across the credit curve. But the country's domestic debt market is still small, and although foreign investors have proven hungry for rupiah exposure in the past, the opportunities have not been large enough for banks or corporations inside the country.
There are signs, however, that investors in both markets, inside and outside the country, may have some exciting times to come in the next few years. The Islamic bond market, although still nascent, is an obvious source of growth for the future. The country's huge infrastructure need will create hurdles, but it will also create rich opportunities for those able to overcome them. These twin sources of future growth dominate conversation among bankers, issuers and investors in the country at the moment.
It is little surprise they did the same when Asiamoney sat down with some of the most prominent figures in Indonesia's capital markets for a discussion of the issues impacting the country's investor base now — and how high those investors' hopes are for the future.
Panelists:
Soufat Hartawan, head of fixed income, Schroder Investment Management Indonesia
Fadlul Imansyah, group head, investment, BPJS Kesehatan
Simon Imanto, chief financial officer, Panin Dai-Ichi Life
Suminto Sastrosuwito, director of Islamic financing, debt management office, Ministry of Finance of the Republic of Indonesia
John Simon, treasury & capital market director, CIMB Niaga
Atsi Sheth, senior vice president, sovereign risk group, Moody's Investors Service
Nor Masliza Sulaiman, global head, capital markets, CIMB
Kiyoshi Nishimura, chief executive officer, Credit Guarantee Investment Facility
Moderator: Matthew Thomas, contributing editor, Asiamoney
Asiamoney (AM): The Republic of Indonesia is one of the best regarded emerging market sovereigns in the international funding markets. What can offshore investors expect from the country in the next few years?
Suminto Sastrosuwito, Ministry of Finance: The current issuance strategy is built around our commitment to a front-loading approach to funding. That means 63% of our issuance is expected to be complete in the first semester. We are on track with that target, and as of this week, the current issuance percentage is around 54%. We expect the remaining 9% to be filled partly by an auction later this month, but also by euro bonds.
In terms of medium-term strategy, we expect to gradually reduce the level of budgetary deficit as well as debt to GDP ratio. We want to make sure we can guarantee fiscal sustainability in the future, so we are aiming to achieve a debt level of around 22-23% of GDP, compared to the 26% that we are seeing now. Despite the fact that we will decrease our debt to GDP ratio in the medium term, the gross issuance is likely remain at around the current level. In addition, we would still maintain our presence in foreign currency markets.
We have long been a frequent issuer in the dollar market, and at the moment we are talking to investors about a euro-denominated transaction. These markets are important to us, and we will certainly continue to be a regular issuer for foreign investors in the future.
AM: How strong is Indonesia from a credit point of view at the moment? Should investors anticipate a ratings upgrade in the near-term?
Atsi Sheth, Moody’s Investors Service: We look at the Indonesian credit story in a global context, because after all that is how foreign investors are going to be looking at this country. It is important to make that point from the outset: we primarily compare Indonesia to other countries in credit terms, rather than to itself five years ago or even longer ago. We compare it to countries like Turkey or India, which are also rated Baa3, or to Brazil and South Africa, which are both rated a notch higher.
These countries are often grouped together as 'the fragile five', but we don't think they're fragile and, for the most part, the market doesn't think they're fragile either. All of these countries have gone through a pretty serious situation in terms of capital flow volatility. But there are two major factors that have played in Indonesia's favour relative to its peers, especially this year.
A clear change has been the election of a new administration. That has buoyed the market, because of the expectation that structural reform will build growth in Indonesia's economy. But the second part that really makes Indonesia stand out relative to its peers is a history of very good fiscal performance. Since the Asian financial crisis, very few other countries have maintained primary surpluses and low budget deficits like Indonesia has. That has brought its debt-to-GDP level down from over 80% to around 25% today. That is really positive.
There is one key factor that constrains Indonesia's rating, however. If you compare Indonesia's budget deficit or debt level to India, which has the worst fiscal profile of the five countries I mentioned, it looks incredibly strong. But only 5% of India's debt is financed in foreign currency or externally. For Indonesia, that number is between 40% and 50%. Indonesia cannot fund itself domestically. The domestic market is relatively shallow, and our stance is that even if you have a very strong fiscal policy, and a very strong credit profile compared to your peers, you can still be held back by a shallow domestic market.
AM: Indonesia has long been regarded as having immense potential when it comes to Islamic finance — partly, of course, because of the large Muslim population, but also because of the eye-catching growth in the economy. But by and large, sukuk issuance remains a rarity in the country. What does the government need to do to encourage more sukuk issuance, particularly in the corporate sector — and when do you see this happening?
Suminto, Ministry of Finance: The government needs to focus on increasing supply in the market, but of course we closely look at the demand-side too. The sukuk market cannot develop in a vacuum. For instance, we need more participation from Islamic institutions. At the moment, Islamic investors only represent about 7% of demand for the sukuk bonds that have been issued here. The rest is being sold to conventional investors.
It is expected that sukuk issuance will be around 23% of our total issuance this year. This could increase gradually in the future, but the main consideration of course is going to be on the demand side. The government's commitment to increase the size of sukuk in the market still has to consider the demand side that could affect the pricing. If the increase of sukuk issuance is not in line with the increase in demand, clearly we should continue to have to offer an additional spread on sukuk compared to our conventional bonds. That clearly limits the extent of quite how much we can shift our funding from conventional to sukuk bonds.
John Simon, CIMB: The government's shariah-compliant bonds are gaining traction with bond investors. We saw the demand from investors for the recent 10-year bond and it was clearly much stronger. But there are, of course, still things we can improve. It is important to create a sense of a level playing field for issuers in this market.
The dominant financial accounting policy does not allow us to hold shariah bonds under the AFS [available for sale] portfolio at the moment. We have to put them under HTM [hold-to-maturity]. I've heard this is going to be revised, and from January, we will be able to hold shariah bonds under AFS. This is something that would help attract investors to the market.
If shariah-compliant bonds can go into the AFS portfolio, there is the chance of capital gain. But in HTM, we don't have that opportunity. That simple change could make a big difference to the willingness of investors to participate in this market.
Masliza Sulaiman, CIMB: We have definitely been passionately supporting the sukuk market with issuer and investor education and efforts to improve sukuk liquidity and we will continue to do so. It is important to encourage higher participation of investors in sukuk. Here, there are two main issues. For borrowers, there is a lack of clarity in terms of tax neutrality. That clarity should be encouraged so there is no ambiguity for issuers considering the sukuk market. For investors, there is still an issue on demand which affects secondary liquidity. Investors should be agnostic when it comes to sukuk versus conventional bonds but the majority of investors are still not really committing to this market. We are working hard to encourage investors that this market is going to be important to them in the years to come.
Kiyoshi Nishimura, CGIF: We should be able to provide a guarantee to a sukuk instrument. We have not done that yet, but our understanding is that as long as the underlying assets are shariah-compliant, there is no need for the guarantor to be shariah-compliant. This is an area we could expand into in the future.
AM: What are the major problems that investors feel are holding them back from greater investment in shariah-compliant bonds? Are there still major hurdles you need to clear before you can dedicate more capital to this market?
Soufat Hartawan, Schroder Investment Management: We have been observing the sukuk market in this country for the last few years. The trend seems to be that the market is developing very slowly, and it is true that a lot of investors are still not committing to this market. But part of the problem is also that the investable universe is not very large.
That said, the performance of our sukuk fund has been good over the last few years, and in some cases better than our conventional funds. We are steadily promoting our sukuk funds to our clients, although the nominal amounts are still small compared to our conventional funds.
Fadlul Imansyah, BPJS Kesehatan: Our portfolio operates on an absolute return basis. It does not matter to us whether it is conventional or sukuk. It needs to hit our absolute return targets in order for us to consider it. But the major challenge is the small size of the market. I agree with Pak Soufat on this point. Indonesian investors are talking about this market a lot, but given how small it is, it is hard for them to dedicate significant resources to it.
Simon, CIMB: There are certainly positive signs. Indonesia's debt management office used to like issuing bonds in new series, in both the conventional and the Islamic bond market. But one change that has been quite positive is that the government has begun to commit more to reopening existing series. That will start to help liquidity in the sukuk market.
Simon Imanto, Panin Dai-Ichi Life: This would help. The sukuk market needs more liquidity. There really needs to be more issuances to create a deeper market before investors like us will start to seriously consider buying more sukuk. It is natural for investors to compare sukuk directly with conventional bonds, and when the conventional bond market is much deeper and offers a lot more diversity, it is clearly going to be more attractive.
Simon, CIMB: The conventional market is, of course, much more developed than the shariah-compliant market. There is always this question of: what's in it for me if I turn to the sukuk market? There needs to be something that entices investors to go in to this market. There is no choice but for issuers, including the government, to provide this sweetener in the market. This is something that is going to stay for a while. Tax breaks would help, too, but for now, we need to be able to provide a yield boost to attract investors.
Imansyah, BPJS Kesehatan: There certainly needs to be something to draw investors to the market. I would like to see us go in the direction of Malaysia and offer a tax relief for sukuk investors, as Pak John mentioned. This is something that could apply to the infrastructure market, too. It is an easy way to give investors in the bond market an incentive to invest in sukuk and infrastructure bonds, both areas that the government is hoping to boost in the next few years.
Sulaiman, CIMB: I agree that there needs to be work done on both the investor and issuer markets. An increase in sukuk supply will definitely help to deepen the local sukuk market and enhance investor familiarity in investing in sukuk. It can be confusing to the corporates here that the sukuk law that was passed in 2008 only applies to the government. It would help if the law included state-owned enterprises and other corporates, removing the ambiguity on structures that would otherwise incur additional taxes.
AM: We talked in the last panel about the need to increase infrastructure spending, and the huge opportunities in that sector. But where do investors stand with regards to increasing maturities, which is a key requirement of increasing greater infrastructure spending? And, more generally, are you optimistic that there is enough demand here to ensure the development of an infrastructure bond market?
Hartawan, Schroder Investment Management: Over the last 10 years, the Indonesian bond market has become one of the most volatile domestic debt markets. This is partly because foreign investors make up around 40% of the investor base in the rupiah market. But while volatility is not always welcomed, it does provide opportunities for local investors to time the market. Indonesian investors are quite familiar with managing volatility, which is one of the factors to consider when buying long-term bonds.
Indonesia's credit market is far from ideal in terms of diversification. Around 70% of local bonds are issued by consumer finance companies and banks. We need to see the universe of issuers here become more balanced, and an increase in infrastructure spending is one key way that we are filling the gap. I'm optimistic that infrastructure projects will get good demand in this market, as long as they come with strong credits and sensible plans.
We have seen a lot of initiatives by the government in terms of establishing infrastructure funds that specialise in financing this area. We would like to see such institutions become more active, and issue bonds to investors more frequently. It makes more sense to let these infrastructure institutions finance the projects and bond investors have exposure to these institutions. That means we do not have to go through the complex study of infrastructure projects. It will make investors much more comfortable.
Imansyah, BPJS Kesehatan: We have an absolute yield target for our fund, but we also have some risk buffers. We need to have at least a rating of A-minus for any corporate bonds we are going to invest in. We also need to compare whether the yield the bonds offer is better than the deposit rate we have from banks. That is very challenging at the moment, because market volatility has made deposit rates in some cases more attractive than bond yields.
We are going to require more yield to invest in long-term bonds. But the reality is that most of the infrastructure companies that are hoping to turn to the bond market will probably give lower relative yields to shorter-term bonds, when you make an allowance for the difference in maturities. These companies are well-rated. They will not want to give generous yields to investors, so there are going to be a lot of deals that institutions like us will avoid. We do not mind whether deals are long-term or short-term, but the yield has to be there.
Atsi Sheth, Moody’s Investors Service: We look at infrastructure development in a lot of countries and one of the things that comes up time and time again is the gap between what kind of financing rate is viable for the direct investor and what kind of financing cost is viable for the risk investor, who is often lending for long maturity profiles. One of the ways to mitigate that risk, which Liza mentioned earlier, is having contracts with a high degree of sanctity. Malaysia has done that very well, but in Indonesia that is still quite nascent.
The role that is played by multilateral institutions to mitigate that risk by offering guarantees is very important, too, but we should not overlook the role of the sovereign. There is often a spending plan that doesn't actually get activated. That is a risk in Indonesia, and is something we have seen in the Philippines as well.
Imanto, Panin Dai-Ichi Life: We manage two major portfolios, which we call a unit-linked fund and a traditional fund. They are quite different from one another. Our unit-linked fund of course depends on the policyholder choices relating to asset type, in particular fixed income. From 52 companies that we see, there are 12 that are managing the bond investments themselves. The rest are just investing in mutual funds. That means there is a lot of potential for the bond market to grow further.
The objective of these unit-linked funds is very return-focused. But it is quite unique and complex to manage: we have to match the currency, of course; we have to manage the return; but ultimately, we have to manage the assets and liabilities as well. Right now, the liabilities are longer than the assets.
There is a mismatch for investors like us when it comes to duration. We need more issuances in the long-term because this is a situation any fund manager would be aiming to avoid. Life insurance companies will certainly benefit from more long term bonds, and infrastructure projects could help fill the gap here. There is a natural fit.
Nishimura, CGIF: This gap of long-term funding required for infrastructure financing in Indonesia is quite an interesting topic to consider. The comparisons with Malaysia have already been discussed, but one of the things to note is that in Malaysia around one-third of bond investors are pension funds. Pension funds are only around 5% of the bond investor base here. That is one limitation that this market faces, but with the rapidly growing insurance sector here we should see another obvious source of long-term funding coming into the market. We would certainly like to use our guarantee to help create more long-term investment in this country.
Sulaiman, CIMB: Long-term investment in Malaysia is driven by mutual fund managers as well as pension and insurance funds. The key reason is liquidity. They do not necessarily want long-term exposure, but when liquidity is present, they can be confident that they can turn-over their bonds when they need to. This is one of the reasons why there should also be more focus on increasing liquidity in Indonesia, it naturally helps make investors more comfortable in participating in longer dated maturities.
Suminto, Ministry of Finance: The government can certainly help create, and benefit, more long-term investors. This year we issued conventional bonds with a maturity of 2044, and sukuk with a maturity of 2043. We are allowing investors to push out their investments a bit. But what we have seen, at this point, is that only a few funds can absorb that sort of long-term issuance. The development of pension and insurance funds is very important to create longer-term sources of investment, not just for corporations but for the government as well.