S ’ AOESIDNN I BOND MARKET CHALLENGE...for RPJMN 2015-2019, BAPPENAS internal analysis. 2Indonesia will be the world’s 4th largest economy by 2045. Source: Jakarta Post, Mar 2017.

territory while its bond market capitalisation was

18% in 20164. This ratio is among the lowest in

Asia. A further breakdown reveals that corporate

bonds account for a mere 2.5%. The bulk was

driven by government debt issuance.

Hengky Tambunan

Head of Fixed Income

Eastspring Investments, Indonesia

MARKET IN USD BN IN % OF GDP

Gov Corp Total Gov Corp Total

Japan 8966 671 9637 195.2 14.6 209.8

Korea 703 1011 1714 48.1 69.2 117.3

Malaysia 141 119 260 51.5 43.4 94.9

Singapore 133 97 230 47.1 34.2 81.3

Thailand 222 81 303 55.3 20.3 75.6

China 4974 2155 7129 46.4 20.1 66.5

Philippines 80 18 98 27.5 6.2 33.7

Vietnam 42 2 44 21.1 1 22.1

Indonesia 139 23 162 15.1 2.5 17.6

INDONESIA’S BOND MARKET CHALLENGE

In Jakarta, an imported orange can cost

much less than a homegrown one. As bizarre

as it sounds, it is unfortunately a consequence

of Indonesia’s notoriously high logistics costs

arising from inadequate infrastructure. While

the Jokowi administration has prioritized

infrastructure spending, there are state budget1

limitations. The private sector needs to fill the

funding gap; an effective way is to tap a wider

investor base through capital markets but

these are currently notably underdeveloped.

If President Jokowi is to achieve his economic

vision2, Indonesia’s financial landscape has to

develop, diversify and evolve for the future.

CURRENT STATE OF PLAY---------------A country’s banking sector is usually the main

channel for capital distribution. However being

overly reliant on bank lending is a risk. External

financial shocks can trigger a systemic banking

crisis and impact the economy via credit disruption.

Indonesia falls into the bucket of countries with

a bank-dominated financial sector. When it comes

to the breadth and depth of the financial sector,

Indonesia lags its Asian counterparts. Its bank

deposit as a % of GDP is a paltry 38% (most Asian

countries exceed 100%), its pension plan, insurance

and mutual fund assets to GDP3 are in single digit

Fig. 1: Indonesia lags its Asian peers - Bond Market Capitalisation is a mere 18%5

Broadening the financial base not only

supports the country’s economic development

but also enhances financial stability and reduces

vulnerabilities to exchange rate shocks and

sudden capital outflows.

A World Bank Group research6 has shown

that emerging market countries with robust

government bond markets were better able

to withstand the 2008 global financial crisis,

averting major economic dislocations and

helping its firms and citizens maintain financial

solvency and liquidity.

A TWO-WAY STREET IS NECESSARY---------------Well developed markets not only have a diverse

group of institutional and private investors but also

boast a variety of both government and corporate

bonds. To work towards this goal, the Indonesian

government can take a number of steps.

First and foremost, government-related entities

or state-owned enterprises can lead the way by

taking a prominent role in bond issuance and

diversifying their funding sources. Asian countries

serve as an example; Cagamas, the largest issuer

of debt instruments in the Malaysian capital

market was established as a joint venture

between the government and the financial services

industry. It issues corporate bonds and sukuk

to finance the purchase of housing loans and

receivables from financial institutions, selected

corporations and the public sector. In Singapore,

three of the five largest corporate issuers are

government-related companies.

Next, education plays an important role; private

companies can be shown the benefits of issuing

bonds to meet their long-term financing needs. In

a rising rate environment, the fixed interest rate

payment obligation of a bond is a major advantage

for corporate bond issuers. A bond also allows one

to raise capital without diluting the shareholder

value that comes with additional share issuance.

Some markets with underdeveloped capital

markets have even thought about restricting the

proportion of borrowings by large corporates from

banks to encourage the use of corporate bonds

and commercial papers although this may not be

well received by the business community.

Broadening the investor base has to work in

tandem. Currently Indonesian banks are the largest

investors in the local bond market although most

of it is in government securities. Best practice

dictates that banks hold a portion of their assets in

liquid securities to fulfil their risk-weighted capital

adequacy needs. Given this inclination, the option

is to promote the growth of domestic non-bank

financial institutions (“NBFIs”) such as life insurance

companies and pension funds. Compared to banks,

NBFIs tend to hold much larger portions of their

investment portfolios in corporate bonds relative to

government bonds, probably in pursuit of higher

yield. Countries with the most developed corporate

bond markets tend to be those with the most

developed NBFIs.

Improving the liquidity is another way to

promote the bond market. More can be done

to encourage investors to adopt a mark-to-

market and trading culture which will help boost

secondary market liquidity. To this end, better

infrastructure, transparent credit ratings and less

restrictive investment policies in pension and

insurance funds would spur demand and broaden

the investment base for corporate bonds.

Lastly, investor diversification can also be

Fig. 2: Concentration risk in Indonesia - Top 30 largest corporate bond issuers account for 77% of total issuance in 20167

100

80

60

40

20

0

China

39%

77%

63%57%

51%

89%

55%

Indonesia Korea Rep. Malaysia Singapore Philippines Thailand

cultivated at the retail level by disseminating

policies to incentivise the middle class population

to place savings in mutual funds, investment-linked

investment products and pension schemes.

CHALLENGES AND CONSIDERATIONS ---------------Reducing the role of banks in Indonesia’s

development funding is a key priority for

Indonesia’s government and the Bank Indonesia

(BI). On the other hand, one cannot totally

sideline the banks. Active bank-led repo markets,

for example, assist in the development of bond

markets by deepening secondary market liquidity.

A well-functioning repo market is a precondition

for feasible market making system by dealers.

In theory the suggestions stated above seem

straightforward but implementation is never easy.

Investor confidence, for example, can be an issue

given the past history of bond defaults. To rebuild

confidence, the local credit rating agencies (CRAs)

must be reliable, objective, independent and

transparent. Proper regulatory frameworks must

be in place to improve the accountability of CRAs

and a consistent methodology has to be applied in

the credit rating assessment process. Currently the

OJK, the supervisory agency of CRAs only performs

inspections on the adequacy of the system and

procedure and does not supervise the contents of

the credit rating reports.

One quick win to improve liquidity and spur

demand is to open up the corporate bond market

to foreign investors. On the flipside, greater

international financial openness may make the

economy vulnerable to volatile international capital

flows that may threaten domestic financial stability.

Policymakers should thus consider financial stability

issues before considering this option. Ensuring a

stable macroeconomic environment is essential to

maintain a growing participation of foreign investors.

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Sources: 1Indonesia’s estimated approximately IDR 4,800 trillion (or USD 370 billion) of infrastructure investment between 2015-2019. The central and regional government budgets can only contribute 41.3% of the total, while Indonesia’s state-owned enterprises (SOE) can only contribute 22.2%, implying the remaining 36.5% needs to be supported by the private sector. Ministry of National Development Planning (Bappenas), Republic of Indonesia and JICA, 2014: Background Study for RPJMN 2015-2019, BAPPENAS internal analysis. 2Indonesia will be the world’s 4th largest economy by 2045. Source: Jakarta Post, Mar 2017. 3OJK Indonesian Financial Service Authority data as at 2016. 4Asian Development Bank data as at Dec 2016. 5ADB per Dec 2016. 6Public Debt Management in Emerging Market Economies: Has This Time Been Different?, World Bank, Policy Research Working Paper No. 5399, 2010. 7ADB per Q2 2016.