It's Blue Skies for Indonesian Bonds as Investors Wager on Yields
Indonesia's bond market is drawing a rush of foreign capital as a rare combination of the country's high yields, low inflation and a stable currency promises growth-starved global investors an attractive return.
But investors are treading carefully, choosing strategies that allow them to reap a quick and rich reward as they weigh up the inherent risks of investing in a historically volatile market.
They have two big worries at the moment.
One is that Bank Indonesia, which cut rates for the first time in nearly a year in January, might provoke a damaging slide in the rupiah currency by rushing in more easing.
The other is the possibility that the US Federal Reserve's interest rate rises or a slowing Chinese economy might trigger a destabilizing flight of capital from high-yielding markets such as Indonesia.
"In short, we like the carry. The way that we think that you want to play Indonesia is you want to buy long-dated bonds," said Desmond Soon, head of investment management Asia ex-Japan at Western Asset Management.
Global asset manager Amundi has also been long duration — which is effectively the weighted average tenor of the bond — in Indonesian bonds.
The long-dated bond strategy would be particularly handy in the event the Indonesian central bank's recent shift to an accommodative policy stance leads to a faster pace of rate cuts — a scenario that would stoke a rally in prices of back-end bonds.
The allure of high yielding Indonesian bonds, which have long been a magnet for offshore investors clamoring for a slice of Southeast Asia's biggest economy, have been further burnished by aggressive monetary easing by global policymakers and negative yields in some debt paper in Europe and Japan.
Generally, bond investors are encouraged by the combination of slow growth, inflation under the central bank's 3-5 percent target for 2016 and a narrowing current account deficit. Indonesian equities have seen no such flows, however, with foreigners bailing out in favor of domestic bonds and other products.
Its the yield
The flood of cash into the bond market since September has helped the rupiah outperform its emerging market peers and has led to a staggering response at central bank auctions of government bonds.
The rupiah has climbed 7.6 percent against the dollar since the end of September, outperforming other high-yielding emerging market currencies such as the Brazilian real, South African rand, the Indian rupee and the Malaysian ringgit.
Unsurprisingly the big draw for investors is Indonesia's high yields; at 8.1 percent, its 10-year government bonds have the highest yield among comparable emerging Asian paper.
Foreigners held Rp 578.32 trillion ($42.31 billion) of Indonesian government bonds at the end of January. They have increased their holdings by Rp 54.94 trillion in the four months to January, accelerating from an increase of just Rp 8.9 trillion rupiah in the previous four months.
"We see very good potential for Indonesian bonds to outperform the region," Raymond Lim, head of Asian bonds at Amundi Singapore said.
Central bank lesson
Indeed, the investment case for Indonesia has improved from a year ago, when an injudicious rate cut by the central bank, disappointment over President Joko Widodo's slow reforms and worries about the Fed's planned rate hike sent the rupiah down 10 percent in 2015 — the second-worst performing emerging Asian currency.
The collapse in Indonesia's main export commodities added to the misery, and while risks still remain a narrowing current account deficit has reduced the reliance on capital flows.
A relatively calm market response to the Fed's much-anticipated rate hike in December has also soothed anxious investors.
Moreover, while Indonesia's economy could do with more stimulus, ING economist Tim Condon reckons Bank Indonesia has learned its lesson after its premature easing in early 2015 roiled the rupiah and bond markets.
"So they won't cut if financial market conditions are really volatile or if the rupiah is under a lot of pressure," he said.