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The dramatic drop in the prices of rupiah bonds brings back
memories of the market crash triggered by the U.S. subprime mortgage
meltdown.
At that time -- back in August -- the government's rupiah bond yield
index rose to 9.815 percent. After that, however, yields declined.
But in November yields started to rise again, with the government bond
index increasing from 9.019 percent in early November to 10.194 percent
at the end of the third week of the month. This is the index's highest
level of the year.
One ramification of high yields is that it has reduced the desire of
companies to issue bonds. This is because high yields make bond
issuances more expensive. Some bond issuances have been postponed. All
in all, we estimate that between Rp 4 trillion and Rp 5 trillion of
corporate bond issuances planned for 2007 have not been realized.
These bond issuances are likely to be postponed until next year. As
such, it is likely that the total amount of corporate bond issuances in
2007 will fall short of the previously anticipated Rp 32 trillion.
As of the end of October 2007, rupiah corporate bond issuances stood at
Rp 28 trillion. And given the current conditions, there are unlikely to
be any more issuances until the end of this year, we believe.
One of the most important factors for corporations in deciding on
whether to issue bonds is developments in the interest-rate arena. This
is because bond issuers seek to lock in a lower cost of servicing the
debt.
This occurs when bond issuers believe interest rates are at their
lowest. To achieve this goal, companies can issue fixed-rate corporate
bonds. These bonds also prove attractive to investors, since they have
a lower required yield when interest rates are low.
As we can see from the table, declining interest rates are followed by
a significant increase in corporate bond issuances. This shows that
there is a strong negative correlation between interest rates and the
amount of bond issuances.
For more than one year now interest rates have not increased. As such,
some may wonder why the bond yield has been so volatile and risen so
much.
To answer this question, it is necessary to have an appreciation of the
elements determining the bond yield. In this regard, there are two
elements: the market interest rate plus the risk premium. This risk
premium is a cushion to cover the risks shouldered by the investor who
has purchased the bond. Thus, changes in the risk premium affect the
bond yield. This shows that volatility of the risk premium is
accompanied by volatility in the bond yield.
Rising investor risk perceptions toward Indonesia's credit quality is
reflected in the increase in the price of the Indonesian sovereign
credit default swap (CDS).
The CDS is a derivative instrument to hedge credit risk on a specific
investment asset. The CDS seller acts as the guarantor for default
risk, while, on the other side, the buyer of the CDS attains default
protection on a specific instrument.
When the subprime mortgage crisis erupted in the United States in
August, the CDS price rose significantly as did the price of Indonesian
sovereign CDS. And the price of CDS rose again on Nov. 7, following
sharp increases in world oil prices. This reflects the risk that
sky-high crude oil prices will push up global inflation.
In short, then, it can be concluded that the increase in rupiah bond
yields is attributable to heightening risks toward the Indonesian
economy stemming from the threat of rising inflation.
Looking ahead to 2008, the outlook for bond issuances will be
determined by the interest rate trend at that time.
Under an optimistic scenario, we expect that the benchmark BI-rate can
be cut to a level of 7.5 percent. This scenario assumes that the
Indonesian central bank, together with the government, can rein in
inflation to between 5.5 and 6 percent. Nonetheless, much will depend
on developments in the crude oil markets.
If the oil price remains stubbornly above US$90 per barrel, for
instance, then it will be difficult for the central bank to cut rates
lower than 8 percent.
Fortunately, if interest rates remain at the current level, or even
decline, investors are unlikely to seek a higher required yield on
holding corporate bonds. Moreover, it should also be noted that the
risk premium has stood at a relatively high level since 2005.
Hence, if interest rates remain at their current levels, or even
decline further, then we are optimistic that corporate bond issuances
will be as sizable in 2008 as they were in 2007.
And as regard the Rp 17 trillion of corporate bonds that will mature,
most are expected to be refinanced. As such, we expect corporate bond
issuances to reach between Rp 25 trillion and Rp 30 trillion in 2008.
Much hinges, however, on the government's ability to keep inflation in
check. This is crucial since the central bank would be faced with
hiking interest rates if inflation does pick up. And, at the same time,
of course, it is also important for the government to manage investor
risk perceptions toward Indonesia. All in all, next year promises to be
a very interesting year for the corporate bond market.
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