Emerging Markets, May 2010

Indonesia’s finance ministry believes the country’s galvanized local bond market will protect it from any sudden reversal in capital inflows.

Concern has been growing about asset bubbles developing in Indonesia, with the country’s own central bank warning about the pace of inflows into Jakarta’s stock market.

But Rahmat Waluyanto, Director General for Debt Management in the Ministry of Finance, said he believes foreign capital with stay in rupiah bonds. “I don’t see there is potential danger in the near future,” he said. “We have been through many crises and there has never been a sudden reversal with investors pulling out drastically [from bond markets],” he said. Mr Waluyanto estimated that 50 to 60% of the money coming into bonds from overseas was from Indonesians keeping their money overseas, creating stability, and that the biggest institutional flows have been from long-term pension funds and insurers.

Foreigners hold 24.8% of all tradable government rupiah bonds, worth more than Rp140 trillion, compared to 14.6% and under Rp80 trillion as recently as March 2009. The market has managed to attract more than 100,000 new retail investors in the last two years and is growing in size and trading volumes. While there is some fear that an escalation of the European sovereign debt problems would lead to foreign money being pulled out of emerging markets, as happened in the global financial crisis, Mr Waluyanto claimed this would instead bolster the attraction of Indonesian bonds.

While Mr Waluyanto may be right about debt holdings, that does not address the broader concern about the stock market. In March alone foreigners bought a net Rp4.9 trillion of shares and are now believed to account for about half the market. The Central Bank has said it has studied the feasibility of capital controls to avoid more of a bubble developing, though it does not yet feel it needs them.  However Mr Waluyanto pointed out that trading volumes in the local government bond markets, at Rp 6 trillion a day, are now much bigger than those in stocks, at Rp4 trillion.

Fund managers in the region are cautious but not yet alarmed. “There are various bubbles in Asia but they are largely property related, not really the stock market,” said Hugh Young of Aberdeen Asset Management, which manages $55 billion in Asia. “However stock markets are due a fall after their rapid rises.” Goldman Sachs last month recommended investors buy Indonesian bank stocks despite climbing valuations.

From the ministry’s perspective, the inflows have been a welcome windfall.  They have allowed the country to finance not only its budget deficit but also maturing debt, allowing it to revamp its debt profile and ease a bottleneck of maturing bonds in 2014. The inflows are also pre-financing next year’s budget and have improved the country’s finances so much, Mr Walayanto said, that it is considering cancelling either a samurai or a global sukuk issue planned for later this year. “It might be counterintuitive, people giving us more money,” he said.

With the economy humming – Deutsche economist Taimur Baig sees a strong chance of “an extended period of 6% plus growth” – Mr Waluyanto said he was confident Indonesia would soon be upgraded by rating agencies. Indonesian ministry officials were due to meet Moody’s yesterday having seen Standard & Poor’s the day before. “Given they appreciate the progress we have made in managing our fiscal and monetary position, I hope there will be another upgrade.”

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