Bank Indonesia Builds Up Bond Stocks - Mandiri

Review: Continue to rally on foreign fund inflows. Foreign fund inflows were still the dominant factor in sustaining the bond market rally. Foreign holding of the government’s rupiah bonds amounted to more than Rp239tn as of 8-Jul, increasing by Rp4.7tn from a week earlier. Thus foreign holding of the government bond was almost 35% of the total amount -the highest ever. Interestingly, foreigners are more bullish with more than Rp1.7tn (36%) of nett additional coming to bonds with tenors of over 20years (Figure 1).

IDR yield curve shifted downward, Indonesia recorded the highest return among Asian Peers. Yield curve shifted downward on average by 25bps as the rupiah bond prices rose by 1.5% on average according to MSGBI. This makes total return in the government’s local currency bonds reaching 8.7% ytd. HSBC’s Asian local currency bond index reported Indonesia (again) gave the highest return i.e. +1.7% in a week followed by the Philippines (+0.47%), Singapore (0.3%), Malaysia (0.18%), China (0%), Korea (-0.05%) and Thailand (-0.13%).

Bank Indonesia building bond stock: steps to replace SBIs as monetary tools. It is interesting to examine the bonds ownership data. Besides increasing foreign ownership, the different pattern was showed on banks’ ownership in the government bonds: after their holding fell in the last two years significantly by Rp4.4tn and Rp37.1tn, but as of early second semester this year they have increased their portfolio by Rp7.6tn to Rp224.8tn as of 8-July. In the mean time, Bank Indonesia’s ownership also declined significantly by Rp13.9tn. The outstanding reverse repo with BI has increased quite significantly by Rp19.4tn, thus we think banks actually are still net sellers of the government bonds. Bank Indonesia seems building bond stocks to make reverse repo to replace SBI as its monetary policy more aggressively this year (Figure 2). In our calculation, Bank Indonesia might buy government bonds at least Rp5tn in 1H this year. Currently total outstanding SBI reached Rp197tn as of June 2011, while Term Deposit and Bank Indonesia’s government bonds ownership has reached Rp201tn and Rp29.7tn respectively. The build-up of the bond stocks by Bank Indonesia also supports the bond market.

Government has issued more than 57% of their target. The Government planned to increase budget deficit from 1.8% to 2.1% of GDP this year in anticipation of higher fuel subsidies as a result of higher oil price. But, it it won't affect its bond issuance target as it will use the excess financing from the 2010 budget (Rp96tn), optimizing tax revenue and budget efficency. The government has issued Rp124.6tn or 57.9% of its target for FY2011. It plans to issue global sukuk amounting to US$500mn (slightly lower than previous issuance of US$650bn) in 4Q 2011. With the absence of samurai bond issuance this year, the government will issue Rp93.8tn in domestic bonds in the second semester this year. There is also Rp34.3tn in government bonds falling due in that period.

Very strong demand on latest bonds auction. Bonds auctions showed strong demand of Rp32tn much higher than in the previous auction of only Rp11.4tn. The demand was well spread to all series, except for the 10-yr FR0053 and 15-yr FR0056 that only attracted bid of less than Rp2tn, while other series got Rp7.1tn each on average. We think significant increase of bid was supported by two factors: the ebbing worries over Greek debt problem and the Indonesian government's strategy to auction more series. However the government issued 7.5tn, only slightly higher than Rp7tn target, out of Rp10.5tn maximum it can issue. The weighted average yield awarded for the 3-month and 1-year SPN were 4.63% and 5.21% with the highest yield awarded being 4.72% and 5.25% respectively. The average yield awarded for the 10-yr FR0053, 15-yr FR0056, 20-yr FR0054, 30-yr FR0057 were 7.46%, 8.19%, 8.62%, and 9.12% with the highest yield awarded 7.47%, 8.22%, 8.63%, and 9.16% respectively.

Government budget increase but net bond issuances won’t change. The government proposed a budget revision that set to increase the deficit by Rp26.4tn to Rp151tn or 2.1% of GDP from 1.8% previously. The increase was mainly to accommodate higher oil prices and increase subsidized fuel consumption. To finance additional deficit, the government will utilize unused budget from last several year (SAL) around Rp39tn, while keeping the government bond issuance unchanged for the year at Rp126tn. The government has issued Rp124.6tn or 57.9% of its target for FY2011. It plans to issue global sukuk amounting to US$500mn (slightly lower than previous issuance of US$650bn) in 4Q 2011. With the absence of samurai bond issuance this year, the government will issue Rp93.8tn in domestic bonds in the second semester this year. There is also Rp34.3tn in government bonds falling due in that period.

Trading volume remained solid. Strong demands on the last auctions while the government only absorbed in line with its target to maintain the bonds’ attractiveness in the secondary market trading. Average trading volume in the secondary market reached Rp13tn per day after auctions or 9.9tn in a week. The long-end series such as the 20-yr FR54 and 15-yr FR56 became the most actively traded security which were traded at 111.7 and 103.75 or up by 3.4ppt and 1.8ppt respectively compared with the previous week.

Outlook: increasing volatility in the near term. Lingering European debt problems and the debt-ceiling problems in the US may raise volatility in the bond market in the near term. We still maintain our yield forecast for the 2- and 10-year bonds at 7% (range 6.3%-7.8%) and 8.8% (range 8%-9.6%, 95% confidence interval) assuming BI rate of 7%, inflation of 5.7% and the rupiah at 8,450 in the end of 2011. We are more biased to lower end range as foreign fund inflows persist. With flush liquidity in banking system, bonds warehousing by Bank Indonesia and stable of supply government bonds might support IDR bond market.

Another sukuk auction. The Government will auction sukuk bonds Tuesday after canceling two auctions in the past waiting for parliament's approval on the underlying assets for the sukuk. Now, the government has additional underlying assets of Rp30.2tn, bringing the total value to Rp90tn the (government targets the value to reach Rp120tn this year). The government will auction reopening of the 5-year IFR5, 13-year IFR7, 19-year IFR6, and 25-year IFR10 on Tuesday, targeting to raise Rp1tn. Our yield curve model suggests that the fair yields are 6.35% (range: 6.31%-6.38%), 8.06% (range: 8.03%-8.09%), 8.60% (range: 8.56%-8.63%) and 8.88% (range: 8.84%-8.91%) for IFR5, IFR7, IFR6 and IFR10. Beside regular IFR issuances, the government also will issue project-based sukuk in the 2H and global sukuk in 4Q.