Foreign buying of Indonesian govt bonds at record, but risks mount
HONG KONG, March 8 (Reuters) - Foreigners have raised their investment in Indonesia's government bond market to record levels this year, giving the country the benefit of the doubt for now as the lure of returns too attractive to ignore offset increasing risks.
Foreigners have also pitched in to the stock market, betting that Jakarta will be more concerned about accepting inflows to fill a gaping current account deficit than imposing controls that might support its shaky currency by limiting outflows.
"There is no way they are going to stop money coming in - they still have currency issues," said Wee Khoon Chong, interest rate strategist with Societe Generale in Hong Kong.
So far this year, investors have bought more than $3 billion in Indonesian government bonds and stocks. Their bond holdings are at a record high of more than $29 billion, representing a third of the overall market. About $1.65 billion has flowed into stocks.
The foreign investment has helped hold the rupiah steady around 9,680 per dollar this year after a 6 percent slide last year made it Asia's worst performing emerging market currency among those monitored daily by Reuters.
On the face of it, Indonesia presents impressive investment numbers. The main stock market index is up 12 percent so far this year and trading at record highs.
Indonesian 10-year government bonds fetch 100 basis points over equivalent Philippines debt, 160 bps over Thailand and 380 bps more than AAA-rated Singapore.
"It is quite costly to underweight this market versus the index and given the yield on Indonesian bonds," said Aberdeen fund manager Kenneth Akintewe.
Still, analysts suspect the positions are being kept on a short leash as investors see a number of risks building up.
"Indexed investors are still underweight on Indonesian bonds relative to benchmark indices because of the potential that the business cycle shifts to a less market-friendly inflation and current account trend," said Sid Mathur, a UBS strategist in Singapore.
The major concern for investors is the government's hefty fuel subsidy bill, which cost $22 billion last year and contributed to a $24.2 billion current account deficit because of the need to import oil.
With presidential elections due in 2014, they do not expect the government to cut them back, so the bill will weigh on the current account this year and chip away at Jakarta's hard-earned reputation for fiscal discipline.
The current account deficit was the first since the Asian financial crisis in the late 1990s. Although the gap was partly offset by capital and other financial accounts, the balance of payments surplus was hammered down to $165 million in 2012 from $11.9 billion in 2011.
Further pressure this year could see the country eat into some of its foreign exchange reserves of $109 billion.
Even a government surprise of cutting back on the subsidies by raising domestic prices would be a double edged sword. Such a move would offer relief for markets, but equally concern that it would boost short-term inflation, which already topped 5 percent in February, a 20-month high.
"The strong portfolio flows have had the effect of limiting the rupiah's decline so far this year," said currency strategist Thio Chin Loo of BNP Paribas in Singapore. "The inflation outlook and rising political risk pose a threat to these flows continuing. We expect the rupiah to weaken given these factors and given the crowding in Indonesian assets," she said.
To be sure, not everyone is downbeat. HSBC strategist Pin Ru Tan recommends investors adopt overweight positions in Indonesian government bonds.
"Investors should extend duration for maximum yield pickup given that inflation is not a key concern at this juncture and current account deficit fears have been well factored in by the market," said Tan.
In addition, many see longer-term investment value in Indonesia, with an economy growing around 6 percent a year and a vibrant work force. Half of Indonesia's population is aged below 30.
Foreign ownership of government bonds has been steadily rising since 2009 from around 15 percent and was bolstered further when Fitch and Moody's upgraded the country's credit rating around the turn of 2011/2012.
"The investor base of Indonesian bonds has broadened over time to include more buy-and-hold players, including central banks, sovereign wealth funds and global real money investors. In contrast to fast-money players, these investors tend to take a long-term view on economic fundamentals," said Desmond Fu of Western Asset Management. ($1=9,700 rupiah)
(Additional reporting by Adriana Nina Kusuma in JAKARTA; Editing by Neil Fullick)