Domestic bond market lucrative for investors

Reny Eka Putri

The global economic slowdown continues, as reflected in several key indicators. The International Monetary Fund has revised down its global economic growth forecast for 2019 to 3.2 percent, lower than the rate of 3.6 percent achieved in 2018.

Investors have become more selective in investing their funds, as the global economic slowdown has pushed major central banks to cut their benchmark rates. Market players tend to direct their funds to safe haven assets, such as hard currencies (such as US dollar, Japanese yen, Swiss franc), commodities (such as gold and oil) and investment grade-rated bonds.

As one investment option in the domestic market, bonds are still worth collecting. The domestic bond market remains attractive due to a combination of external and internal factors. The prospects of economic slowdown and the absence of higher interest rate risks in developed countries have prompted foreign capital to flow back into the domestic market. The US Federal Reserve is leaning toward cutting the federal funds rate due to lower US economic growth expectations and a lower-than-expected inflation rate.

In September 2019, the US inflation rate was recorded at 1.7 percent, leaving room for further interest rate cuts. This year, the Fed has cut its benchmark interest rate by 50 basis points (bps) — 25 bps in July and 25 bps in September. In Indonesia, stable economic activity and inflation continue to support the performance of the capital market.

The government has a target for the net issuance of Rp 381.83 trillion (US$27 billion) worth of government bonds (SBN) in 2019. At present, net issuance has reached Rp 354.63 trillion, or 92.9 percent of the full-year target. The largest share is rupiah-denominated bonds, issuance of which reached Rp 443.36 trillion.

In the fourth quarter, the government is still targeting to offer Rp 101 trillion through eleven auctions, although it will only need Rp 27.2 trillion more to reach the target. With eleven more auctions, the government’s target can be met by offering around Rp 2 trillion to Rp 3 trillion worth of SBN per auction.

In 2019, inflows of foreign funds to the domestic capital market reached around Rp 190.6 trillion, namely Rp 140.3 trillion to the bond market and Rp 50.3 trillion to the stock market.

According to Finance Ministry data from Monday, total tradable SBN ownership amounts to Rp 2.69 quadrillion. Of this figure, foreign ownership was recorded at Rp 1.03 quadrillion or 38.4 percent of outstanding SBN, followed by the banking sector with Rp 631.4 trillion or 23.5 percent and pension funds holding Rp 251.1 trillion or 9.3 percent.

Most foreign investors still have appetite for government bond instruments with tenors of more than five years. In October, 35 percent of the bonds owned by foreigners has tenors of 5 to 10 years, while SBN with tenors of above 10 years accounted for 34 percent of foreign holdings.

In an effort to strengthen the performance of the domestic bond market, the government implemented several marketing strategies as it seeks to broaden the investor base. In addition to drawing foreign investors' interest by providing a number of bond instruments with attractive tenors and yields, the government also continues to issue individual or retail bond instruments on a regular basis as an alternative investment that can be owned by the public and could get domestic investors to hold more bonds.

In the first three quarters of 2019, eight series of retail bonds were issued with a total value of Rp 36.4 trillion. Supportive market demand for bonds is indicated by a decline in yields of benchmark bonds for all tenors. Bond yields with 10-year maturity decreased by 79.7 basis points from the beginning of the year to the level of 7.23 percent as of Monday. At the beginning of the year, bond yields for the period of maturity were still at the level of 8 percent due to the high tension of the trade war between the US and China and the absence of a downward interest rate trend.

Going forward, we still see a sustainable flow of investment funds as the main driver for the domestic bond market. This can support market liquidity. Investor confidence can be improved with the support of several positive catalysts from the domestic economy this year. With prudent fiscal management, the supply of domestic bonds will be maintained in line with the 2019 state budget deficit target of below 2 percent.

More support will come from the monetary side, as Bank Indonesia is expected to cut another 25 bps off its benchmark rate. Furthermore, rupiah volatility is expected to be lower than in 2018, and the currency is expected to strengthen to around 14,100 to 14,300 against the US dollar until the end of the year. Foreign fund flows into the Indonesian bond market will support the 10-year rupiah bond yields at the range of between 6.8 and 7.3 percent in 2019. Hence, the domestic bond market can continue to develop and play an important role as an investment tool as well as the source of state budget financing.

As a developing country with a potentially greater market share, Indonesia still needs strong sources of investment to sustaining national development. Therefore, capital flow management must be consistent and effective to have an optimal impact on the Indonesian financial system in the long run, so that it is not vulnerable to external shocks.

The writer is a senior quantitative analyst at Bank Mandiri.