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Indonesia's foreign bond investors getting twitchy about the rupiah

Foreign portfolio investors are showing signs of losing faith in Indonesia's ability to support the rupiah, going by their lacklustre interest in the latest government debt auction.

[SINGAPORE] Foreign portfolio investors are showing signs of losing faith in Indonesia's ability to support the rupiah, going by their lacklustre interest in the latest government debt auction.

At Tuesday's auction of bonds ranging in maturity from 3 months to 19 years, foreign investors picked up just about 10 per cent of the 10 trillion rupiah (S$1.05 billion) worth of total issuance, analysts at Maybank estimated.

That indicates a sharp drop in foreign appetite, given offshore investors bought bonds at a vigorous pace in the first two months of 2015. According to ANZ, they picked up 45.7 trillion rupiah worth of bonds via auctions and secondary market purchases, which amounted to 82 per cent of net rupiah-denominated bonds issued in January-February.

The rupiah's steady decline, along with the possibility it will fall further and faster, could be deterring foreign investors, analysts said, or it could mean that offshore investors heavily invested in Indonesian debt need a breather.

"Yields have moved lower, the currency is weakening and it's not that they can keep on buying more bonds," said Kumar Rachapudi, senior rates strategist at ANZ in Singapore.

Yet Mr Rachapudi also sees enough value in Indonesian bonds, one of Asia's highest-yielding markets, to keep foreign investors hooked, particularly given the increasing odds of more monetary easing by Bank Indonesia, which surprisingly cut the policy rate on Feb 17.

Buying protection against a weakening rupiah is so expensive it would wipe out returns on the bonds, but there are ways to minimise currency exposure by investing less in longer tenor bonds, Mr Rachapudi said.

Indonesian policymakers have gone to some lengths to convince market participants they stand ready to defend the rupiah, which is trading at its weakest levels since August 1998 - close to 13,000 per dollar - and is down 4.5 per cent against the dollar this year.

"The 12,500 level is average for a year and it is possible that it will strengthen or weaken by 3 to 5 per cent," Bank Indonesia Governor Agus Martowardojo told reporters on Monday.

Senior Deputy Governor Mirza Adityaswara has said the economy needs a competitive currency and yet, on a visit to Singapore this week, he assured bank analysts the central bank was committed to keeping the currency stable.

Not surprisingly, financial markets have their doubts, given the rupiah's volatile history and the country's heavy dependence on foreign portfolio flows. Foreigners own about 40 per cent of outstanding government bonds.

Forward rupiah markets are pricing a 7-to-8 per cent depreciation in the currency against the dollar in 12 months.

Bond yields have also fallen far, with 10-year yields now at 6.9 per cent or 140 basis points lower since mid-December. One-year bonds yield 6.1 per cent, while one-year rupiah bank deposits offer upwards of 8 per cent.

Still, Indonesia's bonds offer the highest yield after India in Asian fixed income markets and are more accessible than India's.

The prospect of rate cuts makes them even more appealing for foreign investors who can lock in the "carry" from yields of 6-to-7 per cent and then wait for capital gains as yields decline.

"Indonesian bonds make great sense from a total return perspective," said Prashant Singh, managing director and a portfolio manager at Neuberger Berman. "If you look at the carry, the potential for monetary easing and the macro backdrop, on a risk-reward basis it makes sense to be long Indonesian cash bonds."

Mr Singh, like most other investors, advises some caution because of the pressures on the currency and therefore suggests going for medium-term bonds, albeit without a currency hedge.