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Rupiah sovereign bonds beckon

NEIGHBOURING Indonesia has always offered immense potential. A vast population of 260 million with a relatively young demographic, working population that is expected to peak only in 2030 and low penetration of products and services.

In particular, the penetration of financial services such as insurance and mortgages is as low as 3 per cent. And less than 40 per cent of its adult population has a bank account. The above translates into captive demand to support economic growth for easily another few years.

The reality, though, is more nuanced. Looking just at its equity market, returns over the past two years were 16 per cent in local currency. In Singapore dollars, though, they were a paltry 2 per cent. The rupiah has been a major bugbear for foreign investors. Until it is deemed structurally more stable, led by higher foreign reserves and an improving current account, taking a longer buy-and-hold stance on Indonesia's financial assets is a tough call.

For novice investors, a more appealing and less burdensome approach is to gain exposure through rupiah sovereign bonds. Interest rates in Indonesia have always been far superior to Singapore bonds. The largest risk thus comes from currency volatility.

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At present, Indonesian government rupiah bonds look attractive on a risk-reward basis (that typical disclaimer for any investment recommendation). In response to weakness in the rupiah, the country's central bank has raised policy interest rates five times this year, by 175 basis points. This has widened the spread between Indonesian and Singapore 10-year bond yields by 100 basis points in just one year, to around 5.7 per cent.

Other reasons for finding its bonds attractive include:

  • A return of five percentage points above inflation on a real-yield basis, as our chart suggests. And Indonesian bonds offer the highest real yields in Asean;
  • Opportunities for inflation to slide further following oil price's recent retreat;
  • Potential improvements in its current account with the downtrend in oil prices, as it is a net importer of oil. Some 40 per cent of its current account deficit this year is due to its net oil imports;
  • The government's fiscal health will improve through lower oil subsidies;
  • GDP growth still stable at 5 per cent in the third quarter of 2018. The latest car and cement sales still grew 12 per cent and 9 per cent year-on-year, respectively, in October; and
  • Among emerging countries, Indonesia stands on a better footing. Its current account deficit to GDP is 1.7 per cent versus the 5 per cent plus in Turkey and Argentina.

We see a reprieve for rupiah depreciation as the Federal Reserve tones down its interest rate hikes in 2019. Another pressure point for the USD is rolling-over economic indicators in the US. This will help calm outflows from emerging markets.

The Indonesian presidential elections in April 2019 could be another positive catalyst. At present, President Joko Widodo has a material lead in opinion polls and boasts a larger coalition of political parties than in the 2014 election. His era has also been characterised by lower fuel subsidies, with the savings channelled to more infrastructure spending. Since his administration began, the budget for infrastructure spending has more than doubled to 400 trillion rupiah (S$37.9 billion). The continuation of this more productive use of fiscal spending is welcomed by foreign investors.

  • The writer is head of research at PhillipCapital.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.