INDONESIA’S

BOND MARKET
CHALLENGE
In Jakarta, an imported orange can cost
much less than a homegrown one. As bizarre
as it sounds, it is unfortunately a consequence Hengky Tambunan
of Indonesia’s notoriously high logistics costs Head of Fixed Income
arising from inadequate infrastructure. While Eastspring Investments, Indonesia
the Jokowi administration has prioritized
infrastructure spending, there are state budget1
limitations. The private sector needs to fill the territory while its bond market capitalisation was
funding gap; an effective way is to tap a wider 18% in 20164. This ratio is among the lowest in
investor base through capital markets but Asia. A further breakdown reveals that corporate
these are currently notably underdeveloped. bonds account for a mere 2.5%. The bulk was
If President Jokowi is to achieve his economic driven by government debt issuance.
vision2, Indonesia’s financial landscape has to
develop, diversify and evolve for the future.
Fig. 1: Indonesia lags its Asian peers - Bond Market
Capitalisation is a mere 18%5
CURRENT STATE OF PLAY
--------------- MARKET IN USD BN IN % OF GDP
A country’s banking sector is usually the main Gov Corp Total Gov Corp Total
channel for capital distribution. However being Japan 8966 671 9637 195.2 14.6 209.8
overly reliant on bank lending is a risk. External
Korea 703 1011 1714 48.1 69.2 117.3
financial shocks can trigger a systemic banking
Malaysia 141 119 260 51.5 43.4 94.9
crisis and impact the economy via credit disruption.
Singapore 133 97 230 47.1 34.2 81.3
Indonesia falls into the bucket of countries with
a bank-dominated financial sector. When it comes Thailand 222 81 303 55.3 20.3 75.6

to the breadth and depth of the financial sector,
Indonesia lags its Asian counterparts. Its bank
deposit as a % of GDP is a paltry 38% (most Asian
countries exceed 100%), its pension plan, insurance
and mutual fund assets to GDP3 are in single digit
China 4974 2155 7129 46.4 20.1 66.5
Philippines 80 18 98 27.5 6.2 33.7
Vietnam 42 2 44 21.1 1 22.1
Indonesia 139 23 162 15.1 2.5 17.6
 Broadening the financial base not only
supports the country’s economic development
but also enhances financial stability and reduces
vulnerabilities to exchange rate shocks and
sudden capital outflows.
A World Bank Group research6 has shown
that emerging market countries with robust
government bond markets were better able
to withstand the 2008 global financial crisis,
averting major economic dislocations and
helping its firms and citizens maintain financial
solvency and liquidity.
A TWO-WAY STREET IS NECESSARY
---------------
Well developed markets not only have a diverse
group of institutional and private investors but also
boast a variety of both government and corporate
bonds. To work towards this goal, the Indonesian
government can take a number of steps.
First and foremost, government-related entities
or state-owned enterprises can lead the way by
taking a prominent role in bond issuance and
diversifying their funding sources. Asian countries
serve as an example; Cagamas, the largest issuer
of debt instruments in the Malaysian capital
market was established as a joint venture
between the government and the financial services
industry. It issues corporate bonds and sukuk
to finance the purchase of housing loans and
receivables from financial institutions, selected
corporations and the public sector. In Singapore,
three of the five largest corporate issuers are
government-related companies.
Next, education plays an important role; private
companies can be shown the benefits of issuing
bonds to meet their long-term financing needs. In
a rising rate environment, the fixed interest rate
payment obligation of a bond is a major advantage
for corporate bond issuers. A bond also allows one
to raise capital without diluting the shareholder
value that comes with additional share issuance.
Some markets with underdeveloped capital
markets have even thought about restricting the
proportion of borrowings by large corporates from
banks to encourage the use of corporate bonds
Fig. 2: Concentration risk in Indonesia - Top 30 largest
corporate bond issuers account for 77% of total issuance
in 20167
100
89%
80 77%
63%
60
57% 55%
51%
40
39%
20
0
China Indonesia Korea Rep. Malaysia Singapore Philippines Thailand
and commercial papers although this may not be
well received by the business community.
Broadening the investor base has to work in
tandem. Currently Indonesian banks are the largest
investors in the local bond market although most
of it is in government securities. Best practice
dictates that banks hold a portion of their assets in
liquid securities to fulfil their risk-weighted capital
adequacy needs. Given this inclination, the option
is to promote the growth of domestic non-bank
financial institutions (“NBFIs”) such as life insurance
companies and pension funds. Compared to banks,
NBFIs tend to hold much larger portions of their
investment portfolios in corporate bonds relative to
government bonds, probably in pursuit of higher
yield. Countries with the most developed corporate
bond markets tend to be those with the most
developed NBFIs.
Improving the liquidity is another way to
promote the bond market. More can be done
to encourage investors to adopt a mark-to-
market and trading culture which will help boost
secondary market liquidity. To this end, better
infrastructure, transparent credit ratings and less
restrictive investment policies in pension and
insurance funds would spur demand and broaden
the investment base for corporate bonds.
Lastly, investor diversification can also be
cultivated at the retail level by disseminating
policies to incentivise the middle class population
to place savings in mutual funds, investment-linked
investment products and pension schemes.
CHALLENGES AND CONSIDERATIONS
---------------
Reducing the role of banks in Indonesia’s
development funding is a key priority for
Indonesia’s government and the Bank Indonesia
(BI). On the other hand, one cannot totally
sideline the banks. Active bank-led repo markets,
for example, assist in the development of bond
markets by deepening secondary market liquidity.
A well-functioning repo market is a precondition
for feasible market making system by dealers.
In theory the suggestions stated above seem
straightforward but implementation is never easy.
Investor confidence, for example, can be an issue
given the past history of bond defaults. To rebuild
confidence, the local credit rating agencies (CRAs)
must be reliable, objective, independent and
transparent. Proper regulatory frameworks must
be in place to improve the accountability of CRAs
and a consistent methodology has to be applied in
the credit rating assessment process. Currently the
OJK, the supervisory agency of CRAs only performs
inspections on the adequacy of the system and
procedure and does not supervise the contents of
the credit rating reports.
One quick win to improve liquidity and spur
demand is to open up the corporate bond market
to foreign investors. On the flipside, greater
international financial openness may make the
economy vulnerable to volatile international capital
flows that may threaten domestic financial stability.
Policymakers should thus consider financial stability
issues before considering this option. Ensuring a
stable macroeconomic environment is essential to
maintain a growing participation of foreign investors.
Sources: 1Indonesia’s estimated approximately IDR 4,800 trillion (or USD 370 billion) of infrastructure investment between 2015-2019. The central and regional
government budgets can only contribute 41.3% of the total, while Indonesia’s state-owned enterprises (SOE) can only contribute 22.2%, implying the remaining
36.5% needs to be supported by the private sector. Ministry of National Development Planning (Bappenas), Republic of Indonesia and JICA, 2014: Background Study
for RPJMN 2015-2019, BAPPENAS internal analysis. 2Indonesia will be the world’s 4th largest economy by 2045. Source: Jakarta Post, Mar 2017. 3OJK Indonesian
Financial Service Authority data as at 2016. 4Asian Development Bank data as at Dec 2016. 5ADB per Dec 2016. 6Public Debt Management in Emerging Market
Economies: Has This Time Been Different?, World Bank, Policy Research Working Paper No. 5399, 2010. 7ADB per Q2 2016.

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