Secondary Market

Development Of
Government Bonds
DANAREKSA
BAHANA
SECURITIES
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
1
Organization of Presentation

History of
Bond Market
Development
Problems &
Recommendation
Ultimate
Goals
Towards More
Transparent Market
Development of
Government Bonds
Market
Characteristics Of
Government Bonds
Legal Aspect
Dissemination of
Information on Trading
& Settlement
Regulation on
Investment Policy
Repo Market
Tax Scheme
Liquid Bond
Market
Yield Curve
Institutional &
Retail Investors
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
3
Towards More Transparent Market

Free Style OTC
(No Standard Rule)
Ordered OTC
(Convention Among
Players)
Before 1997
Current
When ?
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
4
Development of
Government Bond Market (1)
Year Bonds Listed (Rp bio) Volume Frequency
1997 15,181.74 7,301.95 1,910
1998 13,835.17 4,860.79 1,476
1999 14,180,27 4,844.02 1,522
Jan-June 2000 19,037.39 5,195.41 1,240
Before May 1999 : The bond market totally dominated by
corporate bonds.
Secondary Corporate Bonds Market Activities
1997 June 2000
Source: Surabaya Stock Exchange, 2000
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Development of
Government Bond Market (2)
Government issue bonds for recapitalization purposes in
May 1999. However the bonds listed in the exchange since
February 1, 2000. From May 1999 to February 2000 the
recapitalized banks could not trade the bonds due to
inexistence of rules for government bonds trading.
February 1, 2000: Government list Rp 255.19 trillion in
Surabaya Stock Exchange. From February 1, 10% of the
recap bonds were shifted from investment portfolio to
trading portfolio.

DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Development of
Government Bond Market (3)
Bond Listed
Dominated by government
bonds
Out of bonds listed, 93.79
% are government bonds.

Secondary Market
However, the secondary
market still dominated by
corporate bonds.
Trading of Government
bonds up to June 2000 only
contribute 1.98% of the
total trading. (note:
government bonds trading
up to 30 June only Rp 98.38
billion)

After February 1, 2000:
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
8
Characteristics of Government Bonds


Type Maturity
Coupon
(%)
Amount
Listed
(Rp
trillion)
Coupon
Payment
Amount
Traded
(Rp
trillion)
Fixed
Rate
5 years 12 22.41
Every 6
months
0.323
Fixed
Rate
10 years 14 28.88
Every 6
months
7
Variable
Rate
Range
from 3 -
10 years
SBI 3 -
months
rate
203.9
Every 3
months
1.84
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
9
Characteristics of Government Bonds
Problems:
Low Yield
The current government bonds are unattractive due to
relatively low yield both for domestic as well as foreign
investor. For 5 years fixed the coupon offered at 12%,
for 10 years fixed the coupon offered at 14% while for
variable rate now SBI 1-month rate is 13.45% and 3-
month rate is 13.04% as of 20 July 2000. Some
outstanding corporate bonds (such as HMSP,
ASDF,AALI) offer more attractive yield (around 17%)
with tolerable risk.

DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Characteristics of Government Bonds
Yield Dichotomy
As of 20 July 2000, estimated yield for Indonesian USD
yankee bonds (RI 06) is 12.81% (in USD) equivalent to
19.5% (in IDR). Meanwhile IDR fixed rate bonds only offer
yield 12.62% (in IDR - assume the price is set at 98) in July
20, 2000
Issuance
The purpose of government issuance was recapitalizing the
banks. At the time, interest rates were extremely high.
Therefore, the issuance of bonds disregard the actual market
yield (investor required yield) in order to keep the continuity
of bank recap program without jeopardizing government
budget.

DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Characteristics of Government Bonds
Recommendation :
Government should issue new bonds with more market
friendly structure. The amount not necessarily as much
as the bonds for recap program.
This new bonds should consider its attractiveness to
investors (market yield).
This new issuance could starts from short-term (T-bills)
to longer term (T-Bonds).
Government should give more attention on sovereign
rating by international rating agency.
DANAREKSA
Secondary Market Development of Government Bonds
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Legal Aspects
Problem : Domestic investors had experience of disputes
in the repayment of Indonesian government bonds in the
1960s.
Recommendation: The government should draft a Law
(UU) on government bonds issuances and secondary
government bonds trading to ensure the payment of
coupon and principal payments and transparency in the
market. Under this proposed Law, the government would
have the authority to pay the interest or principal even
though the government budget (APBN) had not yet been
approved (still under review by DPR).
DANAREKSA
Secondary Market Development of Government Bonds
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Dissemination of Information on
Trading and Settlement
Problems: Most of the investors (domestic and
foreign) are not well informed on
the terms and conditions of the issuance,
the coupon structure,
how to trade government bonds, and
the settlement mechanism, related to the unequal access
between banks and other potential government bond
players (e.g securities houses which act as a Primary
Dealer) to the central registry (BI).


DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Dissemination of Information on
Trading and Settlement
Recommendation :
The government should issue and disseminate a
prospectus (circular offering) which would consist
of information on how to trade government bonds
and the terms & conditions of the issuance.
Regarding settlement, BI and Bapepam need to
design the mechanism which would ensure a level
playing field for the players in the bond market.
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
15
Tax Scheme
Problems
Under PP 46/1996, banks, mutual funds, and
pension funds are exempted from tax payments on
interest, while securities houses have to pay 15%
final tax. Foreign investors follow tax-treaty rules.
This applies for all kinds of bonds.
This raises the issue of an unfair playing field (in
terms of tax) between players in the secondary
bond market which ultimately results in poor
market liquidity and price distortion.
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Tax Scheme
Recommendation
In several countries, government bonds are
tax-free (0%) for residents. Non-residents
follow tax-treaty rules. This become
necessary condition for improving the
liquidity of the bond market.
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
17
Regulations on Investment Policy
Problems :
Institutional investors face restrictions over their
investment policy in the bond market, including
government bonds. This may hamper domestic
investors from investing in government bonds.
Recommendation :
Remove investment restrictions for government
bonds (risk-free instruments). For banks,
government bonds should be treated as secondary
reserves and/or part of the reserves requirement.
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Repo Market
Problems :
The fact that there is no repo market for government
bonds is of concern to potential investors.
Recommendation :
BI could increase the effectiveness of government
bonds by using monetary policy tools to maintain
Open Market Operations through a repo market. By
doing so, BI could reduce its cost of monetary policy
(which accounts for a large proportion of BIs costs).
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Ultimate Goals: A liquid Bond Market
A liquid bond market could provide continuous bids and
offers, which would subsequently provide a yield curve.
The government would be able to refinance mature bond
recapitalization. In the long term, government will be able
to finance their budget through bond market.
It would reflect the improvement of investor confidence in
the Indonesian market.
It would provide a wide range of investment alternatives
which could become underlying assets for a derivatives
market (hedging instruments)

DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Ultimate Goals: Yield Curve
The yield curve will be the benchmark of interest
rates (required yield) resulting in the better pricing
of fixed income instruments,
The basis for creation of mortgage bonds, asset-
backed securities or other securitization program
for financing consumer loans and municipal
bonds.
The reference for foreign and domestic investors
which, in turn, reduce the yield dichotomy
between domestic and foreign market.
DANAREKSA
Secondary Market Development of Government Bonds
BAHANA SECURITIES
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Ultimate Goals: Strong Institutional &
Retail Domestic Investors
Strong Institutional & Retail Domestic Investors
could benefit the whole market
Investment characteristics will shift from a short-term
to longer term horizon.
Reflects the improvement of domestic market
confidence
Increase domestic investors base
Lead to increasing market cap of the bond market
(given the higher demand in the market).