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Indonesian rupiah bonds should maintain their allure for foreign investors this year, with high demand just as much a result of the economy’s brightening outlook as of high yields that reflect its debt-market’s shortcomings.

Analysts say it may be hard to repeat the performance of last year, when returns of up to 22 percent on local currency government bonds, combined with the rupiah’s 17 percent rise, provided a windfall for foreigners.

But Indonesia’s notoriously illiquid bond market and the price it is still paying for mishandling of past bouts of high inflation mean yields will stay well above those offered by its Asian peers and prove simply irresistible for many debt players.

“We expect local market funds to continue witnessing inflows this year,” said Ashish Agrawal, a strategist at Bank of America Merrill Lynch. “Indonesian bonds are among the highest-yielding in the region and will naturally attract inflows.”

For example, 10-year bonds yield about 9.65 percent, similar to issues from Pakistan, rated 3 notches below Indonesia’s Ba1 rating by Moody’s Investors Service. In inflation-adjusted terms, Indonesian bonds yield 7.1 percent, at least 5 percentage points more than Pakistani debt.

With the rupiah still seen poised for further gains, albeit not as spectacular as last year, HSBC estimates average dollar returns on rupiah bonds can reach 14.32 percent this year, much above those offered by any other Asian market.

Even if the central bank were to raise rates in 2010 and stand in the way of the rupiah’s rise, investors see value in merely buying and holding these bonds until maturity. “Even if Indonesian bonds don’t rally more from these levels, it still remains an absolute investor haven because of its high yield,” said Kenneth Akintewe, a fund manager at Aberdeen, who manages $500 million in assets.

The perceived difficulty with liquidating positions quickly, however, remains an issue and most foreign funds flow into short-term and liquid central bank bonds, or SBIs, often infusing more volatility into short-end yields and the rupiah.

So at times of market turmoil, prices can swing wildly and spreads widen sharply. One analyst noted that at the height of the credit crisis in 2008, bond yields surged to 22 percent despite little evidence of selling by foreign funds. Bid-offer quotes can often be as wide as 10 basis points, he said.

Memories of the near 80 percent inflation during the Asian financial crisis a decade ago, and double-digit price growth in 2005 and 2008, as well as doubts how quickly the central bank would respond to another spike also mean Indonesian debt comes at a discount.

The Philippines has public debt at around 60 percent of GDP, twice Indonesia’s ratio, and yet keeps its 10-year yields near 8 percent., whereas Indonesia’s are closer to Argentina’s, which has billions of dollars in unsettled bonds for the past eight years.

“Historically, inflation in Indonesia averaged around 6 percent and policy rates were around 7.5 to 8 percent at their lowest, and therefore people are reluctant to drive down bond yields below a particular level,” said a Hong Kong-based analyst.

Several analysts argue, however, that the risks of investing in Indonesian debt may not be as high as rates suggest. The fiscal deficit is relatively small and manageable, at 1.6 percent of GDP, and expected 5.5 percent economic growth this year is in line with its long-term trend, meaning no big threat of aggressive central bank tightening, says Jens Lauschke, a strategist at DBS Bank in Singapore.

“The sustainability depends on how much revenue you can generate and how fast your economy can grow and for Indonesia its quite sustainable,” he said.

Government statistics confirm that there are many investors who share that view. Latest data showed foreigners owned a record Rp 109.5 trillion worth of Indonesian federal debt early in January after boosting their holdings by $2.2 billion or nearly a fifth last year.



Reuters