Indonesia Default Risk Jumps Most in Asia on Fund Exit Concerns

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The cost to insure Indonesia’s bonds against default rose to the highest this year as the falling rupiah and accelerating inflation fueled concern foreign investors will pull out of the country.

Five-year credit default-swaps on the debt jumped 19 basis points to 180 in the past two weeks. Malaysia’s risk rose the same amount to make the nations the worst performers in Asia. Indonesia's central bank Governor Agus Martowardojo said Monday that the authority sees opportunities to buy the notes when yields rise.

Inflation will remain above 7 percent through September, Bank Indonesia forecasts, as an El Nino weather pattern threatens to damage crops. The rupiah’s descent to a 17-year low is limiting scope for the central bank to support the economy by cutting interest rates.

“The concern is that all these factors will see investors demanding much higher yields and readjusting their positions,” said Ikhwani Fauzana, head of rates trading at PT Bank Negara Indonesia in Jakarta. “But it’s too risky for the central bank to lower rates to help growth as the rupiah’s response would be drastic, so they’re caught in a difficult place.”

Break-Even Point

The rupiah has led declines in Asia to drop 7.5 percent this year to 13,385 a dollar and reached the weakest since August 1998. If it falls past 13,400, foreign investors who pumped 46 trillion rupiah ($3.4 billion) into Indonesian debt in January and February, will start to incur losses, according to PT Mandiri Sekuritas, a unit of the country’s largest lender.

The yield on 10-year sovereign bonds jumped 25 basis points this week to a 15-month high of 8.77 percent. Four of the last five sovereign auctions failed to meet their targets.

The central bank sees risk of a currency war over the next three years if the Federal Reserve rates normalization happens gradually, Martowardojo said Monday, adding that the authority will seek to maintain exchange-rate stability.

Bank Indonesia forecast on Monday that the economy would expand 4.9 percent this quarter, compared with 4.71 percent in the previous three months, the least since 2009. Slow state spending has hampered growth, with only 31 percent of 2015’s targeted disbursement spent by the end of May.

Supply Concern

Indonesia’s government has achieved 49 percent of its full-year bond sales target, according to Finance Ministry data. President Joko Widodo’s plan to boost tax revenue by 30 percent in 2015 is looking tough to meet, which could lead to an increase in the issuance goal, said Handy Yunianto, who manages fixed-income sales at Mandiri Sekuritas in Jakarta.

“Investors still see large supply pressures going forward, especially with the fiscal risk posed by slowing growth,” he said. Yunianto sees 8.1 percent as a fair 10-year yield by year-end, assuming Bank Indonesia maintains its benchmark rate at 7.5 percent.

Inflation accelerated to 7.15 percent in May and the central bank forecasts it will be 4.2 percent by year-end.

That prediction could be upset by El Nino. Indonesia, along with India, will be most harmed in Asia by the weather pattern as 18 percent of GDP is driven by agriculture, forestry and fisheries, Bank of America Merrill Lynch wrote in a research note.

Foreign funds are still adding to rupiah sovereign bonds, boosting holdings by 6.43 trillion rupiah in the past month, Finance Ministry data show, as yields have risen. They now own 38.5 percent of the debt, the highest ratio in Southeast Asia, making the market vulnerable to outflows.

PT Manulife Aset Manajemen Indonesia still sees potential in Indonesian debt, said Ezra Nazula, who manages more than $2 billion as head of fixed-income in Jakarta.

“We see opportunity in the volatility, especially with expectation for lower inflation in the second half,” he said. “Even if investors see the rupiah weakening past their break-even point, they won’t sell on reflex if they still think conditions will improve going forward.”

Rabobank International recommends investors to remain “on the sidelines,” said Michael Every, head of financial markets research in Hong Kong.

“We’re not seeing a major push forward in terms of infrastructure investment,” he said. “There doesn’t seem to be much value in Indonesian bonds.”

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