S&P's Late Late Indonesia Show
It took S&P Global Ratings five extra years of hand-wringing to acknowledge that Indonesian sovereign debt was investment grade. Now that it has, expect the ripples to be felt in places other than the bond market.
Fitch Ratings gave the Southeast Asian nation the all-important upgrade in December 2011. That was 14 years after the Asian crisis led 59 percent of banking system assets to turn sour, requiring 236 trillion rupiah ($18 billion) of liquidations. Moody's Investors Service followed suit a month later. Only S&P refused to budge.
Until last Friday, that is, when it finally lifted the country to BBB minus, the lowest investment-grade rung, citing Jakarta's "new focus on realistic budgeting."
To investors, it's more a case of S&P's new focus on realistic ratings. As Gadfly wrote a year ago, Indonesia was coping pretty well with the collapse of Chinese commodities demand, with the default risk of publicly traded companies receding faster than in several other emerging markets.
Will the upgrade go unnoticed? Probably not. Many Japanese debt investors can't buy securities that are scored junk by even one of the three main rating companies: HSBC Holdings Plc predicts they will plow in between $2 billion and $3 billion. There's also history to consider. As HSBC notes, the two auctions of government bonds following the Moody's move in January 2012 drew average bids of 46 trillion rupiah, compared with the usual 15 to 20 trillion rupiah.
All that, however, was when Indonesia was still viewed as a high-yield haven. Those buying 10-year government bonds at a yield of almost 9 percent in early 2011 rode the profit escalator to 5 percent before the 2013 taper scare.
Now, the notes are yielding about 7 percent. While that may be compelling to some investors, the margin of safety isn't what it was five years ago. The risk of a drop in the rupiah, which has been steady as a rock since October 2015, may be too much to ignore.
Buying the Indonesian benchmark bond using rupiah swapped from dollar funding would mean accepting an 18-basis-point lower yield than just buying a comparable U.S. Treasury note. Even private-bank clients in Asia may not want to indulge their perennial hunger for yield by stuffing Indonesian bonds into their portfolios, especially if the Federal Reserve ends up raising interest rates more aggressively than it has signaled so far.
Where the S&P action may matter more is in equity markets. A vote for good housekeeping from a difficult-to-please monitor will encourage investors at a time when the Jakarta Composite Index is still reasonably priced compared with other Asian markets on metrics such as price-to-sales and enterprise value to Ebitda. The benchmark gauge rose to a record on Monday.
Besides, to the extent Indonesian banks now have superior collateral -- thanks to their holdings of upgraded sovereign bonds -- they may be able to get better prices from counterparties on trades. PT Bahana Sekuritas, which raised its stock-index price return target to 8 percent, from 3 percent, cited lower funding costs for banks as one of its key expectations.
Although unfashionably late, S&P's Friday surprise is not a complete non-event -- except perhaps in the bond market.
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