Growth and stability
Indonesia has worked hard to develop its domestic and international bond markets and since 2012 there has been an upsurge in the number of government and corporate bond issuances, which is very much in line with Indonesia’s economic growth. It is an active market but the country’s volume of issuance compared to other jurisdictions around Asia is relatively low, particularly in view of the size of the country’s economy. It is fair to say that the Indonesian bond market is still in the early stages; indeed, there were no government bonds prior to 1997.
Amidst the background of an expected 6% GDP growth, 20% loan growth and low credit costs, the general trend is one of increased activity in the bond markets. Ji Liu, a Partner at Norton Rose in Hong Kong and Ferzana Haq, Of Counsel at Norton Rose in Singapore who advise financial institutions, sovereign and corporate issuers on debt capital markets instruments and Shari’ah-compliant products, observe that interest in tapping the debt capital markets is on the rise in Indonesia. This is because the coupon rates on bonds have fallen, making it a cheaper source of funding than bank lending, both in the domestic and international bond markets. According to the Jakarta Globe, many Indonesian companies are turning to the debt market to capitalise on low borrowing costs, with Bank Indonesia having kept its benchmark interest rate at a record low of 5.75% since February last year in an effort to spur economic growth.
Bond momentum
With a focus on Indonesian government and companies cross-border bond issuance, mostly in US dollar, Haq has seen the activity in the past three years gather serious momentum. The government has done a lot to encourage cross-border issuance, she notes, pointing to a number of “large scale” sovereign bonds, both conventional and sukuk.
As an example, both Haq and Liu led and represented the Government of Indonesia’s landmark $1 billion sukuk issuance in November 2011 and the Government’s first international sukuk programme of up to $3 billion in 2012, both of which were made available to US and non-US investors. These issuances were complemented this week with a further $3 billion dual-tranche (ten and 30-year) conventional bond, predominantly allocated to US investors. This most likely concludes the country’s conventional offshore funding for this year, but further sukuk issuance may come later in the year.
The burst of activity and the size of the issuances reflect the general improvement of Indonesia’s improved credit rating, achieving investment-grade status for the first time since the 1997 Asian financial crisis. Moody’s assigned a Baa3 rating to Indonesia’s global bond offering and a stable outlook. Standard & Poor’s (S&P) currently offers a BB+ and positive outlook, whilst Fitch goes for a BBB- and stable. Becoming investment grade has made it more attractive for international institutional investors to invest in Indonesian government bonds, and it also means the government has access to a cheaper source of funding in terms of coupons.
This has had a knock-on effect. By going through the credit rating process in respect of its $1 billion sukuk issuance in 2011, Indonesia’s credit rating was raised to investment grade, which in turn gave it access to a wider pool of investors and cheaper funds. Much of these funds were used, or are to be used, for the national budget and to develop Indonesia’s infrastructure projects. Infrastructure development remains a major requirement – and improvements to the country’s infrastructure (including road networks, transportation, utilities, etc) is a major part of Indonesia’s economic progress and would go some way to enhancing the overall profile of the country and contributing to the maintenance of its credit rating. And, as Haq points out, the sovereign’s rise to an investment grade rating creates an environment of confidence, and would enable Indonesian corporates to tap the international bond markets too.
Stable environment
Practical delivery and trading of international debt instruments is handled entirely electronically, says Haq. Trading of non-domestic bonds takes place over-the-counter (OTC) and are cleared for international bond issuance handled either via Euroclear or Clearstream and, if issuing into the US, through the Depository Trust Company (DTC). It’s a very stable, well run process and I don’t see any concerns on that front.
The market is also a lot more stable now in terms of its general risk, but companies may span the whole range of risk profiles. At the one end of the scale are the state-owned companies and large and steady corporate entities that are highly rated and enjoy low-coupons and limited covenants because there is confidence they can meet their debt obligations. At the other end of the scale are low rated or distressed businesses that often refinance through bond issuance, getting into the market by issuing high yield bonds which are subject to far more restrictive covenants.
The consistency of activity over the last couple of years contributes to the general impression that Indonesia is a more stable country and this has created a lot more interest from international investors, notes Haq. Companies such as the state-owned power utility, PLN, and the privately-owned national airline, Garuda, have engaged with the bond markets in the past, and she believes that current market buoyancy and the low coupon rate that highly rated entities can command will see a number of sizeable bond issuances this year. “All of this contributes to the increased confidence in Indonesia, making it much easier for other Indonesian corporates to tap the markets, ensuring the coupon rates they have to pay remain attractive.”
The level of bond issuance remains strong globally and with many banks now unable to fully fund the demand for loans, in part because of their own capital requirements, Haq sees many seeking to act as arrangers or managers to distribute bonds into the institutional bond market where there is more appetite for longer-term debt. “The bond markets still have enough room to take up that form of funding so it is covering the gap where international banks may no longer be able to, because they are facing their own credit squeeze,” she explains.
Infrastructure, regulation and the future
Two years ago the Indonesian government announced its Rp 4,000 trillion infrastructure programme (known as MP3EI) aimed at creating more domestic jobs and spurring economic growth. The scheme covers aspects such as the redevelopment of seaports, airports, roads, water and energy facilities.
A number of state construction companies have talked about plans to tap funds from the bond market, including Wijaya Karya, Waskita Karya and Adhi Karya. In March this year, the latter announced plans to issue Rp750 billion ($77.5m) worth of bonds to finance its various investment plans. The company said it would be offering conventional and Islamic bonds and listing the notes on the Indonesia Stock Exchange (IDX).
Some companies are not tapping the markets to fund a specific project but instead to satisfy their own capital expenditure needs. Garuda Indonesia airline is a good example of this. It announced in March this year, a Rp2 trillion ($205.52m) corporate bond issue set for the second quarter of 2013. Earlier this year Garuda’s low-cost division, Citilink, was reported to have ordered 25 Airbus A320 aircraft (around $2.4 billion at list price) as a means of fending off rising competition in Indonesia’s budget airline sector. The bond market, notes Ferzana Haq, presents a “logical” source of funding for such plans.
Project bonds
Some of the infrastructure developers that have set up special-purpose project companies, as opposed to fully operational ongoing businesses, do face some extra challenges in the bond markets, says Haq. “The bond markets have not been overly amenable to project bond financing because the ability to repay bondholders is dependent on the revenue stream from the project, which, especially in the case of greenfield projects, would take a long time to materialise and are subject to construction risks, amongst other things. Historically, the bond markets have had little appetite for that kind of risk.” However, because bank funding is becoming harder and more expensive to obtain, she believes this will change over the next three to five years.
In particular, as projects which have already gone through the construction phase come up for refinancing, the bond market may present an attractive and cheaper alternative to bank lending. The challenge is to make sure these projects get their rating up to a level that fits within the investment policy guidelines of a broader sweep of investors (typically pension funds and insurance companies). Alternatively, they must find some form of support, perhaps coming from a government-backed guarantee or an export credit agency (ECA). “I think the way bonds are structured will need to adapt – project bonds tend to have more restrictive covenants, which require more monitoring; this is a big change for bond investors.”
The established corporate bond issuances in Indonesia – such as those issued by Garuda – have a secondary market because the bonds are relatively easy to sell and bond investors are particularly keen on corporate credit. The difficulty with a project bond, even if it can achieve the correct rating, is one of liquidity; investors need to be sure they can be in it for the long term, as the secondary market is not well-established. The same requirement applies to the sukuk market, where the secondary market is not of sufficient size to ensure strong liquidity – but Islamic investors tend to adopt an ‘invest and hold’ approach anyway.
Market regulation and legal standing
In terms of market oversight, Indonesia’s capital markets regulator, Bapepam, has worked to ensure that its laws and guidelines have not restricted domestic companies from issuing bonds, either domestically or internationally. “But when it comes to the corporate bond market, the challenge faced sometimes in Indonesia is one of perception rather than the actual rules,” notes Haq. Even though there has been increasing confidence in Indonesia, there is still a perception it presents more legal risks simply because its legal system is not viewed as being as stable as other countries in the region. There is, she explains, a concern amongst some looking to invest in the country, whether in bonds or otherwise, around what the legal risks are and whether it is certain they can enforce their rights as foreign entities.
If a dispute arises over the terms in the bond document and a judgment is granted in favour of the investors by a foreign court under foreign law, judgements will still need to be recognised and enforced by the Indonesian courts. Uncertainty as to whether Indonesian courts will recognise a judgement in all instances can be mitigated by incorporating within the documentation provision for arbitration. This takes it out of the Indonesian court system and into an arbitration forum in a country such as Singapore, which is currently one of the main regional forums. As Indonesia is a party to the New York Convention, an arbitral award would, in general, be enforceable in Indonesia.
Challenges can also arise where bonds are secured over assets in Indonesia. For example, if security is granted over land, it raises concerns over the application of foreign ownership restrictions and thus how long it may take to enforce the security. Making sure that any monies, which are part of that security package, are held in accounts overseas can give investors more assurance that they will be able to access the security if there is a default, says Haq.
Progress
Overall, the Indonesian debt capital markets are steadily improving in terms of access and security. The fact that the government itself has issued a number of large-scale bond and sukuk issuances shows its own commitment to turning the country into an attractive investment opportunity. However, Haq feels that the country needs to look more closely at its stance on Islamic finance. “Whilst the Indonesian government has issued sukuk internationally, a lot of the methods and structures for issuing sukuk would not be available to corporate entities in the country, in part because existing laws impose high taxes when it comes to the transfer of assets, which is a structural element of a sukuk transaction.”
By way of contrast, she notes that Singapore, which is not an Islamic country and does not have a large Islamic finance market, had passed regulations to incentivise companies to use Islamic finance, removing any additional taxes or constraints. Malaysia has the largest Islamic finance market, with much of the growth in sukuk stemming from its government’s amendment of regulations to level the playing field with conventional bond issuance.
“Indonesia, as the most populous Muslim country in the world, has huge potential for Islamic finance but it has not yet changed its regulation to allow for that; this has restricted the Islamic bond market from developing,” states Haq. Having gone to both conventional and sukuk markets over the past few years, its government has certainly given strong encouragement to corporate entities to follow suit. However, the regulations need to change and the laws need to be adapted before the sukuk market in Indonesia can reach its true potential.
