Thursday, 18 July 2019

Changing course

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The darling of the credit markets only six months ago, Indonesia has become a symbol of just how fast sentiment can change.

A view of drainage canals, which are supposed to be developed for farming, in a peat area in Mangtangai in Indonesia's central Kalimantan.

Source: REUTERS/Ferry Latif

A view of drainage canals, which are supposed to be developed for farming, in a peat area in Mangtangai in Indonesia’s central Kalimantan.

The Republic of Indonesia has something of a mixed reputation in the international debt capital markets, having been criticised for drawn-out deal execution and paying up on primary issues. As the country wrestles with a growing current account deficit and a weakening currency, however, it is likely to rely more than ever on offshore funding.

Investors’ exit from emerging market offshore bonds in May on fears the US Federal Reserve would soon begin scaling back its quantitative-easing programme hit Indonesia hard as fast-money investors sold the currency of countries with high current-account deficits. The most damage was inflicted on the Indian rupee and Indonesian rupiah.

With Indonesia’s current-account deficit hitting 3.2% of GDP in August and its currency in a freefall, it was no surprise yields on the sovereign’s 10-year bonds hit the highest since 2009 over the summer, while, at the same time, the country’s credit spreads ballooned 100bp over US Treasuries.

The country began bleeding hard currency foreign-exchange reserves in July in a bid to stem the rupiah’s decline. At the end of July, its reserves fell to US$92.67bn from US$98.1bn in June, and were on their way to US$91bn, which would have been the lowest level since 2010.

This backdrop woke Indonesia to the reality it needed to issue in US dollars urgently if it was to stem the rupiah’s decline and bring back a measure of confidence among international investors.

“Everyone knows that Indonesia needs the money,” said a Hong Kong-based syndicate banker, in the midst of the currency’s decline.

To this end, it swiftly priced in mid-July a US$1bn 10.25-year Global that went some way to altering the perception of the issuer as a bit of a foot dragger when it came to execution. Indonesia’s typical modus operandi of conducting long, drawn-out roadshows was viewed as becoming a thing of the past.

Still, the sovereign paid 200bp more on the deal’s coupon than it did barely three months earlier, when it issued a US$1.5bn 10-year Global, underlining the sense it was backed into a corner.

In the meantime, global investor sentiment returned to securities that were perceived to be safer. As Indonesia overshot its budget deficit in August by 0.8% over the government’s target, it was more or less forced to revisit the offshore dollar market again.

The sovereign began marketing a US dollar sukuk in early September. The time could hardly have been worse, with markets anticipating US military intervention in Syria and a scaling back of US bond purchases.

This shaky backdrop and the damage done to Indonesia’s credibility among offshore investors prompted the country’s treasury officials to bring the sukuk deal, arguably as cheap as any offshore paper it had marketed in the last five years. With a 6.375% yield, the US$1.5bn 5.5-year issue offered a 77bp new-issue concession at initial guidance versus the country’s seasoned dollar curve, including 20bp of concession against the seven-month extension of Indonesia’s sukuk due November 2018.

The new bond was priced to yield 6.125%, a new-issue concession of roughly 50bp. That was in marked contrast to deals the sovereign printed over the past five years, when it had succeeded in pricing flat or through its seasoned curve. The result brought home the new reality Indonesia faced in approaching the offshore debt markets.

Still, the deal was something of a success and remarkable as it priced a day after the rupiah had shed another 3% of its value against the dollar, bringing the loss, since the start of the year, to more than 16%.

It might be argued that Indonesia’s funding officials and lead managers Citigroup, Deutsche Bank and Standard Chartered erred on the side of caution with the offering. After all, it traded up to 101 bid a day after being reoffered at par. The risk of being too ambitious was too great to face, however, and the solid reception to the paper – it received  orders ofUS$5.7bn from 300 accounts – went some way to restoring Indonesia’s reputation and paved the way for a return if the sovereign required it.

There was speculation in July that, in having an October maturity on its 10.25-year deal, the sovereign was leaving the door open to add to the issue. That might well prove to be the case, as investors renewed their appetite for risk after the reopening of the US Government and an agreement on the debt ceiling.

“This looks like as good an issuance window as we have seen all year and I wouldn’t be surprised to see Indonesia move with an opportunistic tap,” said a Singapore-based syndicate head. “Its fundamentals haven’t altered, and it still needs to boost its reserves.”

To see the digital version of this report, please click here.

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