Foreigners Hedge Bets on Indonesian Markets
From soaring hedging costs to steepening bond curves, Indonesian markets are showing clear signs that foreigners still don’t take for granted the relative stability of the nation’s economy as the financial crisis deepens.
Unlike in 2008 or earlier crises, Indonesia’s war chest is bigger, its growth sturdier and policies more sound.
The high-yielding bonds are deemed less risky as investors grow increasingly comfortable with the central bank’s handling of inflation — the economy’s Achilles’ heel in the past.
Economists reckon the country is almost a safe-haven as investors flee euro zone’s debt-ridden markets. But overseas investors in rupiah assets haven’t made a complete leap of faith yet. They have hedged aggressively in the onshore and offshore rupiah markets, switched from long-term bonds to shorter ones and bought credit insurance.
“It’s never possible to predict crashes in advance,” said Woon Khien Chia, RBS’s emerging markets strategist in Singapore. “I don’t see a big run for the exit, but whoever comes in to buy now is going to be mainly the short-term type of investor — quick in, quick out.”
Overseas investors held about Rp 215 trillion ($23.9 billion) of Indonesian government debt as of last Thursday, according to latest government data, representing about 30 percent of total outstanding debt, easily the highest in Asia.
Although that is down from a peak of about Rp 250 trillion in early September, it indicates the extent of foreign bets on the economy even now.
That drop in bond holdings also masks the underlying sharp change in portfolios. Investors cut their holdings of debt maturing more than five years from now by more than 11 percent since late August and also slashed their investments in short-terms bills by 40 percent.
In October, they increased investments in treasury bills while trimming holdings in long-term bonds, underscoring their lack of confidence in buying long-term bonds.
Frances Cheung, a strategist at Credit Agricole CIB in Hong Kong, said the changing composition of Indonesian bond portfolios was symptomatic of a broader change in Asian debt holdings by foreign investors as money markets get jittery.
“We are seeing increased evidence of foreigners shortening duration and getting ready to pull money out in case the euro zone situation gets worse across Asia. And Indonesia is no exception,” Cheung said.
Asia has been relatively sheltered from the euro zone crisis apart from a brief sell-off in September, but the rising costs of obtaining dollar funds in funding markets, coupled with the heavy presence of foreigners in some of the region’s bond markets, particularly Indonesia, have kept market players worried.
While foreign investor perception hasn’t yet been shaken in a country on its way to securing an investment grade rating, the rupiah’s weakness is eating away into whatever little returns bond investments have generated so far. Given that most investments in Indonesia’s high-yielding debt are on an unhedged basis — enabling investors to benefit from currency gains as well as the yield to obtain equity-like returns — this is a ticking time bomb.
Over the last two years, Indonesian bonds in dollar adjusted terms have delivered 42 and 31 percent returns, respectively, according to Thomson Reuters data, attracting a wide range of investors, including leveraged funds in recent months. But in 2011, the story began to turn sour.
After delivering more than 21 percent until October, total returns have fallen by 5 percent since then, raising concerns that funds that have suffered heavy losses elsewhere may look to take profits on one of the few winning trades this year.
Even that window to exit positions may be quickly closing, thanks to the rupiah’s weakness. Chia reckons the time for foreigners to hedge their bond holdings in Indonesia “may be up already due to the rising hedging FX costs” in the offshore derivatives markets.
Annualized implied FX yields derived from the rupiah non-deliverable forwards market, or the approximate cost of hedging, is already a punishing 7 percent for three months, which is about 100 basis points more than 10-year bond’s current yield.
That indicates that the rush to protect their bond holdings is pushing up hedging costs. Even then, NDF yields are a fraction of their peak levels in 2008.
“I don’t think we are there in terms of full blown panic just yet,” said Jonathan Cavenagh, a strategist at Westpac. “But the fact that foreign investors are starting to lighten up on bond holdings once again is a concern.”
Still, the outlook is more positive than it was even three months ago, says Helmi Arman, chief economist at Citibank Indonesia, as some of the short-term funds may have been withdrawn in September’s sell-off. “There was shock in September,” he said.
Short-term player, are you one of them? Do you think Asia will be so much impacted by the crisis? How about Indonesia?