MNI ANALYSIS: Bank Indonesia Rate Hold No Help To Bond Market

--Indonesian 10-Year Yield Pricing In Rising Inflation 

By Stuart Allsopp

     SINGAPORE (MNI) - Bank Indonesia kept interest rates on hold for the sixth

straight meeting Thursday, with the benchmark rate at historic lows of 4.25%,

despite inflation continuing on its declining trend. 

     Headline CPI fell to 3.2% y/y in Feb while core CPI fell to just 2.6% y/y,

its lowest level on record. Despite interest rates also being at record lows,

real yields have been rising over the past year and currently stand at 150bps

using core inflation.

--YIELDS RISE DESPITE BENIGN INFLATION

     The combination of low interest rates and low inflation has failed to

prevent the 10-year bond yield rising 70bps since the start of the year to its

current level of 6.9%. The rise in yields does not appear to have been driven by

rising default risk premiums given that the 10-year CDS has remained low

throughout this period. 

     Although there is negligible default risk on Indonesian local currency

bonds, local yields still tend to track yields of local dollar bonds to an

extent, with the latter largely driven by default risk.

--INFLATION, DEFAULT RISK SEEN HIGHER

     The result is that Indonesian 10-year bonds now yield an attractive 420bps

over domestic core inflation, versus a comparable 100bps for US Treasuries, the

highest spread in over two years. 

     Such instances in the past have been very positive for the Indonesian

rupiah, but this has not been reflected in recent price action, which suggests

that currency and local bond traders either expect the current low inflation

rate to be transitory or are wary of a bout of risk aversion sending default

risk higher. Both of these expectations are likely to prove correct.

--INFLATION BOTTOM

     Regarding inflation, we believe that we are close to the bottom of the

cycle as credit growth set to pick up after a lengthy period of weakness. At a

special occasion at the Presidential Palace in Jakarta on March 15, Indonesian

President Joko Widodo called on local banks to become more aggressive in

expanding their loan books, even as total loans continued to expand by 8.3% y/y

in February. 

     In addition, the ongoing rally in the oil price should add to inflationary

pressures, particularly as the year-on-year price increase rises into mid-year,

while upward adjustments to administered prices such as electricity tariffs

exert upside pressure on consumer prices.

--DEFAULT RISK CONCERNS

     As for default risk, Indonesia's CDS markets have been remarkably stable,

barely flinching in spite of the spike in US high-yield debt that accompanied

the US equity market swoon in February. 

     However, with Indonesia having one of the worst external balance sheets of

all the major Asian economies, any global risk-off event, triggered potentially

by rising global protectionism, would likely hit the country harder than most,

particularly given how low perceived default risk is at present.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

[TOPICS: M$A$$$,MI$$$$,M$$FI$,MN$FI$]