Handy Yunianto
Head of Fixed Income Research PT Mandiri Sekuritas

Ytd, the Government has already issued Rp747.3tn-gross (or Rp367.6tn net) as of 6-Nov or almost 94% of the full year target for this year. There will be six more bond auctions scheduled for the rest of this year, which are three conventional and three sukuk auctions until 18-Dec-2018. We still maintain our view the Government might cancel auctions in December, as budget deficit will most likely be lower than initial government target of -2% of GDP (vs. -2.19% of GDP)–every 0.1% lower budget deficit will reduce bond issuance by Rp14.8tn. Next year, the Government has targeted to issue Rp389tn-net to finance budget deficit of Rp296tn (-1.84% of GDP).

We still believe the government bond supply next year will still be manageable, as interest coupon payments for rupiah government bonds are projected to be Rp220tn for next year. We also believe support from onshore investors might still be high, as there is the possibility of reduced withholding tax for government bond instruments next year. Our calculation, the potential tax revenue shortfall if the Government reduces withholding tax to 10% is Rp7-14tn or less than 1% of the tax revenue target next year of Rp1,786tn.
The government has already issued almost 94% of full year target and may cancel bond auctions scheduled in December. The Government has already issued Rp747.3tn-gross ytd or almost 94% of the full year target–assuming budget deficit of 2.19% of GDP. Thus, the Government only needs to issue Rp50tn-gross for the rest of this year. If we assume government bonds that will mature this year will be reinvested back in the same bonds, then the net additional bonds will be only Rp15tn. Note that interest payments for rupiah government bonds in November and December are Rp35.1tn and Rp3.7tn, respectively.

We also see the gross issuance target for this year might be lowering again, as the budget deficit projection has become smaller to possibly less than 2% of GDP. Note that the Government has revised gross issuances from Rp845tn to Rp799tn since it reduced SPN issuances for cash management, following sufficient tax revenue collection and cash buffer and also following the lowering net issuance target to Rp384.2tn (vs. Rp414.5tn), as the Government is also optimizing the multilateral loan program.

Budget realization in October 2018 showed the deficit was Rp237.1tn or -1.6% of GDP (this is much lower compared to the same period of 2017 which reported –2.21% of GDP and –2.51% of GDP for full year 2017). Lower deficit due to total revenue collection has exceeded the estimate. Until October 2018, total revenue has reached Rp1,483.7tn (+19.7% yoy) or more than 78% of the full year target, while total expenditure was reported at Rp1,720.8 (+11.9%) or 77.5% of full year target (Table 2). Using the average historical budget deficit in November-December in the last four years, then the budget deficit this year will potentially be less than 2% of GDP (Figure 1).

If the budget deficit lowered to 2% of GDP, then gross issuances could potentially lower again by Rp28.2tn (note: every 0.1% lower budget deficit will reduce bond issuance by Rp14.8tn). Therefore, we still maintain our view that the Government might finish its issuance target in Nov-2018 (thus no more bond auctions in Dec 2018). There will be six more bond auctions scheduled for the rest of this year, which are three conventional and three sukuk auctions until 18-Dec- 2018.

Onshore investors are the biggest rupiah government bond buyers this year

In terms investors by institution type, currently the biggest net buyers of government bonds are onshore investors, as foreign only reported net buy of 13% of net rupiah government bond issuances (as of 6-Nov). In the last five years, on average the foreign net buy’s portion to total net issuance of rupiah government bonds is 44% (range: 30-64%). Specific for onshore investors, onshore banks are the biggest net buyers, totaling Rp65.7tn or 26.3% of net bond issuances this year.

This is still slightly lower than 2017, when banks reported net buy of Rp77.8tn. The significant increase in onshore net buyer compared to last year is coming from institutional non-banks (pension funds and insurance companies), which reported net buy totaling Rp63.9tn or almost 26% of net bond issuances (vs. only Rp23.4tn in full year 2017). There are least two factors which we believe support pension fund and insurance companies to remain solid in government bonds:

  • Most pension fund and insurance companies in Indonesia are at net inflow. Thus, the aim is mostly to buy instruments, not to sell. In the last eight years, on average the total investment of insurance and pension funds has grown by 14.3% CAGR. Government portion increased significantly in 2016, since the OJK has mandated their portfolio in government bonds to at least be 20% of their investment, and has continued to increase the portion to 30% in 2017.
  • Most pension fund and insurance companies’ investment portfolio are hold to maturity, meaning that their portfolio are not impacted positively if the government bond market rallies (no mark to market when portfolio is hold to maturity), in fact that will hurt due to lower yield on their reinvestment rate. Some of the biggest institutional non-banks mentioned their target investment is around 8-8.5%.

The big changes in net buy this year compared to last year are also coming from Bank Indonesia, which reported its ownership in government bonds at Rp219tn ytd (vs. Rp149.8tn in 2017). We believe Bank Indonesia has room to buy government bonds and can support the bond market if there’s selling pressure happening, considering:

  1. The total ownership of government bonds by Bank Indonesia is still relatively low at 9.3% compared to 13% during the 2013 taper tantrum. Every 1 ppt of ownership increase gives potential net buy of about Rp25tn from Bank Indonesia.
  2. If we look at the Term Deposit and SBIS amount on OMO instrument, which is also still high at Rp60tn (as of Oct- 2018), possibly this will be replaced by government bonds.
  3. Positive carry, as the yield offering by the Government is still higher than BI’s cost of fund.

The increasing onshore participation is also due to government policy to increase non-auction issuances via private placement and retail bond issuances

To mitigate lower issuance on auctions and increase onshore participation, this year the Government also optimizes non- auction issuances by private placement and retail bond issuances. Ytd, the Government has already issued Rp80.4tn from non-auction issuances or 10.8% of gross issuance realization as of 6-Nov. This is much higher compared to what happened in 2017, when non-auction portions were only 5%. We see onshore support may increase further if the Government reduces the withholding tax of government bonds, which is currently still at 15%.

In our calculation, the potential tax revenue shortfall if the Government reduces withholding tax to 10% is Rp7-14tn – assuming rupiah government bond outstanding of Rp1,165tn (excluding ownership of banks and pension funds as they’re tax-free) and weighted average coupon of 8.2%. This number is only less than 1% of the tax revenue target this year of Rp1,786tn.

Note that tax rate on the government coupon bonds is regulated in the Government Regulation (PP) No. 16/2009, which sets two types of taxes for bonds, they are: 1) 15% for domestic taxpayers and permanent establishments. Note that before 2009, the final tax rate is 20%; 2) 20% for offshore taxpayers, those that are non permanent establishment entities. But also note that offshore can benefit from tax treaty with the lowest final tax at 10%. While the final tax rate for government bonds as mutual funds’ underlying asset is applied in stages: 1) 0% for 2009 to 2010; 2) 5% for 2011-2013; 3) 15% for 2014 and beyond. However, currently the final tax rate is still at 5%.

Government bond supply outlook 2019: Net issuances not changing significantly compared to 2018

There are some positive developments from the 2019 budget to the government bond supply outlook and Indonesia’s sovereign rating outlook in our view.
The Government is lowering fiscal deficit to 1.84% of GDP in 2019 from 2.19% of GDP in 2018 outlook. This is in line with the Government’s aim to maintain stability over growth to reduce widening current account deficit. Lower budget deficit means the supply of government bonds next year might still be manageable. On the financing side, the Government is planning to lower net bond financing to Rp389tn (vs. Rp386.2tn in RAPBN 2019), down from Rp414.7tn in the proposed 2018 budget, which has been subsequently reduced to Rp388tn. Note that, interest coupon payments for rupiah government bonds is estimated to Rp220tn for next year (vs. Rp219tn in 2018).

However, in terms of gross issuances (including maturing bonds and buyback program), it is possibly slightly higher than 2018, as there are more government bonds that will mature in 2019. We estimate the Government is targeting to issue Rp840tn–gross in 2019 (vs. Rp799tn in 2018) – assuming average SPN issuances still the same with 2018 and there being Rp367.5tn of existing government bonds that will mature in 2019. The nett/gross target calculation can be lower if the Government increases multilateral loan program or reduces the SPN issuance target next year.

We don’t have details on the Government’s strategy to finance budget deficit next year, but we believe it might not change significantly compared to 2018. We still expect the Government will do front loading policy (including prefunding global bonds in December or early next year), do more issuances in local currency (expect global bond issuances’ portion to still be 17-20%, max 25% of gross issuances target), and maintain non-auctions’ portion to 10% of gross issuances target.

We also see lowering budget deficit in 2019 is still positive for Indonesia’s sovereign rating perspective.

  1. Lower budget deficit was also triggered by higher revenue. The Government plans tax revenue to grow by 15.4% in 2019 to Rp1,786.4tn (vs. the Government’s tax outlook growth of 15.3% for this year). There are four government tax revenue collection strategies next year to achieve the target: (1) Strengthening tax services and counseling by simplifying the registration process, expanding the service outlets, and expanding the coverage of e-filing services. (2) Monitoring tax compliances by implementing the Automatic Exchange of Information (AEoI) and access to financial information, broadening the extensification, increasing the monitoring to follow up the tax amnesty program, reaching informal economy (SMEs) by end-to-end approach through the business development service program, and reinforcing the tax intensification. (3) Performing tax reform by using information technology, database business process, and regulations. (4) Implementing fair law enforcement by enhancing audit quality and increasing the effectiveness of tax collection. If this happens, the tax ratio to GDP will go up to 12.2% (vs. 11.6% in 2018’s outlook and 10.7% in 2017). Note that, one of the concerns of S&P rating agency on Indonesia’s sovereign rating is that the country still has relatively low tax revenue to GDP compared to peers.
  2. On the spending side, the Government’s emphasis is more on consumption and transfer to region, and slightly less on infrastructure. The Government plans total expenditure to grow by 11.0% next year, slightly higher than 10.5% in 2018’s outlook, with the Central Government spending to ease to 12.4% from 15.0%. Despite the easing figure, the Government emphasizes more on spending to support consumption, as social spending is expected to increase by 28% yoy. Infrastructure spending is expected to slow down to 2.6% of GDP from 2.8% of GDP in 2018. This spending posture suggests the Government aims to maintain spending levels while mitigating the impact on widening the current account deficit.
  3. The primary deficit is expected to decline to Rp20.1tn (-0.12% of GDP) from Rp64.8tn (-0.6% of GDP) in 2018’s outlook and Rp124.4tn (-0.92% of GDP in 2017).

With positive fiscal posture next year, we believe four independent variables which are statistically significant in assessing sovereign rating for all rating agencies – i.e. GDP per capita, inflation, government debt per government revenue, and government fiscal balance to GDP – will slightly improve. We maintain Indonesia’s sovereign rating outlook to be stable this year and possibly it will be upgraded in the next two years if tax revenue consistently increases further- thus reliance on bond issuances can be reduced, current account deficit will be lower, and foreign exchange reserve will be higher.

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