Is the foreign love affair with Indonesian government bonds really over?

Foreign ownership of Indonesian state bonds earlier this month reached a record high of 36 per cent of the total issue, or more than $28bn, capping years of strong inflows. But now those holdings have slid nearly 3 percentage points in less than a week as investors pulled their money out of Jakarta.

The selling has sent the local currency, the rupiah, tumbling the most since the 2008 crisis and prompted intervention by Bank Indonesia, the central bank. That’s serious. But there are few signs that the foreigners are leaving for good.

“We are still very optimistic about Indonesia. It has been one of the most popular destinations for investors,” Destry Damayanti, chief economist at Mandiri, the country’s largest bank by assets, told beyondbrics. “The long-term fundamentals remain strong, but the rupiah will continue to be very volatile in the short-term.”

Jakarta, which had been the best performing stock market in Asia this year, was finally hit heavy selling last week. Equities were dumped, sending the composite down nearly 20 per cent into bear territory. It rebounded 5 per cent Tuesday, but is off 11 per cent this year.

The authorities are worried enough to intervene in the markets. Between Thursday and Monday, the central bank purchased more than $300m of government paper, the finance ministry said. The central bank was also buying in the secondary market.

But the finance minstry did miss its target on Tuesday’s bond auction – raising 4,150bn rupiah ($464 million), below the 5,000bn rupiah target.

Reuters said total bids for the bonds on auction reached 10,250bn rupiah. Demand was much lower than that seen in recent auctions. Bids totalled 19,150bn rupiah at the ministry’s September 13 auction.

Damayanti said she was reviewing her economic growth forecasts for 2011 and 2012 and would likely revise GDP down by 0.2 per cent to 6.4 per cent for this year, due mainly to a slowdown in China, a leading importer of Indonesian raw materials.

However, even at 6 per cent a year, Indonesia would be one of the world’s fastest-growing large economies. It has a potent mix of diverse commodity exports and growing consumer markets – combined with big needs for foreign investment capital for industry and infrastructure.

After their recent falls, shares trade on a price/earnings ratio of 11 times forecast 2012 earnings. That’s not expensive by recent standards. But it is still far above the low hit in the 2008 crisis, when, according to HSBC’s calculations the index dropped much further – to a level where a comparable forward p/e ratio would have been just 8.1.

HSBC suggests there could now be opportunities for bottom-fishing. The real economy is more solid than the markets might indicate:

Our conversation with people in the real sector also indicates that things are still doing fine; they are still spending and expanding capacity despite volatility in the stock market and exchange rates. They seem to agree that this volatility will be short-lived so long as the Central Bank can manage the rupiah.

That’s a good argument when investors are focused on domestic issues. But right now they have too much to think about around the globe.

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