Secondary Market Development Of

Government Bonds

DANAREKSABAHANA SECURITIES

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Organization of Presentation

History of Bond MarketDevelopment

Problems &Recommendation

UltimateGoals

Towards More Transparent Market

Development of Government Bonds Market

Characteristics Of Government BondsLegal Aspect

Dissemination of Information on Trading & SettlementRegulation on Investment Policy

Repo Market

Tax Scheme

Liquid Bond Market

Yield Curve

Institutional & Retail Investors

History of Bond Market Development

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Towards More Transparent Market

Free Style OTC

(No Standard Rule)

Ordered OTC(Convention Among Players)

Before 1997

Current

When ?

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Development of Government Bond Market (1)

Year Bonds Listed (Rp bio) Volume Frequency

1997 15,181.74 7,301.95 1,910

1998 13,835.17 4,860.79 1,476

1999 14,180,27 4,844.02 1,522

Jan-June 2000 19,037.39 5,195.41 1,240

Before May 1999 : The bond market totally dominated by corporate bonds.

Secondary Corporate Bonds Market Activities1997 – June 2000

Source: Surabaya Stock Exchange, 2000

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Development of Government Bond Market (2)

• Government issue bonds for recapitalization purposes in May 1999. However the bonds listed in the exchange since February 1, 2000. From May 1999 to February 2000 the recapitalized banks could not trade the bonds due to inexistence of rules for government bonds trading.

• February 1, 2000: Government list Rp 255.19 trillion in Surabaya Stock Exchange. From February 1, 10% of the recap bonds were shifted from investment portfolio to trading portfolio.

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Development of Government Bond Market (3)

Bond Listed

• Dominated by government bonds

• Out of bonds listed, 93.79 % are government bonds.

Secondary Market• However, the secondary

market still dominated by corporate bonds.

• Trading of Government bonds up to June 2000 only contribute 1.98% of the total trading. (note: government bonds trading up to 30 June only Rp 98.38 billion)

After February 1, 2000:

Problems Encountered and

Its Recommendation

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Characteristics of Government Bonds

Type MaturityCoupon

(%)

Amount Listed

(Rp trillion)

Coupon Payment

Amount Traded

(Rp trillion)

Fixed Rate

5 years 12 22.41Every 6 months

0.323

Fixed Rate

10 years 14 28.88Every 6 months

7

Variable Rate

Range from 3 - 10 years

SBI 3 -months

rate203.9

Every 3 months

1.84

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Characteristics of Government Bonds Problems:

Low YieldThe current government bonds are unattractive due to relatively low yield both for domestic as well as foreign investor. For 5 years fixed the coupon offered at 12%, for 10 years fixed the coupon offered at 14% while for variable rate now SBI 1-month rate is 13.45% and 3-month rate is 13.04% as of 20 July 2000. Some outstanding corporate bonds (such as HMSP, ASDF,AALI) offer more attractive yield (around 17%) with tolerable risk.

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Characteristics of Government Bonds

Yield Dichotomy

As of 20 July 2000, estimated yield for Indonesian USD yankee bonds (RI 06) is 12.81% (in USD) equivalent to 19.5% (in IDR). Meanwhile IDR fixed rate bonds only offer yield 12.62% (in IDR - assume the price is set at 98) in July 20, 2000

Issuance

The purpose of government issuance was recapitalizing the banks. At the time, interest rates were extremely high. Therefore, the issuance of bonds disregard the actual market yield (investor required yield) in order to keep the continuity of bank recap program without jeopardizing government budget.

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Characteristics of Government Bonds

Recommendation : Government should issue new bonds with more market

friendly structure. The amount not necessarily as much as the bonds for recap program.

This new bonds should consider its attractiveness to investors (market yield).

This new issuance could starts from short-term (T-bills) to longer term (T-Bonds).

Government should give more attention on sovereign rating by international rating agency.

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Legal Aspects• Problem : Domestic investors had experience of

disputes in the repayment of Indonesian government bonds in the 1960’s.

• Recommendation: The government should draft a Law (UU) on government bonds issuances and secondary government bonds trading to ensure the payment of coupon and principal payments and transparency in the market. Under this proposed Law, the government would have the authority to pay the interest or principal even though the government budget (APBN) had not yet been approved (still under review by DPR).

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Dissemination of Information on

Trading and Settlement • Problems: Most of the investors (domestic and

foreign) are not well informed on – the terms and conditions of the issuance,

– the coupon structure,

– how to trade government bonds, and

– the settlement mechanism, related to the unequal access between banks and other potential government bond players (e.g securities houses which act as a Primary Dealer) to the central registry (BI).

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Dissemination of Information on Trading and Settlement

• Recommendation :– The government should issue and disseminate a

prospectus (circular offering) which would consist of information on how to trade government bonds and the terms & conditions of the issuance.

– Regarding settlement, BI and Bapepam need to design the mechanism which would ensure a level playing field for the players in the bond market.

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Tax Scheme• Problems

Under PP 46/1996, banks, mutual funds, and pension funds are exempted from tax payments on interest, while securities houses have to pay 15% final tax. Foreign investors follow tax-treaty rules. This applies for all kinds of bonds. This raises the issue of an unfair playing field (in terms of tax) between players in the secondary bond market which ultimately results in poor market liquidity and price distortion.

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Tax Scheme

• Recommendation

In several countries, government bonds are tax-free (0%) for residents. Non-residents follow tax-treaty rules. This become necessary condition for improving the liquidity of the bond market.

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Regulations on Investment PolicyProblems :

Institutional investors face restrictions over their investment policy in the bond market, including government bonds. This may hamper domestic investors from investing in government bonds.

Recommendation :Remove investment restrictions for government bonds (risk-free instruments). For banks, government bonds should be treated as secondary reserves and/or part of the reserves requirement.

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Repo MarketProblems :

The fact that there is no repo market for government bonds is of concern to potential investors.

Recommendation :

BI could increase the effectiveness of government bonds by using monetary policy tools to maintain Open Market Operations through a repo market. By doing so, BI could reduce its cost of monetary policy (which accounts for a large proportion of BI’s costs).

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Ultimate Goals

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Ultimate Goals: A liquid Bond Market• A liquid bond market could provide continuous bids and

offers, which would subsequently provide a yield curve. • The government would be able to refinance mature bond

recapitalization. In the long term, government will be able to finance their budget through bond market.

• It would reflect the improvement of investor confidence in the Indonesian market.

• It would provide a wide range of investment alternatives which could become underlying assets for a derivatives market (hedging instruments)

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Ultimate Goals: Yield Curve• The yield curve will be the benchmark of interest

rates (required yield) resulting in the better pricing of fixed income instruments,

• The basis for creation of mortgage bonds, asset-backed securities or other securitization program for financing consumer loans and municipal bonds.

• The reference for foreign and domestic investors which, in turn, reduce the yield dichotomy between domestic and foreign market.

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Ultimate Goals: Strong Institutional & Retail Domestic Investors

• Strong Institutional & Retail Domestic Investors could benefit the whole market– Investment characteristics will shift from a short-term

to longer term horizon. – Reflects the improvement of domestic market

confidence– Increase domestic investors base– Lead to increasing market cap of the bond market

(given the higher demand in the market).