Indonesia: New money market tool SRBIs to garner interest
- We discuss the characteristics, likely yield range and demand-supply dynamics.
- This instrument provides added flexibility for foreign investors to optimize risk exposures.
- Fiscal outperformance has lowered incremental bond issuance, ….
- …which will likely spur interest in these papers.
- We expect flattening pressures on the IDR rates curve.
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Bank Indonesia (BI) introduced a new pro-market monetary operation (MO) instrument referred to as the Bank Indonesia Rupiah Securities (SRBI) at its August rate review. The instrument will replace the existing reverse repo facility and operation twist bond sales, with its issuance due to start around mid-September. These securities will be a) IDR-denominated issued on the underlying tradable assets of government bonds owned by the BI; b) offered through variable rate tender auctions for 6M, 9M and 12M tenors; d) tradeable by domestic and foreign investors in the secondary market.
There are three objectives behind the introduction of SRBIs. One, is to deepen IDR money markets by introducing a new instrument that would be tradable, easily accessible and liquid. Two, to optimize the SBNs (government securities) held by BI and to issue SRBIs to improve transmission of rate hikes to money market rates. Three, likely the most important, is to attract carry-seeking foreign funds/FII flows to support IDR stability at a time when the current account has fallen back into deficit and government issuances has been slowing.
The SRBI is comparable to the short-term SBI (Bank Indonesia Certificate) which used to be issued earlier, carrying similar characteristics but without using SBNs as the underlying asset. As part of the central bank’s toolkit to control liquidity in the banking system as well as strengthen rupiah liquidity management, the tenor and holding period of SBIs used to be tweaked to modulate offshore investor interests into the domestic financial system. There were instances when SBI-led hot money foreign inflows had caused considerable volatility in the authorities’ FX stability mandate. Subsequently, the issuance of SBIs was discontinued and replaced with SDBIs, i.e., BI Deposit Certificates.
Projections for SRBIs’ yield range
In thinking about SRBIs’ likely yield range, it would be useful to take reference from other short-dated instruments. Compared to SBN Reverse Repos where participation is largely limited to banks, SRBIs would be accessible to a wider range of investors – all else equal, SRBI yields should theoretically be lower than SBN Reverse Repo rates. SRBI yields should also be competitive relative to NDF implied yields, so as to engineer stronger interest from carry-seeking foreign investors. Based on both considerations, 6/9/12M SRBI yields could be in a 6.20-6.40%.
Ultimately, BI holds significant control over the level of SRBI yields, by controlling the size and pace of issuances. The risks to a 6.20-6.40% projection is likely skewed to the upside, as the primary objective is to raise domestic-global rate differentials and attract FPI inflows. Allowing SRBI yields to be to relatively low, in the event of overwhelming demand, would defeat the purpose of introducing SRBIs. Therefore, we widen our projected range in an asymmetric manner to 6.10-6.65%.
Supply and Demand Outlook for SRBIs
As of end of August, liquidity placed at SBN Reverse Repo operations amount to IDR491tn and based on our estimates, IDR350-370tn is in the 6/9/12M term. Assuming no net liquidity impact, outstanding SRBI size is expected to rise to IDR350-370tn over the next 6-12 months as existing 6/9/12M Reverse Repo operations expire. Outstanding size could however grow to a larger amount if BI also replaces 14D/28D/3M Reverse Repo operations with SRBI issuances. Another key factor would be the targeted yield levels for SRBIs – BI is likely to adjust issuances to manage yield levels. All else equal, we expect targeted yield levels to be higher when the broad US Dollar is strong, and relatively lower when the broad US Dollar is weak.
The introduction of SRBIs would be welcomed by the investor groups.
Banks should prefer SRBIs where they can buy/sell in the secondary market according to their short-term liquidity needs, over SBN Reverse Repo operations where their surplus funds would be locked up for a fixed time. Based on enquires from our fund clients, we gauge that investor interest is high. From banks’ perspective, they would want to get hold of sufficient sizes of SRBIs to sell to clients.
Foreign investor interest should also be robust. The low supply of SPN (Indonesia Treasury Bills) and relative illiquidity and difficulty of sourcing SPN/short-dated IndoGBs have been challenges for carry-seeking investors. SRBIs will go a long way to resolving these challenges and in addition, offer higher yields than SPN/short-dated IndoGBs. Critically, SRBIs would give the flexibility for foreign investors to optimize their FX and Duration risk exposures. Previously, buying the liquid 5/10/15/20Y IndoGBs (where there is regular supply) would require investors to be bullish on both FX and Duration. From here on, if investors are bullish on FX but cautious on Duration, they could switch to SRBIs. Considering that the main risk exposure is to the FX, we expect foreign demand for SRBIs to be strongest when the broad US Dollar is weak.
Bond supply to shrink on fiscal outperformance
Fiscal math continues to outperform on year-to-date basis. Compared to the full-year deficit target of -2.3% of GDP, Jan-Jul fiscal balance stands at a surplus of IDR 153.5trn (0.7% of GDP), owing to strong revenue growth, whilst expenditure trails.
State expenditure stood at 48% of the budget target, up 1.2% yoy in the first seven months of the year. Lower subsidy (-3.3% yoy by Jul23) allocations after the last year’s increase in fuel prices and fall in material payments have helped, even as funds towards social assistance, interest payment and capital have gone up. Revenues have been strong, with 65.6% of the annual target met by Jul23. Tax and non-tax receipts have made up for lower customs and excise collections. Even as commodity prices (mainly palm oil and minerals) moderated, resumption in normal activities have helped tax revenues (up 7.8% yoy). Concurrently, change in the tax policy, including the 1% increase in the VAT rate to 11% and new income tax rate for the high earners helped to keep collections buoyant. Under the non-tax receipts, oil & gas (O&G) have declined this year, but non-O&G is still up a healthy 81% yoy and profit transfers from SOEs up a strong 59%.
Assuming these expenditure and revenue run rate persists in 2H23, we expect the fiscal deficit to narrow to -1.8% of GDP. By extension, gross bond supply will be less than the official estimate of IDR 843trn and be closer to IDR 720-740trn. This implies that the size of the weekly auctions heading into late 2023 will narrow to ~IDR10trn, with the cash surplus from the past, likely lowering the need to issue securities in 4Q23 altogether. In this context, the demand for SRBIs utilising SBNs as the underlying asset, are likely to gain from a fall in incremental supply in the short-tenor government securities.
The 2024 Budget projections point to a growth-supportive stance whilst also prioritising macro stability. Pegging annual growth at 5.2% (vs DBSf 5% this year), inflation is seen at the middle end of the new 1.5-3.5% target range at 2.8% (DBSf 3.7% in 2023). Fiscal consolidation will remain a priority, with the deficit target set at -2.3% of GDP vs projected -2.5% this year. A proposed IDR 108.8trn will be set aside for food security to keep prices stable, increase farm output, and expand the ongoing food estate program. Infrastructure will be allocated IDR 422.7trn including IDR 40.6trn towards the construction of the new capital Nusantara. Plans are to set-up the housing facilities in time for the civil servants, military, and police to shift to the new city next year. On the financial markets, USDIDR is assumed at 15000 from 14800 this year, with the 10Y yield at 6.7% vs the prevailing 6.4%.
In all, we don’t expect the SRBIs to influence mainstream policy decisions. While domestic inflation is evolving along expected lines, the central bank is focused on rupiah stability while eyeing the risk of additional rate hikes by the US Fed. We expect the BI benchmark rate to be held unchanged at 5.75% till end of the year.
Impact on IndoGB yields and curve
Higher front-end issuances, from the supply of SRBIs, will likely put flattening pressures on IDR rates curve. That said, between 1-3Y vs 10Y IndoGBs, the curve is already very flat. Scope for further flattening is limited (we don’t expect inversion) and passthrough from higher front-end rates (due to SRBI supply) to long-dated IndoGB yields could be more visible from here. We expect SRBI yields to be more attractive than existing money market instruments, which would drive some reallocation flows away from long-dated IndoGBs and towards SRBIs, in the process, bring re-steepening pressures.
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