Indonesia’s ascension to investment grade at the big three ratings companies has spurred optimism for more inflows to the nation’s bonds. But beyond the hoopla, the risk-reward equation is worsening.
BlackRock Inc., the world’s largest money manager, has moved to an underweight position on Indonesian US-currency debt, although it remains bullish on the country as a whole. Deutsche Bank Wealth Management recommended it’s time to take profits on the dollar bonds.
To some extent, the notes have become a victim of their own popularity. In the local-currency market, some $6.7 billion of inflows this year combined with accelerating inflation have pushed real yields to the lowest since late 2015. Meanwhile, the yield premium that Indonesian dollar debt offers over Treasuries is near the smallest since before 2013’s taper tantrum.
“The sovereign credit is trading tight as market consensus moved closer to the rating upgrade,” said Neeraj Seth, the head of Asian credit at BlackRock in Singapore. There’s “limited scope for further outperformance” of dollar sovereign and quasi-sovereign notes, he said.
On the political front, President Joko Widodo is facing a reenergized opposition after his ally was defeated in the Jakarta governor’s election. The government also said tax revenue is under pressure even after an amnesty that was supposed to broaden the base. Markets got too optimistic about the longevity of the tax reforms and the president’s political capital has been diminished a bit of late, according to Mizuho Bank Ltd.
“A lot of front-running was done in terms of those expectations, the upgrade expectations, the reform expectations, and so valuations are beginning to look rather rich,” said Vishnu Varathan, head of economics and strategy at the Japanese lender in Singapore, referring to the local-currency debt. “We’re beginning to sense the risk-reward has turned and become far less compelling than it was, say, two years ago.”
S&P Global Ratings upgraded Indonesia’s credit rating to investment grade on May 19, more than five years after Moody’s Investors Service and Fitch Ratings raised it from junk. The country’s domestic bonds now have an identical rating to India, the other Asian high-yielder, where the real yield on the 10-year notes is around a percentage point higher.
Indonesian inflation accelerated to 4.33 percent in May, data showed on Friday, compared with 3.02 percent at the end of 2016. By contrast, India’s consumer price index fell to 2.99 percent in April, the least in figures going back to the start of 2012.
The yield on Indonesia’s one-year rupiah notes rose three basis points to 6.26 percent last Friday and that on the five- and 10-year tenors climbed one basis point each.
In the dollar debt market, the yield premium for Indonesian bonds has dropped to 193 from 290 a year ago, according to a JPMorgan Chase & Co. index.
Kyle DeDionisio, investment director for fixed income at Fidelity International in Singapore, is also wary of the dollar bonds. Valuations are “particularly stretched”, he said, adding that local-currency notes look more attractive, but the firm is neutral on them at the moment. “Inflation is fairly stable but has a higher risk of running higher from here than lower.”
Indonesia is still a “good carry” market from a fixed-income perspective and there will be an additional $3 billion to $5 billion of inflows over the next six to 12 months, Goldman Sachs Group Inc. said in a May 30 note. Around $1 billion has flowed into the rupiah sovereign notes since May 19.
While the rating upgrade solidified positive sentiment, there is concern that positioning in Indonesia’s local-currency bonds is quite heavy, said Mitul Kotecha, the head of Asian currency and rates strategy at Barclays Plc in Singapore.
“If you do see some risk-off event, you could see the rupiah being disproportionately impacted by that, just because the positioning shakeout could be quite large,” he said.
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