Review: Bond prices and rupiah weakened ahead of inflation data. Volatility in the rupiah bond market continued during the week. Having rallied in the first three days of the week, bond prices dropped Thursday. The 10-year government bond yield fell to 7.98% on Wednesday before rising to 8.05% on Thursday. Yield curve steepened as short-term yield were relatively stable. The gap between the 10year and 1-year yields was up to 2.06ppt from 1.6ppt in July – still slightly below the long term historical average of 2.4ppt (Figure 1). Overall, government bond prices fell 0.2% on average, according to Mandiri Sekuritas! Governme nt Bond Index. Thus, total return investing in the government bonds is 16.4% year to date with average yield to maturity up slightly by 3bps to 8.88%. The rupiah also weakened during the week by 0.48%, trading at 9,016 against US Dollar.
Transaction volume was relatively high. Total value of the transaction in the secondary bond market was Rp6.7tn (vs. Rp3.7tn on the previous week) on average per day. The most actively traded security was the long-end series such as the 15-year FR40 and the 20-year FR52; both comprising about 38% of the total trading volume during the week. The FR40 was traded at 120, up by 1.1 percentage points yielding 8.60% from a week earlier. Meanwhile, the FR52 was also up by 0.2 percentage points to 112.29, yielding 9.15%. Our fair p! rices for those bonds are 118.50 and 112.39, thus we think FR40 is traded above its fair value, meanwhile we have no recommendation for the FR52 as it’s already traded at its fair value.
Foreigners were still bullish on the rupiah bonds. After slightly reducing their portfolio in the last two week by almost Rp1tn, foreign investors become net buyers during the week by mostly increasing their holdings of the long end tenors. Their holdings of over 10-year tenors increased by Rp1.9tn during the week to Rp96.7tn. Meanwhile, they net sold 2-5 year tenors by Rp0.5tn to be Rp32.2tn. Thus foreigners’ total portfolio of bonds over 10-years rose to 54.1% from 53.4% in the week.
Bond auction result: total bid was still robust but the lowest yield bid increased. Total bid on the bond auction on Tuesday was still high reaching Rp16.1tn— lower than in the previous auction of Rp17.2tn. Demand for the short-term paper was still remarkable with the bid for the SPN20110811 reaching Rp6.8tn or almost 42% of total bids. The average yields awarded were slightly below our fair yield estimate. The SPN20110811, FR53, FR54 and FR50 average yield awarded were 5.82% (vs. our estimates: 6.0%), 8.06% (8.14%), 8.96% (9.07%), and 9.20% (9.46%), with the highest ! yields aw arded being 5.84%, 8.09%, 8.97% and 9.22% respectively. However on Friday the FR53, FR54 and FR50 are closed lower at yield, 8.23%, 9.24%, and 9.43% respectively compared with Tuesday. There are two interesting point on the last auction (1) The government continued to try reducing the T-bill (SPN) issuances, although total bids was very high i.e. Rp6.6tn, The government only issued Rp0.4tn. (2) Although total bids for the long-end tenors were relatively high but the bid for the lowest yield increased from the previous auction. Thus, the government has issued Rp139.6tn (incl. including sukuk private placement with the Ministry of Religious Affairs totaling Rp336bn on 26-Aug) or almost 83% of the new total target to finance budget deficit. The Sukuk SDHI 2014 B is maturing 4 years and offering coupon fee of 7.3%.!
Rising debt issuance in 2011? According to the 2011 budget plan, the deficit would amount to Rp115.7tn, equivalent to 1.7% of GDP, or lower than 2010 budgeted deficit of Rp134tn or 2.1% of GDP. For the bond market perspective there are two things that should be watched carefully (1) financing account. Although budget deficit is narrowing but the government plans to sell more bonds while at the same time reduce offshore borrowings. Net sales of government bonds are targeted to be Rp125.5tn in 2011 or higher by almost Rp18tn than in 2010. On gross issuances basis, the government projected to issue more than Rp200tn in 2011. The government would prio! ritize th e rupiah-denominated bonds emission. Meanwhile, drawings of external loans will be recorded at Rp57.1tn next year, lower than an estimated Rp70.8tn in 2010. However, we think the government might reduce bond issuances if there’s an excess fund from 2010 and government reduces SPN issuances this year. (2) Subsidize account. The government plans to reduce electricity and fertilizer subsidies in 2011. Electricity tariff is projected to rise 15%, allowing subsidies to decline from Rp201.3 trillion in 2010 to Rp184.8tn in the subsequent year. In addition, the government also anticipates lower subsidies for fertilizer, seed, interest on program loans, and taxes, resulting in 10.9% decrease of non-energy subsidies during 2011. This condition might stoke inflation in 2011, although the government still maintains their inflation forecast at 5.3%. Our economist expects inflation to rise to 6.6% in 2011.
Outlook: We still maintain our duration shortening suggestion. Rising inflation risks come with rising debts might continue to yield curve steepening. Augusts’ inflation figure will be released on 1-Sept. In the last five years, average August inflation reached 0.43% m-o-m. Our economist expects 1.14% m-o-m and 6.84% y-o-y inflation following the impacts of electricity tariff hike, school-fees increase, and higher food prices during the fasting month. Market consensus expected inflation will be higher in August ! i.e. 1% m -o-m (6.7% y-o-y). Thus, in terms of risk reward wise, we still maintain our strategy to shorten the duration. We still maintain our view that it’s not comfortable owning the 10-year bond with the yield offered below 9% taking into account mounting inflation pressure and rising debt issuances. Short-term tenors might be safer bets. However, if the 10-year bond yield is higher than 9%, long term tenors will be attractive. We also maintain our yield forecasts for the 2- and 10-year bonds at 7.7% (range: 7%-8.3%) and 9.8% (range: 9.2%-10.4%) by the end of this year, assuming inflation rate of 5.9%, the rupiah at Rp8,900 against the US dollar and BI rate 7% by YE2010
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