CLSA War Games

Interesting piece from Nick Cashmore. He noted that Bank Indonesia has declared a war against free currency markets with forex reserves rising US$1bn a week. Forex reserves rose to US$86.2bn as of end Sept. This is almost double the average increase for the year.

In essence, we think the central bank is engaged in a one way bet. The US Fed wants to drive down interest rates and this will only further drive a tsunami of cash into higher yielding currencies like the rupiah. Pressure is accentuated with Indonesia verging on investment grade status. Markets may already be betting the central bank will not be able to continue intervention at the current pace indefinitely. At one point, when the central bank does slow the intervention, we think the pace of rupiah appreciation will accelerate.

Another interesting highlight is that Indonesian risk premiums also look excessive relative to peers. The spread of local currency sovereign debt over UST10yr is still 500bps with 10-year bond yield at 7.5%. We think there is no reason for Indo bond yield to drop to 6% level, matching the level of the Philippines’ yield.

The government will be a significant beneficiary of falling long-run bond yields and they will be able to roll over debt costing 13.3% at 8% or better. No less than US$860mn of fixed rate debt maturing this year and US$4.4bn by end-2011. Nice cost saving for the government.

Real economy implication
As long-term rates fall banks will be forced to shift the mix of earning assets into higher yielding asset, i.e. loan. It will also spur banks to lend more to micro, SME, and consumer lending.

Investment recommendations:
OWT long-dated bonds and domestic-biased companies. We like Kalbe Farma (KLBF IJ), Jasa Marga (JSMR IJ), and Astra Int’l (ASII IJ).
OWT companies leveraged to the investment cycle. We like Indocement (INTP IJ) and Holcim (SMCB IJ).
OWT stocks benefiting from asset reflation: Bakrieland (ELTY IJ), Summarecon (SMRA IJ), Bumi Serpong (BSDE IJ), Bank Tabungan (BBTN IJ), Bank Central Asia (BBCA IJ) are some names for investors to consider.