BOND MARKET UPDATE INDONESIA Bond

BOND MARKET OUTLOOK 2011 October 20, 2010

Country : Indonesia Investment Highlights:

„ The global and regional growth forecasts for 2010 still
Sovereign Credit Rating remain robust, but downside risks to the outlook for
S&P : BB/positive
the 2H10 and FY11 have increased at certain level.

Moody’s : Ba2/stable
„ Massive capital outflow from the U.S. and Euro region
seek alternative investments in high yielding securi-
Fitch : BB+/stable ties, in Asia specifically.
„ South East Asian countries have not been significantly
Economic Figures impacted by the sovereign debt crisis in Europe
GDP (2QYoY) : 6.2% „ Indonesia's inflation eased to 5.8% YoY in September
from 6.4% YoY in August on a relatively low 0.4% MoM
BI Rate : 6.5%
rise. Bank Indonesia held its policy rate steady
CPI YoY : 5.8%
„ Indonesia’s government bond yield curve showed a bull-
Current Account : $1.485 mn ish flattening pattern as of September 2010

Export YoY : 30.00% „ Foreign inflows rushing in have accelerated the short-
term yield downtrend as foreigners have increased their
Import YoY : 25.89% holdings in government securities
Foreign Rsv : $81.32 bn „ Core inflation is still low as it was supported by a stron-
ger exchange rate, thus we foresee CPI is likely to mod-
Exchange Rate : Rp 8,913/$
erate until 2011
„ We expected an interest rate hike as much as 100bp in
2011 from the current level of 6.5%.
„ We recommend an exit strategy for longer term gov-
ernment bond and shortening duration to midterm and
short term
„ Longer term yields, which are more sensitive to infla-
tion fears than shorter-term yields, may rise more than
shorter term yields do. Supply and demand imbalance
may also cause a distinctive yield curve shift
„ With yields at all-time lows, we find long term corpo-
rate bonds to be unattractive now, while we recom-
mend trading strategy for short term corporate bonds.

Deo Rawendra
Email : deo@bnisecurities.co.id
Phone : (62-21) 25543946 (Hunting)
Fax : (62-21) 57935831
BOND MARKET OUTLOOK - October 20, 2010

Global market review... The global economic recovery has been under concerns since the 2H09 after glo-
bal financial market crisis that led by U.S. in 2008. The situation has been under
fear that advanced economies growth may stay lower for an extended period.
The global and regional growth forecasts for 2010 still remain robust, largely
driven by a strong performance in the first half of the year. However, downside
risks to the outlook for the 2H10 and FY11 have increased at certain level.

The Euro Area has been tumbling as huge fiscal deficits and escalating public debt
persists and affected its banking system and sovereign debt. In addition, concern
over European fiscal risks increased due to Ireland's disappointing 2Q GDP growth.
This condition resulted in downgrades by credit rating agencies. Meanwhile, the
United States (US) Federal Reserve was highly expected to resume quantitative
easing, thus pushed Treasury bond yields lower as investors were rushing into
safe-haven government bonds. At its latest meeting, the FOMC also suggested an
additional quantitative easing which it could be necessary as well as giving warn-
ing of U.S. deflation.
EXHIBIT 1. 5-YEAR CREDIT DEFAULT SWAP FOR EURO AREA (in bps)

Source: Bloomberg

EXHIBIT 2. 5-YEAR CREDIT DEFAULT SWAP FOR SOUTH EAST ASIA (in bps)

Source: Bloomberg

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BOND MARKET OUTLOOK - October 20, 2010

Bond market soars... Globally, demand for government bonds have surged in the 2H10 as attractive
yields and a strong regional growth outlook have out shadowed the uncertainty of
the global economic outlook. In emerging markets, the appreciations of regional
currencies have also given a strong momentum. These resulting in downtrend of
the government bond yield all over the world.
EXHIBIT 3. 10-YEAR GOVERNMENT BOND YIELDS (%)

Source: Bloomberg

Strong growth in emerging The global economic downturn has been relatively favorable to emerging markets
markets... as massive capital outflow from the U.S. and Euro region seek alternative invest-
ments in high yielding securities. In Asia specifically, these foreign inflows were
backed by the relative health of its economies and strong GDP growth. South East
Asian countries have not been significantly impacted by the sovereign debt crisis
in Europe where we saw a decline in credit default swap (CDS) spreads as well as
upgraded sovereign ratings. In addition to global investors' pursue for higher yields,
regional currencies appreciation, have also urged foreign portfolio capital in-
flows into Asian markets. This has led to a flattening of government bond yield
curves in most emerging East Asian markets, especially at the long-end.
EXHIBIT 4. ECONOMIC FIGURES OF EMERGING COUNTRIES

Source: Bloomberg, CEIC

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BOND MARKET OUTLOOK - October 20, 2010

Asia’s local currency bond Local currency bond in Asian developing countries grew 18.8% YTD in June; with
soars... the amount outstanding was US$ 4.8 trillion. The increase was driven by growth
of 24.4% YoY in the corporate bond market which is the source of financing for
private sector investment. The YTD growth of local currency bond markets in Asia
was led by Hong Kong, amounted to 43.3%, Vietnam 35.8%, China 22.5%, and
Thailand 18.4%. The growth of Hong Kong's bond market caused by the issuance
of Exchange Fund Bills and Notes by the Hong Kong Monetary Authority for mon-
etary policy. In summary, foreign investors have rushed in to as much as 27.4% of
Indonesian government bonds, 18.1% Malaysian government bonds, and 7.4% of
South Korean bonds. Most of these investments coming from outside Asia.

EXHIBIT 5. EMERGING EAST ASIAN BOND MARKET GROWTH (YoY%)

Source: Asian Development Bank

EXHIBIT 6. FOREIGN HOLDINGS OF LOCAL CURRENCY GOVERNMENT BONDS

(% of total)

Source: Asian Development Bank

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BOND MARKET OUTLOOK - October 20, 2010

Indonesia’s economy Indonesia's inflation eased to 5.8% YoY in September from 6.4% YoY in August on a
review... relatively low 0.4% MoM rise. Bank Indonesia held its policy rate steady at 6.5% on
the basis that inflation has dropped back into its 4 - 6% target range. The ex-
change rate has provided a monetary anchor with rupiah/USD appreciation of
more than 10% YTD. Non-oil exports rose by 32.3% YoY in August from 29.4%.
Imports, in contrast, were weaker in August slow down to 22.3% YoY from 53.6%
in July. Consumer confidence (BI survey) pick up from the August low at 104 to
107.6 in September. Nevertheless, Indonesia's Credit Default Swap (CDS) has been
declining as much as 89% from its highest in October 2008.
EXHIBIT 7. INDONESIA'S ECONOMIC FIGURES
1Q10 2Q10 3Q10
Jan Feb Mar Apr May Jun Jul Aug Sep
GDP (YoY%) 5.69 6.2
CPI (YoY) 3.72 3.81 3.43 3.91 4.16 5.05 6.22 6.44 5.8
Current Account (US$ mn) 2,031.4 1,707.0 1,801.8 799.4 2,054.8 570.1 (139.0) 1,485.4
Export (YoY%) 59 57.1 48.3 42.4 37.4 31.4 28.9 30
Import (YoY%) 44.58 59.9 67.42 67.53 30.61 48.2 45.4 25.89
Foreign Reserve (US$ bn) 69.56 69.73 71.82 78.58 74.59 76.32 78.79 81.32
BI rate (%) 6.5 6.5 6.5 6.5 6.5 6.5 6.5 6.5 6.5
SBI 3 months (%) 6.60 6.59 6.56 6.50 6.58 6.60 6.63 6.63 6.64
SUN 10 years (%) 9.79 9.85 9.10 8.60 8.94 8.38 8.08 8.26 7.63
Foreign Exchange (US$/Rp) 9,360 9,335 9,095 9,013 9,180 9,053 8,920 9,030 8,913

Source: Bloomberg, CEIC

EXHIBIT 8. INDONESIA'S CREDIT DEFAULT SWAP (in bps)

Source: Bloomberg

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BOND MARKET OUTLOOK - October 20, 2010

Credit rating has im- Moody's have revised the outlook for Indonesia's sovereign credit rating from 'stable'
proved... to 'positive' on June 2010. The positive outlook is valid for Indonesia's sovereign
credit rating which is currently at the level of Ba2 local and foreign currency
sovereign rating. It also implies to Ba1 foreign currency bond ceiling and Ba3
foreign currency deposit ceiling. Moody's latest Indonesia's rating revision was on
September 16, 2009, when the sovereign rating upgraded to Ba2. With improved
outlook by Moody's, the position of Indonesia's sovereign credit rating is currently
Ba2/Positive. The positive outlook indicates Indonesia is likely to gain an increas-
ing rating in 1-2 years ahead. Indonesia still needs two more notches to invest-
ment grade from Moody's. On March 12, 2010, Standard & Poor's revised up
Indonesia's rating outlook to positive on improving debt ratios at BB or two notches
below investment grade.
EXHIBIT 9. INDONESIA'S HISTORICAL SOVEREIGN CREDIT RATING

Source: Bloomberg

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BOND MARKET OUTLOOK - October 20, 2010

Indonesia’s government As of Indonesia, the yield curve showed a bullish flattening pattern as of Septem-
bond yield curve has ber 2010. The central bank, as mostly unexpected, held its base rate at 6.5%,
flattened... where there has been growing prediction that there would be no additional rate
hike within 2010. In particular, the short-term bond yield started to increase as
high expectation on the rate hike diminished. In addition following to the rate
freeze, foreign inflows rushed in and accelerated, pulling the short-term yield
downwards. The government bond yield curve flattened from the short-end to the
long-end of the curve. By mid-October 2010, yields fell the most for the 15-years
tenor, shedding 322 basis points YoY. The yield spread between 2-year and 10-
years maturities narrowed to 88 basis points in mid-October 2010 from 195 basis
points at mid-October 2009.
EXHIBIT 10. INDONESIA'S BENCHMARK YIELD CURVE OF LOCAL CURRENCY
GOVERNMENT BOND (%)
 
2008

2009
2007
2010

Source: Bloomberg

Regulations has affected The decreasing downturn in Indonesia's local currency government bond yield was
the bond market.. also an effect from Bank Indonesia's (BI) new regulation which required a mini-
mum of 28 days holding period for Sertifikat Bank Indonesia (SBI). This has led
investors to switch funds and invest in government bonds. Another strong catalyst
is the government's desire to limit the issuance of Treasury Bills or Surat
Perbendaharaan Negara (SPN). The government intends to gradually reduce the
portion of the SPN, from the previous 18% to 15% over the next three years.

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BOND MARKET OUTLOOK - October 20, 2010

Foreign inflow has been a In just nine months since January 2010, foreign funds have been flushed into
strong catalyst... Indonesia amounting to Rp 115 trillion YTD. Most foreign funds rushed into gov-
ernment bonds, which amounted to Rp 74 trillion, Rp 20.5 trillion going in to Bank
Indonesia Certificates (SBI) and nearly Rp 21 trillion into the stock market.
Indonesia's government bonds outstanding climbed by 13.5% YoY to Rp 892.3 tril-
lion, as the local currency overall bond market expanded 13.8% YoY as of 1H10,
with the total volume of Rp 985.4 trillion.
EXHIBIT 11. INDONESIA'S SIZE AND COMPOSITION OF LOCAL CURRENCY
GOVERNMENT BOND (in Rp bn, as of mid-October 2010)

Source: Indonesia Debt Management Office

EXHIBIT 12. INDONESIA'S HOLDINGS OF LOCAL CURRENCY GOVERNMENT

BOND (in Rp trillion, as of mid-October 2010)

Source: Indonesia Debt Management Office

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BOND MARKET OUTLOOK - October 20, 2010

Foreign ownership in- Outstanding foreign ownership until the end of September 2010 in SBI reached Rp
creases... 64 trillion or about 25% of the total funds in the SBI, where in government bonds or
SUN, foreign funds amounted to Rp 182 trillion or 30% of the total funds in govern-
ment securities. Foreigners have increased their holdings of long term tenor from
Rp 53 trillion in FY09 to Rp 100 trillion in Oct 2010. Foreign proportion ownership
on tenor more than 10yrs rose to 54.6% (from 49.3% FY09), short term-tenor
portion (less than 5yrs) also rose to 31% (from 28.9%), while medium tenor- 5 to
10yrs down to 14.3% (from 21.7%).

EXHIBIT 13. INDONESIA'S FOREIGN HOLDINGS IN GOVERNMENT BONDS

(in Rp trillion)

Source: Indonesia Debt Management Office

EXHIBIT 14. INDONESIA'S FOREIGN HOLDINGS PORTFOLIO PROFILE BY

PROPORTION

Source: Indonesia Debt Management Office

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BOND MARKET OUTLOOK - October 20, 2010

Corporate bond market on Corporate bond issuance reached Rp 7.3 trillion, primarily comprising issuance
the rise... from financial sector firms. Corporate bonds outstanding rose to Rp 93.0 trillion
in 1H10, expanding 16.5% YoY. Most of the bonds issued in 1H10 offer coupons of
10% or more and were consistently oversubscribed. Overall, corporate bonds de-
mand is still high which make risk premium rised on 2H10 as government bond
yields touches record low. Total transaction value of corporate bonds this year is
expected to grow significantly. Indonesian Stock Exchange (IDX) recorded total
transaction of corporate bonds during 2010 has reached Rp 250 billion per day.
This figure is more than doubled compared to 2009.

EXHIBIT 15. CORPORATE BOND RISK PREMIUM AVERAGE (in bps)

Source: Centralized Trading Platform, BNIS Calculation

EXHIBIT 16. NOTABLE 2010 CORPORATE BOND ISSUANCE

Source: Centralized Trading Platform, BNIS Calculation

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BOND MARKET OUTLOOK - October 20, 2010

Budget target for bond As of 1H10, Indonesia's Ministry of Finance reported that government spending
issuance... was slow, resulting in a lower-than-projected budget deficit for FY10. The gov-
ernment managed to spend only Rp 395.8 trillion during 1H10, or 35.1% of the
target set in the FY10 revised state budget. Meanwhile, revenue collection reached
44.7% of the annual target. This resulted in a budget surplus amounting to Rp 47.9
trillion in 1H2010. Indonesia's Ministry of Finance proposes an increase in the
budget deficit in 2011 from 1.7% to 1.8%. The increase was due to the postpone of
the rising electricity tariff (TDL) by 15%. With the soaring deficit, the issuance of
government securities is expected to increase from the original plan. In nominal
terms, an increase in deficit of 0.1% is equivalent to Rp 7 trillion. In other words
the government should seek additional debt of Rp 7 trillion from the previous
target set.

EXHIBIT 17. INDONESIA'S BUDGET (in Rp bn)

Source: Indonesia Ministry of Finance

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BOND MARKET OUTLOOK - October 20, 2010

Inflation still under As Indoneisa's real interest rates remain positive, rising inflation still stands as the
controll... key obstacle for BI in maintaining a relatively flat rate. Inflationary pressures
continue to threaten the CPI of 5.8% (year on year) in September 2010. However,
core inflation is still low as it was supported by a stronger exchange rate. We
foresee CPI is likely to moderate until 2011 hovering 5%-6% level, whereas of
3Q10, the domestic economic growth was sustained by household consumption
and exports fueled by strong demand from China and India. We foresee an interest
rate hike as much as 100bp in 2011 from the current level of 6.5%.
EXHIBIT 18. INDONESIA'S INTEREST RATE & INFLATION (%)

Source: Bloomberg

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BOND MARKET OUTLOOK - October 20, 2010

Yield is expected to With the interest rate expected to rise and bond yields at all time low, we recom-
bounce back... mend an exit strategy for longer term government bond and shortening duration
to midterm and short term. We expect yield to bounce back as market's expecta-
tions of future rate changes which are one important determinant of the yield-
curve shape. In general, when yields trend are rising, the yield curve may flatten.
These shifts happened because shorter-term yields typically respond more posi-
tively to an event like interest rate hike than the longer term yields. Longer term
yields, which are more sensitive to inflation fears than shorter-term yields, may
rise more than shorter term yields do. Supply and demand imbalance may also
cause a distinctive yield curve shift. Suppose a heavy government issuance and
slack demand may force yield to rise and alter the yield curve slope movement.
Conversely, if foreign fund inflow persists, low yield may still have the possibility
to hold on.
EXHIBIT 19. INDONESIA'S GOVERNMENT YILED CURVE FORECAST (%)

Source: Bloomberg, BNIS Estimate

Corporate bonds are still Corporate bonds typically underperform government securities in a recession due
attractive investment... to increasing credit risks; conversely, corporate bonds typically outperform gov-
ernment securities in a recovery. This reflects that, corporate bonds are subject
to interest rate risk, and they are less liquid than government securities. With
yields at all-time lows, we find long term corporate bonds to be unattractive now,
while we recommend trading strategy for short term corporate bonds. Lower
benchmark yields has also increased risk premium for high quality corporate bonds.
We find this would give an increase in trading volume of corporate bonds and
higher price volatility in the coming period.

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BOND MARKET OUTLOOK - October 20, 2010

EXHIBIT 20. GOVERNMENT BOND VALUATION (last price data: 19-Oct 2010)

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BOND MARKET OUTLOOK - October 20, 2010

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