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Prabowo’s free meal plan raises investor concerns about Indonesia’s finances
JAKARTA/SINGAPORE, July 8 (Reuters) – Indonesian President-elect Prabowo Subianto wants to give free meals to schoolchildren, but the plan and his pledge to be “bold” in spending have left the country’s debt and currency markets nervous.
Prabowo and his team have sought to distance themselves from any suggestions of fiscal profligacy and assure market participants that the new government respects legal debt limits that cap its budget deficit at 3 percent of economic output.
But for a market that is growing accustomed to stability and a recognition of fiscal prudence under current Finance Minister Sri Mulyani Indrawati, the mere suggestion of heavy spending has been unsettling.
Bond yields rose and the rupee weakened, although the currency’s weakness was largely due to the resilience of the US dollar.
“Our base case remains that this is more noise at the moment, but we see increasing fiscal risk and therefore the market may start demanding more risk premium on Indonesian government bonds,” said Jenny Zeng, APAC fixed income chief investment officer at Allianz.
“Another risk is the change of ministers,” Zeng said, referring to uncertainty over who will take over from the acclaimed former World Bank managing director Sri Mulyani.
A banker at a Chinese bank in Indonesia said fiscal concerns had prompted him to shift about 30% of his portfolio into shorter-term instruments, including diversification into short-term rupiah-denominated bonds (SRBI) issued by Bank Indonesia.
Prabowo won the election in February but does not take office until October. His free meals plan, which his team estimates will cost 71 trillion rupiah ($4.35 billion) by 2025, is not normally likely to cause any consternation.
Southeast Asia’s largest country has seen its finances improve under Jokowi and is running a healthy budget surplus. From being rated junk at the start of the century, its bonds are now considered investment grade.
Some investors even see merit in Indonesia spending more to meet its 8% economic growth target. But there is unease about how much money Prabowo intends to spend on his programs, and whether he will cut fuel and other subsidies and investments to balance the books.
“It looks like there will be more uncertainty than certainty. I’m still invested, but probably not as overweight as I used to be,” said Clifford Lau, a portfolio manager at William Blair.
Foreign portfolio investment has been declining, with foreign investors pulling out $2.8 billion from government rupee bonds and its stock market till June this year.
The rupee is at a four-year low against the dollar, having lost more than 5% this year, though much of that is in line with a broad decline in emerging market currencies due to rising U.S. yields and a stronger dollar.
Investors seeking higher-yielding bonds are also flocking to India, whose bonds not only have comparable yields but have also just entered JP Morgan’s global index.
The sale has pushed Indonesia’s 10-year bond yields up 35 basis points since late May to 7.05%.
IT’S NOT ALL BAD
Some investors are giving Prabowo the benefit of the doubt, pointing out how his administration also plans to raise revenues and improve tax compliance, as well as limit the fiscal deficit to 2.8% of GDP, even though that is higher than this year’s 2.3% target.
“He’s also talking about the need to increase fiscal revenue… so it’s not really all about increasing spending,” said Jerome Tay, Asia investment manager at abrdn. Tay is overweight and positive on Indonesian government bonds over the medium term.
These bonds have long been a favorite among emerging market investors for their high yield.
The spread between Indonesian and U.S. bond yields is now half the 600 basis points it used to be before the Federal Reserve began raising rates in 2022, but they are still attractive to fixed-income investors.
The country is also less vulnerable now, given that foreign holdings account for just 14% of outstanding government bonds. They used to own half the bonds a decade ago.
Expectations that the Fed will start cutting rates soon are a comfort to investors in Indonesian rupiah and bonds, said Rudiyanto, director at local asset manager Panin.
But other risks loom, notably huge debt maturities of around 800 trillion rupiah in 2025, nearly double this year’s, though Sri Mulyani said refinancing would not be a problem as long as the government maintains market confidence. ($1 = 16,335,0000 rupiah) (Reporting by Stefanno Sulaiman, Rae Wee and Ankur Banerjee; Editing by Vidya Ranganathan and Kim Coghill)