Indonesia’s yield curve may steepen as Bank Indonesia unwinds intervention

Indonesia’s sovereign yield curve is set to steepen as the central bank reduces its use of short-term rupiah securities, prompting a shift in demand towards government bonds.

The spread between 2- and 10-year bond yields this week reached the widest since June 2023. Bank Indonesia (BI) is in an interest-rate cutting cycle and investors are redirecting funds from a set of rupiah-denominated tools, so-called SRBI securities, into sovereign bonds, thus likely sinking front-end yields.

The unwinding of SRBI intervention amid rupiah stability is seen complementing interest-rate cuts and steepening the Indonesian bond curve, CIMB Bank economists including Michelle Chia wrote in a recent note. That’s a tailwind for shorter-dated bonds, they said.

The shift in demand towards sovereign bonds is set to lower government borrowing costs, reinforcing BI’s push to ease financial conditions and support the economy. Investors are keeping a close eye on Indonesia’s fiscal outlook, with President Prabowo Subianto planning to release a number of costly programmes during his term.

The amount of outstanding SRBI notes, which were launched in September 2023 to lure foreign inflows and support the rupiah, has declined about 17 per cent from a November peak. In the latest auction on Friday, BI sold just 18 trillion rupiah (S$1.4 billion) – well below the 56 trillion rupiah in total bids, the highest since January. The bid-to-cover ratio jumped to 3.10 times.

The Friday auction saw 6-, 9- and 12-month SRBI notes priced at record lows, making shorter-dated Indonesia bond yields more attractive in comparison. Meanwhile, longer-dated bond yields may not have much scope to fall further. Indonesia’s 10-year spread over Treasuries is already a standard deviation below the one-year average.

Fiscal consolidation is also unlikely to play a major role. While Finance Minister Sri Mulyani Indrawati reiterated this week that the government is on target to hit the fiscal deficit of 2.53 per cent of gross domestic product this year, economists surveyed by Bloomberg offer a median budget gap prediction of 2.8 per cent.

The “Indonesian bond curve has steepened largely because it is in the midst of an easing cycle but reflecting in part some fiscal risk premiums”, said Winson Phoon, head of fixed-income research at Maybank Securities. He expects an additional half-point cut by BI, which may help the curve “steepen slightly further”. BLOOMBERG