Indonesia's Bond Market Liquidity at Risk as Central Bank's Stake Soars

Investors in Indonesia are expressing growing concern over potential strain in the nation's bond markets as Bank Indonesia (BI) significantly increases its debt holdings, according to Bloomberg. BI's bond ownership has surged to approximately 25% of outstanding bonds, a sharp increase from just 5% pre-pandemic, driven by its efforts to stabilize the rupiah.

This aggressive bond-buying strategy, reminiscent of the Bank of Japan's actions that ultimately negatively impacted its bond market, has some investors worried. Asti Raniasari, head of the multi-asset investment team at PT BRI Manajemen Investasi, suggests that BI's bond holdings could further rise to 30% of outstanding debt due to its ongoing quantitative easing program.

"I still see quantitative easing next year," Raniasari stated. "The central bank will need to support markets as the rupiah weakens, but also an economy that's suffering a bout of deflation and soft growth."

BI has already acquired 461 trillion rupiah ($28.5 billion) of Indonesia's sovereign debt this year, pushing its total holdings to a record high of 1,557 trillion rupiah, as reported by Bloomberg. The central bank has also committed to purchasing an additional 150 trillion rupiah of bonds in the secondary market in 2025.

BI's bond purchases have helped to stabilize yields, narrowing the spread between Indonesian 10-year bonds and similar-maturity Treasuries to approximately 246 basis points. However, demand for new bonds at primary auctions has significantly weakened, reaching its lowest point in over a year, according to Bloomberg data.

"If the central bank does boost ownership of the bond market to 30% and that persists for a long time, it can reduce liquidity in the secondary market," warns Adra Wijasena, a senior research analyst at PT Shinhan Sekuritas Indonesia. "Furthermore, if the bond buying is done by printing money, it could lead to inflation."

BI initially ramped up bond purchases during the COVID-19 pandemic to support the state budget. These purchases continue, primarily in the secondary market, in an attempt to stabilize yields and the rupiah amidst a strong US dollar. The central bank is also facing pressure to increase bond purchases as the government increases its own borrowing to fund stimulus spending and refinance pandemic-era debt.

The BOJ's experience, where its bond market share exceeded 30% in 2015, offers a cautionary tale. This led to a significant decline in perceived bond market functioning over the following two years.

While some money managers believe BI's bond purchases are beneficial in curbing market volatility, concerns remain about the long-term consequences of such a strategy.

"It's actually more helpful for them to be in the market because a lot of investors might feel that they are there to help contain volatility," notes Leonard Kwan, a portfolio manager at T Rowe Price. "When you have the BI there helping to contain volatility, it offers a little bit more confidence to market makers to be active providing prices and liquidity."