Bareksa.com - It isn't as worrisome as in 2013, and yet Indonesia's currency and bond markets are showing slight signs of investor anxiety over falling export revenues and the government's failure to raise prices of subsidised oil.

Prices of Indonesia's high-yielding bonds have slipped, investors appear to be buying protection in the currency forwards, and the stock market has stalled since hitting record highs after Jakarta governor Joko Widodo, or Jokowi as he is known, won the presidential election last month.

"This is a classic problem for Indonesia. Only when the government cuts the subsidy bill will the bonds and rupiah rally," said Budi Hikmat, a director at PT Bahana TWC Investment Management.

Hikmat, whose fund manages about 23 trillion rupiah ($1.97 billion) in assets, likened the current situation to 2005 when Indonesian markets rallied sharply after fuel prices were raised.

Fuel subsidies have historically been a sensitive issue for Indonesia.

Attempts to raise the heavily subsidised prices of diesel and gasoline are often accompanied by inflation, capital outflows and volatility in markets - as seen last year, when the rupiah fell sharply in the run-up to an increase in fuel prices as investors worried about the mounting subsidy bill.

When fuel prices were eventually raised in June, markets were seized by concerns over rising inflation and the slow pace of monetary tightening.

The second-quarter 2013 current account deficit hit a record $10 billion, raising worries about Indonesia's ability to attract capital flows at the same time that global emerging markets were selling off on concerns over U.S. monetary policy tightening.

This time is different in that inflation is benign, policy rates are already high, and the primary concern is the growing fuel subsidy bill.

"The longer the government delays adjustment in fuel subsidies, the bigger the impact on government finances," said Ashish Agrawal, Asian rates strategist at Credit Suisse in Singapore. "This would in turn mean that the government needs to issue more bonds, something we are already seeing in the third-quarter issuance.

A drop in exports pushed Indonesia's current account deficit to $9.1 billion in the second quarter. Foreign investors, still bracing for U.S. rate rises in 2015, are demanding higher compensation where they can.

Meanwhile, outgoing Indonesian President Susilo Bambang Yudhoyono has suggested fuel subsidies - which cost the government $20 billion a year, or nearly 20 percent of its total budget - will be cut before Jokowi takes over in October. But Friday's draft budget for 2015 didn't include such plans and there are grave doubts over when oil prices will be raised.

Foreign portfolio flows have come off their peaks, albeit slowly.

Foreign holdings of Indonesian stocks peaked at 58.09 trillion rupiah on August 4. The stock index itself has been sluggish, with only 3 percent gains in the past quarter, but with total gains of 20.5 percent this year.

Foreign ownership of bonds has also dipped since hitting a record 419.1 trillion rupiah, or 36.6 percent of outstanding debt, in early August.

Meanwhile an uptick in rupiah forwards shows foreigners are hedging the currency risk on their investments.

At the last auction of bonds, 10-year yields jumped 17 basis points from a week earlier. Ten-year bond yields are now 8.22 percent.

Yields were pushed higher by foreigners who picked up bulk of the bonds, analysts said, partly because local banks had to conserve cash to meet the heavy seasonal demand for loans.

Strong credit growth isn't the only factor pushing yields up. Local investors also reckon the central bank, Bank Indonesia (BI), is keeping policy rates too high relative to growth rates and inflation, and that forces up domestic deposit rates.

Inflation measured by consumer prices is at the early 2013 lows of 4.5 percent while the economy has slowed significantly.

"Our GDP growth is at 5.2 percent while the BI rate is at 7.5 percent. It's like telling people to just put their money in the bank and go to sleep," said Hikmat. (Source : Reuters)