Currency Is Key in Contest Between Asia’s High-Yielding Bonds

(Bloomberg) -- Indonesia handily beat India last quarter in the battle between Asia's high-yielding bonds, largely due to the rupiah's revival. Currencies are likely to remain the main driver of performance for the rest of the year, too.

The Southeast Asian nation's debt returned 21% to dollar-based investors over the three months to June 30, with the rupiah's rally contributing close to 15% of that amount. India's bonds eked out a gain of just 4% as the rupee ended the quarter almost unchanged.

The central banks in the two countries are both forecast to make only minor cuts to their benchmark rates in the second half: 40 basis points in India, and 25 basis points in Indonesia, according to data compiled by Bloomberg. That means duration gains are unlikely to be a big factor in bond returns over the period.

The rupiah, for its part, may be vulnerable after last quarter's rally. The central bank's next round of policy easing, potentially to purchase as much as $40 billion of government debt at close to zero interest rates, could expose the currency to another steep decline, particularly if global sentiment worsens.

Indonesia is also more exposed to the whims of overseas investors. Foreign funds own around 30% of the nation's government bonds, compared with only about 2% in India. This is likely to mean Indonesia will suffer more heavily if a second wave of the coronavirus unravels the recovery in global sentiment.

The rupee's performance is likely to depend on whether the Reserve Bank of India is prepared to let the currency appreciate. The monetary authority was a big contributor to its underperformance last quarter, snapping up dollars to stock up on foreign reserves. Holdings climbed to a record $508 billion last month, from as low as $429 billion last September.

India's currency looks relatively cheap from a valuation perspective. The real effective exchange rate is 1.1 standard deviations below its five-year average, whereas that for the rupiah is 1.4 standard deviations above. Currencies ranked as cheaper on a monthly REER basis tend to show positive returns against the dollar more frequently than peers over the following year, according to a Bloomberg study.

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On some counts, of course, the outlook for Indonesian bonds is more positive than for India's. The Southeast Asian nation has a lower public debt-to-GDP ratio, better management of its fiscal position, and lower inflation pressures, which should keep real bond yields attractive.

At the end of the day though, the main factor that determines comparative returns for overseas investors in the two markets is likely to be the performance of their respective currencies. Here at least, things are starting to look increasingly positive for the rupee.

What to Watch

• Indonesia's government and central bank will present a debt-monetization plan (known as the burden-sharing scheme) to parliament on Monday
• Bank Negara Malaysia is forecast to keep interest rates unchanged on Tuesday after cutting them by 50 basis points at its previous meeting in May. Indonesia will release foreign-reserves data the same day, while and the Philippines will publish inflation figures
• Thailand will sell 22 billion baht ($707 million) of 10-year bonds on Wednesday. The previous auction of five- and 15-year securities last month drew lackluster bids from buyers
• The Philippines will report trade data on Friday, after exports tumbled by a record in April

©2020 Bloomberg L.P.