What challenges Indonesia is facing in Green bond markets?

As per a recent report published by the Climate Bonds, the bond market for Indonesia is currently valued to be approximately $270.5 bn and foreign currency bond is valued to be $119 bn. The central and local government along with the central bank of Indonesia plays 80% of role in issuing the local bonds whereas in foreign bonds it accounts for 60%.

The Green bond’s issuance reached around $2.7bn in Indonesia where it is one of the largest ASEAN sources.

However, like every other Green bond market, Indonesia is also facing some challenges concerning the Green Bond. 

  1. Currency hedging has been perceived to be complex– the currency preferred by most of the international investors are usually USD, EUR and JPY over IDR (Indonesian Rupiah) as it is considered to be a volatile currency leading to the Indonesian issuers to come to a point where they need someone to intervene so that the currency risk can be mitigated. 
  2. Interest rate– While working with a different currency, the major trouble coma across is through the interest rate which is different for different currency. 
  3. Transaction cost– The trader business runs on actively collecting margins depending on the differential rate and the transaction volume with an active liquid market (EUR, USD, JPY) compare to any illiquid markets. 
  4. Credit risk– International banks face unwillingness to credit risk in markets that are underdeveloped and thereby it’s hard for them to hedge FX risks.
  5. CSA’s agreements– Tenor faces difficulty in investing for credits which are lower in rating, as they need more than a 1-year contract. 
  6. Market liquidity- In a primary market, new bonds are released with pricing which is more accurate and consistent and it allowed by the liquidity of the market. The debts securities and Sukuks in an Indonesian market is illiquid because of the over-the-counter nature and the overall size is smaller. 74% of the largest 30 corporate bonds are represented as an outstanding compare to the total domestic bonds. In the secondary market, out of the total amount of bonds, only a small fraction is traded, including the green bonds and green Sukuks. This situation can be counteracted only if the secondary market contains high liquidity in the green bond market. 
  7. Green bond cost for small issuers- Green bonds of smaller size that cost less than $100m are relatively higher than comparing to financing loans. Even the transaction cost is higher for smaller issuers. 
  8. Ratings of the credits are low- Financing projects become difficult due to the credit profile rating being poor. International ratings are important for foreign issuers to make the decisions for investment which allows them to compare bonds across different countries, even though they have good local ratings. The international credit rating is affected by convertibility, currency exchange. 
  9. Green projects are bankable- At the end, investors need profit in return, green projects (pollution control, land use, natural resources management, water control, and climate change adaptation) even though they are environmentally friendly, they are not considered bankable enough to raise capital depending on exposure of risks and risk-return profiles for underlying projects. Related to the sectors, issuers release bankable projects. 
  10. Awareness about the market- A major challenge faced by most of the emerging markets is related to the lack of awareness and knowledge related to green bonds. It is a major threat for any potential investors or issuers, as the concept is completely new and the stability of the market is also not new. The market can be volatile and how much profit in-return is expected is unknown. There is also limited access to local issuers for advice on green bonds. 

As we go through the challenges, solutions in terms of bankable projects, fixing the tax rates for green projects, or enhancement of credit can be provided to run for the long term but as usual, it’s an unknown zone to be ventured out and investing requires knowledge, time and patience.

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