The Indonesian finance ministry does not pull its punches.
On Jan. 3, it severed ties with JPMorgan Chase, which it had been using as a primary bond dealer, after the bank downgraded Indonesian stocks to "underweight" in response to the policy uncertainty engendered by Donald Trump's upset victory in the U.S. presidential election.
"The government is open to critics, but JPMorgan cut its recommendation ... without a credible assessment," said Finance Minister Sri Mulyani Indrawati.
For a country whose local currency debt market is heavily reliant on the "kindness of strangers," with nearly 40% of domestic bonds held by foreigners, the government's decision appears imprudent. It comes at a time, moreover, when sentiment toward emerging markets has deteriorated significantly.
Following Trump's victory on Nov. 8, emerging market bond and equity mutual funds suffered eight consecutive weeks of net outflows. The adverse market conditions stem mainly from a surge in the dollar since the U.S. Federal Reserve signaled a faster pace of monetary tightening this year in anticipation of expansionary fiscal policies under Trump.
The dollar index, a gauge of the performance of the greenback against a basket of its peers, has risen 4.3% since the U.S. election, hitting a 14-year intraday high on Jan. 3. It now stands at just under 102, a nearly 10% rise since last April.
This has put emerging market currencies under renewed strain, prompting international investors to reduce their holdings of these countries' local bonds.
The domestic bond markets of emerging Asia, which together account for the bulk of global emerging market local debt, have suffered heavy outflows over the past two months. According to JPMorgan, foreign investors sold $10 billion of the region's local bonds in November, the largest monthly outflows since the acute phase of the eurozone crisis in late 2011.
Malaysia, with the highest share of domestic debt held by foreigners in emerging Asia, at 48%, suffered the most redemptions. Indonesia, with the second-highest share, also suffered large outflows, with non-resident investors selling $1.7 billion of its local bonds compared with inflows of $1.2 billion in September, according to JPMorgan. India and South Korea, both markets where foreigners hold a much lower share of debt, also suffered sizable outflows.
Foreign participation in emerging market local debt markets has been a focal point of concern for international policymakers and regulators ever since the Fed triggered a sharp sell-off in developing economies in May 2013 by announcing its intentions to scale back, or taper, its program of quantitative easing.
A new report on local bond markets in developing economies, jointly published last month by the International Monetary Fund and the World Bank, noted that "foreign investor flows are a key risk to watch as they are more fickle and reactive to global financial conditions."
Domestic investor base
However the report also noted that "local banks dominate holdings of local debt" in many emerging markets and that "pension funds and insurance companies are gradually becoming a more important source of funding."
Indeed, one of the crucial differences between today's emerging market asset class and the one that existed prior to the 2008 global financial crisis is the presence of a large domestic institutional investor base which provides a stable and long-term source of funding for governments and companies.
Since the 2013 "taper tantrum," retail investors, via mutual funds based in the U.S. and Europe, have accounted for the bulk of outflows from emerging market bond funds; local and foreign institutional investors, according to JPMorgan, now hold more than 70% of emerging market debt.
Domestic institutional capital is particularly "sticky" and just as importantly, tends to absorb debt which foreign investors are unable to hold. Emerging Asian pension funds and insurers are helping stabilize local debt markets by picking up the slack amid a sharp decline in foreign purchases of domestic bonds.
According to JPMorgan, foreigners bought $10.6 billion of emerging Asian local bonds between January and November last year, roughly half the amount bought during calendar 2015. Strong support from domestic institutions is one of the main reasons why the region's bond yields have remained relatively low despite the sharp deterioration in market conditions.
The yield on 10-year Malaysian local bonds currently stands more or less where it was at the beginning of 2016 while its Indonesian equivalent is 100 basis points lower.
The resilience of Indonesia's local bond market to external shocks increased early last year when the country's financial regulator ordered pension funds and insurers to gradually increase the share of domestic debt in their investment portfolios to at least 30%. This may explain why Indonesia's finance ministry felt it could afford to punish JPMorgan for downgrading the country's stocks.
Still, taking the kindness of strangers for granted carries significant risks in the current environment.
Nicholas Spiro is a partner at Lauressa Advisory, a specialist macroeconomic and property consultancy in London.