Market fears that Indonesia may impose capital controls to rescue the rupiah may prove to be a self-fulfilling prophecy, but only if the finance minister loses a power struggle with influential business leaders.
The Indonesian currency fell to a new decade low on Friday and has lost a fifth of its value against the dollar this year, battered by collapsing export revenue, capital flight from risky emerging-market assets and worries among foreign investors that the country is set to adopt comprehensive capital controls.
Boediono, the central bank governor, sought to reassure markets on Friday with a renewed pledge that Jakarta was committed to free capital movement. It is a position strongly backed by popular and market-friendly Finance Minister Sri Mulyani Indrawati. The question is whether she can defend this position in the face of pressure from powerful business leaders whose companies will be unable to service their debts with the rupiah at its lowest levels since the Asian financial crisis of 1997-98.
Many analysts were reluctant to comment on the issue, given its political sensitivity, but any capital controls in Indonesia seemed unlikely for now. “It’s clear Sri Mulyani is against the idea,” an Indonesian financial analyst said. “And she is still deciding policy.”
Indonesia’s media has been abuzz with talk of a power struggle between Indrawati, who is also acting chief economics minister, and Aburizal Bakrie, the coordinating minister for social welfare and one of the country’s most influential tycoons.
For decades, the nexus between powerful business interests and the political elite has been a key factor determining economic policy. Sri, who entered politics after a career at the International Monetary Fund, has put battling corruption and promoting market-friendly policies at the top of her agenda.
Local media reported this month that Sri Mulyani had threatened to resign over alleged political interference to prop up shares in PT Bumi Resources Tbk, a Bakrie company. The government denied the reports. Analysts said that as long as she retains the upper hand in the struggle, extensive capital controls are unlikely.
Last week Indonesia changed its currency rules to make it harder to buy foreign exchange, requiring any purchases of $100,000 per month or more to be supported by transaction in goods or services. But the measure did not halt the rupiah’s slide. On Friday, the rupiah fell as low as 12,500 to 13,000 to a dollar.
Deutsche Bank economists Samir Goel and Mirza Baig said in a research report last week that the government’s efforts to curb speculation could do more harm than good by stoking market fears. “The bigger, and unintended, consequence . . . could be in worsening investor perception of potential convertibility risk,” they said.
Given Sri’s opposition to capital controls and determination to move away from past policies of bailing out endangered conglomerates whatever the costs, a change of course is unlikely while she remains at the helm.
But with fears of capital controls helping push the rupiah lower, some say the country’s economic problems could tip the power struggle against her. If she resigns or is forced out, market fears could become a self-fulfilling prophecy.
But perhaps the strongest reason why capital controls are unlikely is that they could do little to stem the rupiah’s fall.
“The increased risk of capital controls is likely to deter capital inflows and expedite capital flight, further weakening the rupiah,” said Stewart Newnham, a Morgan Stanley analyst. “And if controls were implemented, we think the rupiah would continue to decline, as Indonesia’s external deficit would likely dominate the balance of payments.”