Bank Indonesia -- Another regulatory failure<\/p>\n
John Le
\nJakarta<\/p>\n
It has been five months since Bank Indonesia introduced
\nregulation 7\/14\/PBI\/2005, entitled, "Restrictions on Rupiah
\nTransactions and Foreign Currency Lending by Banks", which aimed
\nat restoring integrity and stability to the rupiah.<\/p>\n
Contrary to Bank Indonesia's intention, however, it has also
\nbeen five months of rough riding for the rupiah in the foreign
\nexchange market.<\/p>\n
In the month of August 2005, for example, the rupiah was
\ntraded as high as 11,200 to the dollar. In the dollar-rupiah
\noptions market, the one-month volatility rate, which serves as a
\nuseful indicator for the volatility of the rupiah, was quoted at
\nmore than 25 percent.<\/p>\n
This raises some basic questions -- what has gone wrong with
\nregulation 7\/14\/PBI\/2005? Why has it not stabilized the rupiah as
\nintended?<\/p>\n
Let us start with some simple facts. The gist of regulation
\n7\/14\/PBI\/2005 is intended to block out foreign speculators and
\nhedge funds from trading on the rupiah freely, thus, driving the
\ncurrency beyond the control of Bank Indonesia.<\/p>\n
This means that offshore parties cannot transact with onshore
\nparties using foreign exchange, swap, and derivatives, without
\ndeclaring to Bank Indonesia the economic basis for doing so.<\/p>\n
If an offshore party wants to do a simple foreign exchange,
\nbuying dollars and selling rupiah, it must first be able to
\ndeclare to Bank Indonesia that such a transaction is done in
\norder to buy Indonesian assets (i.e., fixed income, equities,
\netc.). Similarly, swap and derivatives, such as foreign exchange
\noptions, are permitted as long as they are used to hedge an
\nunderlying economic investment in Indonesia.<\/p>\n
While this regulation is successful in blocking out foreign
\nspeculators from playing with onshore rupiah via direct foreign
\nexchange and their derivatives instruments, the intended effect
\nof stabilizing the rupiah is far from being accomplished.<\/p>\n
In fact, the rupiah itself is now more prone to volatility due
\nto the creation of a vibrant and unregulated offshore market for
\nthe rupiah as a result of this regulation.<\/p>\n
Without direct access to the onshore market, foreign players
\nare now jumping onto the now mighty non-deliverable-forward (NDF)
\nfor the rupiah in the offshore market. This means rupiah
\ntransactions can be settled in dollars, based on an exchange rate
\nset by the offshore players. This market lies beyond Bank
\nIndonesia's legal jurisdiction.<\/p>\n
The dual existence of onshore and offshore markets for the
\nrupiah naturally gives rise to price differential. Many foreign
\nbanks, with operations both onshore and offshore, are taking
\nadvantage of this arbitrage opportunity.<\/p>\n
If the rupiah is traded at a higher price in the offshore
\nmarket than the onshore market, the banks will sell rupiah in the
\nformer and buy in the latter. This simultaneous purchase and sale
\nof rupiah in two different markets allows foreign banks to book a
\nhandsome profit in the foreign exchange market and its
\nderivatives instruments.<\/p>\n
However, arbitrage is the least of Bank Indonesia's problem.
\nThe biggest worry for Bank Indonesia now is that foreign banks,
\nwith both onshore and offshore operations, are serving as
\nconduits for foreign speculators and hedge funds, to drive the
\nonshore rupiah market.<\/p>\n
This can happen whenever offshore speculators spot a weakness
\nin the rupiah, they will buy dollars and sell rupiah in massive
\namounts in the NDF market. This selling of rupiah will then drive
\nthe onshore rupiah market through trades with foreign banks that
\nhave branches in Indonesia.<\/p>\n
An example of rupiah manipulation was the energy subsidy
\ncrisis during the month of August 2005. Bank Indonesia could not
\ncontrol the massive speculation done offshore against the rupiah,
\nwhich caused a run on the rupiah onshore, despite billions of
\ndollars spent on defending the currency.<\/p>\n
Clearly, the experiment with regulation 7\/14\/PBI\/2005 so far
\nhas not worked. The rupiah has not been stabilized; and in fact,
\nit has been more volatile since the inception of this regulation
\nin July 2005.<\/p>\n
The only true achievement of this regulation so far is that it
\nhas successfully driven the speculators into establishing a
\nvibrant and dynamic offshore market for the rupiah.<\/p>\n
More dangerously and unintentionally, the NDF market has the
\nability to move the onshore market without legal repercussion
\nfrom Bank Indonesia.<\/p>\n
So it is time for Bank Indonesia to stop wasting its time and
\nresources on issuing ineffectual regulations that only bark but
\ncannot bite.<\/p>\n
The writer works as foreign currency trader for a foreign bank
\nbased in Jakarta. He can be reached at legonave@yahoo.com.<\/p>",
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