Bad news hits rupiah

Bad news hits rupiah

The Indonesian rupiah remained at its new lows on Tuesday
after falling 2 percent on Monday to almost Rp 9,890 against the
U.S. dollar, already its lowest level since October 1998,
suffering from an accumulation of bad news over the past ten
days. Though the currency was up slightly amid significant dollar
sales by state banks, it still hovered at over Rp 9,850, much
weaker than the Rp 9,680 last Friday.

Without any positive factor, either in the economic or
political and security fields, market sentiment on the local unit
will continue to be negative. The signal from the central bank of
an increase in its benchmark interest rate to defend the rupiah
will not mean much in the absence of good news.

The rupiah had actually remained rather steady since mid-
January, despite the censure of President Abdurrahman Wahid by
the House of Representatives in early February over his alleged
involvement in two financial scandals. The central bank had
consequently been able to curb further increases in its benchmark
interest rate.

All this was made possible after the imposition in January of
stricter foreign exchange regulations on offshore rupiah markets,
which ban rupiah transfers to non-residents and impose a lower
ceiling of US$3 million on cumulative forward deals that onshore
banks may conduct with non-residents in the absence of underlying
transactions.

But this gain has been nullified by the string of bad events
affecting Indonesia over the past ten days, notably the worsening
ties between the government and the International Monetary Fund
(IMF), grave warnings from Abdurrahman's international advisers,
the gloomy report by the World Bank on the country's economic
outlook and renewed concern over the brutal ethnic clashes in
Central Kalimantan that have so far killed more than 400 people.

Coordinating Minister for the Economy Rizal Ramli, who
returned last weekend from a series of talks with IMF executives
in Washington, failed to inject any new hope to remedy the murky
situation. Though he did not explicitly acknowledge total failure
of his talks in Washington, he did not have any significant
progress to show off either.

Rizal could only claim that the government and the IMF had
bridged their differences regarding the controversial amendments
planned for the central bank law and had agreed to form a panel
of independent Indonesian and foreign experts to review the
proposed amendments. All this still boils down to a likely
protracted uncertainty about the IMF's bailout program for the
country.

Little wonder then, that pressure on the rupiah since early
this week did not come from the offshore market but from domestic
demand, as more companies and investors moved to hedge their long
rupiah positions before the dollar strengthens further.

Acknowledging that lingering political and economic problems,
and sporadic bouts of violence in Aceh and Maluku, had eaten away
at the rupiah in the past year, wiping off some 25 percent of its
value against the dollar, this new bout of depreciation will
certainly portend a bleaker outlook of the economy.

Further depreciation of the rupiah will hurt the budget,
although oil revenues will rise in rupiah terms as foreign debt
servicing and import costs increase as well.

A more devastating blow, however, would come from a rise in
the central bank's benchmark interest rates which, a move
suggested by Bank Indonesia's Senior Deputy Governor Anwar
Nasution on Monday. This is because most of the Rp 650 trillion
in government bonds issued to bail out the banking industry are
in the form of floating-rate bonds. The World Bank estimated last
week that a one percent rise in the central bank's benchmark
interest rate would mean additional costs of around $500 million
(Rp 4.7 trillion) to the state budget.

However, because the pressure on the rupiah is swelling from a
complex mix of economic, political and security issues, a further
increase in interest rates will not help much. Such a drastic
monetary measure may even increase the economic woes as the weak
banking industry will become more heavily burdened by negative
spread, thereby eroding their capital base, and more loans may
turn sour.

The central bank would therefore be well advised not to
steeply raise its benchmark interest rate in the weekly auction
of its promissory notes (SBI certificates) on Wednesday (today).

More market participants will continue to cover their short
dollar positions, thereby putting stronger pressure on the
rupiah, if President Abdurrahman, currently on his umpteenth
travel overseas, does not immediately start leading the nation
and seriously managing the government.