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.