Capital inflows to stay strong despite deficit

Capital inflows to stay strong despite deficit

JAKARTA (JP): Capital inflows are expected to remain strong this year despite the projected increase in the country's current account deficit, according to JP Morgan.

The company's Singapore-based research unit said that the capital inflows will remain in excess of the deficit financing in 1996.

Morgan said that the accelerated depreciation allowed by the widened intervention band has raised the rupiah's exchange rate risk.

"But heightened risk has been largely offset by a higher interest rate differential. Thus the hot money inflows are likely to remain strong," the company said. "Moreover, the huge buildup of foreign investment approvals promises further increases in foreign direct investment."

As a result, according to Morgan, forcing faster depreciation will require increased central bank intervention, which would boost domestic money supply and add to current overheating pressures.

Since investors might well judge the policy posture as unsustainable, there would a distinct risk of a sudden exodus of foreign capital, it added.

The sharp widening of the current account deficit has raised concern that the rupiah is overvalued. Exporters, in particular, are complaining that the rate of depreciation is not fast enough to maintain competitiveness.

No official statements have come from the government, including the central bank, but some officials are listening to the exporters' complaints. Moreover, there are signs that the central bank may indeed try to engineer a faster depreciation of the rupiah.

Before widening the intervention band of the rupiah's exchange rate against the U.S. dollar on Jan. 2 -- which should be seen as a move to let the currency fluctuate more freely in response to market liquidity -- Bank Indonesia (the central bank) chose at the end of last November to hike the rate of depreciation of the mid-level of the band from a previous annualized pace of 5 percent to a new pace of 7 percent.

Faster

At this stage, said Morgan, it is too early to know whether the faster mid-level depreciation rate will be either short- lived, possibly prompted by seasonal concerns, or long-lasting, showing Bank Indonesia's intention to depreciate the rupiah faster in the coming fiscal year.

"Either way, however, the exchange rate and trade fundamentals may not justify faster depreciation. Moreover, trying to force depreciation could actually worsen the current account deficit," the company noted.

Whatever the pros and cons, accelerating the rupiah's actual descent is not easy, it said, adding that while the mid-level of the intervention band points to a desired depreciation rate of more than 5 percent for the 1995/1996 fiscal year, the actual depreciation to date since the start of the fiscal year in April has been just 2.6 percent at an annual rate.

The rupiah's relative strength, according to Morgan, can be ascribed to massive foreign capital inflows.

Net inflows surged 150 percent between 1994 and 1995, so much in excess of the simultaneously mounting current account deficit that Bank Indonesia had to intervene heavily to keep the rupiah inside the intervention band. (hen)