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)