If they act like RI capital controls, they are

By Benjamin Pedley

SINGAPORE (Dow Jones): Bank Indonesia's decision earlier this week to clamp down on speculative trade in the rupiah isn't a capital control in the strictest sense, but the effect of the move -- at least for now -- appears to be the same: offshore trade in the rupiah is drying up.

Bank Indonesia said Monday it would aggressively enforce existing curbs on the supply of rupiah available to offshore institutions, making it more difficult for speculators to attack the currency. The central bank also tightened the limit on how much money onshore banks can lend to offshore institutions for non-investment-related purposes, lowering the amount to US$3 million from $5 million previously.

Although the measures aren't nearly as restrictive as the capital controls Malaysia imposed in September 1998, they generate "worrying echoes" of that policy, said Desmond Supple, analyst at Barclays Capital.

"For the private sector, on a risk-reward basis, the attraction of placing investments in Indonesia has been reduced from an already low base," Supple said.

The central bank has steadfastly maintained it is not implementing capital controls, and many observers in Jakarta take the Bank at its word. But uncertainty over the steps has damaged investor sentiment and raised concerns about liquidity in the currency market. This in turn has driven many players from the offshore rupiah market.

"We are encouraging Bank Indonesia to clarify the regulations," John Dodsworth, the International Monetary Fund's local representative, told Dow Jones Newswires Thursday.

The move by Bank Indonesia comes at time of heightened uncertainty across much of southeast Asia, where many nations have seen their currencies weaken sharply amid political turbulence of one sort or another.

The initiative has fueled speculative talk that Thailand and the Philippines might enact new capital restrictions of their own in a desperate attempt to stabilize their currencies, which like the rupiah have slumped on political instability. The impact has spread all the way to Singapore's stock exchange, which has slumped in line with the overall dip in sentiment.

Some analysts say Jakarta is trying to carry out capital controls in a disguised fashion. "You can't have your cake and eat it too, which is what they are trying to do," said Arjuna Mahendran, head of economic research at SG Securities in Singapore.

When Indonesia liberalized capital controls in the early 1990s, the central bank rescinded its powers to prohibit foreign banks from lending foreign currencies to Indonesian companies and individuals and to prohibit local banks from lending rupiah to foreigners.

These powers, said Mahendran, are critical elements of a central bank's armory to prevent speculation against the local currency. Authorities in Thailand, the Philippines and Singapore still retain these powers.

"So the announcement to curb such transactions is a reimposition of capital controls to strengthen its control over the exchange rate, which can weaken on very small volumes," he said.

Mahendran warned that other Southeast Asian central banks could further tighten their controls if their currencies continue to slide. For example, he said a further slide in the peso beyond PHP56 to the dollar might force the Philippine Central Bank to take "emergency measures" in relation to capital controls. "If the currency went into free fall they would really have to curtail it," he said.

The peso has lost more than 10 percent of its value during the last two weeks amid the deepening crisis of confidence in the economic and moral leadership of Philippine President Joseph Estrada. The peso's precipitous fall follows several failed attempts by the central bank to stabilize the currency through interest rate hikes and periodic intervention in the foreign exchange market.

A sharp weakening of a nation's currency raises the risk of inflation -- a particular threat to central bankers facing the probability of slowing economic growth, as rising prices would make it difficult to lower interest rates.

Inflation also makes it more difficult for local companies to repay foreign currency denominated debt and discourages foreign investors from buying local assets.

The restart of capital controls in Indonesia would normally raise the ire of the IMF, which recently postponed a $400 million loan payment after Jakarta failed to meet attached conditions.

"The general drift for the IMF is to liberalize capital controls globally, so reintroducing them would be unacceptable, but implementing rules that were already there is more difficult for the IMF to protest," said Mahendran. The IMF, he says, may therefore eventually give its grudging approval.

A lack of rupiah liquidity in offshore markets because of the Bank Indonesia decision is already apparent. The interbank rupiah market in Singapore -- previously a major trading center for the currency -- was suspended indefinitely after the change.

"No one is trading anymore offshore, and the local guys are slowing down a lot," said a trader at a major European bank. At 0600 GMT the dollar was quoted at IDR9,500.

"The rupiah is no longer on the agenda," said an Asian bank dealer. "It's going to be like the ringgit."

Unlike the situation after Malaysia imposed capital controls, offshore trade in the rupiah can continue in theory as spot transactions remain unrestricted.

"But in practice the offshore market will die as offshore holders of rupiah will seek to translate these into dollars onshore at the earliest opportunity," said Barclays Capital's Supple.

For interbank trade to be viable outside Indonesia, institutions need easy access to rupiah to fund short positions in the currency.

With onshore banks the only source of such funding it is difficult for banks offshore to have sufficient liquidity to offer consistent pricing to counterparties.

Investors can still get money out of Indonesia through the spot market as there is no lock-in period for investments like in Malaysia. Finding sufficient liquidity, however, may be difficult, analysts say.

Although constraints on the offshore supply of rupiah are aimed at curbing speculative rather than investment related activity, fears more draconian measures may be enacted are affecting Asian commodity markets. Cocoa prices surged Wednesday on these liquidity concerns.

"There is a major problem at the moment: major banks are not dealing in dollar-rupiah. So essentially there is no (cocoa) market today," said a Singapore-based cocoa trader.

Though the supply of rupiah offshore is drying up, analysts say this won't prevent the currency, which fell 25 percent against the dollar in 2000, from falling further. The reason, balance of payments problems rather than speculators have been the source of its troubles.

Indonesia badly needs an infusion of foreign capital, and repairing relations with the IMF to win approval for the disbursement of more funds would be a step in the right direction.

In the absence of any progress on this front, and with the spot market still operating, analysts say the rupiah can weaken against the dollar beyond the key psychological level of IDR10,000 -- clearly not the reaction Bank Indonesia would be hoping for.