If they act like RI capital controls, they are

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.