Indonesian crisis fuels new Asia contagion fears

Indonesian crisis fuels new Asia contagion fears

HONG KONG (Reuters): Indonesia is a wild card with the potential to damage the entire region, but analysts are divided on whether its economic turmoil will drag Asia back to the brink of economic chaos.

"I think it will have an impact, but it's a hard call," said Andrew Ballingal, equity strategist at Schroders Investment.

"People look at Indonesia very differently than they do Korea, or the Philippines, or Thailand. They see it as a bit of a wild card. Indonesia hasn't really kowtowed to the great American capitalist way."

And at times heated stand-off with the International Monetary Fund (IMF) has fueled fears of another slide in the Indonesian rupiah and a new period of regional market mayhem reminiscent of late last year, when currencies plunged in unison.

But some analysts felt investors would view Indonesia's problems as separate from other Asian markets, which have shown more resilience since the beginning of the year.

"Indonesia will put a nervous tone to the regional markets but I think there's a bit of delinking that's taken place," said Eric Nickerson, head of currency research at Bank of America.

"As long as the currency bounces around in a range at levels we've seen before, I don't think it is necessarily going to pull down the rest of the region," he said.

Most Asian financial markets have stabilized since the beginning of the year. Stock markets have gained and credit risk premiums have declined while currencies stabilized.

But recent gains in many financial instruments could prove unsustainable, particularly if the rupiah succumbs to another sharp slide from current levels of around 10,000 to the U.S. dollar.

Analysts saw potential for further weakness on fears that re- elected Indonesian President Soeharto would try, but fail, to implement a currency board system (CBS), an idea that lies at the heart of the IMF's reluctance to disburse a US$3 billion tranche from a more than $40 billion aid package.

Most analysts believed the CBS would push interest rates sky- high in the short term, destroying Indonesia's fragile financial system. Low foreign exchange reserves could also invite further speculative attacks that could drive the currency back down to record lows of around 17,000 to the dollar.

But views were divided on whether sudden weakness in the rupiah would infect other Asian currencies and markets.

One equity strategist said the Asian financial crisis had been driven by competitive devaluations, and it seemed unlikely that current Indonesian policies would enhance the nation's competitiveness against its neighbors.

"What Indonesia is about to do, or may be about to do, in no way wins any market share back," he said.

But other analysts said most Asian markets were overbought at current levels, and vulnerable to a sell-off -- perhaps sparked by a sudden slide in the rupiah.

"The situation in Indonesia has therefore put the whole issue of stability to the test," C.S. First Boston wrote in a recent research note.

Recent comments by U.S. Federal Reserve chairman Alan Greenspan seemed to support this view, CSFB said. The Fed chairman said some Asian currencies had fallen to levels understandable only in the context of a collapse of confidence in an economy.

"The fact the Fed Chairman was so open in voicing his concerns suggests he believes the implications for another down-leg in Asia may be worse than the markets had at first thought," CSFB wrote.

One analyst also noted that Southeast Asian currencies showed renewed signs of trading as a group after weeks of divergence, indicating a heightened regional sensitivity to the rupiah's movement.

"We have had renewed, general selling across the board and that harks back to one of the previous stages where we had panic across the board," said Callum Henderson, managing analyst at MMS International. "But we aren't there at the moment."

Henderson said he believed rioting on the streets of Jakarta or a declared default on external debt would be required for Indonesia to have a major impact on regional markets.