Iraq war to hurt rupiah: Analysts

Iraq war to hurt rupiah: Analysts

Benjamin Pedley, Dow Jones, Singapore

While the rupiah recovered in recent weeks on negative sentiment toward the dollar after a slew of weak U.S. economic data, geopolitical factors are conspiring again to create significant downside risks for the Indonesian currency.

The rupiah Tuesday was at a level not traded since before a series of bomb blasts Oct. 12 on the Indonesian resort island of Bali left almost 200 people dead. Foreign investor sentiment toward Indonesia was damaged by the attacks - whose victims were mainly Western tourists, particularly Australians - as the island had been a relative safe-haven amid sectarian violence in recent years elsewhere in the archipelago.

And with the heightened prospect of military conflict between Iraq and Western interests led by the U.S. and U.K. come risks for the Indonesian currency and bond markets.

"Indonesia is extremely vulnerable to a deterioration in sentiment in the event of war versus Iraq," said Bank of America in a research report.

It recommends selling the rupiah against the dollar on any moves in the U.S. currency below Rp 9,000 with a 2 percent stop- loss on the position and 6 percent profit target "inclusive of carry."

At 0200 GMT (9.00 am Jakarta time) the dollar was at Rp 8,990, down from a post-Bali high of Rp 9,400.

Weak U.S. economic data hurt sentiment toward the dollar against many currencies in the Asia-Pacific, and prompted the Federal Reserve Nov. 6 to slash its target interest rate 50 basis points to a 41-year low 1.25 percent.

This widened the margin of short-term Indonesian rates over their U.S. equivalent to just under 12 percentage points based on one-month rates in Jakarta of 13.1 percent.

Indeed, this rate gap explains the "slow drift out of expensive long dollar-short rupiah positions from those banks who understandably took a very bearish view on Indonesia following the Bali bombing," said Bank of America.

The high cost of funding short positions in a high-yielding currency is sometimes referred to as negative carry. The corollary is positive carry associated with, for example, borrowing yen at near zero interest to buy a financial instrument offering a higher return.

How expensive is a long dollar-rupiah position?

Well, this is reflected in the rupiah forwards market.

If investors want to buy dollars three months forward, they need to add Rp 280 to the spot price to get their entry point, rising to Rp 565 for six months, and Rp 1,100 for one year.

Also helping to spur the dollar-rupiah pullback were sales by Indonesian Bank Restructuring Agency, which usually exchanges some of its dollars into rupiah before it transfers funds to the government. And steady progress in the investigations into the Bali blast buoyed sentiment toward the rupiah a little, though this dynamic could change in a trace in the event of war with Iraq.

Just as events of 9/11 polarized Western and Islamic interests to the detriment of the rupiah and Jakarta's financial markets, so to would conflict with Iraq.

Baghdad has made no secret of the fact it will strike Israel if it is attacked, and unlike the Gulf War in the early 1990s Jerusalem said it would retaliate this time, increasing the chance other Arab states could be drawn into war.

The more immediate problem for the Indonesian economy is the Bali blasts, which without question was hurt by the attacks as tourism contributes around 4 percent to Indonesian gross domestic product, and employs eight million people across the archipelago, said UBS Warburg.

Bali was the most popular Indonesian destination for foreign tourists, attracting 1.35 million of them in 2001.

Just how much the economy has been hurt is unclear at this stage though most analysts expect the terror attacks will be a serious brake on growth in coming months.

Third quarter numbers issued Friday showed GDP grew 3.9 percent on-year, exceeding analysts' forecasts of 3.4 percent expansion.

But these numbers weren't a factor in the rupiah's drift higher this week, said Jan Lambregts, head of research Asia- Pacific at Rabobank Group Treasury.

Lambregts said what little relevance GDP data has on the Indonesia currency is in terms of what happens in the current quarter and beyond rather than a a growth figure before the Bali terrorist attacks even took place.

In the medium term, he expects the dollar-rupiah to edge modestly higher again, as negative sentiment toward the U.S. currency peters, and year-end dollar buying by Indonesian companies to service foreign currency loans kicks in.

Moreover, the Singapore-based analyst noted Jakarta recently revised its exchange rate forecast for this calendar year to Rp 9,200-Rp 9,400 from Rp 8,700-Rp 9,000, suggesting some upside risk for the dollar from here.

Rabobank said first key resistance for the dollar is at the post-Bali high after which Rp 9,570 would be the next target.

"We think the dollar is likely to meet intermediate psychological resistance at Rp 9,100 on its move up, after which it could be confined to the Rp 8,950-Rp 9,100 region toward the year-end," said Lambregts.

To be sure, such a non-volatile end to the year is a possibility, but this assumes neither the United Nations nor Washington move significantly closer to war with Iraq.