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.