Jakarta mulls stricter capital controls

Jakarta mulls stricter capital controls

SINGAPORE (Dow Jones): Despite Indonesian government
statements to the contrary, Jakarta is probably mulling stricter
capital controls to prevent the rupiah spiraling down any
further.

This, say analysts, is the only policy option that would have
any lasting, uplifting effect on the currency, which at one point
yesterday had fallen more than 13 percent against the dollar so
far this month.

Though political instability and violence in the troubled
resource-rich province of Aceh were undoubtedly the catalyst for
the plunge in the rupiah, the introduction Jan. 15 of new curbs
limiting the availability of rupiah offshore - described by some
analysts as a form of capital controls - is at the root of the
currency's problems.

The restrictions effectively killed offshore trade and
worsened an already dismal balance of payments position by
further distancing Jakarta from the International Monetary Fund,
which continues to delay the disbursement of a crucial $400
million loan tranche.

The loan is more significant than its mere dollar value.

Before bilateral and multilateral creditors agree to
restructure and rollover the billions of dollars in sovereign
debt maturing each month, they want the administration of
President Abdurrahman Wahid to undertake economic and corporate
reforms attached to the IMF loan.

In particular, the IMF is opposed to new legislation that it
feels might curb the independence of the central bank and it
wants Jakarta to cancel borrowing mandates of the provincial
governments.

The agency also wants greater transparency in the operations
of the Indonesian Bank Restructuring Agency (IBRA), which is
charged with resurrecting the nation's embattled banking sector.
Although an IMF official in Washington expressed hope Monday of
further progress on talks with Indonesia, the Fund isn't likely
to extend the new loan any time soon.

Credit shock

With this is mind, Barclays Capital expects the government
will take a two-pronged strategy in a bid to arrest the rupiah's
slide.

"We expect the government's answer to a growing fiscal and
balance of payments crisis will be a broad-based debt
restructuring or default, and stricter capital controls" that
would make it harder for investors to get capital out of the
country, it says in a research note.

A debt standstill would aid the rupiah as outflows to service
foreign debt are a key source of weakness. Last year, this meant
a $28 billion trade surplus became a mere $8 billion current
account surplus.

Curbs on capital outflows from Indonesia would tighten
existing rules that allow investors to move funds offshore but
restrict the ability of foreigners to borrow rupiah offshore,
making it almost impossible for them to "short" the currency.

Barclays says the double-barreled approach may give Bank
Indonesia more leeway to monetize part of public debt - that is
buy back the debt, pushing bond yields down, and flooding the
commercial banking system with cash - without the rupiah
spiraling out of control.

"Therefore we continue to warn the market of what we fear will
be a coming credit shock in Indonesia," says Barclays.

The spark for this financial wildfire is, as usual, politics.

Though the rupiah plunged during the Asian financial crisis of
1997-98, it was the resignation of President Suharto in May 1998
after months of protests, riots and bloodshed that triggered the
currency's capitulation to an all-time low a month later of Rp
17,000 to the dollar.

The surge of the dollar Monday to an intraday high of Rp
11,500 from a close last week around Rp 10,000 was reminiscent of
those dark days, and without an end to political turmoil - moves
to impeach Wahid continue - and civil unrest, the outlook for the
currency will remain bleak.

"The risks remain high...and Bank Indonesia has limited
options to defend the currency," says DBS Bank analyst Wong Chee
Seng. The dollar is set to head toward Rp 12,500-13,000 in the
medium-term, says Wong.

Traditional options

More traditional options to defend a currency are not
available to the central bank because: foreign currency reserves
at $29 billion are limited and only modestly more than the $26
billion in external debt maturing this year; and steep rate hikes
would hurt local banks.

So even though dollar sales by the central bank and an
interest rate hike may have helped the rupiah stage a mild
rebound to around Rp 10,400, the respite likely will be short-
lived.

Indeed, Bank Indonesia Deputy Governor Anwar Nasution conceded
the central bank's ability to support the rupiah through
intervention is limited, as the catalyst for the fall is mainly
political instability.

Also not helping the currency are ill-advised, though perhaps
accurate, remarks from government officials.

Chief Security Minister Susilo Bambang Yudhoyono Monday warned
of the nation's collapse if "questions over the national
leadership, stability and security are not quickly resolved."

Alluding to the House of Representatives impeachment process,
Yudhoyono said the uncertainty could last until July or August,
which, even with radical policy action, would be disastrous for
the rupiah.

And the violence and social unrest in Aceh is starting to have
a real effect on the economy, says Simon Flint, currency
strategist with Bank of America in Singapore. Energy companies
Exxon Mobil Oil Indonesia Inc., PT Arun NGL, and Pertamina all
report partial or total shutdowns of operations in the strife-
torn province, which accounts for more than 4 percent of national
gross domestic product.

A further break down in social order across the archipelago
may increase security risks in neighboring countries, which have
so far escaped much of the economic downdraft from Indonesia this
time because Indonesia is viewed as a special case, rather than
the norm in Asia.

In light of these extraordinary circumstances, assurances from
Senior Economics Minister Rizal Ramli that the government won't
resort to capital controls in its bid to support the rupiah might
reasonably be viewed with a little skepticism.