Let speculators panic

Let speculators panic

Bank Indonesia should not budge on its move last week to slash
the supply of rupiah that can be used for speculation overseas
despite noisy protests and complaints from banks in Singapore,
where the bulk of offshore rupiah trading is done.

The rules that severely limit rupiah transactions between
onshore banks and offshore parties will obviously have a big
impact on how the Indonesian currency is traded in Singapore.

Many Singapore-based banks may have to begin soon unwinding
their rupiah positions, and as the rupiah trade offshore dries
up, many speculators will likely move their deposits back
onshore. Banks may also decide to change their rupiah into
dollars, thereby further pressuring down the rupiah. But this
impact will only be temporary.

Most important is that offshore trade in rupiah will dwindle
to a trickle or even die because banks will not be able to get
fresh supplies of rupiah, and with the interbank market so short
of liquidity, not many offshore speculators will be willing to
take speculative positions against the rupiah.

True, as most analysts have persistently argued, the main
reasons for the rupiah's weakening and its volatility are the
political uncertainty, heavy foreign debt servicing by local
corporate debtors and Indonesian exporters' preference to keep
the bulk of their earnings overseas. But these factors are not
completely new, having been looming over the economy for the past
two years.

These risks should have been factored in by the market and
should have been reflected in the rupiah rate at least since mid-
2000, when political pressures against President Abdurrahman
Wahid began to escalate. If it had only these factors, the rupiah
rate should not have fluctuating so wildly. As Bank Indonesia has
found from its close monitoring of the foreign exchange market,
speculators also have been largely responsible for the wild
volatility.

Moreover, rupiah trading overseas does not benefit the
Indonesian economy at all. It, instead, only adds to pressure on
the rupiah. Speculators who use the rupiah simply as a trading
commodity have made the local unit highly vulnerable to rumors,
however wild they may be, and have put the rupiah rate mostly way
below the level of what is considered commensurate with the
economic fundamentals.

Of most importance is that the new rules do not slap any
impediment on Indonesians and foreigners with trade and
investment deals in Indonesia. And the central bank does still
firmly uphold the fundamental principle of free capital account
in the sense that spot onshore transactions and those with
underlying trade and investment deals remain fully free, and
Jakarta-based foreign banks are treated as residents.

Moreover, Bank Indonesia has said that maturing foreign
exchange transactions agreed to before the new rules took effect
must be honored.

The impact would have been more chaotic, had the central bank
taken the option of making it compulsory for Indonesian exporters
to repatriate their earnings in a bid to increase the country's
foreign exchange reserves. Given the inadequate administrative
capacity to administer such a rule, that policy would only
deteriorate into a new source of corruption and collusion.

Several Latin American countries which had tried this measure
found themselves with more complex problems as exporters tried to
circumvent the measure by underinvoicing their export prices,
thereby enabling them to keep most of their earnings overseas.
The governments had to hire international surveyor companies to
make preshipment inspections of exports to check their actual
market prices.

It should be realized, however, that the new rules will not
altogether stop speculation on the rupiah, nor will they be fully
effective in preventing the rupiah from further weakening in so
far as the risk factors that have been looming over the economy
are not reduced. Nonetheless, the slash of rupiah supply to
speculators overseas will, at least, neutralize one source of
pressure on the rupiah.