Loose monetary policy dragging rupiah down

Loose monetary policy dragging rupiah down

SINGAPORE (Dow Jones): Overly loose monetary policy in
Indonesia is pushing up inflation and could very well drag the
rupiah down through key psychological support at Rp 10,000 to the
dollar.

Also weighing on the currency, say analysts, is the Southeast
Asian nation's weak balance of payments position and Jakarta's
unorthodox - and some say flawed - efforts to attract foreign
capital.

In late December the dollar hit a 26-month high of Rp 9,800,
which represented an 8.1 percent rise in the U.S. currency
against the rupiah over the preceding two months. The dollar was
traded at Rp 9,600 in the morning trade on Friday.

Ray Farris, analyst with ING Barings, says Bank Indonesia has
fallen behind the curve on inflation and is now attempting to
play catch up through interest rate increases. It is losing this
battle, however, because inflation is in a sharp upward spiral.

The government aims to keep inflation below 7 percent, but
prices rose 9.4 percent on year in December, accelerating from a
6.8 percent pace of increase in September. Inflation excluding
volatile food prices was even worse, rising to an 11.3 percent
rate in December.

Farris says excessive growth in the monetary base - otherwise
known as M0 - of close to 20 percent year on year throughout most
of the second and third quarters of last year is driving the
trend. Instead of tightening supply in the fourth quarter, Bank
Indonesia, the central bank, allowed M0 growth to accelerate to
23.4 percent growth on year in December.

"This (M0) growth seems very high even given the holiday
period, and we expect this acceleration to push inflation up to
10 percent-11 percent in the first half of 2001," says Farris.

M0 comprises notes and coins in circulation and banks'
operational balances with Bank Indonesia.

During this recent sharp increase in Indonesian prices, Farris
says interest rate rises have failed to keep pace, causing
monetary conditions to become overly easy. "With inflation
accelerating, nominal SBI rates need to rise 100-200 basis
points," he says in a research note titled "Losing Hope In
Monetary Policy."

Since the end of September, the nominal one-month deposit rate
has risen 40 basis points to 11.2 percent, while the one-month
SBI, a short-term bill issued by the central bank, is up around
120 basis points.

Both increases are far less than the 260 basis point rise in
inflation during the same three-month period.

Coordinating Minister for the Economy, Rizal Ramli, earlier
this week said to achieve a government economic growth target of
5 percent-6 percent for 2001 means SBI rates cannot "be too
high."

So with the government against sharply higher interest rates
for fear of damping economic activity, and the administration
still imposing its political will on Bank Indonesia, there seems
little reason to expect monetary conditions will tighten any time
soon.

With this is mind, Farris says ING Barings cuts its 2001-year
end forecast for the rupiah to Rp 10,500 from Rp 9,000.

But there are risks to long dollar positions against the
rupiah.

"The main risk we see to long dollar positions is that as
pressure on the rupiah builds, and if tensions with the IMF
escalate, the government may resort to some sort of capital
controls," say Farris.

The expected slide in the rupiah will also be driven by
balance of payments weakness, says Barclays Capital in a research
note.

Soured relations between President Abdurrahman Wahid and the
International Monetary Fund, which withheld a $400 million loan
after Indonesia failed to meet attached conditions, and a spat
between Abdurrahman and the central bank governor have caused
capital inflows to slow.

"Indonesia's external liquidity position is fragile," it says.

"Only a fraction of the country's outstanding foreign debt
with a face value of $152 billion, which exceeds gross domestic
product, can be repaid," says Barclays Capital.

With government debt around $77 billion and net foreign
exchange reserves a mere $29 billion, it says Indonesia faces the
prospect of a succession of foreign debt rescheduling in coming
years.

But rather than address the root cause of its external
liquidity crisis by appeasing the IMF and Abdurrahman calling a
truce with Bank Indonesia Governor Sjahril Sabirin, Jakarta is
focusing on flawed and unusual methods of attracting foreign
capital.

In this regard, Barclays cites government consideration of a
$400 million bond issue - the same size as the delayed IMF loan -
backed by liquefied natural gas assets.

Using energy assets to obtain much needed foreign capital
inflows worked during the 1995 Mexico peso crisis, during which
Mexico used oil receipts as security, or collateral, for a
currency swap arrangement with the U.S. Treasury.

But using LNG assets to securitize a bond would be difficult
for Indonesia because seizing assets in this country is
difficult, and complicated by the granting Jan. 1 of greater
autonomy for provinces.

The move new autonomy laws allow regions greater claim to
revenue from oil, gas and mining projects.