NDF market poses a threat to rupiah

NDF market poses a threat to rupiah

SINGAPORE (Dow Jones): In defiance of Bank Indonesia's recent moves to curb speculative trading in the rupiah, a handful of major foreign banks in Singapore have agreed to start trading rupiah non-deliverable forwards from Monday, dealers said on Thursday.

An offshore interbank non-deliverable currency forward market could make the rupiah vulnerable to speculative attack - as it was until a month ago, when the central bank essentially shut down offshore trade in the currency.

The new market, beyond Bank Indonesia's jurisdiction because settlement would be in dollars, might allow arbitrageurs to capitalize on discrepancies in NDF and onshore rates, putting the rupiah in a dangerous position given the smoldering social and political problems in Indonesia.

"It opens the door to a lot of arbitraging - onshore players can arbitrage between the spot market and the NDF market," says a dealer at a foreign bank in Singapore. "It is definitely going to drive the spot (dollar against rupiah) market higher."

In Jakarta Bank Indonesia Deputy Governor Miranda Gultom commented on Thursday that the new market would have an impact on the rupiah.

But she declined to provide further explanation.

Miranda said Bank Indonesia can't stop overseas banks from trading rupiah via the non-deliverable market as they are outside the central bank's jurisdiction.

Pardi Kendy, a Jakarta-based director at PT Bank Buana Indonesia, said, "This is going to bring volatility back on the rupiah. At the initial stage it will create two prices - offshore and onshore. I expect the offshore market price will be higher than the onshore market. This will give an opportunity to arbitrageurs to take advantage of the difference. Excessive volatility may upset Bank Indonesia."

The step by the foreign banks is important not only for Indonesia but also because it might set a precedent for how bankers respond to regulatory changes in other nations in Southeast Asia as well.

For example, the Thai central bank is scheduled to meet with bankers on Friday to discuss baht trading regulations. Some dealers speculated on Thursday that foreign bankers would consider setting up a baht NDF market if Thai authorities announce drastic measures to curb offshore trading in the currency.

A non-deliverable forward market involves trading in a currency based on different forward rates calculated by interest rate differentials.

Because settlement is in dollars, such trading is thought to lie beyond the jurisdiction of local central banks.

In Asia, there are non-deliverable forward markets for the South Korean won, New Taiwan dollar, Philippine peso, Indian rupee and Chinese yuan.

There are also concerns Bank Indonesia might respond to the new market by going a step further in its effort to clamp down on speculation.

Some fear Indonesia could resort to Malaysian-style capital controls if the new NDF market damages the rupiah, although Jakarta's commitments to the International Monetary Fund would make this scenario unlikely, others said.

In September 1998, Kuala Lumpur pegged the ringgit at MYR3.80 to the dollar and the regime has remained in place ever since.

Bankers began discussing a non-deliverable currency forward market to replace spot rupiah trading shortly after Bank Indonesia announced Jan. 15 that it would deny speculators access to funding for short rupiah positions. As a result of the central bank's regulations, banks outside Indonesia can no longer buy or sell rupiah among themselves.

The move Thursday came after bankers finally agreed at a meeting late Wednesday on technical aspects of the new market, including the point of reference for fixing rates, sources told Dow Jones Newswires.

Banks will post their quotes on the Association of Banks in Singapore's fixing page on Bridge Telerate page 50157, dealers said, adding that the tenor of the contracts will extend out to six months.

"We anticipate that over time there will be approximately four to eight participating banks and anticipate that the initial size of the transactions will be up to $2 million," said a source at a European bank.

Despite the news of this latest development, the rupiah held steady Thursday around IDR9,600 to the dollar.

Dealers said there is keen interest to trade rupiah NDFs, although the market will likely evolve slowly.

"A lot of people didn't want to trade dollar-rupiah because of the capital risks, but there's actually a lot of interest to trade or hedge the rupiah offshore," said a dealer at a U.S. bank. "It will be a slow start, but after a few months, it certainly will pick up."

Indeed, most of the banks behind the genesis of the rupiah NDF market were already offering NDF rates arbitrarily at the request of their customers in recent weeks.