No panic reaction

No panic reaction

Although the financial market in Jakarta did not panic after
Thursday's bomb attack near the Australian embassy compound, it
is no longer business as usual in so far as the market's
perception of Indonesia's country risk is concerned.

The huge terrorist attack, the third in the past three years,
certainly increased the degree of concern about security and
safety affairs -- the No. 1 enemy for investors and tourists.

Stocks on the Jakarta Stock Exchange (JSX) did tumble more
than 4 percent on the news of the mid-morning bomb blast but
recovered quickly in afternoon trading so that the JSX price
index was down only a mere 0.8 percent to end that day at 782.65.

Likewise, the rupiah weakened 1.2 percent against the dollar
immediately after the attack but rebounded later to regain most
of its loss to close at Rp 9,300. The financial market also
remained firm on Friday.

Businesses in the country have indeed been operating under
continued fear and warnings of terrorist attacks, especially
after the first devastating bombs in Bali in October, 2002. But
the financial market seemed already capable of distinguishing an
isolated incident from deep-rooted trend that could damage the
fundamentals of the economy. Whether this perception would
sustain or turn into heightened fears depends on the speed and
credibility with which the government can resolve these terrorist
threats.

However insignificant the initial impact of the bomb attack
seems to be, the blast will certainly slow down the process of
regaining investor confidence. If before last week's terrorist
attack, it was mainly the political risks related to the
presidential election that stood in the way of capital inflows,
the causes of uncertainty have now increased to include high
security risks.

The financial market is most vulnerable to uncertainty as
portfolio investors can easily shift their investment from one
place to another. True, volatility is the natural character of a
financial market, but too-high fluctuations make sensible
business-risk calculations almost impossible.

Moreover, due to its huge foreign and domestic debt burdens,
the state budget is also highly vulnerable to the movements in
the currency and interest rates. The government has estimated
that every Rp 100 depreciation of the rupiah rate against the
U.S. dollar will immediately add Rp 9.70 billion to its foreign
debt-servicing burdens.

Yet more damaging is that a weakening rupiah always increases
inflationary pressures (imported inflation) as the costs of
imports accordingly become higher and this in turn will require
the central bank to tighten its money policy by raising interest
rates to control inflation.

The problem though, is that higher interest rates will
immediately increase the interest charges on government bonds.
The finance ministry has estimated that every single percentage
point rise in the central bank's benchmark interest rate will add
almost Rp 2.3 trillion (US$247 million) to the domestic debt-
servicing burden.

Tourism is another sector that could immediately get a severe
hit. The growth of tourist arrivals, which reached as high as 31
percent in the first seven months of this year, may slow down,
cutting into the revenues of airlines, hotels, restaurants,
souvenir shops and other related businesses such as suppliers of
food and water and land transport services.

Insurance premiums on doing business in and with Indonesia
will also rise. Worse still, heightened fears of security
disturbances may prompt buyers overseas to divert orders from
Indonesia to other countries out of concerns about delivery.
Further down the line, sharp drops in exports would adversely
affect the balance of payment conditions and consequently
increase downward pressures on the rupiah.

These ominous signs are quite saddening indeed because the
pace of Indonesia's economic recovery was poised to increase
after the presidential election.

However, the damage could still be contained and the healing
(confidence-rebuilding) process could be speeded up if the latest
bomb attack can be resolved quickly and credibly -- meaning that
those masterminding the attack are caught -- and the presidential
election on Monday runs smoothly and fairly. Anything less would
abort the economic recovery and could lead the country into an
even worse crisis.

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