Price increases to aid rupiah

Price increases to aid rupiah

Dow Jones, Singapore

Though the rupiah has failed to match recent gains posted by most other Asian currencies, tighter fiscal policy and high local interest rates mean it could soon play catch-up with its neighbors, according to DBS Bank strategist Philip Wee.

But a tighter policy carries risks for domestic demand, and most analysts say the prospect of slower growth later this year, as well as nervousness ahead of a 2004 national election, poses a threat to the rupiah over the longer term.

Earlier this month Jakarta announced a slew of higher charges for public utilities through the reduction of government subsidies in compliance with conditions of its borrowing from the International Monetary Fund and other multilateral and bilateral creditors.

To be sure, the price hikes prompted demonstrations across the country, but they were poorly attended and peaceful, which is an encouraging sign for foreign investors and creditors worried about current political risks in the country.

Wee says that just as the Philippine peso has been punished due to Manila's ballooning budget gap, the rupiah will reap the rewards of Jakarta's fiscal prudence, allowing it to capitalize on the current period of broad-based dollar weakness.

"One should not be too hasty in discounting the rupiah's resilience to the weakness of the dollar and the country's high yield," says Wee. "For the short term, we are beginning to like the rupiah again as a catch-up play to the appreciation in the region's exchange rates. The fat (interest) rate spread of 116.5 basis points over dollar rates also appeals," he says.

The Indonesian rupiah recovered during the day as mass protests against recent hikes in fuel and utility prices remained peaceful.

The dollar finished at Rp 8,918, down from Rp 8,935 Thursday.

So far this year, Asian currencies, with the exception of the peso, have faired much better than the rupiah, and are up around 1 percent against the dollar as it succumbs to fears of war with Iraq and jitters over the nation's widening budget and trade gaps.

While George W. Bush wants to pump prime the U.S. economy, heavily indebted Indonesia is implementing the type of contractionary fiscal policy needed to ensure stability, and possibly strength, for the rupiah, says Wee.

The price hikes announced Jan. 1 by Indonesia include an average increase of 15 percent in telephone charges, a 24 percent rise in electricity prices, and a total removal of subsidies on fuel, which will lift prices 22 percent.

Demonstrations by students and labor unions were scheduled to climax Jan. 9 with threats by unions to bring ports and other strategic facilities to a standstill should President Megawati Sukarnoputri refuse to rescind the price increases.

As it turned out, there was little disruption of the economy with just 7,000 people across the nation participating in the protests, far short of local newspapers' estimates that 25,000 to 100,000 demonstrators would march on Jakarta alone.

Wee says abandonment of the price hikes would have caused Indonesians more hardship.

"The price hikes are necessary short-term pain for long term gains, which are already evident in 2002," he says. We notes that last year's cuts in subsidies helped narrow the budget deficit to 1.6 percent of gross domestic product - a far more favorable outcome than an original target of 2.4 percent of GDP.

"The gap was not only narrower, but significantly better than the 5.6 percent posted by the Philippines," he says.

The Singapore-based strategist says the current round of price hikes also are aimed at preventing ailing utility companies from going bankrupt, unlike in the Philippines, where troubles at Meralco cast a pall over the whole banking sector.

A fiscal policy-induced rise in the rupiah would please the local central bank, which this week talked up the currency's prospects in 2003 after a breathtaking 19 percent leap in 2002.

Bank Indonesia said Thursday that the dollar is likely to trade lower toward Rp 8,800 this year, but gave no reasons.

Nevertheless, analysts' optimism toward the rupiah isn't universal, and dissipates over a six- to 12-month time horizon.

A number of U.S. and European institutions expect it will surrender some of last year's gains, with Merrill Lynch, for example, saying the currency is 10 percent-15 percent overvalued.

A decline in the rupiah to its measure of fair value would involve a dollar rise to between Rp 10,000 and Rp 10,500.

Merrill's concerns center on slowing consumer demand and falling investment, which likely will crimp growth this year. The official forecast calls for a 3.5 percent-4.0 percent expansion in the economy.

And though recent higher oil prices help Indonesia - a net exporter of crude products and OPEC's only Asian member - the overall poor investment climate is likely to negate these positive factors, Merrill Lynch says.

And with the political climate likely to heat up ahead of national elections, there are a slew of factors - fiscal policy aside - that could work against the rupiah throughout the year.