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.