Strong U.S. economy may wreak havoc in RI

Rendi A. Witular, The Jakarta Post, Jakarta

Plans by the U.S. Federal Reserve to increase its interest rate could cause a devastating impact on the Indonesian economy particularly in the form of massive capital flight, economists warned.

Jakarta-based economists believe that a higher U.S. interest rate would prompt investors here to switch some of their investments in local assets to dollar-based assets, which, after the rate hike will offer better yields.

"I think the (most) negative impact from a possible rate hike by the Fed is capital flight, which will not only undermine the rupiah but also the capital markets, such as stocks, bonds and mutual funds," said Bahana Securities chief economist Budi Hikmat on Tuesday.

Economists urged the government and the central bank to take preemptive measures by also raising local rates to help avert a huge swing toward dollar-based assets.

Most experts are convinced that the Fed will gradually start raising its interest rate this year in a bid to ease inflationary pressure in the U.S. economy. Some predicted the rate hike would start in the latter part of June, while others see it beginning in August.

On Monday, stock markets worldwide plunged as investors bet that the Fed would raise interest rates soon. Indonesian stocks and the rupiah, which have displayed strong performances over the last 12 months, were also under heavy pressure.

Standard Chartered economist Fauzi Ichsan concurred with Budi, saying that capital flight would have a chain-reaction effect, as the weakening of the rupiah would in turn push inflation up.

"The weakening rupiah will trigger inflation," said Fauzi, pointing out that the country's production system was still heavily dependent on imported raw materials.

A high inflationary environment will not only undermine people's purchasing power but also prevent the central bank from further reducing its benchmark interest rate. A further cut in the rate would help ease the government's burden in servicing its huge domestic rate, and push banks to provide cheaper loans for the corporate sector.

Fauzi said that if the rupiah plunged too far beyond the Rp 9,000 mark for an extended period, Bank Indonesia would have to push interest rates higher to prevent depositors from transferring their funds to dollar accounts in foreign banks, a condition that would create a severe liquidity problem for Indonesian banks.

"Higher rates are needed to prevent capital flight and protect the rupiah from wild volatility. A stable rupiah can ward off inflation," he said.

University of Indonesia economist Chatib Basri agreed with Fauzi, saying that the local authorities had no other choice but to increase domestic rates, although it would undermine bank lending to a certain extent.

"Keeping the banks' liquidity at a safer level is more important. How can banks lend at all if they don't have enough liquidity because of the capital flight?," said Chatib.

The economy has enjoyed relatively benign inflation during the past few years, thanks largely to a stronger and stable rupiah in relation to the relatively weak dollar over the past year. Low inflation, coupled with prudent fiscal policies have generally improved sentiment in the economy.

Despite the negative impacts, both Budi and Fauzi also see some positive impacts from the Fed's rate-hike plan.

They said that the decline in the rupiah, as a result of the plan, would actually help boost the competitiveness of the country's exports, at a time when the U.S. economy -- a major importer of Indonesian products -- is further improving.

"A weaker currency will make Indonesia's export products relatively cheaper compared to products coming from other countries whose currencies are higher or do not depreciate as fast as the rupiah," said Budi.

For eyebox

Rupiah extends its slide

The rupiah extended its losses against the U.S. dollar on Tuesday amid lingering concerns over the political situation in the country ahead of the July 5 presidential election, a possible hike in U.S. interest rate and China's decision to slow down its overheating economy.

The rupiah ended at Rp 9,000 per dollar, compared to 8,950 on Monday, which is the lowest level in 13 months.

A possible U.S. rate hike is creating pressure on the local currency and other units in the Asian region as funds move out of the regional markets, dealers said.

Dealers said the rupiah may continue to fall in the coming days.

Although Bank Indonesia has said it would intervene in the financial market to help defend the rupiah, dealers speculated that so far the central bank had no made such move.

Meanwhile, Jakarta shares ended slightly higher on Tuesday amid a technical rebound in other stock markets in the region, which had helped the rupiah pull back on its intraday low of 9,040 per dollar.

The Jakarta Stock Composite Index closed up 1.6 percent at 718.26 points on technical rebound as investors purchased some stocks which had fallen in the previous several days.

The index, however, is still 12 percent lower than the record high of 818.18 points reached on April 27.

Dealers said that overall sentiment remained weak on Tuesday due to the rupiah's fall and concern over the political situation here. -- JP