Strong U.S. economy may wreak havoc in RI

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