Weakening fundamentals worsen rupiah free fall

Weakening fundamentals worsen rupiah free fall

Riyadi Suparno, The Jakarta Post, Jakarta

The rupiah's plunge over the past few weeks may not have spoiled
last weekend's wedding party for President Susilo Bambang
Yudhoyono's son, but it could eventually undermine his
government.

For most people, especially those in the middle class, the
rupiah's fall to over Rp 9,800 a dollar -- its lowest level since
March 2002 -- will likely serve as one more visible sign, after
the fuel shortages, of the government's failure to meet their
needs.

Although the responsibility for guarding the rupiah lies more
with Bank Indonesia, the government also shares responsibility
for maintaining the stability of the rupiah.

According to a special report on the rupiah by Standard
Chartered Bank, the recent fall of the rupiah is not just a
matter of an imbalance in the supply and demand of the dollar and
rupiah, but rather is the result of the country's weakening
fundamentals.

This includes the deteriorating current account due to rising
imports as a result of increased domestic demand. The current
account surplus is expected to drop to about US$2 billion this
year from almost $2.9 billion last year and $8.1 billion in 2003.

Another fundamental factor weighing on the rupiah is the
government's suspension of the privatization program for state-
owned companies. Whereas president Megawati Soekarnoputri was
quick to sell state companies, President Susilo is taking a more
cautious approach to privatization. So far, very few dollars have
been raised from the privatization program under Susilo.

As a result, the supply of dollars from trade and
privatization has declined, thus providing little support for the
rupiah.

The government seems to have expected this decline, and hopes
to compensate for it by increasing official capital flows as a
result of multibillion foreign grants and loan commitments from
donors to help rebuild Aceh following the tsunami.

Foreign money for Aceh has indeed begun to trickle in, but
less than expected because of perceived problems of governance in
Indonesia.

Despite the weak official capital flows, the government and
the private sector had hoped for better private capital inflows
this year following the $5 billion acquisition of the country's
second largest cigarette producer, HM Sampoerna, by Philip Morris
of the United States.

Looking into the details of the acquisition, however, the
expected dollars will not enter Indonesia any time soon.

According to Standard Chartered Bank's report, the Sampoerna
family, who received $2 billion for its 40 percent stake in the
cigarette company, has not reinvested the money in Indonesia.
Also, more than 70 percent of public investors who sold their
stake through a tender offer were foreigners, who may not hold on
to their rupiah. Last, Philip Morris funded the purchase partly
by borrowing rupiah onshore.

Thus, the expected private flows have not yet materialized,
and consequently, no additional support is coming for the rupiah.

This delicate situation has been worsened by rising crude oil
prices in the international market. As Indonesia becomes a net
oil importer as a result of a lack of private investment in the
oil sector, the government -- through state oil and gas company
Pertamina -- has to fork out more dollars to import fuel to meet
a quarter of the country's demand.

While dollar support for the rupiah is slim, the dollar has
suddenly strengthened globally as a result of rising interest
rates in the United States.

On the other hand, the adjustment of local interest rates has
been too slow, compared to the rate increases in the United
States. The U.S. Federal Reserve has raised its benchmark rate by
225 points to 3.25 percent per annum, while Bank Indonesia has
only raised its benchmark rate by 90 points to 8.25 percent.

As a result, people with excess liquidity have been dumping
their rupiah and rushing to the greenback.

Given the situation, where the weakening of the rupiah has
been driven by both global factors -- the strengthening of the
dollar -- as well as weakening local fundamentals, the government
and Bank Indonesia must strengthen their cooperation to defend
the rupiah.

Bank Indonesia should continue to do its part by adjusting its
interest rates so real interest rates -- interest rates adjusted
to inflation -- are positive, and by smartly intervening in the
market.

To make the measures more effective, the government needs to
do its part to help increase the supply of dollars in the market.

The government should be commended for instructing state and
state-owned companies to repatriate their dollars from offshore
to onshore banks. However, it is a challenge to persuade private
exporters to bring their dollar earnings back to the domestic
market.

The government also needs to improve its governance to help
expedite the disbursement of money for Aceh, and thus increase
the dollar supply in the domestic market.

But most importantly, both the government and the central
banks need to take longer term measures to bring the rupiah to
the desired level of Rp 9,000 per dollar by improving economic
fundamentals; especially better inflation management by the
central bank and sound fiscal policies by the government.