Indonesia vulnerable to hot money reversal

[Ulhas Joglekar <joglekarulhas@xxxxxxxx>]

Reuters.com

Indonesia vulnerable to hot money reversal
http://today.reuters.com/news/articlenews.aspx?type=reutersEdge&storyid=2006-04-21T070616Z_01_HKG109021_RTRUKOC_0_US-ECONOMY-INDONESIA-HOTMONEY.xml

Fri Apr 21, 2006

By Gde Anugrah Arka and Umesh Desai

JAKARTA/HONG KONG (Reuters) - Indonesia may be Southeast Asia's hottest
market but some analysts warn that speculative funds could flee at the
slightest hint of trouble, as they did during the Asian financial crisis of
1997-1998.

Foreign investors have beaten a path to Indonesia's financial markets, lured
by the highest government bond yields on offer in Asia as well as an
improved fiscal performance and the prospect of rate cuts, which help make
the stock market attractive.

But worries about global oil prices and inflation could spoil the party and
the risk remains that this hot money could make an abrupt exit, which would
have a disastrous impact on the small local markets, where foreign cash
plays a disproportionate role.

"There is undoubtedly some reliance on an inflow of money which could leave
the country if things turn negative," said Irene Cheung, a sovereign debt
analyst with ABN AMRO.

"You could get a weakening bond market and a weakening rupiah situation --
it would be a double whammy," she said, although she felt the environment
had improved since the start of the year.

The vulnerability was illustrated last August when the rupiah plunged to a
four-year low of 11,750 per dollar because of worries that the soaring cost
of oil would exacerbate Indonesia's current account and budgetary problems.
In a bid to shore up confidence, the government slashed fuel subsidies last
October, raising domestic prices -- which had been among the cheapest in
Asia -- by an average 126 percent.

"The fuel price hike, achieved without triggering significant social and
political unrest, has prompted foreign funds to flow in," said Yudhi Ismail,
executive director of Himdasun, an association of Indonesian government bond
dealers.
Investors took the view that the government would be able to
raise prices again if necessary, reinforcing confidence in the team under
President Susilo Bambang Yudhoyono, who won election in 2004 pledging to
fight corruption and revive the economy.

This week the California Public Employees' Retirement System (CalPERS), the
biggest pension fund in the United States, added Indonesia to the list of
emerging equity markets in which it can invest, noting in particular its
improved political stability.

The government has also raised interest rates sharply, both to support the
rupiah and to fight inflation.

But dollar demand for imports such as oil remains high and Jakarta's thin
markets could quickly come under pressure if sentiment turned and foreigners
pulled out.

HUGE HOLDINGS

Foreign holdings of treasury bills, known as SBIs, and bonds, together worth
about $7 billion, dwarf daily trading volumes in the spot dollar/rupiah
market of about $400 million.

According to Nomura International, Indonesian stocks saw cumulative net
foreign selling of $2.9 billion in the year to August 2005 -- a period that
saw the rupiah fall 21 percent.

Since then, foreign funds have been net buyers to the tune of half a billion
dollars, helping to push the rupiah up 32 percent. The stock market has
climbed more than 25 percent this year to a record high.

Chief economics minister Boediono said on Thursday that net capital inflows
were running at about $1 billion a month.

"If those foreign funds holding government bonds decide to move
out, who is capable of buying them except the central bank?" asked Yudhi
Ismail of the association of Indonesian bond dealers.

"Otherwise the market will crash again."

The authorities are alive to the potential problems and are
drawing up plans to sell bonds to local retail investors, which would cut
the dependence on foreigners.

There is also a plan to introduce primary dealers, or market makers, who
would have to stand ready to buy bonds in the event of a sell-off by
investors.

For the moment, the foreigners seem happy enough.

As of late March, offshore investors held a record 22 trillion rupiah ($2.47
billion) of short-term central bank paper, double what they had last
October. Foreign holdings of rupiah government bonds hit a record high of 46
trillion rupiah.

The rupiah's strength has helped bring down inflation to 15.7 percent in
March from a six-year high of 18.4 percent last November, prompting hopes of
a reduction in interest rates.

Lee Boon Keng of DBS Bank in Singapore says the prospect of rate cuts --
which would be likely to push up bond prices -- and of robust economic
growth had led him to recommend Indonesian government rupiah bonds."The 
inflows into Indonesia are looking to capture not just the humongous
interest rate differential ... The improvement in the budget situation will
translate into a much better picture for government bonds," Lee said.

The benchmark one-month interest rate, currently at 12.75 percent, would be
at 10 percent by the end of the year, Lee said. He expects the yield on the
five-year bond to fall to 10-10.5 percent from 11.8 percent now.

Bond yields have already fallen sharply in recent months. The government
sold a 13-year bond at 12 percent on Tuesday, four percentage points below
the yield at an auction last August.

($1 = 8,900 rupiah)

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