Indonesia faces rupiah test with rate move on record deficit

(c) 2013, Bloomberg News.

JAKARTA, Indonesia — Indonesia's surprise interest-rate increase on Thursday boosted the rupiah, stemming the currency's biggest monthly decline in nearly five years. To drive a sustained revival, the government needs to curb the country's record current-account gap.

Bank Indonesia increased the benchmark reference rate to 7 percent from 6.5 percent, it said after a meeting in Jakarta Thursday that came before the next scheduled policy review. It also raised the deposit facility rate by half a percentage point to 5.25 percent, and extended a bilateral swap deal with the Bank of Japan valued at $12 billion that will allow the two to borrow from each other's foreign-exchange reserves.

"The interest-rate hike is a more concrete and immediate step to tackle the current-account deficit even at the cost of slowing growth," said Handy Yunianto, head of fixed-income research at PT Mandiri Sekuritas in Jakarta, a unit of the nation's largest lender. "But the impact will be short-lived until investors can see for themselves that the deficit has indeed narrowed."

Indonesia joins Brazil, Turkey and India in taking steps to support their currencies this month as the prospect of reduced U.S. monetary stimulus prompts investors to sell emerging-market assets. A record current-account deficit last quarter for the Southeast Asian nation, and worse-than-estimated economic growth and inflation data have led to a stock-market slump and helped push the rupiah to its lowest level since April 2009 this week.

"What they can do now is to limit the collateral damage from the potential U.S. policy shift," said Wellian Wiranto, a Singapore-based investment strategist at the wealth management unit of Barclays. "The Fed's previously abundant fountain of liquidity is turning into a black hole pulling everything in. BI can only try to anchor things as much as they can."

The rupiah, which reached a four-year low of 10,955 on Wednesday, has fallen 5.9 percent this month, the biggest monthly drop since November 2008 and making it the second-worst performer in August among the most traded Asian currencies, according to data compiled by Bloomberg.

The central bank forecast on Aug. 28 that the currency would average 10,500 to 10,700 per dollar in 2014. Bank Indonesia has said it is allowing the rupiah to find a "new equilibrium," as intervention to support the currency took its foreign-exchange reserves down to $92.7 billion at the end of July from $112.8 billion in December 2012, according to data compiled by Bloomberg.

"Lower reserves directly impact the sovereign balance sheet while a tail-spin for the rupiah would risk a destabilizing surge in inflation," Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch Ratings in Hong Kong, said in an interview Thursday.

Fitch and Moody's Investors Service rank Indonesia's debt at the lowest investment-grade level, while Standard & Poor's rates Southeast Asia's largest economy at the highest junk level.

Indonesia's bond yields show investors may already be pricing in a rating downgrade. The yield on the nation's global bonds due October 2023 rose to 6.18 percent Friday, rivaling the 6.18 percent rate on similar-maturity dollar debt from Hungary, rated one level lower at S&P.

S&P could lower the nation's credit ranking should authorities fail to address fiscal and external pressures with "timely and adequate policy responses," Associate Director Agost Benard said on Aug. 28, before Thursday's actions. S&P revised its outlook to stable from positive in May.

Moody's is keeping its stable outlook for now, said Christian de Guzman, a Singapore-based sovereign analyst.

"Bank Indonesia has become more aware of pressures on the rupiah, inflation and the balance of payments, where previously there was much more of a bias toward growth," de Guzman said in an email Thursday after the rate move.

The Jakarta Composite Index of shares closed 1.9 percent higher Thursday and gained 0.9 percent Friday. The market is still down 10.2 percent in August, to be the world's worst- performing major stock index this month, according to data compiled by Bloomberg.

"The central bank is finally responding to the market pressure," Jemmy Paul, a Jakarta-based equity fund manager at Sucorinvest Asset Management, said in an email. If the rupiah remains weak, there will be more tightening measures, he said.

Indonesia raised the key rate by a combined 75 basis points in June and July before keeping it unchanged at its meeting on Aug. 15 as slowing growth deterred a third consecutive increase. The rupiah's more-than-5 percent slump in the past two weeks may have pressured the central bank to increase borrowing costs again before a scheduled policy review on Sept. 12.

Bank Indonesia Thursday reduced the holding period for its SBI debt certificates to one month from six months, in a move aimed at drawing funds back to the instrument. It had extended the holding period in May 2011.

Market losses accelerated after data this month showed the current-account deficit reached a record in the second quarter. Indonesia's government said on Aug. 23 it will allow more mineral exports this year and increase a luxury goods tax to narrow a trade deficit, while the central bank said it is increasing foreign-currency supply.

The central bank ordered lenders to set aside more funds in government and central bank bonds earlier this month as officials used policy tools other than benchmark rates to rein in liquidity and cool inflation expectations.

Indonesia's bilateral swap deal with the Bank of Japan, in place since 2003, was due to expire Aug. 31, said Peter Jacobs, director of communications at Bank Indonesia. It has been renewed every two years, he said.

Economic expansion has slowed in the last four quarters, dipping below 6 percent in the three months through June for the first time since 2010. The slowdown leaves President Susilo Bambang Yudhoyono seeking to shore up his legacy of political and economic stability in the world's fourth-most populous nation before he hands over power in elections next year. Yudhoyono in June raised domestic fuel prices for the first time since 2008 to cut subsidy costs.

Bank Indonesia sees the economic slowdown continuing in the second half of the year, it said Aug. 28. The inflation rate may climb to between 9 percent and 9.8 percent by the end of 2013, the central bank said Thursday. Indonesia's consumer prices rose 8.61 percent in July from a year earlier, the fastest pace in more than four years.

_ With assistance from Berni Moestafa, Neil Chatterjee and Harry Suhartono in Jakarta.

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