Continued depreciation seen as Indonesia's best strategy for rupiah

[SINGAPORE] To prevent the often-volatile rupiah from collapsing when United States interest rates begin to rise, analysts say Bank Indonesia should just keep doing what it is doing - let the currency slowly depreciate.

The rupiah is in the spotlight as investors prepare for the Federal Reserve to start lifting rates from near zero as early as June. It is one of Asia's highest-yielding currencies, with a history of turbulence and vulnerability to foreign capital flows.

In 2013, Indonesia's central bank burned up foreign-exchange reserves as the rupiah plunged 21 per cent after then-Fed Chairman Ben Bernanke said its bond-buying would be reduced.

This time should be different, analysts believe, because the economy is stronger. Lower inflation has allowed the central bank to cut rates and Bank Indonesia (BI) has let the rupiah gradually depreciate.

"At the very least, Bank Indonesia is aware now that the currency should be allowed to adjust in greater accordance to market forces, unlike in 2013," said Lee Jin-yang, a macro analyst at Aberdeen Asset Management in Singapore.

"The danger is that BI starts defending the FX level aggressively and runs down FX reserves," he said. "That is the last thing they ought to be doing if they want to convince markets that they are in control."

In other words, many analysts believe it is the lack of confidence in Indonesia's ability to defend the rupiah during periods of global turmoil that begets those bouts of volatility.

This year, BI has stayed relaxed as a broad dollar rally has made the rupiah weaken more than 5 per cent, to past the psychological support of 13,000 per dollar, the weakest level since August 1998.

The central bank has gradually built up reserves to US$115.5 billion in February, the most since April 2012.

Heng Koon How, Credit Suisse Private Bank's senior currency strategist, said Indonesia's reserves account for about 12 per cent of total economic output, lower than other Asian countries' average of about 30 per cent, so BI's options for defending the currency are limited.

Earlier this month, BI Governor Agus Martowardojo said there was no need to worry, as the rupiah "is in good condition and we are always in the market to reduce volatility".

Indonesia's current account deficit narrowed to 2.8 per cent of gross domestic product in October-December, but remains a concern.

On Tuesday, Finance Minister Bambang Brodjonegoro said steps including imposition of temporary anti-dumping duties would be taken to help narrow the current account shortfall.

The economy expanded 5 per cent last year, its weakest pace in five years. Foreign investors now hold more than US$39 billion worth, or about 40 per cent, of government bonds.

Bertram Sarmago, investment director at Nikko Asset Management in Singapore, said a 3-5 per cent rupiah depreciation could be managed well but the central bank would have to lower inflation more and keep the current account shortfall below 3 per cent of GDP to convince markets.

Others see the rupiah weakness as deliberate policy to help exports recover.

"The stance now is aimed to support economic growth, by strengthening exports," said Ezra Nazula, head of fixed income at Manulife Aset Manajemen Indonesia in Jakarta.

"Rupiah weakening is OK, as long as there is no shock and steep fall," he said.

"I am sure BI knows what it is doing."

REUTERS