We are vulnerable

The Jakarta Post , Jakarta | Tue, 08/14/2007 1:12 PM | Opinion

Even though the underlying outlook of our economy remains reasonably good with growth expected to exceed 6 percent this year and the balance sheet of most companies looking healthy, Indonesia is nevertheless vulnerable to the rout that has gripped the global financial markets since July 26.

With more than one third of the US$52 billion foreign exchange reserves held by Bank Indonesia consisting of short-term ""hot"" money derived from foreign portfolio investments in rupiah bonds, shares and the central bank's debt papers, the country has been facing a higher risk of market turbulence caused by a sudden reversal in capital flow.

This is the consequence of the open-capital account policy the government has been pursuing over the past four decades. But what has made Indonesia's condition even more vulnerable than other countries, which also have liberalized their foreign exchange market, is that most of the foreign capital inflows over the past two years consisted of short-term, hot money that could fly out at the slightest sign of trouble.

In fact, the fallout from the American subprime-mortgage (high risk property loans) crisis has been hitting our financial market as foreign portfolio investors began unloading their rupiah assets, causing the rupiah and the Jakarta stock market index to fall significantly over the past two weeks.

What made things worse was that amid such a negative market sentiment many domestic investors tended to follow foreign portfolio investors, even though the American home-loan crisis had no direct impact on Indonesian banks. But that is simply the consequence of a globalized financial market.

Many analysts did predict everything would return to normal within a few weeks, but a possible credit crunch to cope with the situation could make it even harder and more expensive for businesses and consumers to get loans and cash.

Initial indications so far say market volatility will persist over the next few weeks because it could take sometime to restore faith in the American mortgage markets and the plethora of investments derived from them.

The $213 billion the European Central Bank pumped into the euro-zone banking market last week and the $61 billion injected by the U.S. Fed earlier last week could provide a temporary calm. But even further cuts in interest rates will not likely resolve the underlying problem.

Bank Indonesia needs to closely monitor the developments and prepare contingency measures to prevent a sense of panic because once this kind of utterly negative sentiment starts to grip the market, there will be a massive run on the rupiah and we will see a vicious-cycle impact on the market.

But any form of contingency measures prepared by Bank Indonesia should not include any form of direct foreign exchange control.

Imposing now any form of foreign exchange control would be counter-productive because the market does not believe the government has an adequate institutional capacity, in terms of technical competence and integrity, to manage such restrictive measures.

There are already many regulations and directives in place which essentially facilitate a more effective monitoring of foreign exchange transactions by Bank Indonesia and restrict speculative currency trading.

This is also the time for Bank Indonesia to improve cooperation and coordination with the central banks in other east Asian countries, which are flush with more than $3 trillion in hard currency and are facing the risks of an unmanageable balance of payments consequences.

The international reserves held by Bank Indonesia are more than enough to cope with capital outflows caused by some jittery investors but certainly those reserves are not powerful enough to address a massive days-long stampede away from the rupiah.

The market needs new positive factors to make foreign and domestic investors remain bullish about the Indonesian economic outlook, thereby containing the damage from the American subprime mortgage debacle.

Greatly significant progress in the implementation of reform measures in the sectors of investment or infrastructure, for example, could help improve market sentiment. It is this kind of incentive that is most effective in attracting foreign direct investment (fixed assets).

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