T

he central bank announced the introduction of a new mechanism to maintain stability of the rupiah and government bonds by using its foreign exchange reserves — mainly US dollars — to buy government bonds.

In a circular published on its website, Bank Indonesia said it would buy government bonds at special auctions as part of an open market intervention to protect the local currency in the event of massive capital outflows.

BI said it would use the strategy if the rupiah or the price of government bonds touched or approached certain levels.

The move, announced on Aug. 8, was introduced following massive recent sell-offs in local and global stock markets.

Deputy BI governor Budi Mulya told The Jakarta Post on Thursday that the new system was one of the central bank’s financial tools to maintain the stability of the rupiah against foreign currencies.

“At the same time, with this framework, BI will also maintain the stability of government bonds,” he said in a text message.

In the event of a massive sell-off of government bonds, yields spike, leading to increased borrowing costs for the government and straining the state budget, which should be spent on development projects.

“Now BI can hold auctions to minimize excess demand for dollars at times of massive capital outflows,” Citi Indonesia economist Helmi Arman said.

“In the past two years, government bonds were purchased mostly by foreign investors, so when external volatility hits, the risks fall into two variables: government bond yields and the rupiah.”

Foreign ownership in government bonds has more than doubled since 2008 to a record 35.5 percent compared with 16.7 percent by the end of 2008, 18.6 percent in 2009 and 19.5 percent in 2010.

The foreign ownership of the government bonds fell 2.6 percent to Rp 243.19 trillion (US$28 billion) in the first three days of this week, according to the Finance Ministry’s debt management office.

Bank Central Asia (BCA) economist David Sumual welcomed BI’s announcement, saying that with the mechanism, “foreign investors dealing in dollars don’t have to seek dollars in the market as BI would provide them”.

Central bank officials pledged to stabilize the volatility of the rupiah at all times.

BI Governor Darmin Nasution previously said the central bank was ready to use government bonds as a monetary instrument to maintain the stability of the rupiah.

The central bank conducts open market operations regularly using the rupiah, foreign exchange and government and BI debt papers to ensure a stable rupiah by maintaining sufficient liquidity in the market.

Government bonds have different types, maturities and series ranging from three-month treasury bills to 30-year regular bonds spanning retail to institutional investors, other than Islamic bonds (sukuk) and US dollar- and Japanese yen-denominated debt papers.

The rupiah declined Thursday, approaching its lowest level in six weeks as concern over Europe’s debt crisis spreading sparked further losses in stocks. Benchmark bonds also fell.

Overseas funds sold $269 million more Indonesian shares than they bought in the last three days, exchange data show, contributing to this week’s 1.4 percent drop in the Jakarta Composite Index, Bloomberg reported.

The rupiah, Asia’s second-best performing currency, has gained 5.2 percent against the dollar so far this year.

The currency lost 0.2 percent to Rp 8,548 to the dollar as of 4:01 p.m. in Jakarta, according to data compiled by Bloomberg.

The Indonesian currency earlier fell as much as 0.4 percent to Rp 8,564, near the six-week low of Rp 8,609 reached on Aug. 9.

Ten-year benchmark bonds fell Thursday. The yield on the 8.25 percent security due July 2021 climbed 2 basis points, or 0.02 percentage point, to 6.96 percent, according to closing prices from the Inter Dealer Market Association.