INDONESIA IMPOSES CONTROLS ON FOREIGN EXCHANGE

UNCLAS SECTION 01 OF 03 JAKARTA 002092 SIPDIS SENSITIVE DEPT FOR EAP/MTS, EAP/EP AND EEB/IFD/OMA TREASURY FOR IA/MALACHY NUGENT AND TRINA RAND COMMERCE FOR 4430/KELLY DEPT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN DEPARTMENT PASS EXIM BANK SINGAPORE FOR SBAKER TOKYO FOR MGREWE USDA/FAS/OA YOST, MILLER, JACKSON USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER USDA/FAS/OGA CHAUDRY, DWYER DEPT PASS USTR WEISEL, EHLERS E.O. 12598: N/A TAGS: EFIN EINV ECON EAGR ID SUBJECT: INDONESIA IMPOSES CONTROLS ON FOREIGN EXCHANGE TRANSACTIONS ¶1. (SBU) Summary. Bank Indonesia (BI) announced measures to regulate foreign exchange purchases on November 12 in an effort to shore up the weakening Rupiah (IDR). The new rules require individuals and firms to provide documentation about the underlying transaction for foreign exchange purchases in excess of $100,000 per month. The IDR/USD, which has fallen 14% over the past month, hit 12,000 in trading on November 13. Many market analysts were surprised by the move and worried that the regulations would prompt additional short-term outflows and could undermine long-term investment inflows. Although Standard & Poor's recently affirmed Indonesia's sovereign credit rating, analysts also are increasingly concerned about Indonesia's ability to finance its budget deficit if current market conditions persist. The World Bank, in conjunction with Japan and Australia, is close to finalizing a $5.5 billion standby line of credit for Indonesia to provide some insurance against adverse market conditions. Uncertainty surrounding the fate of BI's wholly owned Netherlands-based subsidiary, N.V. De Indonesische Overzeese Bank ("Indover Bank") has also weighed on Indonesia's markets in recent weeks. End Summary. BI Announces New Foreign Exchange Regulations -------------- ¶2. (SBU) Bank Indonesia (BI) announced measures to regulate foreign exchange purchases on November 12 in an effort to support the rapidly declining Rupiah (IDR). The new measures require domestic investors to provide banks with documentation of an underlying transaction, such as the purchase of imports or the repayment of loans, for any foreign exchange purchase in spot, forward or derivative markets that exceed $100,000 per month. For transactions less than that amount, domestic investors must sign a document declaring that they have not purchased more than $100,000 in foreign exchange over the course of that month from other Indonesian banks. The same rules apply to foreign individuals and entities, but the restrictions for foreigners apply only to spot market transactions. The documentation required for foreign exchange transactions will include a description of the underlying transaction type and amount, the individual or firm's taxpayer ID, and a written declaration confirming the accuracy of the information. ¶3. (SBU) BI targeted the new rules at domestic investors and depositors, whom the government asserts are exacerbating current pressure on the Rupiah. William Wallace, Chief Economist for the World Bank's Indonesia office, believes the move was implemented to discourage domestic investors from moving their bank deposits to neighboring countries such as Singapore that have implemented a blanket deposit guarantee. While many BI officials reportedly also favor implementing a blanket deposit guarantee, Vice President Kalla remains publicly strongly opposed. IDR Hits 12,000 -------------- ¶4. (SBU) The new regulations also reflect BI's increasingly narrow policy options amid financial market volatility and markedly lower growth prospects. The central bank is reluctant to raise interest rates given the outlook for slower world and domestic growth and cannot continue to defend the exchange rate through direct market intervention indefinitely. Indonesia's official foreign exchange reserves have declined by $10 billion since early August, in part due to BI's defense of the IDR. Despite this intervention and a series of measures designed to inject liquidity into the banking sector, the currency continues to perform poorly, undermining price stability and investor confidence. The IDR has depreciated 18.0% against the USD in the last month, and breached 12,000 USD during trading on November 13. Indonesia's currency has underperformed other Asian currencies, with the Korean Won, the Indian Rupee and the Philippine Peso, declining 13.3%, 2.1%, and 4.1%, respectively, over the same 30-day period. Significant Short-term and Long-term Implications JAKARTA 00002092 002 OF 003 -------------- -------------- ¶5. (SBU) Many market analysts were surprised by the move and worried that the regulations would prompt additional short-term outflows and undermine long-term investment inflows. Analysts in the region generally concur that BI's new regulations do not represent a significant increase in control over foreign exchange transactions. The new rules impose a documentation requirement rather than a limit on the size of foreign exchange transactions. However, the ease of implementation of the new rules and their effectiveness remains unclear, according to IMF resident representative Milan Zavadjil. In addition, BI will not fully implement documentation requirements until December 1, potentially prompting individuals and firms to rush to purchase foreign exchange in the coming weeks, further depressing the value of the currency. ¶6. (SBU) A number of analysts worried that the new rules would undermine investor confidence in Indonesia over the longer-run as global markets stabilize and funds return to emerging markets. In addition, a November 13 Bank Danamon report points out that the new regulations contain no export repatriation requirements, a caveat that may discourage exporters from converting foreign currency earnings back into IDR over time. Citibank and Bank Danamon analysts also offered a more positive assessment of the new rules, noting that if the new regulations successfully curb domestic capital outflows and stabilize the IDR, longer-term investor confidence in Indonesia may improve. Sovereign Rating Affirmed, but Risk Remain High -------------- -- ¶7. (SBU) Standard & Poor's recently affirmed Indonesia's 'BB-' long-term foreign currency sovereign credit rating and 'BB+' long-term local currency rating with a stable outlook. S&P also affirmed the 'B' short-term sovereign credit rating and all senior unsecured debt ratings. However, the stable outlook was based on "...debt reduction in recent years and an improved policy environment, particularly the flexible exchange rate regime, that will enable the government to sustain an adequate external liquidity cushion in the face of ongoing negative external shocks," a view that may be adjusted in light of the new foreign exchanges rules. S&P changed its sovereign rating outlook to negative for Pakistan, Sri Lanka, and Vietnam. ¶8. (SBU) Despite S&P's vote of confidence, analysts remain concerned about Indonesia's ability to finance its budget deficit if current market conditions persist. The GOI moved early to reduce its budget deficit and financing requirement, easing some concerns. However, Indonesia's tax revenues are likely to fall more sharply in 2009 than first anticipated, particularly from commodity-based businesses, as the global slowdown worsens, reducing Indonesian corporate earnings. In a recent discussion with the embassy, mining firm Freeport executives noted that their earnings in Indonesia and tax revenues are likely to drop dramatically in the coming months. Indonesian government bond yields also remain high, despite some decrease in recent weeks. The yield on 10-year government bonds was 15.0% as of November 13, up from 12.1% in early September. The World Bank, in conjunction with Japan and Australia, is close to finalizing a $5.5 billion standby line of credit for Indonesia to provide some insurance against adverse market conditions. Indover Debacle Continues -------------- ¶9. (SBU) Bank Indonesia's wholly owned Netherlands-based subsidiary, N.V. De Indonesische Overzeese Bank ("Indover Bank") is now in the process of being settled by a court-appointed curator in the Netherlands, as requested by the Netherlands Central Bank following its October 7 default. BI abandoned a planned 546 million euro bailout when it was unable to secure approval from a plenary session of the Indonesian House of Representatives by October 31. While a House Commission had approved the bailout in principle, BI was JAKARTA 00002092 003 OF 003 unwilling to take action without plenary approval for fear of future legal liability. On November 11, BI announced appointment of a team to handle ongoing measures related to Indover. ¶10. (SBU) BI has stated it will coordinate with the Indonesian government to mitigate possible impacts on the Indonesian banking system arising from the liquidation. Several local banks have announced significant lending exposure to Indover. On November 10, IMF resident representative Milan Zavadjil told embassy he expected BI will attempt to assist exposed Indonesian banks, but he did not expect a quick resolution due to fear of associated legal risks. Meanwhile, the Finance Ministry has requested the Attorney General's Office to investigate the case, alleging that Indover management misused a BI support letter provided to auditors in order to secure two syndicated loans valued at $187.5 million. Indover Bank has been the subject of previous investigations and BI and GOI officials have been long rumored to have benefited from Indover operations. HUME