Indonesian Outflows Spur Pressure for Further Policy Tightening; “There was a time window in which the government could ride on the positive momentum and push through more concrete measures, but it’s now gone,”

Indonesian Outflows Spur Pressure for Further Policy Tightening

Indonesia’s policy makers delivered the country’s first benchmark interest-rate increase since 2011 and first fuel-price boost in five years in June. Capital outflows since then have spurred pressure for further moves.

The rupiah remains among the worst performers in Asia in the past year, falling about 0.8 percent after Indonesia on June 13 became the region’s first major economy to raise rates this year. Global funds sold 2.5 trillion rupiah ($250 million) of local-currency government bond holdings in the week after the June 22 fuel adjustment, aimed at containing a current-account deficit that has hurt the currency.“The mood among investors is still to wait and see,” said Eric Alexander Sugandi, a Standard Chartered Plc economist in Jakarta. “Further rate increases will help restore market confidence and manage accelerating inflation, which affects the real rate of return on investing in Indonesia.”

The finance minister signaled yesterday he wouldn’t be too concerned with higher rates, after the central bank pledged to strengthen its policy mix against inflation at the July 11 meeting. Costlier fuel and monetary tightening could push full-year expansion below 6 percent for the first time since 2009, according to Credit Suisse Group AG, underscoring President Susilo Bambang Yudhoyono’s failure to wean the economy off subsidies and fix infrastructure gaps that spur price pressures.

“There was a time window in which the government could ride on the positive momentum and push through more concrete measures to take growth to the next level beyond 7 percent, but it’s now gone,” said Wellian Wiranto, an investment strategist at the wealth management unit of Barclays Plc in Singapore.

Bonds Fall

Indonesia’s bonds declined yesterday, pushing the 10-year yield to the highest level since September 2011, while stocks sank the most in about two weeks on concern the central bank will raise borrowing costs. The rupiah declined 0.1 percent to 9,940 per dollar, prices from local banks compiled by Bloomberg show.

A recovery in the currency has hitherto been thwarted by the prospect of a scaling back in U.S. monetary stimulus, which spurred outflows from emerging markets in recent weeks. The country will need to undertake even harder measures to improve investor confidence, including further fuel subsidy cuts and boosting infrastructure spending, according to Royal Bank of Scotland Group Plc.

‘More Proactive’

Bank Indonesia stands ready to intervene in markets if needed, Peter Jacobs, its director of communications, said in an interview with Bloomberg TV Indonesia yesterday. The central bank’s policy options can include interest-rate and macro-prudential measures, he said. The authority released a rare statement after its July 2 weekly board meeting citing plans to boost the policy mix against accelerating inflation at the next monthly board meeting.

“Bank Indonesia wants to be more preemptive, more proactive instead of re-active,” said Destry Damayanti, chief economist at PT Bank Mandiri. The comments foreshadow another increase in the deposit facility rate, or Fasbi, as slowing growth prevents a change in the benchmark reference rate at this month’s policy review, she said.

Standard Chartered’s Sugandi predicts the central bank will raise its benchmark rate to 6.5 percent by year-end from 6 percent currently, forecasting increases in July and August.

The World Bank cut its 2013 forecast for Indonesian growth to 5.9 percent this month, saying accelerating inflation could hurt domestic demand as exports and investment cool. The increase in subsidized fuel prices, combined with monetary policy tightening, will probably hit already weakening investment growth and drag economic expansion to 5.7 percent in 2013, according to Credit Suisse.

No Blow

Finance Minister Chatib Basri said yesterday he doesn’t expect any further rate increase to deal a blow to growth. Consumption accounts for a bigger share of gross domestic product than investment, and if authorities can manage inflation, purchasing power would remain strong, he said.

“So long as the rupiah is under pressure, they will crank up the dial,” Wiranto said. “The recent emerging-markets sell-off can be a positive thing in that it has shaken the policy makers out of their complacency to some extent.”

The onus to counter the slumping currency may fall on the central bank as an election due next year hinders another fuel-price increase. While Yudhoyono’s administration has said it’s studying a new price structure for fuel subsidies, protests before last month’s fuel-policy adjustment underscore the political impediments to subsidy cuts in a nation where riots spurred by soaring living costs helped oust the dictator, Suharto.

Aiding Rupiah

“Bank Indonesia’s latest move to hike rates before the fuel-price hike is another signal that they’re very forward looking, which I think should eventually increase the credibility of the central bank and aid the rupiah,” said Enrico Tanuwidjaja, a regional economist at Royal Bank of Scotland.

The central bank is grappling with pressure to act in the midst of a leadership revamp that began with Agus Martowardojo replacing Darmin Nasution as governor in May. A parliamentary committee assessed three candidates for a vacancy on the central bank’s policy board this week and is due to announce its choice for deputy governor on July 8.

In the days leading up to the June benchmark rate increase, the central bank signaled it was preparing to tighten policy. Bank Indonesia Deputy Governor Perry Warjiyo said late May that the authority was “moving toward a tightening bias.” At a June 11 board meeting, it decided to raise the Fasbi rate to 4.25 percent.

“If this marks the turning of a new leaf, of something fairly fundamental, then clearly the currency markets will sit up and take notice,” Robert Prior-Wandesforde, an economist at Credit Suisse, said after last month’s moves. “Obviously the market will be looking for” more tightening if the pressure remains, he said.

To contact the reporters on this story: Neil Chatterjee in Singapore at nchatterjee1@bloomberg.net; Yudith Ho in Jakarta at yho35@bloomberg.net