Indonesia Advisory

Market fears that Indonesia may impose capital controls to rescue the rupiah may prove to be a self-fulfilling prophecy, but only if the finance minister loses a power struggle with influential business leaders.

The Indonesian currency fell Friday to a new low for the decade and has lost a fifth of its value against the dollar this year, battered by collapsing export revenue, capital flight from risky emerging-market assets and worries among foreign investors that the country would adopt comprehensive capital controls.

"For Indonesia to introduce capital controls would be shooting itself in the foot," said Helmi Arman, an economist at Bank Danamon in Jakarta. "The government relies on foreign funds in the bond market to finance its budget deficit." The central bank governor, Boediono, sought to reassure markets on Friday with a renewed pledge that Jakarta was committed to free capital movement. It is a position strongly backed by the popular and market-friendly finance minister, Sri Mulyani Indrawati.

The question is whether she can defend this position in the face of pressure from powerful business leaders. Their companies will be unable to service their debts with the rupiah at its lowest levels since the Asian financial crisis of 1997-98, and they argue that speculative selling is destroying the economy.

Many analysts were reluctant to comment on the issue, given its political sensitivity, but any capital controls in Indonesia seemed unlikely for now.

"It's clear Sri Mulyani is against the idea," an Indonesian financial analyst said. "And she is still deciding policy."

The Indonesian media have been abuzz with talk of a power struggle between Indrawati, who is also acting chief economics minister, and Aburizal Bakrie, the co-ordinating minister for social welfare and one of the country's most influential tycoons. Bakrie was until recently the wealthiest man in Indonesia, with a business empire estimated by Forbes Asia at $5.4 billion. He was a crucial financial backer of President Susilo Bambang Yudhoyono's 2004 presidential campaign. But his Bakrie & Brothers conglomerate has been battered by the global financial crisis.

With the conglomerate facing severe debt problems, worsened by the plummeting rupiah, Bakrie-linked stocks have been tanking, prompting the authorities to suspend their shares and even close the Jakarta bourse for three days last month. For decades, the nexus between powerful business interests and the political elite has been a key factor in determining economic policy. Indrawati, who entered politics after a career at the International Monetary Fund, has put battling corruption and promoting market-friendly policies at the top of her agenda.

The local media reported this month that Indrawati had threatened to resign over alleged political interference to prop up shares in Bumi Resources, a Bakrie company. The government denied the reports. Analysts say as long as she retains the upper hand, extensive capital controls are unlikely. Last week, Indonesia changed its currency rules to make it more difficult to buy foreign exchange, requiring any purchases involving $100,000 or more per month to be supported by transactions in goods or services. The measures, mostly affecting Indonesians rather than foreigners, would make speculative bets against rupiah depreciation more difficult.

But the measures did not halt the rupiah's slide, and prompted more foreign investors to pull their capital out of the country, fearing that more stringent controls were on the way. On Friday, the rupiah fell as low as 13,000 per dollar, and investors were predicting a 12 percent depreciation within a month.

The currency has been battered by falling exports and a collapse in palm oil prices, as well as contagion from widespread capital flight away from risky emerging markets. But perhaps the strongest reason why capital controls are unlikely is that they could do little to stem the rupiah's fall. "The increased risk of capital controls is likely to deter capital inflows and expedite capital flight, further weakening the rupiah," said Morgan Stanley analyst Stewart Newnham. "And if controls were implemented, we think the rupiah would continue to decline, as Indonesia's external deficit would likely dominate the balance of payments."

Source: http://www.iht.com