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Indonesia Tightens Rules on Foreign-Exchange Holdings

Bank Indonesia Deputy Governor Budi Mulya
Bank Indonesia Deputy Governor Budi Mulya. Photographer: Munshi Ahmed/Bloomberg

Indonesia said it will tighten rules on banks’ foreign-exchange holdings and overseas borrowing to cope with capital inflows that have pushed up inflation and strengthened the rupiah this year.

Bank Indonesia will also reintroduce a 30 percent cap on lenders’ short-term overseas borrowing to minimize the risk of sudden capital outflows, it said yesterday. Banks must set aside 5 percent of their total foreign-exchange holdings as reserves as of March 2011, from 1 percent currently, Deputy Governor Budi Mulya said at a press briefing in Jakarta yesterday. The reserve requirement will rise to 8 percent effective June.

“These rules will ease pressure on the rupiah,” said Anton Gunawan, chief economist at Jakarta-based PT Bank Danamon Indonesia. “The central bank wants to absorb excess liquidity in the banking system.”

Indonesia and its peers are grappling with increasing capital inflows as borrowing costs and growth rates that are higher than those of developed economies boost the appeal of emerging-market assets. Taiwan tightened curbs on exchange-rate derivatives this week and South Korea plans similar measures, according to an official at the country’s financial regulator.

The rupiah rose to a one-month high today, helped by demand for higher-yielding assets. The currency climbed 0.3 percent to 8,973 per dollar as of 11:12 a.m. in Jakarta, according to data compiled by Bloomberg. That’s the strongest level since Nov. 29.

Delayed Impact

The steps by the central bank “will be implemented in March; that is why it is not having an impact on the currency,” said Lindawati Susanto, head of foreign-exchange trading at PT Bank Resona Perdania in Jakarta. “The liquidity will be drying up next year.”

The benchmark Jakarta Composite Index of stocks has surged 47 percent in the past year and was up 0.4 percent at 11:24 a.m. today. It is among the top 10 performing equity indices in the world this year, together with those in Sri Lanka, Peru, Thailand and the Philippines.

Bank Indonesia has resisted imposing capital controls or raising its benchmark interest rate from a record-low 6.5 percent, choosing instead to increase bank reserve requirements and encourage investors to keep their money in the country for longer periods.

The current benchmark rate is consistent with Indonesia’s goal of achieving inflation of 4 percent to 6 percent in 2011 and 3.5 percent to 5.5 percent in 2012, Mulya said yesterday.

Absorb Liquidity

The higher foreign-exchange reserve ratios may absorb as much as $3 billion in excess liquidity, and are “prudent banking” measures aimed at helping Southeast Asia’s largest economy cope with capital inflows, Mulya said.

“If money is pulled into the reserve requirement then it cannot circulate within the system,” said Purbaya Yudhi Sadewa, an economist at PT Danareksa Research Institute in Jakarta. “That’s a disincentive to avoid banks attracting too much dollar since they must pay interest on that dollar whereas the money is put away at Bank Indonesia, which may not even earn interest.”

Lenders will be required to limit their short-term overseas borrowing to no more than 30 percent of their capital starting in January, the central bank said. The rule aims to encourage a shift to long-term foreign borrowing and reduce the risk of sudden reversals in capital flows, it said. The requirement was scrapped in 2008 because of the global financial crisis.

Korea, Taiwan

South Korea plans to tighten curbs on banks’ holdings of foreign-exchange derivatives, lowering existing limits by a fifth, according to an official at the Financial Supervisory Service, who declined to be identified because the plan isn’t public yet. The finance ministry will announce the changes in January, he said.

Taiwan’s curbs on derivatives will help to combat currency speculation by foreigners, the central bank said this week. The island last month also restricted offshore funds to investing no more than 30 percent of their portfolios in local government debt and money-market products.

Five state-owned Indonesian financial institutions, including PT Bank Mandiri, have given their commitment to buy back bonds to ease the impact of sudden capital outflows during a crisis, Agus Suprijanto, acting head of fiscal policy at the Finance Ministry, said this week. The government is still in talks over the use of their funds and will prioritize funding from the state budget for any buybacks, he added.

Indonesia will also require lenders with assets of at least 10 trillion rupiah ($1 billion) to announce their prime lending rates, effective in March 2011. This rule will push banks to decrease their net interest margin and become more efficient, the central bank said. Lending growth may reach 22 percent this year, it said.

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