Morgan Stanley Cuts Rupiah Target Amid Policy Risks

Morgan Stanley, the most-accurate forecaster of the Indonesian rupiah in the past year, expects the currency to extend its three-month slide as incoming president Joko Widodo struggles to gain parliamentary support.

The U.S. bank cut its year-end projection by 8.7 percent to 12,600 per dollar this month from 11,500 after Widodo’s opponents scored several parliamentary victories including the selection of a house speaker. ING Groep NV lowered its forecast 5.6 percent to 12,500, saying it anticipates “investor-unfriendly gridlock.” The rupiah has fallen 3.3 percent to 12,010 in the past three months.

Widodo, known as Jokowi, has failed to persuade any of the parties that backed Prabowo Subianto in July’s presidential election to switch sides, leaving him in control of just 37 percent of parliament as he prepares to take office today. That threatens his ability to rebuild investor confidence in Southeast Asia’s largest economy, which is vulnerable to capital flight because it has less foreign reserves than many neighbors and a bigger current-account deficit.

“We’re less optimistic than before that some parties will switch over to Jokowi’s side, hence our change in outlook,” Geoffrey Kendrick, head of foreign-exchange and rates strategy at Morgan Stanley, said in an Oct. 13 interview from Hong Kong. “The main guard for the rupiah is the capital inflows, so the question is whether or not that’s going to be able to cover the current-account deficit, which is largely unchanged.”

The rupiah has been the worst-performing emerging-market Asian currency over the past three months, leaving it up just 1.3 percent for the year following a 21 percent slump in 2013. It will end 2014 at 12,050 per dollar, according to the median view of 28 analysts surveyed by Bloomberg. That compares with an estimate of 11,800 on Sept. 30.

Outflows, Reserves

The rupiah has weakened against the dollar because of the Indonesian political elite’s ignorance in considering the market’s negative response to their actions, Jokowi told reporters in Jakarta on Oct. 8.

Inflows into stocks and bonds have turned into outflows on the political friction and as investors started bracing for increases in U.S. interest rates next year. Foreign funds pulled $1.1 billion from local shares since the end of August, paring net purchases this year to $3.8 billion. Some 6.55 trillion rupiah ($545 million) of debt has been offloaded this month, following net purchases of 123.5 trillion rupiah in the previous nine months.

The popularity of Indonesian sovereign bonds, which pay the highest yields among Asian emerging markets after India, also makes the country vulnerable to sudden outflows. Foreigners hold 37 percent of the securities, compared with 31 percent in Malaysia and 18 percent for Thailand.

Current Account

The country’s low foreign-exchange reserves add to the rupiah’s fragility. Reserves have increased 12 percent to $111.2 billion this year, but are still only enough to cover 6.5 months of imports, central bank data show. That compares with 10.9 months for the Philippines and 8.7 months in Malaysia.

“The rupiah is vulnerable to volatility from external events,” Tim Condon, head of Asia research at ING in Singapore, said in an Oct. 15 interview.

Bank Indonesia boosted its key rate by 1.75 percentage points last year to try and stem the rupiah’s plunge, while the government raised the price of subsidized gasoline by 44 percent. Those measures made only a small dent in the current-account shortfall. The deficit, the broadest measure of trade in goods and services, was $9.1 billion in the second quarter, compared with a record $10.1 billion in the same period in 2013.

Cabinet Selection

The red-white coalition that backed losing presidential candidate Prabowo Subianto controls 63 percent of the legislature. The grouping will make it harder for Jokowi to cut fuel subsidies, which would free up funds to be spent on education, health and roads and sea ports. The coalition may also make it tougher for the incoming president to make good on his promise to appoint a cabinet in which technocrats outnumber politicians.

“Jokowi is going to need some of the other parties to switch sides in order to reform the fuel subsidy,” Morgan Stanley’s Kendrick said.

The president-elect can still make headway on increasing the tax take, streamlining the bureaucracy and cutting red tape without having to pass new laws.

The rupiah strengthened 0.8 percent today as of 10:31 a.m. in Jakarta following a 1.2 percent gain on Oct. 17 after Jokowi and Prabowo met in public for the first time since the election. Investors took that as a signal that the political tensions between them have eased, John Teja, a director at PT Ciptadana Securities in Jakarta, said in an interview on the day.

‘Continued Disappointment’

“It’s clear that there will be a significant narrowing of the trade deficit this year,” ING’s Condon said. “Domestic considerations are positive.”

The red-white coalition’s selection of a house speaker followed the passage of a law scrapping direct local elections on Sept. 26, ending a decade-long system of regional democracy that produced leaders like Jokowi, a former mayor. If the political friction continues, the nation could miss out on $20 billion of mining investment, Poltak Sitanggang, chairman of the Indonesian Association of Minerals Entrepreneurs, said Oct. 8.

“Week after week, there’s continued disappointment on the political front,” Michael Every, the head of Asia-Pacific financial-markets research at Rabobank International, said in an Oct. 9 interview from Hong Kong. It looks less likely that Jokowi will “have a cabinet capable of pushing ahead with the reforms that we hoped for,” he said.

(Corrects headline of story published Oct. 20 to remove suggestion that Morgan Stanley views Widodo as powerless on rupiah.)
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