Bank Indonesia Relaxes FX Rules to Rein in Most-Volatile Rupiah

Bank Indonesia is relaxing rules on derivatives in an attempt to double their role in the onshore foreign-exchange market by 2020 and rein in swings in Asia’s most-volatile currency.

The central bank wants to raise the proportion of such contracts including forwards and swaps to 50 percent of the $5 billion to $6 billion of daily currency trading, from less than 30 percent, Nanang Hendarsah, head of the authority’s financial market deepening task force, said in an interview in his office in Jakarta on Wednesday.

The monetary authority revised rules on Monday to allow cross-currency swaps, erased a requirement for banks to maintain their net positions every 30 minutes and allowed foreign funds to enter into contracts with durations shorter than a week. The changes will provide more avenues for local companies to hedge their foreign-currency debt as the U.S. prepares to raise borrowing costs for the first time since 2006.

“What’s clear going forward is that volatility will increase as U.S. interest rates begin to rise, so we need to be ready,” Hendarsah said. “I’m confident that real-money investors will still be interested in Indonesia as long as we ensure the market is liquid and efficient. That’s my aim.”

The rupiah’s one-month implied volatility, a gauge of exchange-rate swings, was 10.50 percent on Wednesday, the highest among Asia’s emerging-market currencies. It exceeded 20 percent in 2013, when the rupiah plunged 21 percent as funds pulled out of emerging markets after the Federal Reserve signaled it would unwind its asset-purchase program.

Hedging Sanctions

Under a rule released Dec. 29, Bank Indonesia will require companies to hedge at least 25 percent of short-term external debt that’s not offset by their foreign-currency assets, with sanctions coming into effect from October. That will increase demand for derivative products used to guard against exchange-rate swings, Hendarsah said.

State-owned oil producer PT Pertamina signed a $2.5 billion hedging facility in May, following similar deals by PT Garuda Indonesia and electricity utility PT Perusahaan Listrik Negara.

Local lenders can “theoretically” provide $150 billion worth of hedging instruments, which would be enough to deal with rupiah volatility of as much as 18 percent, Hendarsah said in a briefing in Jakarta on Monday. Insufficient accounting systems and limited understanding by bank employees may prevent some banks from providing such facilities, he said.

“The issue now is there’s a lot of demand for hedging but there’s a lack of supply from the other side,” Hendarsah said in the interview. “Now our challenge is to ensure the banks are capable of meeting that demand.”

Net Positions

The monetary authority is doing so by allowing lenders to exceed the 20 percent-of-capital limit for their net open positions during the day, instead of requiring them to stay within that restriction every 30 minutes. Lenders must still close their books at the end the day within the limit. The authority also clarified rules to include cross-currency swaps in its list of allowed simple derivatives.

“The net position rule will likely allow banks to provide more liquidity to end-users during the day,” said Irene Cheung, a senior foreign-exchange strategist at Australia & New Zealand Banking Group Ltd. in Singapore.

The central bank is also considering relaxing restrictions on structured products as an additional hedging instrument, Hendarsah said, adding that “proper precautions must be taken because it’s a complex derivative.”

The rupiah has led declines in Asia, dropping 6.5 percent this year to 13,243 a dollar as of 8:55 a.m. in Jakarta, according to prices from local banks. It will weaken to 13,500 by the end of 2015, according to the median estimate of 26 analysts surveyed by Bloomberg.

“What we don’t want is for dollar demand to pile up in the spot market whenever there’s expectations for a weaker rupiah,” Hendarsah said. “By getting swaps and forwards, companies can secure their dollar needs and we can prepare the liquidity one to three months ahead of time. That will greatly reduce volatility.”