Bank Indonesia announced a number of restrictive fx regulations on June 14 that came into effect Thursday. The regulations, which are detailed below, are aimed at restricting onshore access to offshore liquidity and amounts to driving a wedge between the offshore and onshore markets. In particular, offshore banks will not be allowed to trade freely with onshore banks. Note that the restrictions will not apply to hedging that involves underlying transactions. The ultimate aim of Bank Indonesia is to regain control of the Indonesian rupiah, which has depreciated 3.9% year-to-date against the U.S. dollar.
Prior to these regulations, Bank Indonesia effectively had an asymmetric framework of capital controls, where there were no restrictions on the amount of dollar purchases in outright forward transactions and swaps. Banks, however, were only allowed to conduct derivative transactions in foreign currencies against the rupiah with non-residents up to a maximum nominal amount of USD3 million, unless there was an underlying investment purpose that could be proved. From Thursday both transactions are now capped at USD1 million or equivalent in foreign currency.
The market's initial reaction was to buy USD/IDR sending spot higher. The longer-term implication is that liquidity will become more restricted and may actually lead to greater volatility. The near-term risk is that USD/IDR spot could be squeezed higher even further as offshore investors have been net sellers of USD/IDR forward, leaving intermediary offshore banks to offset and fund this forward exposure by selling dollars tomorrow/next day on a rolling basis in the onshore market, earning the higher rupiah rate of interest.
Since Thursday, this rollover of spot positions is no longer permissible and may prompt offshore banks to unwind this position by buying USD/IDR spot and hedge the remaining exposure and tenor through the non-deliverable forwards market. The net result is USD/IDR spot heads higher. The implication for non-deliverable forward points is uncertain, as intermediary offshore banks attempt to reposition their books and hedge in the NDF market by selling USD/IDR forward, pressuring points to narrow. This NDF selling pressure could, however, be offset if the original offshore investors look to unwind their existing forward positions by buying USD/IDR NDFs.
JPMorgan maintains its year-end call for USD/IDR 9,800 as the restrictions will still not resolve the underlying issue of the deterioration in the balance of payments that stems from robust domestic demand and high oil import costs. The broader lesson for Asia fx is that the specter of regulatory risk remains. Thailand also tightened restrictions last month, and there is still the possibility Malaysia could impose similar restrictions to curtail offshore activity should it decide to move to a managed float in the future.
BI Regulation 7/14/PBI/2005 In A Nutshell
The following key excerpts are perhaps the most pertinent to foreign investors, while the full unofficial translation can be found on the BI Web site: http://www.bi.go.id/web/en/Peraturan
Chapter 3
Article 3:
Onshore banks are prohibited from conducting the following with foreign parties:
a) Provision of credit in IDR or FX;
b) Placements in IDR;
c) Purchase of IDR denominated securities by foreign parties;
d) Inter-office accounts in IDR;
e) Inter-office FX for provision of credit outside Indonesia;
f) Equity participation in IDR; and
g/h) IDR transfer to a foreign party account or joint account at either domestic overseas bank.
Chapter 4
Article 6:
Onshore banks face restrictions in the selling and buying of derivative transactions against IDR. These derivative transactions are defined as the following under articles 7 and 8. Any other derivative structures that are equivalent to the following are also included:
a) The purchase or sale of FX outright against IDR;
b) Swap transactions for sale or purchase of FX against IDR;
c) Sale of FX put and call options against IDR; and
d) Purchase of FX put and call options against IDR;
Total derivative position of the each onshore bank with a offshore party is limited to a maximum of USD1million.
Chapter 5
Article 9:
The prohibition of credit referred to in Article 3 will not apply to syndicated credit that has engaged:
a) A prime bank to participate as a lead bank. Prime bank must meet certain requirements;
b) That involves project financing in Indonesia; and
c) Where foreign banks acting as syndicate members are contributing more than domestic banks.
Article 10-12
These restrictions do not apply to transactions that have underlying investments, which include marketable securities and foreign direct investment. However, the underlying minimum investment and hedging period is three months.
A key caveat of point two is that one- and three-month SBI certificates issued by Bank Indonesia will be excluded from being classified as an underlying instrument that is allowed to be hedged. Bank Indonesia's view is that these are part of its benchmark monetary instruments which should not be used as a vehicle for foreign funding onshore.
Article 13
During a bidding process for direct investment a foreign participant will be allowed to hedge for a month period in anticipation of being awarded the investment right or contract. This one-month hedge will be allowed to be rolled over for one additional month.
The implication of the third regulation is that cross border hedging of one- and three-month SBI will no longer be permissible. This comes as Bank Indonesia is preparing to move to an inflation targeting framework this month, which will involve the soft launch of money market operations and a move away from the key benchmark one-month SBI auction for monetary policy guidance.
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| Claudio Piron |
This week's Learning Curve was written by Claudio Piron, regional currency strategist at JPMorgan in Singapore.
