After witnessing its currency's biggest drop since January 1999, the Indonesian government has stepped up efforts to stabilize the rupiah and calm investor jitters by raising interest rates and announcing further details of a new dollar bond issue.
The government has shortlisted six overseas banks to handle a second $1 billion sovereign bond to ease an estimated at Rp40 trillion ($3.87 billion) budget shortfall. They include Credit Suisse First Boston, HSBC, Citigroup, Goldman Sachs, Lehman Brothers and Merrill Lynch.
Indonesia last issued a 10-year dollar-denominated sovereign bond in April, raising $1 billion to help plug the budget deficit. Citigroup, Deutsche Bank and UBS managed the sale.
However, the B2/B1/BB- rated deal was badly timed and hit a market trough as emerging market spreads were spiralling outwards and ended up being priced wider than the government had originally anticipated. About a month prior to launch, a one-year shorter dated deal had been bid at a record tight of 6.3%.
By contrast, the new deal came nearly 1% wider. Pricing was fixed at 99.127% on a coupon of 7.25% to yield 7.375% or 302bp over Treasuries. At yesterday's close in Asia, it was trading around the 353bp bid level.
Analysts believe a new government bond only makes sense in the context of a series of morale boosting measures. Says Singapore-based ING economist Tim Condon, "If this (new bond) is not supported by policies aimed at fixing the sources of rupiah weakness, it is a bad idea."
Since the April deal the government has had to consistently buy US dollars, dipping into its foreign exchange reserves, which have dropped from $37 billion early in 2005 to $32 billion on 23 August.
"For the past year Bank Indonesia has tried to meet the resulting demand for US dollars by selling dollars. As a result, forex reserves have declined $300 million for almost every $1 rise in the price of oil," notes Sin Beng Ong, an economist at JPMorgan in Singapore.
One of the key measures implemented by the Indonesian central bank yesterday (Tuesday) was an increase in the benchmark interest rate from 8.75% to 9.5%. This second increase, which follows a quarter point rise on August 9, is designed to stem the flow of capital out of Southeast Asia's largest economy caused by an increase in oil prices.
Higher oil prices hit Indonesia hard because the government subsidizes fuel costs for its 238.5 million people, increasing the dollars needed by state oil company PT Pertamina. But some analysts say the 9.5% rate is not high enough -- last week, researchers at HSBC and Goldman Sachs called on the central bank to boost the rate to at least 10%.
The government also ordered banks to place more reserves with the central bank in an effort to cut the amount of rupiah in circulation. It also raised the seven-day intervention rate by a percentage point to 8.5%, after having raised it a quarter-point last week.
Finally, the central bank announced that it will sign a swap arrangement worth $6 billion with the Bank of Japan. The bank's central governor, Burhanuddin Abdullah, said the loan commitment of the Japanese central bank would only be used if Indonesia`s foreign exchange reserves had been depleted. Bank Indonesia has similar proposed arrangements with South Korea and China, which it hopes to complete by the end of the year.
"Signing the swap agreements may shore up confidence in the rupiah a bit, but the problems undermining the currency are related to the economic fundamentals, the especially overly accommodative monetary policy, which they have begun to fix, and fuel price subsidies that contribute to excessive oil imports," says Condon.
After all, as he notes, "If it gets to the point that all their reserves have been exhausted and they're using the swap lines it will already be too late."
However, President Susilo Bambang Yudhoyono has also acknowledged that the oil subsidy is unworkable. He said he hoped to announce further new measures today and analysts believe this will include the phased withdrawal of the subsidy.