Indonesian Rate Hike May Slow, Not Stop, Foreign Funds Exit

If the rupiah’s slide is any indication, Bank Indonesia will need to make good its pledge for stronger measures after its first interest-rate hike since 2014 failed to stymie a market selldown.

The rupiah fell as much as 0.6 percent to 14,138 against the dollar, its weakest since October 2015, as markets reopened after Bank Indonesia’s policy decision. The benchmark 10-year bond is headed for a fifth weekly loss.

“This interest rate increase is probably enough to slow the outflow but it’s certainly not enough to reverse the selling pressure,” said John Teja, director at PT Ciptadana Sekuritas. “The central bank and the government really have to restore confidence in the rupiah and the economy,” he said, predicting a 25-basis point hike in the rate in the second half.

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Global funds have dumped a net $2.3 billion of Indonesian sovereign bonds since the end of March, set for the biggest quarterly withdrawal based on data compiled from 2009, and pulled $1.2 billion from the shares amid a rout in emerging markets. Outgoing Governor Agus Martowardojo said that the central bank is ready to add to Thursday’s 25-basis point rate increase to ensure stability.

Should Bank Indonesia carry through with its promise, the bond markets may then stabilize, said Vivek Rajpal, a strategist at Nomura Holdings in Singapore. “That said, not all is clear on the external front. U.S. longer end is still rising and making newer highs which is weighing on markets.”

The Federal Reserve is poised to add to its six rate increases since December 2015 as soon as next month, and concerns of a faster tightening pace have propelled the 10-year Treasury yield to more than 3 percent. Bank Indonesia said it anticipates the U.S. to hike three times in 2019.

Reserves Spent

The rupiah has declined 4 percent this year even as the central bank burnt through more than $7 billion of reserves since the start of February to halt the slump. The benchmark bond yield is trading near its highest in 14 months, while the stock index has dropped 8 percent in 2018.

Read: Indonesia Pledges ‘Stronger Measures’ as Market Selloff Deepens

Bank Indonesia’s hike “reflects the need for the central bank to strike a balance between the reality in the financial markets and the needs from businesses and consumers,” said Agus Yanuar, president director and chief investment officer at PT Samuel Aset Manajemen. “We are expecting more interest rate increase this year, at least by another 25 basis points.”

Bank Indonesia is caught between the need to ensure that growth doesn’t stutter further while limiting the impact of further capital outflows. First-quarter economic expansion fell short of estimates. It isn’t alone in its challenges, with peers in the Philippines and India also tussling with weakness in their markets.

Foreign Holdings

Foreigners own about 38 percent of the sovereign bonds in Indonesia, among the highest of Asian emerging markets, making it susceptible to capital outflows. To preserve the yield appeal, the central bank may be persuaded to tighten again in two to three months, according to PT Sinarmas Sekuritas.

The yield on the benchmark government bond has risen 65 basis points this quarter to 7.324 percent, set for the biggest quarterly increase since December 2016. It reached a 14-month high of 7.39 percent on May 9.

“I don’t think our market can decouple from external forces,” Jeffrosenberg Tan, head of investment strategy at PT Sinarmas Sekuritas, said by phone. “This rate increase will not stop foreign investor outflows from our sovereign bond market. It may provide some relief and temporarily restore some confidence.”

To be sure, not all investors are bearish on Indonesia.

Tai Hui, chief market strategist for Asia Pacific at JPMorgan Asset Management, reckons that the dollar will weaken. When that happens, the higher yields offered by emerging markets including Indonesia will lure back funds, Hui said.

“I think this is a temporary phenomenon,” Hui said of the sell-off. “If Indonesia or India or some of the other emerging-market currencies are weak on the back of their current-account positions, then I’d argue the same for the U.S. dollar in the longer term.”

— With assistance by Karlis Salna

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