Managing the problems of surging capital inflows

Monday, May 14, 2007 Vincent Lingga, The Jakarta Post, Jakarta

President Susilo Bambang Yudhoyono, Vice President Jusuf Kalla, chief economics minister Boediono and Bank Indonesia Governor Burhanuddin Abdullah asserted Friday the economy is resilient enough to weather any sudden decline in the risk appetite of foreign portfolio investors, as the rupiah fell almost 1.5 percent after a few months of steady appreciation.

Yudhoyono summoned his economics ministers for a special briefing Friday afternoon, Kalla convened a special news conference after Friday's Islamic prayer services and Boediono, Burhanuddin, Finance Minister Sri Mulyani Indrawati and other economics ministers held a breakfast meeting earlier Friday, all to discuss the same issue: the problems of burgeoning capital inflows.

They all played down the risks of sudden reversals of foreign portfolio (hot) capital inflows, citing the country's foreign reserves of US$49.2 billion, strong economic fundamentals, expanding exports, a higher pace of investment and low inflation.

The rupiah gained a lot in recent months on the back of short-term capital inflows into local stocks, bonds and money market instruments, pushing the local unit to a one-year high last Thursday, while the Jakarta Stock Exchange boomed to an all-time high of over 2,000.

So, why the sudden uproar among the top economic policy-makers and economic management team?

It seems to have been set off by Sri Mulyani's statement Thursday, which was headlined by several newspapers Friday. The finance minister, who had just returned from a May 5 meeting of East Asian finance ministers and central bank governors in Kyoto, Japan, said the surge in capital inflows to Asia in recent months was similar to those that caused the financial crisis that started in Thailand in mid-1997.

What Sri Mulyani told the press was, by and large, the concerns of the Kyoto meeting, which consequently adopted a basic agreement to pool almost $3 trillion in foreign reserves to prevent the kind of currency runs that led to the Asian financial crisis a decade ago.

Many seemed to read too deeply into those remarks, apprehensive that the current situation was as vulnerable to speculative attacks on the rupiah as that in mid-1997. Hence, the 1.5 percent decline in the rupiah on Friday.

Many in the government appeared shocked by Sri Mulyani's remarks, criticizing what they saw as an exaggeration of the dangers of capital inflows.

True, the condition of Indonesia's economy and the capacity of the country's state and economic institutions are now much stronger than in 1997, but that does not negate the threat of a sudden change in the sentiment of foreign portfolio investors.

Bank Indonesia, like the central banks in most other Asian countries, has been struggling with the problem of steadily surging short-term capital inflows, wondering what to do with these reserves.

The accumulation of reserves, derived from hot money rather than foreign direct investment, is not an inherent sign of strength, but actually represent deep-seated structural imbalances, which policy makers need to address.

This is the message Sri Mulyani wanted to convey. Under the surging capital inflows and rising foreign trade surplus, Bank Indonesia, in a bid to keep the rupiah rate competitive, must buy up dollars, thereby fueling money supply growth. This loose liquidity is driving up asset prices and potentially stoking inflationary pressures.

As Frederic Neumann, an economist at HSBC bank in Hong Kong, recently observed, "by most yardsticks Asian central banks have long surpassed the levels of reserve holdings deemed sufficient to counter a potential external payments crisis".

Indeed, as Sri Mulyani noted last week, the main macroeconomic risks facing the region, including Indonesia, at present are the consequences of unmanageable balance of payments surpluses, which might spread Asian crisis-style through the region.

What the government is encountering now is excess financial market liquidity, not economic liquidity.

Yet, making Indonesia more vulnerable to currency speculators is that while most of the foreign hot money flowing into other East Asian countries is parked in stocks, the bulk of recent inflows to Indonesia went mostly into fixed income and money market instruments.

The excess liquidity Bank Indonesia is now coping with is tremendously huge. As of last month there was more than Rp 250 trillion ($27.8 billion) of private funds, including Rp 45 trillion of foreign hot money, invested in central bank debt instruments (SBI).

In addition, another Rp 77 billion of foreign money was parked in government bonds and billions more in stocks. This is quite a mountain of ammunition that could immediately be used to attack the rupiah anytime the risk appetite of foreign portfolio investors falls.

The central bank has said it has the leverage to intervene in the market to prevent too much market volatility, pointing out that prudent banking regulations and economic reforms over the past few years would minimize the impact of sudden reversals of capital inflows.

However, such assurances are meaningless unless the real business climate is conducive for attracting new investment, particularly foreign direct investment, allowing for a high rate of bank lending expansion.

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Pressure mounts for Temasek to divest stake in Indosat

Friday, May 11, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Remember Mexico's Cemex, the world's third largest cement group, which sold its 25 percent equity stake in PT Semen Gresik, Indonesia's largest cement company, to local conglomerate Rajawali in mid-2006 when Indonesia's cement market was enjoying robust growth?

Cemex, a financially strong company with operations in almost 50 countries, felt compelled to divest itself of Semen Gresik after suffering through more than five years of smear campaigns, a string of lawsuits and worker demonstrations orchestrated by renegade management at Semen Gresik's units, in collusion with politicians and senior officials.

The whole experience was quite disheartening for Cemex because it acquired, through an international competitive bid, the Semen Gresik shares by paying a premium price of more than 125 percent in October 1998, when Indonesia was still mired in political and economic crisis and shunned by most foreign investors.

A similar campaign seems to have been mounted over the last few months to discredit Singapore's government-owned Temasek, which acquired, through its subsidiary ST Telemedia, 42 percent of PT Indosat, Indonesia's second largest mobile phone operator.

Temasek won that stake through an international competitive bid in late 2002 by paying a premium price of more than 50 percent.

No one is sure who is behind the escalation of the negative information campaign against Temasek, but the bad publicity has increased, especially since October 2006, a few weeks before Russia's Altimo telecommunications investment company opened an office in Jakarta.

Altimo's representative in Jakarta, Soeharto, has repeatedly denied his company would resort to such dirty tactics, but he did confirm Altimo's commitment to investing up to US$2 billion in Indonesia's mobile telephone market.

Last October, the federation of trade unions at Indonesia's state companies lodged a complaint against Temasek with the Business Competition Supervisory Commission, accusing the Singapore company of violating the anti-trust law by dominating the market and engaging in price-fixing practices in collusion with PT Telkomsel.

Temasek also owns 35 percent of state-controlled Telkomsel, the largest mobile phone operator in Indonesia, through its subsidiary Singapore Telecommunications Ltd.

Copies of confidential documents profiling Temasek, its operations and investment strategy overseas, and providing technical briefings on the alleged monopolistic practices by Indosat, were circulated to trade union leaders and several analysts and newspaper editors critical of the Singapore firm.

Several local media ran news stories quoting analysts and politicians denouncing what they called Temasek's control of Indonesia's mobile phone market. In essence, they argued that foreign ownership of such a strategic company as Indosat was a threat to Indonesia's security and defense and the safety of databases.

Political analyst Mochtar Pabottingi came out with a 29-page analysis last month concluding that Temasek's acquisition of Indosat's shares caused the government billions of dollars in losses and jeopardized the country's defense and security sectors.

Pabottingi urged the government to buy back the Indosat shares from Temasek.
However, only one week after the release of his analysis, the country's largest telecom company -- state-controlled PT Telkom -- disclosed that its subsidiary, Telkom International, would team up with Singapore Telecommunication Ltd. (Singtel) to expand operations overseas, notably in data communications in Asia.

Metro TV ran a discussion program with three observers, all critical of Temasek's shareholding in Indosat, on Tuesday evening. Their message was similar to Pabottingi's views.

Curiously though, a counter-campaign suddenly sprang up against Altimo. Copies of documents allegedly linked to Altimo and reprints of Russian Tribuna newspaper stories circulated in Jakarta last month.

They revealed what was alleged to have been a conspiracy involving Indonesian senior officials and politicians, public relations consultants and several senior editors to discredit Temasek and force it to sell its Indosat shares.

Then in early April, in a new twist in favor of Temasek, the federation of unions at state companies withdrew its complaint against Temasek over the alleged monopoly and abuse of market power, due to what federation chairman Arief Poyuono called a lack of legal evidence.
"In addition, we felt that some people had taken advantage of the issue to make Temasek ... uncomfortable and sell its shares," Arief told weekly news magazine Tempo.

The complaint by the trade unions did seem weak, given the wide range of technology available and the number of players in Indonesia's cellular market. Besides Indosat and Telkomsel, there are a number of other mobile and fixed wireless, 3G and CDMA operators, including Telkom, Bakrie Telecom, Excelcomindo, Mobile 8, Lippo Telecom, Mobisel, Primasel, Mandara, Hutchison CP, Bimantara Citra and Batam Bintan Telecom.

And there is still room for more players because Indonesia's cellular phone market, though the fastest growing segment of the telecommunications industry, is still very young. Only about 25 percent of the country's 230 million population have cell phones.

The Business Competition Supervisory Commission, however, should go ahead with an investigation of the federation's allegation of a monopoly and abuse of market dominance to resolve once and for all the controversy.

The smear campaign is not likely to prompt Temasek to follow Cemex's exit from the country, as long as it remains clean with regard to all the allegations used by the "conspirators" as ammunition to attack it. After all, telecommunications is one of the most promising industries in the country.

However, if such public-opinion "harassment" continues, the Singapore company may eventually get tired and call it a day.

Such subterfuge to discredit foreign investors may be deployed again in the future by vested interests conspiring to buy corporate shares below market price. There are still many politicians in the country who tend to exploit nationalist sentiments as a means to advance their hidden agendas.

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