ANALYSIS-Soaring Indonesia rupiah takes forex world by storm

NEW YORK, July 30 - After a 14 percent plunge in 2008, the Indonesian rupiah has emerged as one of the star performers in the emerging market world.

Resilient economic growth, healthy commodity exports, and relatively high interest rates of 6.75 percent have boosted this dynamic if sometimes politically-unstable Asian economy.

"Indonesia is in a good spot, managing to sustain growth even in a down year," said Samarjit Shankar, director of global strategy at Bank of New York Mellon in Boston. "The most important part is the policy focus and political will, which continue to support growth."

The rupiah has surged 10 percent this year, easily Asia's best performer, bested only among emerging market currencies by the Brazilian real , up 23 percent in 2009 so far, and the South African rand , with a 22 percent gain.

The rupiah's rise came as Indonesia's stocks soared. Jakarta's stock index <.JKSE> has jumped nearly 70 percent this year, more than recouping a 50 percent rout in 2008.

Bombings at the JW Marriott and Ritz-Carlton hotels in Jakarta two weeks ago had limited impact on the rupiah and the stock market, although it was a painful remainder of Indonesia's unpredictable political landscape.

Indonesia has remained vulnerable to activities of militant Muslim groups that seemingly seek to drive away foreigners, especially those from the West.

Overall, however, foreign investors have been net buyers of Indonesian stocks, according Bank of New York Mellon's flows data, lured by a resource-rich economy whose gross domestic product per capita has grown at the second fastest rate in Asia over the last five years, second only to China.

Economists have forecast a 7.0 percent growth for Indonesia from 2011, prompting analysts to suggest making the country part of the currency reserve-rich BRIC nations of Brazil, Russia, India, and China -- calling the group BRIC + I.

"Indonesia is emerging as a legitimate contender to join the rest of the established emerging nations," said Mike Moran, senior FX strategist, at Standard Chartered in New York.

"It has the raw characteritistics of a Brazil or an India. Clearly, in the next few years, we will see the long-term level of investment that would modernize and promote productivity in Indonesia."

UPSIDE POTENTIAL

Just like China and India, Indonesia has a huge population, about 226 million people, making it the fourth largest country. Its economy is mostly driven by domestic demand, analysts said, with consumption accounting for around 60 percent of GDP.

This year's elections have also underpinned the economy, re-installing President Yudhoyono, the chief executive who helped double the country's per capita income during his first five-year term. His victory should help ensure the country's fiscal reforms remain intact.

"Strong political foundations and a natural advantage from demography and commodity resources are likely to unleash Indonesia's growth potential," said Christian Nolting, lead strategist for Asia Pacific at Deutsche Bank Private Wealth Management.

Indonesia today is one of the low-cost suppliers of palm oil and thermal coal, key commodities used in food and energy.

Still, despite a multitude of assets, challenges persist for this predominantly Muslim country. For one, liquidity in the rupiah is limited and its currency regime remains restricted. Investors can only buy the currency via the offshore non-deliverable forwards, which are cash contracts on a non-covertible and thinly-traded foreign currency.

Another obstacle is the rupiah's high volatility, which increases foreign-currency risk. Among Asia's 10 most-traded currencies, the rupiah is one of the most volatile currencies on a one-year basis.

One-year implied volatility, a gauge of expected swings in a currency used when pricing options contracts, is 15 percent for the rupiah compared with 10 percent for the Philippine peso, and 9.0 percent for the Malaysian ringgit.

The currency also remains vulnerable to a rise in global risk aversion and the local security situation. Bombings in Jakarta two weeks ago and similar exlosions in the Indonesian island of Bali several years earlier have raised concerns about the country's political stability.

Still, Moody's has affirmed its positive outlook on Indonesia's sovereign rating despite the Jakarta blasts, reinforcing the market's belief that Indonesia's surge this year was no fluke.

"Although this latest terrorist attack comes as a shock...it is unlikely to imperil Indonesia's overall political stability or severely dent its economic outlook," Moody's said in a statement.