Q+A-Market impact of Indonesia's moves to curb hot money

Published: 17 Jun 2010 23:08:16 PST

HONG KONG, June 18 - Indonesia unveiled a series of measures on Wednesday aimed at curbing volatile capital inflows to short-dated central bank debt, or SBIs.

Here are some questions and answers on the latest measures and what are the implications of them.

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WHAT WILL BE THE IMPACT ON SBI TRADING AND AUCTIONS?

A new minimum holding period requirement on SBIs will likely turn off offshore investors who use SBIs to make short-term bets on the rupiah and lead to a shrinking in secondary market trading volume.

A widening of the rate corridor also means that the BI can spawn more uncertainty around auction yields, and therefore make buying SBIs a more risky instrument for foreigners.

HOW WILL THIS SHAPE THE YIELD CURVE?

The yield curve is likely to steepen, with excess liquidity in the banking system seen moving to shorter-dated bonds as a result of the wider rate corridor.

Though aimed at discouraging banks from parking excess cash at the central bank to promote interbank lending, analysts say a lower Fasbi rate will lead many financial institutions to put funds in higher yielding government bonds.

On Thursday, the 10-year bond yield dropped eight basis points to a record low to below 8.5 percent while five-year bond yields fell by more than 15 basis points, steepening the curve.

HOW WILL IT IMPACT THE FX AND THE NDF MARKETS?

The limited reaction by the rupiah to the announcement so far indicates the measures are unlikely to prompt foreigners to flee from Indonesian assets.

But some suggest that the latest restrictions may increase volatility in the dollar/rupiah NDF markets.

For example, when the rupiah is strengthening hedge funds will sell one-month offshore dollar/rupiah forwards (NDFs), driving down the NDF implied rupiah yields to levels below cash SBI yields.

Until now, such selling in NDFs were offset by buying from arbitrageurs who used them to hedge against purchases of higher-yielding SBIs.

But shrinking liquidity in the secondary SBI market will see such arbitrage trading decline, meaning swings in the NDF market will likely increase, some analysts say.

WILL FOREIGNERS KEEP BUYING SBIs?

They will, but at a sharply lower pace than seen recently and in much smaller amounts.

Foreigners will gradually reduce their positions in SBIs and buy more government bonds. SBIs will become a liquidity management tool for the central bank, which was their original purpose.

Net foreign holdings of SBIs stood at 36 trillion rupiah ($4 billion), or 12 percent of total issuance, as of May.

Net holdings government bonds by foreigners was at a record peak of 150 trillion rupiah, or 24 percent of all outstanding debt, as of June 17.