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Cablegate: Restrictions On Foreign Purchase of Bank Indonesia

VZCZCXRO0198
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #3099/01 3111054
ZNR UUUUU ZZH
R 071054Z NOV 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 6963
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1077
RUEHBJ/AMEMBASSY BEIJING 4458
RUEHBY/AMEMBASSY CANBERRA 1513
RUEHUL/AMEMBASSY SEOUL 4279
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 003099

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
COMMERCE FOR 4430/BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: RESTRICTIONS ON FOREIGN PURCHASE OF BANK INDONESIA
CERTIFICATES?


1. (SBU) Summary. Despite a modest retreat in the June-August
period, gross capital inflows to Indonesia remain high and have
accelerated in recent months. Concern about a sudden reversal of
portfolio inflows prompted public comments from two Bank Indonesia
(BI) officials as well as an internal debate on the desirability of
foreign ownership of Bank Indonesia Certificates (SBIs). BI
officials confirmed in meetings with the Embassy that it has no
plans to restrict foreign ownership of SBIs or introduce capital
controls in the near term. The SBI debate is part of BI's broader
discussions on how to encourage longer-term portfolio investment in
Indonesia. End Summary.

Capital Flows Continue to Increase
----------------------------------

2. (U) Despite a modest retreat in the June-August period, gross
capital inflows to Indonesia remain high and have reaccelerated in
recent months. Gross portfolio inflows totaled $8.8 billion during
the first half of 2007 compared to $5.7 billion during the full year
2005 according to official Bank Indonesia balance of payments data.
According to a recent report by Standard Chartered's team in
Indonesia, the ratio of hot money (defined as debt flows and equity
investments by portfolio managers with short-term investment
horizons) to Indonesia's foreign exchange reserves has risen to 85%
from 60% in 2005. BI data also reveals that foreign investors own
68% of the Jakarta Stock Exchange and account for 17% of total
government bond ownership.

3. (U) The level of capital inflows has prompted comments from a
number of high ranking officials in recent weeks that the current
situation is reminiscent of the days leading up to the 1997-98
financial crisis. Other comparisons to the period preceding the
1997-98 crisis are less analogous. The Indonesian banking sector
has significantly less short-term foreign currency exposure and a
much healthier balance sheet. Indonesian investors have diversified
their investment portfolios away from only Rupiah denominated
investments and foreign exchange reserves are high, exceeding $50
billion.

BI Debates Restricting Foreign Ownership of SBIs
--------------------------------------------- ---

4. (U) Although equity markets were the most volatile asset class in
the wake of global financial turmoil in August, SBIs have also
proven vulnerable to changes in global financial market conditions.
Foreign investment in SBIs was close to Rp 30 trillion ($3.3
billion) prior to the onset of the sub-prime credit crisis. That
number dropped quickly to Rp 12 trillion ($1.3 billion) in August as
investor risk aversion increased. (Note: The percentage of foreign
ownership of SBIs was 12.2% in September 2007, a figure equal to
proportion of SBIs owned by foreigners in December 2005.)

5. (U) The resurgence of capital inflows since August prompted
public comments from two prominent BI officials as well as an
internal debate on the desirability of foreign ownership of SBIs.
On September 17, during his Parliamentary screening hearings,
incoming Deputy Governor Budi Mulya stated that, foreign investors
should be restricted from owning SBIs. He does not believe the
presence of foreign investors in the SBI market benefits the central
bank. He also stated that BI uses SBIs to absorb domestic
liquidity. "If a foreign party has an SBI, than additional liquidity
has entered the country," he said. On October 8, the Indonesian
press reported that BI Deputy Governor Hartadi also expressed
concern about the level of foreign ownership of SBIs given that BI
never intended for the SBI to be used as an investment instrument.


6. (SBU) Experts close to BI assert that there are two schools of
thought on foreign ownership of SBIs. On one side, in line with the
public statements of the Deputy Governors, a number of BI officials
have questioned the desirability of paying high rates of interest to
short-term foreign investors on the instruments BI uses to conduct
monetary policy. In addition, these officials are concerned that
SBIs, which BI prices at a fixed rate, are acting as a magnet for
hot money flows and introducing increased foreign exchange

JAKARTA 00003099 002 OF 002


volatility. On the other side, officials, who also acknowledge that
the central bank is paying a significant premium on SBIs to
short-term investors, argue that the flow of short-term foreign
funds into SBIs has reduced volatility in other Indonesian fixed
income and equity instruments. Short-term foreign investors have
been attracted to the 30-day SBI as it provides a relatively high
rate of return for a liquid instrument.

7. (SBU) An International Monetary Fund (IMF) representative in
Indonesia has discouraged BI from placing restriction on foreign
purchases of SBIs given the negative signal such a move would give
to the markets. The IMF has cautioned BI against making policy
changes during periods of financial sector instability. Local
bankers and capital markets experts have questioned the
enforceability of such a move. Foreign investors would likely be
able to work around the new rules by using local banks as agents.
On the other hand, analysts in the region have also questioned the
prudence of restricting foreign purchases of SBIs given the lack of
comparable instruments in Indonesia. Since no good alternative
investments are available, foreign restrictions on SBI purchase
could lead to a significant outflow of funds in the short run,
potentially destabilizing the Rupiah.

BI Unlikely to Impose Restrictions in Near Term
--------------------------------------------- --

8. (SBU) Embassy meetings with BI officials indicate that the
central bankers are aware of the problems associated with any
restrictions on foreign ownership of SBIs. They noted BI has
debated restricting foreign ownership of SBIs for many years,
including the years preceding the 1997-98 crisis, and that this
policy view currently has little support. BI officials maintain
that they have no plans to introduce capital controls and will not
make any policy changes without active consultations with the
private sector. BI officials are also aware of the negative market
signals and enforceability problems associated with any restrictions
on foreign ownership of SBIs. At a September 29 press conference,
Senior Deputy Governor Miranda Goeltom stated explicitly that there
is no need or plan to restrict SBI foreign ownership or any
short-term capital inflows. She warned against changing policies
every time a new development occurs in financial markets. She also
pointed out that Indonesian capital markets need funds available to
absorb additional issuances and help deepen markets.

BI Contemplates Policies to Deepen Capital Markets
--------------------------------------------- ------

9. (SBU) The SBI debate is part of BI's broader discussions on how
to encourage longer-term portfolio investment in Indonesia. (BI
public communications are not always seamlessly coordinated.) BI
bank has contemplated restricting foreign investment in SBIs
recently as a means to redirect funds towards other assets in an
attempt to deepen capital markets. BI is also considering a wide
range of banking reforms to encourage banks to channel their
resources toward capital market development. The Banking Research
and Regulation Directorate at BI is leading discussions to permit
banks to engage directly in capital markets activities under a
universal banking model. The same BI unit is also contemplating
policy incentives, e.g. easing minimum reserve requirements, to
encourage banks to invest in corporate bonds. Finally, BI is
considering relaxing some rules around off-balance-sheet positions
in an effort to encourage banks to increase asset securitization and
use of derivatives. Central bank officials note, however, that
policy discussions around these issues are in an embryonic stage.

HUME

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