Sunday, April 18, 2010

Foreign Investment Critical to Indonesia

Indonesia has attracted its fair share of foreign funds in recent months. International investors have been pumping fresh capital into emerging markets in a hunt for returns as Western markets struggle to emerge from their long recession. Fueled by a combination of high GDP growth, mild inflation and expected further credit-rating upgrades, Indonesia has been attracting strong foreign interest since last year. Up to the first week of April this year, offshore players had invested $3.2 billion and $2.2 billion in bonds and Bank Indonesia Certificates (SBIs), respectively, bringing the combined amount to a record high of $22.8 billion, according to recent Citi reports.

The country’s equity markets have also benefitted from the net inflow of $460 million during this same period. The strong inflows into the country are not an exception, but rather an emerging market-wide phenomenon. Owing to Indonesia’s strong macroeconomic fundamentals, however, investors have been drawn to it more than to other similar markets.

Going forward, Asia will continue to attract a larger share of global capital inflows because of its strong growth prospects and the resultant rising share of global GDP that it will enjoy. Asia and Indonesia must continue to ensure that this trend continues as it will clearly bring long-term benefits. These funds could help countries in the region finance their much-needed development. For Indonesia in particular, the funds would be very welcome and could help expand the country’s infrastructure. Because of the relatively shallow nature of Indonesia’s domestic market, foreign funds provide the needed depth and breadth. Foreign players’ trading activities still represent a large chunk of the total market volume — a significant trading liquidity provider. This inflow also helps support US dollar supply to the onshore forex market, as the local market may not have the capacity to meet the dollar demand.

Foreign funds also provide critical funding liquidity to the local capital market. Offshore holdings represent more than 20 percent of outstanding domestic government debt and 40 percent of local bourse capitalization. As such, Indonesia’s reliance on foreign capital remains strong. Against this background, any move to impose capital controls, as reports have cited some officials at the central bank as suggesting, may spook foreign investors, driving them to liquidate their domestic positions.

This could lead to the collapse of the equity and fixed-income markets.

Bank Indonesia is correct to be concerned about a potential asset bubble building given the large capital inflows. It is right to be cautious, but rather than impose some form of capital control, the central bank should ensure that the economic fundamentals remain solid and that the economy continues to power ahead. This will raise incomes across the board and help raise living standards for all Indonesians. The Jakarta Globe Editorial

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