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