VZCZCXRO8746
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #2002/01 3040635
ZNR UUUUU ZZH
R 300635Z OCT 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 0471
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2661
RUEHBJ/AMEMBASSY BEIJING 5546
RUEHBY/AMEMBASSY CANBERRA 3216
RUEHUL/AMEMBASSY SEOUL 5063
RUEHGP/AMEMBASSY SINGAPORE 6351
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 002002 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS, EAP/EP AND EEB/IFD/OMA 
TREASURY FOR IA/MALACHY NUGENT AND TRINA RAND 
COMMERCE FOR 4430/KELLY 
DEPT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN 
DEPARTMENT PASS EXIM BANK 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
USDA/FAS/OA YOST, MILLER, JACKSON 
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER 
USDA/FAS/OGA CHAUDRY, DWYER 
DEPT PASS USTR WEISEL, EHLERS 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: COMMODITY PRICE COLLAPSE UNDERMINES GROWTH AMID ONGOING 
TURMOIL 
 
¶1. (SBU) Summary:  The global financial crisis, slower global 
growth, and falling commodity prices continue to weigh heavily on 
Indonesian financial markets.  The sharp decline in world prices for 
Indonesia primary commodity exports clouds the already diminished 
outlook for economic growth over the next twelve months and adds 
additional pressure on the Indonesian Rupiah (IDR).  The negative 
commodity price shock also threatens to weaken the banking system, 
given rapid expansion of lending to commodity-based sectors in 
recent years.  Food prices, which have seriously strained Indonesian 
household budgets this year, have not fallen significantly in 
Indonesia, limiting the potential positive impact of lower world 
prices on Indonesian households.  Analysts worry that growing 
political pressure to ease monetary policy and lower subsidized fuel 
prices will further undermine investor confidence, putting pressure 
on the IDR and destabilizing prices.  End Summary. 
 
Financial Market Turmoil Continues 
---------------------------------- 
¶2. (SBU) The global financial crisis, global growth, and falling 
commodity prices continue to weigh heavily on Indonesian financial 
markets.  The Indonesian stock market fell an additional 4.7% on 
October 28, bringing the decline in value since its peak in January 
2008 to over 60%. The yields on 10-year government bonds continued 
to rise rapidly on October 27, jumping over 400 basis points in one 
day to 20.9%.  The one-month Jakarta interbank lending rates also 
continued to move upward, rising to 11.5% this week, up from 9.5% in 
July.  Market analysts attribute much of the recent volatility to 
Indonesia's thin capital markets and open capital account, which 
allows investors to move money quickly out of Rupiah-based assets. 
 
 
¶3. (SBU) The IDR has also depreciated sharply, crossing the IDR/USD 
12,000 mark during trading on October 28.  As of October 29, the IDR 
has lost almost 18% yoy of its value, despite active intervention by 
the central bank.  Bank Indonesia's (BI) official reserves fell by 
$4.1 billion during the first 15 days of October, suggesting that 
BI's over $50 billion in foreign currency reserves may be 
insufficient to fight further depreciation.  To date, analysts have 
attributed the decline to both an increase in across the board 
emerging market risk and an increase in Indonesian sovereign risk. 
Other currencies in the region have suffered similar or worse 
declines, with the Korean won down 35% yoy, the Indian Rupee down 
over 20% yoy, and Philippine dollar down almost 11% yoy.   The 
leading indicator of Indonesian sovereign risk, Indonesia's credit 
default spread over US Treasuries, rose to over 1200 basis points in 
recent trading, several hundred basis points above the Philippines 
and Vietnam.  The swift move in the currency prompted the Government 
of Indonesia (GOI) to announce several measures to stem the decline 
in financial markets increase demand for the IDR, including a plan 
for the GOI and BI to purchase government bonds and a requirement 
for state-owned enterprises to deposit all foreign exchange in 
state-owned banks (septel). 
 
¶4. (SBU) The risk of capital flight from foreign investors remains 
significant, but capital flight from domestic investors poses a much 
bigger risk to macroeconomic stability.   The face value of foreign 
holdings of Indonesian government bonds is roughly $10 billion, 
according to the IMF resident representative.  However, the market 
price of these assets has fallen significantly, reducing the 
probability and impact of foreign investors selling their holdings. 
Moreover, shorter-term investors such as hedge funds hold less than 
$16 billion of the total $54 billion of foreign investment in 
Indonesian equities, limiting the potential impact of foreign 
capital flight from the stock market, according to Joshua Tanja, a 
banking analyst with UBS Jakarta.  Tanja notes that a decision by 
large domestic investors to move money out of the country poses a 
significant risk to the stability of Indonesia's currency and 
capital markets.  To date, however, UBS Jakarta has not seen signs 
of significant movement of domestic wealth. 
 
JAKARTA 00002002  002 OF 003 
 
 
 
Commodity Price Reversal Threatens Exports, Growth 
--------------------------------------------- ----- 
¶5. (SBU) The recent reversal in commodity prices will slow 
Indonesia's export growth in coming months and may significantly 
slow overall growth in 2009.  Rubber, coal and palm oil, which 
comprise 30% of Indonesia's exports, have fallen 10%, 17% and 33%, 
respectively from July to September 2008, and are expected to 
continue to decline.  Indonesia recorded a trade deficit in July and 
a small surplus in August, compared to larger surpluses during most 
of the last two years.  In addition to lowering overall economic 
growth, the weaker trade balance has put pressure on the currency, 
as currency traders worry that a potential trade deficit combined 
with capital flight will undermine Indonesia's balance of payments. 
Analysts expect demand for Indonesian commodities to continue to 
decline in line with the forecast for markedly lower world growth 
rates in 2008 and 2009.  The GOI reduced the export tax on crude 
palm oil to zero in an attempt to offset the impact of declining 
prices. 
 
¶6. (SBU) A number of analysts have also raised concerns about the 
level of leverage among commodity-based firms, given the sharp 
increase in borrowing over the past two years.  The Indonesian 
corporate sector has undergone significant deleveraging since the 
financial crisis of 1997-98, with debt-to-equity ratios of listed 
firms falling from 180 to below 40 over the period 2001-2007. 
However, lending to the corporate sector, particularly the mining 
sector, expanded rapidly over the past two years.  The year-on-year 
increase in bank lending rose from less than 10% in the third 
quarter of 2006 to 35% by July 2008.  Lending to the mining sector 
rose 65% yoy as of August 2008.  In addition, a Deutsche Bank 
representative in the region reported to the Embassy that some large 
Indonesian corporations borrowed USD from foreign banks using 
various interest-linked structured products to reduce borrowing 
costs in recent years.  These products have since reversed direction 
and now significantly increase borrowing costs, according to the 
bankers.  It remains unclear if this is a widespread problem or 
confined to a few firms. 
 
Banking Sector Asset Quality May Deteriorate 
-------------------------------------------- 
¶7. (SBU) Banking sector analysts expect Indonesian bank exposure to 
the commodity sector to strain asset quality and liquidity, but the 
scale of the problem is uncertain.  Indonesian plantations and 
mining firms that over expanded during the commodities boom may face 
significant cash flow shortages in light of the commodity price 
reversal and limited access to new credit.  According to Raihan 
Zamil, the IMF's resident adviser in BI's banking supervision 
department, there is very limited information available about the 
underwriting standards used for loans to the plantation and mining 
sectors during the boom.  If the banks based these loans on 
assumptions of rising commodities prices, the banks may be facing a 
new wave of non-performing loans.  Although Indonesia's largest 
banks are well capitalized and able to absorb an increase in 
nonperforming loans (NPLs), a rise in NPLs levels could further 
tighten liquidity conditions in the sector given the rising level of 
risk aversion associated with the global financial crisis. 
 
¶8. (SBU) Indonesian banks are also facing a rapidly rising cost of 
funds that may strain earnings and slow loan growth considerably, 
further constraining growth in the real sector.  Deposit growth 
rates have failed to keep pace with loan growth in 2008, and 
competition for deposits in the current environment has become 
fierce.  Although the large banks have agreed to cap retail deposit 
rates at 13%, analyst reports indicate that banks are paying rates 
as high as 15% for large corporate deposits.  The banks also hold a 
significant amount of government bonds, which have sharply declined 
in value in recent weeks and remain largely illiquid. 
 
 
JAKARTA 00002002  003 OF 003 
 
 
¶9. (SBU) The higher funding costs will squeeze net interest margins 
and likely impact access to credit for the corporate and consumer 
sectors.  A growing number of analysts and business leaders have 
commented on the difficulty of securing USD denominated trade 
finance from local and foreign banks in Indonesia.  Note: The GOI 
has recently announced plans to guarantee all local bank trade 
finance to ensure banks continue to extend to economically viable 
firms, but the details of the plan remain unclear. End note.] 
Deutsche Bank representatives suggest corporate debt rollovers are 
also becoming increasingly difficult to secure in Indonesia. 
Mortgage and motorcycle lending rates at many Indonesian banks have 
also increased, in some cases as much as 500 basis points, according 
to UBS' Tanja. 
 
Limited Local Food Price Adjustments 
------------------------------------ 
¶10. (SBU) The sharp decline in commodity prices has failed to 
provide significant price benefits to Indonesia's poor.  Lower world 
rice, wheat and soybean prices should eventually increase purchasing 
power among low-income Indonesian households who spend over 50% of 
their income on food.  However, local food prices have been slow to 
adjust to declining world prices, according to local market data 
collected by the Foreign Agricultural Service.  The local price of 
rice is down 3% from its peak in June 2008, but remains near 
historical highs.  The price of wheat-based instant noodles has 
continued to rise steadily.  Both local and imported soybean prices 
also remain near peak levels.  While international prices may ease 
further as global demand continues to slow, continued depreciation 
of the IDR may offset the effect of lower international food prices 
in local markets. 
 
Political Pressure on Economic Team Increases 
--------------------------------------------- 
¶11. (SBU) Analysts worry that growing political pressure to ease 
monetary policy and lower subsidized fuel prices will undermine 
investor confidence, further destabilizing the IDR and spurring 
inflation.  On October 27, Senior Deputy Governor of Bank Indonesia 
(BI), Miranda Goeltom, stated BI plans to shift its focus to 
addressing risks to economic growth, which now clearly outweigh the 
risk of inflation.  Local press reports indicate that BI had already 
faced considerable political pressure not to raise rates on October 
¶7.  A reduction in interest rates in the current environment may 
contribute to additional capital outflows and further undermine the 
value of the IDR. 
 
¶12. (SBU) At the same time, the sharp fall in global oil prices has 
prompted calls from politicians to lower the price of subsidized 
fuel.  The GOI increased the subsidized fuel price by almost 29% in 
May to ease pressure on the GOI's budget, as world oil prices rose 
to over $140 a barrel.  A reduction in subsidized fuel prices, which 
would increase the GOI's subsidy bill and financing requirements, 
would heighten concerns about fiscal sustainability at a time when 
Indonesia's sovereign risk is already on the rise. 
 
HUME